Strategic Corporate Expansion

by Vivek Singh and Simerjeet Chawla

ABSTRACT

Growing liberalization and internationalization has led the firms to a race for expansion. Firms are more enthusiastic to trap new market segments than ever before. Expansion is an unpredictable, high-stacks game. The paper puts forth a Corporate Expansion Strategy to deal with such a scenario . Case studies have also been used to understand the expansion phenomenon. Efforts have been made to take a generic view of expansion which is independent of line of business, market segment, or type of expansion.

Expansion and investment are compared to have a clear understanding of how expansion for a firm and investment for a individual are similar to each other and how they differ with each other.

INTRODUCTION

Firms are attracted to capture the new liberalized market segments to pronounce their global existence and enhance their customer base. The literature emphasizes the points that should be discussed and resolved ,before making any decision regarding expansion. It is a design process for building a new set-up. Expansion involves various critical factors to be considered e.g risk of market, return from a new set-up, risk estimation, opportunity cost, expansion revision analysis , resource availability, dominant market study etc.
Expansion decision is a strategic decision which is related to firm's objectives and mission. To quantify the expansion benefits is a very complex process as analysis involves various intangible variables like brand-value, employment generation, forward and backward integration, bringing competition to the market etc. One can safely say expansion is a "strategic decision" which has an eye on market, competitors and future of the firm . Psycho-socio behavior also plays a very important role in taking expansion decisions.

Expansion Design process involves the following steps:

1.) Optimization of correlation-matrix
2.) Optimization of resource-matrix
3.) Minimization of risk
4.) Maximization of return
5.) Socio-Psycho analysis

1. Optimization of correlation-matrix

Assumptions involved in optimization of correlation-matrix are as follows:
1.) Firm has quantified the correlation factor for all its set-ups and coming set-up also.
2.) The established set-ups(Units) of the firm are already in optimized state.
3.) Correlation factors are constant for a range (Discreet function) and the firm has an idea about the approximate values of correlation factor for all practical ranges.
4.) Parameters of production are not interrelated and the firm knows the level of parameters , it can acquire , if firm is planning to opt for an expansion.
5.) Neoclassical growth model for production can be extended for firm's production also.

When a firm opts for expansion, it kicks off flow of resources from established units to the upcoming unit, in terms of assets, technology, personnel and so on. The flow for new set-up will change the market behavior and production of the firm.
Barro et al. (1995) have developed a neoclassic growth model for production function of open economies. We are extending the same model for firm's production because same attributes are responsible for firm's production also.
Our aim is to recognize all resources responsible for production and then distribute them to optimize the production of firm.

P = K^a*H^b*(A*L)^(1-a-b) , 0 < a+b < 1 ......... equ(1)

where P = production, K = stock of physical capital , H = stock of human capital , A = level of technology , L = labour
and a, b are correlation factors where 'a' is share of physical capital and 'b' is share of human capital in production function.
The correlation factors depend on the stock of resources because marginal utility changes with the change in stock. It is a real difficult task to assign a continuous function which correlates the stock value and the coefficient value. We are taking discreet function.

Prototype of the function

 fn( x )      = { const A , D < x < E }
              = { const B , E < x < F }
              = { const C , F < x < G }
                 .......................

The combination of coefficient value and stock value gives production.

Taking log both sides of equ(1) ...
logP = alogK + b logH + (1-a-b)(log(A*L)) ......... equ(2)

assume c = (1-a-b) and M = A*L

Since labour and technology are closely related, the new variable 'M' which will incorporate both and would not be related to other resources is coined.

logP = alogK + b logH + clogM

assume p = logP , k = logK ,h = logH , m = logM then the equ(2) can be rewritten as

p = ak + bh + cm ........ equ(3)

The total production of the firm can be represented as the following matrix

 | a1    b1    c1 |    | k1     h1     m1 |             | p1 | 
 | a2    b2    c2 |    | k2     h2     m2 |             | p2 | 
 | a3    b3    c3 |    | k3     h3     m3 |   ==        | p3 | 
 | a4    b4    c4 |    | k4     h4     m4 |             | p4 | 
 | a5    b5    c5 |    | k5     h5     m5 |             | p5 | 
 | ..    ..    .. |    | ..     ..     .. |             | .. | 
 | an    bn    cn |    | kn     hn     mn |             | pn | 

                       SUM k  SUM h   SUM m

        assume a firm has n units.

SUM k = Known to firm ; SUM h = Known to firm ; SUM m = Known to firm

The different units of the firm can be viewed as nodes and their production value as potential charge on them. Our aim is to maximize the sum of potential. It can be done in two ways
First one is to take the maximum coefficient of a particular resource , assign the maximum stock to it for the range of that coefficient, go to the next maximum coefficient,assign the maximum stock to it for that range and so on. Similarly for other resources also . But it might fail in some situations where it will not find minimum stock to be assigned for lower coefficients.
So it is better to do other-way round . Take the lowest coefficient , assign the minimum value of the range , go to the next higher coefficient, again assign the min value of the range and so on. When you reach to the highest coefficient and you have stock left, assign maximum value of the range, come down to the next one and so on until your stocks are finished. Do it for all resources one by one .

2. Optimization of resource-matrix

Assumption for resource optimization
1.) It is assumed that firm knows the quantifiable respective efficiency of the resources for all possible destination.
2.) Resources and destinations are mutually exclusive.
In this growing competitive age, a firm can not afford to be rigid. It has to use its resources in such a way as to get maximum through-put . The innovation in science and technology has made transfer cheaper and realizable in lesser time . A firm should be flexible in its distribution , allocation, and policies.
An excellent example of this dynamic at work is Denmark's Lan & Spar Bank. CEO Peter Schou explains that bank's key diversification moves such as its recent entry into the direct banking business have been supported and fully harvested because 17 employee working groups from throughout the organization meet regularly to share new business ideas and information. In addition certain people in the company are continually transferred from one area to another to act as "Integrators" and "Messengers" of new information. By moving knowledge around inside the company in the way, Lan & Spar has taken full advantage of diversification. Indeed, even though the company ranks fortieth in Denmark in terms of the size of deposits, it is ranked no. one in industry profitability in five of the last seven years. [Excerpts from "To Diversify or not to diversify" from HBR Nov-Dec 1997]
We can make use of Demand Flow Technology® (DFT) which suggests a flexible distribution and it is largely objective. It uses simple mathematics for storage and distribution of resources . It is demand driven technology and it would be inimical to use just-in-case theory.
Robert & Emmanual in their paper say:
The concept of DFT is to pull raw materials and products through the process strictly according to the dictates of customer demand . Methodical accurate analysis of the product and the process which yields it including a detailed knowledge of the value added and non value added steps as well as the dimensions and standards of quality requirements are a prerequisite for the successful implementation of DFT.

Although DFT is in infancy state and a lot is needed to be done but it gives a resilience and flexibility that is necessary for resource distribution. When we have resources which can be re- adjusted and redistributed we can well use Graph Theory for optimization .
Say we have n resources - n1,n2, n3 ..... nn and d destinations d1,d2,d3 .. dd
The effectiveness of resource n1 for destination d1 is n1d1 , for destination d2 is n1d2 and so on. set X = {n1,n2,n3 ... nn} and Y = { d1,d2,d3 .. dd } are mutually exclusive so they are vertices of bipartite graph G. Weighted edges give their efficiency for those vertices.
Now optimization can be achieved using Kuhn-Munkres algorithm .

At first look the algorithm provided above appears same as one provided in Optimization of Correlation matrix. Both algorithms optimizing the resource distribution so that production is maximum. But the underlying difference is - in Optimization of resource-matrix we use the algorithm assuming we can distribute the resource but can not divide it, like some machinery,implementation of technology etc. - while in Optimization of Correlation Matrix we redistribute the resource by splitting it ,like labour, capital and other aggregate variables. Depending upon the nature of resource, one should choose proper algorithm .

3. Minimize the risk

There is always some risk involved when a new unit is set-up. These risks can be minimized by
1.) Diversification
2.) Sequential Entry

Diversification
Assumption
1. The firm knows the performance index of other firms in same line of business and market index of all possible potential markets.
Diversification is one among the most challenging decisions for a company. Diversification reduces the risk of operating in volatile market. Previous experiences and knowledge of the firm can be a guide for future operations.
A manger has to think on various lines before making a strategic decision like what are the tangible and intangible benefits of entering in new business, Will it be in line with companies objectives and mission, Can the knowledge acquired will be of use to the company in future expansion and allow them to learn competencies that can be reapplied in their existing business. A forward thinking manager is more worried about wining a war than winning a battle.
In the research paper "International expansion strategy of Japanese firms : Capability building through sequential entry " author has shown that firms with more LOB ( Line of business ) , HBG ( Horizontal business group ), VBG ( Vertical business group ) have greater advantage . Following table shows his finding.


Table 1a : Data Description and Predicted Sign for Independent variables

 Variable          Definition                                          Predicted Sign 
 
 LOB Size          Sales in each line of business to total sales, 
                   normalized by the average LOB size of the firm, 
                   average of 1976-1989.                                        (+) 

 Number of         Accumulated count of FDI until the time of entry  
 previous entry                                                                 (+) 

 Horizontal        Dummy variable indicating firms association with
 business group    a horizontally - connected group .                           (+)     
                  
 Vertical          Dummy variable indicating firms association with 
 business group    a vertically-connected group .                               (+)

Table 1b : Proportional Hazard Modeling of Entry Decision

 LOB size          0.25         0.20            0.24            0.20
                   (2.53)*      (2.15)*         (2.50)*         (2.15)*

 Accumulated       0.02         0.01            0.02            0.01
 total entry       (3.71)***    (0.58)          (3.27)**        (0.21)
 
 Horizontal        0.44         0.48            0.66            0.65
 business group    (1.82)+      (2.02)*         (2.63)**        (2.65)** 

 Vertical          0.36         0.42            0.42            0.45
 business group    (1.54)       (1.77)+         (1.73)+         (1.82)+ 

  Note: t-statistics are in parenthesis ***:p<0.001, **: p<0.01, *:p<0.05,+:p<0.10 
        Data shown here are four time spans , positive correlation shows they are 
        helpful in expansion

To reduce the risk firm should diversify . A firm can diversify in a new market or in a new LOB or both . we can make use of Markowitz " full covariance theory " for getting the efficient frontier . Past behavior and performance of other firms ( in same LOB ) can be used for calculating standard deviation . Other variables such as covariance , coefficient of correlation can also be calculated using inter-active risk and interrelation of firms as they are calculated in investment analysis. It will give a set of options for expansion.
Sharpe's Index Model can also be applied for expansion analysis . For new markets we can calculate market index depending on the most stable market ( for international market it can be US/Europe) and for new LOB it can be one of core LOBs. Other variables can be calculated as they are calculated in investment analysis.


Sequential Entry

As per SEA JIN CHANG, " Sequential investment pattern can be best described as exercising a series of call options over a long period of time while making the best use of learning from experience and taking the best opportunity on the way."
Literature has shown that there are less chances of failure and more profit in Sequential Entry than random entry. Sequential Entry gives you a knowledge of market, culture ,work environment and above all a niche for future operations. You enter a new market with small core operation and then grow both horizontally and vertically. It lessens risks and reduces entry barrier threshold.
SEA JIN CHANG in his research work said " We find that firms sequentially enter business where they have a strong competitive advantage over locals and core business, first in order to reduce the hazard of failure. The learning from early entry enables firms to launch a future entry into an area of less strong competitive advantage".
Sequential entry is a "strategic option " which from experience firms know when to encash. Firm learns from other related firms' experience also . The president of Mitsubishi semiconductor once expressed: " When we came to US , we asked other Mitsubishi Companies to support us . If we had to develop everything from scratch or ask other ( outside ) companies we are not familiar with , it would be more difficult ." Sequential entry reduces the entry level threshold.
In the table shown below , the expansion pattern of Sony Corporation is displayed . This is a good example that shows how MNCs are expanding. 


TABLE 2


Selected dates in Sony Corporation history
 1946  May  Founding of Tokyo Tsushin Kogyo(Tokyo Telecommunication Engg. Com.).
 1950  Jul  Marketing of first magnetic tape recorder.
 1958  Jan  Name changed to Sony Corporation.
 1960  Feb  Founding of Sony Corporation of America.
 1972  Aug  Opening of color television assembly plant in San Diego , CA.
 1974  Jun  Opening of color television assembly plant in Bridgend, Wales, U.K. .
 1974  Aug  Opening of CRT plant at San Diego, creating the first integrated 
            color television production facility established by a Japanese firm.
 1977  Feb  Opening of magnetic tape plant , Dothan , Alabama .
 1980  Dec  Opening of magnetic tape plant in Bayonne ,Aquitaine , France .
 1982  Apr  Opening of CRT plant at Bridgend, Wales, U.K. .
 1982  Jun  Acquisition of Music Center Inc. , Lt . Lauderdale , FL .
 1984  Sep  Opening of CD Software plant in Terre Haute , Indiana .
 1987  Apr  Opening of plant for production of key components for CD players and
            8 mm video equipment in Colmar , France.
 1987  Jul  Opening of CD Software plant in Salzburg , Austria.
 1988  Jan  Acquisition of CBS records , Inc. .
 1988  Apr  Opening of audio equipment plant , Penang , Malaysia .
 1988  Sep  Opening of audiocassette plant in Rovereto , Italy .
 1988  Sep  Opening of videocassette plant , Bangkok , Thailand .
 1989  Sep  Acquisition of Material Research Corporation , US .
 1989  Nov  Acquisition of Columbia Pictures Entertainment Inc .
 1990  Feb  Acquisition of semiconductor manufacturing facility from Advanced 
            Micro Devices, San Antonio , TX.

        Source : Sony Corporation Annual Report , 1993 , p.29

4. Maximize the return

There are many different modes of expansions, like franchising , licensing , acquisition , merger as we have different modes of expansions , like common stock, preferred stock , bond , call- option . The risk and return for each mode is different . We mix them so get maximum return while risk is minimum. For investment Weighted Average Cost of Capital ( WACC) analysis gives you maximum return . This analysis can be extended for expansion also as risk and return from different modes of expansion are not similar . Such analysis will provide you a balanced expansion mode . A balance expansion plan is a must for a firm's long term perspective .

5. Socio-Psycho analysis

The story of unsuccess is not new for expansion. Expansion is a very tricky decision. Some companies failed to retain their position after expansion, where as some companies are quite successful . " Researchers who have examined the performance of mergers and acquisitions in the U.S. and Britain , over the last 90 yrs. report their success rate at about 50% . Others say the failure rate runs as high as 75% ( Ellis and Pecker , 1978). A study of joint ventures formed by U.S. companies reveals that most failure occurs in the first four or five yrs. . The pattern , they say is even more pronounced among international joint ventures ,especially joint ventures with Japanese partners (Kogut,1988). "
The statement clearly shows it is difficult to go hand in hand with a partner of distant culture . Management must be experienced and efficient to handle these situations. When you are opting for merger, acquisition, collaboration you should be prepared to work with a new culture. You should choose partners meticulously in order to take care of cultural difference factor.
The management responsibility is to, have a proper understanding of the nature of the firm - whether it is a risk neutral, risk seeker or risk averse firm. Firm should pick the projects pertaining to their type.

Expansion Vs Investment

On an abstract level , one can think of expansion as investment , which inherently has some risk and is supposed to bring a return. Of course , it is much more complex than investment decisions. Let's discuss why it is like investment and also what attributes of expansion are likely to differ from investment attributes . Here we will assume that firms have finite resources to be allocated judiciously, to fulfill firm's objective and minimize the cost of return.
When we compare risk of market, return from new set-up, minimization of risk by diversification, opportunity cost, expansion revision analysis ( very similar to portfolio revision analysis), extension of frontier theory( efficient set theory ) and dominant markets theory, - expansion looks another name of investment. But it is not all the same.
Expansion decisions do not depend only on the financial status of the firm, it is a strategic decision which is related to firm's objectives and mission. It is very difficult to determine the present value or future value of a firm . The value of a firm is determined by the product and not by the time . Expansion is less liquid than investment. Selling or Buying of a set-up takes more time than an investment buy or sell event . Expansion decisions are more complex than investment decisions because they involve many domains . An expansion has substantial intangible implications also which is not true for investment. We assume that an investor's sole purpose is to maximize his wealth, but firms might be having objectives other than just making profit like employment generation, brand imaging, entering new market segments, strategic move, forward integration, backward integration etc. The units of a firm are more interrelated than the assets of an investor.

We compared the expansion of a firm with the investment for a individual for the ease of understanding the phenomenon of expansion as investment is a well understood subject.
 

CONCLUSION

When a company plans to expand it should go through all the five steps described above . For designing a model we adopt top-down approach but when we actually build it , it is bottom-up approach. ( when we design a building we start from top floor but when we actually start constructing, the first thing we do is, laying foundation ). So we should start from Socio-Psycho analysis . If management thinks it is advantageous or they can cope with it, a firm should think of the mode that will maximize their return . Then to minimize the risk firm should try for a sequential entry or diversification or both. Last thing it can plan is resource distribution for maximum production.


Some steps might be interrelated so management should plan accordingly.

REFERENCES:

1. "A process model of MNC evolution: The case study of Sony Corporation in the United States " -- Sea Jin Chang, Philip M. Rosenzweig.

2. "International expansion strategy of Japanese firms: Capability building through sequential entry" -- Sea Jin Change.

3. "Some consequences of globalization for developing countries"-- Erich G., Peter N.

4. "Demand Flow Technologies for translational companies" -- Robert , Emmanual .

5. "Diversify or Not to Diversify" -- Constantinos C. Markides, Harvard Business Review , Nov-Dec 1997.

6."Macroeconomics" -- Dornbusch, Fischer Stanley[1994], McGraw Hill Inc.

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