Chapter 8 - Corporate Diversification

Value-Neutral Diversification

1. Antitrust regulations 2. Unsatisfactory performance in existing businesses.

Financial economies of scope

1. Capital allocation efficiency Premise: insiders can allocate capital across divisions more efficiently than the external capital market. example: Business growth/competitive matrix 2. Firms diversify to gain tax benefits 3. Firms diversify to reduce risk

3 Types of corporate diversification

1. Limited diversification (>70%) 2. Related diversification (<70%) 3. Unrelated diversification (<70%)

Anti-competitive economies of scope

1. Multipoint competition(mutual forbearance) A firm chooses not to compete agressively in one market to avoid competition in another market Airlines example: Heavy in Dallas/Ft. Worth but not in Atlanta because competitor is heavy in Atlanta and not in Dallas/Ft. Worth. 2. Market Power using buying power in one business to obtain advantage in another business Nestle & Gerber example: be introduced to american market

Value-creating diversification

1. Operational economy of scope 2. financial economy of scope 3. Anticompetitive economy of scope

Antitrust regulations

1. Prohibits mergers that create increased market power (via either vertical or horizontal integration) 2. Firms diversify so to avoid violation of antitrust regulations

Operational economy of scope

1. Sharing activities - exploiting efficiencies of sharing business activities -- Frito Lay Example ---- picking up deliveries on the way back to the company. 2. Spreading core competencies --Exploiting core competencies in other businesses --Competency must be strategically relevant Example: Honda motors

Why diversification?

1. Value-creating 2. Value-neutral 3. Value-reducing

Related diversification

<70% 1. Related-Constrained 2. Related-linked

Limited diversification

>70%. Single business: > 95% of sales in single business Dominant business: 70 - 95% in single business Example: Delta airlines revenue is 95% passenger revenue/ 5% cargo revenue. So mostly all from one source. 1. These firms are not leveraging their resources/capabilities beyond a single product or market 2. Still on business-level strategies

Unrelated diversification

Businesses are not related example of GE -- Aviation -- Leasing services -- NBC Universal -- Health Care

Unsatisfactory Performance

Firms diversify in response to their unsatisfactory performance in their existing businesses.

Value-reducing diversification

Managerialism 1. An economy of scope that accrues to managers at the expense of equity holders 2. Managers of larger firms receive more compensation (larger scope - more compensation) -- Therefore, managers have an incentive to acquire other firms and become ever larger

Value of diversification

There must be some economy of scope. 1. Cost(A+B) < Cost(A) + Cost (B) 2. Revenue (A+B) > Revenue(A) + Revenue (B)

Related-Constrained

all businesses share a significant number of inputs, production technologies, distribution channels, similar customers, and so forth example: Bic does plastic parts for shavers/ pens and lighters. 1. plastic injection molding 2. Retail distribution 3. Brand name

Related-linked

different businesses are linked on only a couple of dimensions or different sets of businesses are linked on different dimensions. Newell Rubbermaid example: cleaning, organizing, & decor/ Tools & hardware/Home & family/ office products Common distribution channels: supermarkets & office supply stores