corporate diversification 7-1 copyright © 2006 pearson prentice hall. all rights reserved....

Corporate Corporate DiversificationDiversification

7-7-11Copyright © 2006 Pearson Prentice Hall. All rights reserved. Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & HesterlyStrategic Management & Competitive Advantage - Barney & Hesterly

Chapter 7Chapter 7

2

Corporate DiversificationCorporate Diversification


Mission Objectives

ExternalAnalysis

InternalAnalysis

StrategicChoice

StrategyImplementation

CompetitiveAdvantage

The Strategic Management Process

Corporate LevelStrategy

Which Businessesto Enter?

• Vertical Integration

• Diversification

3



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

4



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

5



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…

7



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

8



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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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


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,

14



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

15



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

16



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

17



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

18



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

19



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

20



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

21



International Diversification

Three Types of International Risk

Cultural/Popular Financial Political

• product may not beaccepted simplybecause of yourcountry of origin

Example: Resistanceto McDonald’s byFrance’s oldergeneration

• currencyexchange

• generaleconomicconditions

Example: Asianeconomic crisisof the 1990s

• nationalization

• quotas

• tariffs

• regulations

Example: Bolivianationalized itspetroleumindustry in the ’70s

22




Managing International Risks

Cultural/Popular• avoidance

• neutral branding (disguising country of origin)

Example: Where is Häagen-Dazs from?

Financial

• currency hedging

• geographic diversification

• spreading risk across several countries

23




Managing International Risks

Political

• negotiation with governments

• political neutrality

• foreign governments often have an interestin direct investment

Example: Case International in Brazil

• find a local partner

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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!

corporate diversification 7-1 copyright © 2006 pearson prentice hall. all rights reserved....

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