corporate diversification 7-1 copyright © 2012 pearson education, inc. publishing as prentice hall....
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Corporate Corporate DiversificationDiversification
7-7-11Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
Chapter 7Chapter 7
Corporate Diversification
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Corporate DiversificationCorporate Diversification
7-7-22Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
Mission Objectives
ExternalAnalysis
InternalAnalysis
StrategicChoice
StrategyImplementation
CompetitiveAdvantage
The Strategic Management Process
Corporate LevelStrategy
Which Businessesto Enter?
• Vertical Integration
• Diversification
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Corporate DiversificationCorporate Diversification
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Logic of Corporate Level Strategy
Corporate level strategy should create value:
1) such that businesses forming the corporate wholeare worth more than they would be under independent ownership
2) that equity holders cannot create throughportfolio investing
• a corporate level strategy must createsynergies
Therefore,
• economies of scope - diversification
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Integration and Diversification
Integration
Diversification
Custo
mer
Distrib
ution
Focal
Firm
Suppli
er
Raw M
ater
ials
ForwardBackward
CurrentBusinesses
NoLinks
ManyLinks
Unrelated Related
OtherBusinesses
OtherBusinesses
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Types of Corporate Diversification
Product Diversification:
Geographic Market Diversification:
Product-Market Diversification
• operating in multiple industries
• operating in multiple geographic markets
• operating in multiple industries in multiplegeographic markets
At a general level…
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Types of Corporate Diversification
Limited Diversification
Related Diversification
Unrelated Diversification
• single business: > 95% of sales in single business
• dominant business: 70% to 95% in single business
• related-constrained: all businesses related on mostdimensions
• related-linked: some businesses related on somedimensions
• businesses are not related
At a more specific level…
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Corporate DiversificationCorporate Diversification
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Product and Geographic Diversification
Possibilities:
• single-business in multiple geographic areas
• single-business in one geographic area
• related-constrained in one or multiple geographic areas
• related-linked in one or multiple geographic areas
• unrelated in one or multiple geographic areas
Note:• relatedness usually refers to products
• seemingly unrelated products may be related onother dimensions
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Corporate DiversificationCorporate Diversification
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Competitive Advantage
If a diversification strategy meets theVRIO criteria…
Is it Valuable?
Is it Rare?
Is it costly to Imitate?
Is the firm Organized to exploit it?
…it may create competitive advantage.
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Value of Diversification
Two Criteria
1) There must be some economy of scope
2) The focal firm must have a cost advantage overoutside equity holders in exploiting any economies of scope
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Value of Diversification
Business X Business Y Business Z
Independent: equity holder could buy shares of each firm
Value
Business X
Business Y
Business Z
Focal Firm
Value
+ +
EconomiesOf
Scope
Combined: equity holder buys shares in one firm
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Economies of Scope
Four Types
Operational
Financial
Anticompetitive
Managerialism
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Economies of Scope
Operational Economies of Scope
Sharing Activities
• exploiting efficiencies of sharing businessactivities
Example: Orbitz
Spreading Core Competencies
• exploiting core competencies in other businesses
Example: Frito-Lay’s Trucking
• competency must be strategically relevant
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Economies of Scope
Financial Economies of Scope
Internal Capital Market
• premise: insiders can allocate capital acrossdivisions more efficiently than the external capitalmarket
• works only if managers have better information
• may protect proprietary information
• may suffer from escalating commitment
Example: Hanson Trust, PLC
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Economies of Scope
Financial Economies of Scope
Risk Reduction
• counter cyclical businesses may providedecreased overall risk
Example: Snow Skiis & Water Skiis
• individual investors can usually do this moreefficiently than a firm
however,
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Corporate DiversificationCorporate Diversification
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Economies of Scope
Financial Economies of Scope
Tax Advantages
• transfer pricing policy allows profits in onedivision to be offset by losses in another division
• this is especially true internationally
Example: Ireland
• can be used to ‘smooth’ income
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Economies of Scope
Anticompetitive Economies of Scope
Multipoint Competition
• mutual forbearance
• a firm chooses not to compete aggressivelyin one market to avoid competition in anothermarket
Example: American Airlines & Delta: Dallas & Atlanta
Market Power• using profits from one business to compete in
another business• using buying power in one business
to obtain advantage in another business
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Corporate DiversificationCorporate Diversification
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Economies of Scope
Managerialism
• an economy of scope that accrues to managersat the expense of equity holders
• managers of larger firms receive more compensation(larger scope = more compensation)
• therefore, managers have an incentive toacquire other firms and become ever larger
• even though the incentive is there, it is difficultto know if managerialism is the reason for anacquisition
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Equity Holders and Economies of Scope
Most economies of scope cannot be capturedby equity holders
• risk reduction can be captured by equity holders
Managers should consider whether corporatediversification will generate economies of scopethat equity holders can capture
• if a corporate diversification move is unlikelyto generate valuable economies of scope,managers should avoid it
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Rareness of Diversification
Diversification per se is not rare
Underlying economies of scope may be rare
• relationships that allow an economy of scopeto be exploited may be rare
• an economy of scope may be rare becauseit is naturally or economically limited
• a soft drink bottler buys the only source ofspring water available
• a hotel in a resort town creates a large water park,there are only enough customers to support one park
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Imitability of Diversification
Duplication of Economies of Scope
Less Costly-to-Duplicate Costly-to-Duplicate
Employee Compensation
Tax Advantages
Risk Reduction
Shared Activities*
Core Competencies
Internal Capital Allocation
Multipoint Competition
Exploiting Market Power
(codified/tangible) (tacit/intangible)
*may be costly depending on relationships
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Corporate DiversificationCorporate Diversification
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Imitability of Diversification
Substitution of Economies of Scope
Internal Development Strategic Alliances
• start a new business underthe corporate whole
• find a partner with thedesired complementaryassets
Competitors may use these strategies to arrive at aposition of diversification without buying another firm
• avoids potential cross-firm integration issues • less costly than
acquiring a firm
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Summary
Corporate Strategy: In what businesses shouldthe firm operate?
• an understanding of diversification helps managersanswer that question
Two Criteria:
1) economies of scope must exist
2) must create value that outside equity holderscannot create on their own
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Summary
Economies of Scope
• a case of synergy—combined activities generategreater value than independent activities
• may generate competitive advantage if theymeet the VRIO criteria
Firms should pursue diversification only if carefulanalysis shows that competitive advantage is likely!
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the
United States of America.
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
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