STRATEGICACTIONS:STRATEGYFORMULATION

STRATEGICACTIONS:STRATEGYFORMULATION

Corporate-Level Corporate-Level StrategyStrategy

6–3

The Role of DiversificationThe Role of Diversification

• Diversification strategies play a major role in the Diversification strategies play a major role in the behavior of large firms.behavior of large firms.

• Product diversification concerns:Product diversification concerns:

The scope of the industries and markets in which the The scope of the industries and markets in which the firm competes.firm competes.

How managers buy, create and sell different How managers buy, create and sell different businesses to match skills and strengths with businesses to match skills and strengths with opportunities presented to the firm.opportunities presented to the firm.

6–4

Two Strategy LevelsTwo Strategy Levels

• Business-level Strategy (Competitive)Business-level Strategy (Competitive)

Each business unit in a diversified firm chooses a Each business unit in a diversified firm chooses a business-level strategy as its means of competing in business-level strategy as its means of competing in individual product markets.individual product markets.

• Corporate-level Strategy (Companywide)Corporate-level Strategy (Companywide)

Specifies actions taken by the firm to gain a Specifies actions taken by the firm to gain a competitive advantage by selecting and managing a competitive advantage by selecting and managing a group of different businesses competing in several group of different businesses competing in several industries and product markets.industries and product markets.

6–5

Corporate-Level Strategy: Key Corporate-Level Strategy: Key QuestionsQuestions• Corporate-level Strategy’s ValueCorporate-level Strategy’s Value

The degree to which the businesses in the portfolio The degree to which the businesses in the portfolio are worth more under the management of the are worth more under the management of the company than they would be under other ownership.company than they would be under other ownership.

What businesses should What businesses should the firm be in?the firm be in?

How should the corporate How should the corporate office manage the office manage the group of businesses?group of businesses?

Business UnitsBusiness Units

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Levels of Diversification: Low LevelLevels of Diversification: Low Level

Dominant BusinessDominant Business

Between 70% and 95% of Between 70% and 95% of revenue comes from a single revenue comes from a single business.business.

AA

AA

BB

Single BusinessSingle BusinessMore than 95% of revenue More than 95% of revenue comes from a single business.comes from a single business.

6–7

Levels of Diversification: Moderate to Levels of Diversification: Moderate to HighHigh• Related ConstrainedRelated Constrained

Less than 70% of revenue Less than 70% of revenue comes from a single comes from a single business and all business and all businesses share businesses share product, technological product, technological and distribution linkages.and distribution linkages.

• Related Linked (mixed Related Linked (mixed related and unrelated)related and unrelated)Less than 70% of revenue Less than 70% of revenue

comes from the dominant comes from the dominant business, and there are only business, and there are only limited links between limited links between businesses.businesses.

CC

AA

BBCC

AA

BB

6–8

Levels of Diversification: Very High Levels of Diversification: Very High Levels Levels • Unrelated DiversificationUnrelated Diversification

Less than 70% of revenue comes from the dominant Less than 70% of revenue comes from the dominant business, and there are no common links between business, and there are no common links between businesses.businesses.

CCBB

AA

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High Low

Value-Creating Strategies of Value-Creating Strategies of DiversificationDiversification

Operational and Corporate Relatedness

Corporate Relatedness: Transferring Skills into Businesses through Corporate Headquarters

Operational Relatedness:

Sharing Activities between

Businesses

High

Low

Related Constrained Related Constrained DiversificationDiversification

Vertical Integration Vertical Integration (Market Power)(Market Power)

UnrelatedUnrelatedDiversification Diversification

(Financial Economies)(Financial Economies)

Related Linked Related Linked DiversificationDiversification

(Economies of Scope)(Economies of Scope)

Both Operational and Both Operational and Corporate RelatednessCorporate Relatedness

(Rare capability that creates (Rare capability that creates diseconomies of scope)diseconomies of scope)

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Related DiversificationRelated Diversification

• Firm creates value by building upon or Firm creates value by building upon or extending:extending: ResourcesResources CapabilitiesCapabilities Core competenciesCore competencies

• Economies of ScopeEconomies of Scope Cost savings that occur when a firm transfers Cost savings that occur when a firm transfers

capabilities and competencies developed in one of its capabilities and competencies developed in one of its businesses to another of its businesses.businesses to another of its businesses.

6–14

Related Diversification: Economies of Related Diversification: Economies of ScopeScope• Value is created from economies of scope Value is created from economies of scope

through:through:

Operational relatedness in sharing activitiesOperational relatedness in sharing activities

Corporate relatedness in transferring skills or Corporate relatedness in transferring skills or corporate core competencies among units.corporate core competencies among units.

• The difference between sharing activities and The difference between sharing activities and transferring competencies is based on how the transferring competencies is based on how the resources are jointly used to create economies resources are jointly used to create economies of scope.of scope.

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Sharing ActivitiesSharing Activities

• Operational RelatednessOperational Relatedness

Created by sharing either a primary activity such as Created by sharing either a primary activity such as inventory delivery systems, or a support activity such inventory delivery systems, or a support activity such as purchasing.as purchasing.

Activity sharing requires sharing strategic control over Activity sharing requires sharing strategic control over business units.business units.

Activity sharing may create risk because business-Activity sharing may create risk because business-unit ties create links between outcomes. unit ties create links between outcomes.

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Transferring Corporate CompetenciesTransferring Corporate Competencies

• Corporate RelatednessCorporate Relatedness Using complex sets of resources and capabilities to Using complex sets of resources and capabilities to

link different businesses through managerial and link different businesses through managerial and technological knowledge, experience, and expertise.technological knowledge, experience, and expertise.

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Corporate RelatednessCorporate Relatedness

• Creates value in two ways:Creates value in two ways:

Eliminates resource duplication in the need to allocate Eliminates resource duplication in the need to allocate resources for a second unit to develop a competence resources for a second unit to develop a competence that already exists in another unit.that already exists in another unit.

Provides intangible resources (resource intangibility) Provides intangible resources (resource intangibility) that are difficult for competitors to understand and that are difficult for competitors to understand and imitate.imitate.

• A transferred intangible resource gives the unit receiving it an A transferred intangible resource gives the unit receiving it an immediate competitive advantage over its rivals.immediate competitive advantage over its rivals.

6–18

Related Diversification: Market PowerRelated Diversification: Market Power

• Market power exists when a firm can:Market power exists when a firm can: Sell its products above the existing competitive level Sell its products above the existing competitive level

and/or and/or Reduce the costs of its primary and support activities Reduce the costs of its primary and support activities

below the competitive level.below the competitive level.

6–19

Related Diversification: Market Power Related Diversification: Market Power (cont’d)(cont’d)• Multipoint CompetitionMultipoint Competition

Two or more diversified firms simultaneously compete Two or more diversified firms simultaneously compete in the same product areas or geographic markets.in the same product areas or geographic markets.

• Vertical IntegrationVertical Integration

Backward integrationBackward integration—a firm produces its own inputs.—a firm produces its own inputs.

Forward integrationForward integration—a firm operates its own —a firm operates its own distribution system for delivering its outputs.distribution system for delivering its outputs.

6–20

Related Diversification: ComplexityRelated Diversification: Complexity

• Simultaneous Operational Relatedness and Simultaneous Operational Relatedness and Corporate RelatednessCorporate Relatedness

Involves managing two sources of knowledge Involves managing two sources of knowledge simultaneously:simultaneously:

• Operational forms of economies of scopeOperational forms of economies of scope

• Corporate forms of economies of scopeCorporate forms of economies of scope

Many such efforts often fail because of Many such efforts often fail because of implementation difficulties.implementation difficulties.

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Unrelated DiversificationUnrelated Diversification

• Financial EconomiesFinancial Economies

Are cost savings realized through improved Are cost savings realized through improved allocations of financial resources.allocations of financial resources.

• Based on investments inside or outside the firmBased on investments inside or outside the firm

Create value through two types of financial Create value through two types of financial economies:economies:

• Efficient internal capital allocationsEfficient internal capital allocations

• Purchase of other corporations and the restructuring their Purchase of other corporations and the restructuring their assetsassets

6–22

Unrelated Diversification (cont’d)Unrelated Diversification (cont’d)

• Efficient Internal Capital Market AllocationEfficient Internal Capital Market Allocation

Corporate office distributes capital to business Corporate office distributes capital to business divisions to create value for overall company.divisions to create value for overall company.

• Corporate office gains access to information about those Corporate office gains access to information about those businesses’ actual and prospective performance.businesses’ actual and prospective performance.

Conglomerates have a fairly short life cycle because Conglomerates have a fairly short life cycle because financial economies are more easily duplicated by financial economies are more easily duplicated by competitors than are gains from operational and competitors than are gains from operational and corporate relatedness.corporate relatedness.

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Unrelated Diversification: RestructuringUnrelated Diversification: Restructuring

• Restructuring creates financial economiesRestructuring creates financial economies

A firm creates value by buying and selling other firms’ A firm creates value by buying and selling other firms’ assets in the external market.assets in the external market.

• Resource allocation decisions may become Resource allocation decisions may become complex, so success often requires:complex, so success often requires:

Focus on mature, low-technology businesses.Focus on mature, low-technology businesses.

Focus on businesses not reliant on a client Focus on businesses not reliant on a client orientation.orientation.

6–24

External Incentives to DiversifyExternal Incentives to Diversify

• Antitrust laws in 1960s and 1970s Antitrust laws in 1960s and 1970s discouraged mergers that created discouraged mergers that created increased market power (vertical or increased market power (vertical or horizontal integration.horizontal integration.

• Mergers in the 1960s and 1970s thus Mergers in the 1960s and 1970s thus tended to be unrelated.tended to be unrelated.

• Relaxation of antitrust enforcement Relaxation of antitrust enforcement results in more and larger horizontal results in more and larger horizontal mergers.mergers.

• Early 2000: antitrust concerns seem to Early 2000: antitrust concerns seem to be emerging and mergers now more be emerging and mergers now more closely scrutinized.closely scrutinized.

Anti-trust Anti-trust LegislationLegislation

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External Incentives to Diversify (cont’d)External Incentives to Diversify (cont’d)

• High tax rates on dividends cause a High tax rates on dividends cause a corporate shift from dividends to corporate shift from dividends to buying and building companies in high-buying and building companies in high-performance industries.performance industries.

• 1986 Tax Reform Act1986 Tax Reform Act

Reduced individual ordinary income tax Reduced individual ordinary income tax rate from 50 to 28 percent.rate from 50 to 28 percent.

Treated capital gains as ordinary Treated capital gains as ordinary income. income.

Thus created incentive for shareholders Thus created incentive for shareholders to prefer dividends to acquisition to prefer dividends to acquisition investments.investments.

Anti-trust Anti-trust LegislationLegislation

Tax LawsTax Laws

6–26

Internal Incentives to DiversifyInternal Incentives to Diversify

• High performance eliminates the High performance eliminates the need for greater diversification.need for greater diversification.

• Low performance acts as Low performance acts as incentive for diversification.incentive for diversification.

• Firms plagued by poor Firms plagued by poor performance often take higher performance often take higher risks (diversification is risky).risks (diversification is risky).

Low Low PerformancPerformanc

ee

6–28

Internal Incentives to Diversify (cont’d)Internal Incentives to Diversify (cont’d)

• Diversification may be Diversification may be defensive strategy if:defensive strategy if:

Product line matures.Product line matures.

Product line is threatened.Product line is threatened.

Firm is small and is in mature Firm is small and is in mature or maturing industry.or maturing industry.

Low Low PerformancPerformanc

ee

Uncertain Uncertain Future Future

Cash FlowsCash Flows

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Internal Incentives to Diversify (cont’d)Internal Incentives to Diversify (cont’d)

• Synergy exists when the value created Synergy exists when the value created by businesses working together by businesses working together exceedsexceeds the value created by them the value created by them working independentlyworking independently

• … … but synergy creates joint but synergy creates joint interdependence between business interdependence between business units.units.

• A firm may become risk averse and A firm may become risk averse and constrain its level of activity sharing.constrain its level of activity sharing.

• A firm may reduce level of technological A firm may reduce level of technological change by operating in more certain change by operating in more certain environments.environments.

Low Low PerformancPerformanc

ee

Uncertain Uncertain Future Future

Cash FlowsCash Flows

Synergy Synergy and Risk and Risk

ReductionReduction

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FIGUREFIGURE 6.46.4

Summary Model of Summary Model of the Relationship the Relationship between Firm between Firm Performance and Performance and DiversificationDiversification

Source: R. E. Hoskisson & M. A. Hitt, 1990, Antecedents and performance outcomes of diversification: A review and critique of theoretical perspectives, Journal of Management, 16: 498.