Ch. 6: Corporate-Level Strategy
Value-neutral diversification: Uncertain future cash flows
Diversification may be defensive strategy if: --- product line matures --- product line is threatened --- firm is small and is in mature or maturing industry
Forward integration
a firm operates its own distribution system for delivering its outputs
Backward integration
a firm produces its own inputs
Corporate-level core competencies
complex sets of resources and capabilities that link different businesses, primarily through managerial and technological knowledge, experience, and expertise
Product diversification
concerns the scope of the markets and industries in which the firm competes as well as how managers buy, create and sell different businesses to match skills and strengths with opportunities presented to the firm
Economies of scope
cost savings a firm creates by successfully sharing resources and capabilities or transferring one or more corporate-level core competencies that were developed in one of its businesses to another of its businesses
Financial economies
cost savings realized through improved allocations of financial resources based on investments inside or outside the firm
Market power
exists when a firm is able to sell its products above the existing competitive level or to reduce the costs of its primary and support activities below the competitive level, or both
Synergy
exists when the value created by business units working together exceeds the value that those same units create working independently
Multipoint competition
exists when two or more diversified firms simultaneously compete in the same product areas or geographical markets
Free cash flows
liquid financial assets for which investments in current businesses are no longer economically viable
Research suggests that a firm using a related diversification strategy is
more careful in bidding for new businesses, whereas a firm pursuing an unrelated diversification strategy may be more likely to overbid because it is less likely to have full information about the firm it wants to acquire.
Single-business diversification strategy
o A corporate-level strategy wherein the firm generates 95% or more of its sales revenue from its core business area o Develop capabilities useful for these markets and provide superior service to their customers o Economies of scale
Resources and diversification
o A firm must have both: --- incentives to diversify --- the resources required to create value through diversification—cash and tangible resources (e.g., plant and equipment) o Value creation is determined more by appropriate use of resources than by incentives to diversify o Strategic competitiveness is improved when the level of diversification is appropriate for the level of available resources
Unrelated diversification strategy
o A highly diversified firm that has no relationships between its businesses o Conglomerates
Corporate relatedness
o Achieved when corporate-level core competencies are successfully transferred into some of the firm's businesses o Eliminates resource duplication in the need to allocate resources for a second unit to develop a competence that already exists in another unit o Provides intangible resources (resource intangibility) that are difficult for competitors to understand and imitate --- A transferred intangible resource gives the unit receiving it an immediate competitive advantage over its rivals o Using complex sets of resources and capabilities to link different businesses through managerial and technological knowledge, experience, and expertise
Operational relatedness
o Achieved when the firm's businesses successfully share resources and activities to make and sell their products o Created by sharing either a primary activity such as inventory delivery systems or a support activity such as purchasing o Activity sharing requires sharing strategic control over business units o Activity sharing may create risk because business-unit ties create links between outcomes
Value-neutral diversification: Anti-trust legislation
o Antitrust laws in 1960s and 1970s discouraged mergers that created increased market power (vertical or horizontal integration) o Mergers in the 1960s and 1970s thus tended to be unrelated o Relaxation of antitrust enforcement results in more and larger horizontal mergers o Early 2000: antitrust concerns seem to be emerging and mergers are now more closely scrutinized
Value-neutral diversification: External incentives to diversify
o Antitrust regulations o Tax laws
Two strategy levels
o Business-level strategy (competitive) --- Each business unit in a diversified firm chooses a business-level strategy as its means of competing in its individual product markets o Corporate-level strategy (companywide) --- Specifies actions taken by the firm to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets
Role of diversification
o Diversification strategies play a major role in the behavior of large firms o Product diversification concerns: --- the scope of the industries and markets in which the firm competes --- how managers buy, create, and sell different businesses to match skills and strengths with opportunities presented to the firm
Vertical integration
o Exists when a company produces its own inputs (backward integration) or owns its own source of output distribution (forward integration) o Commonly used in the firm's core business to gain market power over rivals
Related diversification: Market power
o Exists when a firm can: --- sells its products above the existing competitive level and/or --- reduce the costs of its primary and support activities below the competitive level o Multipoint competition --- Two or more diversified firms simultaneously compete in the same product areas or geographic markets o Vertical integration --- Backward integration --- Forward integration
Unrelated diversification
o Financial economies --- Based on investments inside or outside the firm --- Create value through: >>>>> efficient internal capital allocations >>>>> purchase of other corporations and the restructuring their assets o Efficient internal capital market allocation --- Corporate office distributes capital to business divisions to create value for overall company >>>>> corporate office gains access to information about those businesses' actual and prospective performance --- Conglomerate life cycles are fairly short life cycle because financial economies are more easily duplicated by competitors than are gains from operational and corporate relatedness o Restructuring of assets creates financial economies --- A firm creates value by buying and selling other firms' assets in the external market o Resource allocation decisions may become complex, so success often requires: --- focus on mature, low-technology businesses --- focus on businesses not reliant on a client orientation
Related diversificiation
o Firms create value by building upon or extending resources, capabilities, and core competencies o Economies of scope
Value-neutral diversification: Low performance
o High performance eliminates the need for greater diversification o Low performance acts an incentive for diversification o Firms plagued by poor performance often take higher risks (diversification is risky)
Value-neutral diversification: Tax laws
o High tax rates on dividends cause a corporate shift from dividends to buying and building companies in high-performance industries o 1986 Tax Reform Act --- Reduced individual ordinary income tax rate from 50 to 28 percent --- Treated capital gains as ordinary income --- Created incentive from shareholders to prefer dividends to acquisition investments o Increased depreciation produces lower taxable income, thereby providing an additional incentive for acquisition
Levels and trypes of diversification
o Low levels of diversification --- Single business --- Dominant business o Moderate to high levels of diversification --- Related constrained --- Related linked o Very high levels of diversification --- Unrelated
Value-neutral diversification: Internal incentives to diversify
o Low performance o Uncertain future cash flows o The pursuit of synergy o Reduction of risk for the firm
Value-reducing diversification: Managerial motives to diversify
o Managerial motives to diversify --- Managerial risk reduction --- Desire for increased compensation --- Build personal performance reputation o Effects of inadequate internal firm governance --- Diversification fails to earn even average returns --- Threat of hostile takeover --- Self-interest actions of entrenched management
Value-creating diversification strategies
o Operational relatedness o Corporate relatedness
Moderate to high levels of diversification
o Related constrained --- Less than 70% of revenue comes from the dominant business --- All businesses share product, technological, and distribution linkages o Related linked (mixed related and unrelated) --- Less than 70% of revenue comes from the dominant business --- There are only limited links between businesses
Related diversification: Complexity
o Simultaneous Operational Relatedness and Corporate Relatedness --- involves managing two sources of knowledge simultaneously: >>>>> operational forms of economies of scope >>>>> corporate forms of economies of scope o Many such efforts often fail because of implementation difficulties.
Low levels of diversification
o Single Business - 95% or more of revenue comes from a single business. o Dominant Business - Between 70% and 95% of revenue comes from a single business.
Value-neutral diversification: Synergy and firm risk reduction
o Synergy creates joint interdependence between business units o A firm may become risk averse and constrain its level of activity sharing o A firm may reduce level of technological change by operating in more certain environments
Corporate-level strategy: Value
o The degree to which the businesses in the portfolio are worth more under the management of the firm than they would be under other ownership. o What businesses should the firm be in? o How show the corporate office manage the group of businesses
Related linked diversification strategy
o The diversified company with a portfolio of businesses that have only a few links between them is called a mixed related and ounrelated firm o Share fewer resources and assets between businesses o Concentrate on transferring knowledge and core competencies between businesses
Very high levels of diversification
o Unrelated --- Less than 70% of revenue comes from the dominant business --- There are no common links between businesses
Related diversification: Economies of scope
o Value is created through: --- operational relatedness in sharing activities --- corporate relatedness in transferring skills or corporate core competencies among units o The difference between sharing activities and transferring competencies is based on how the resources are jointly used
Reasons for diversification
o Value-creating o Value-neutral o Value-reducing
Related constrained diversification strategy
o When the links between the diversified firm's businesses are rather direct (similar sourcing, throughput, and outbound processes) o Shares resources and activities across its businesses
Research suggests that although unrelated diversification has decreased,
related diversification has increased, possibly due to the restructuring that continued into the 1990s through the early twenty-first century.
Corporate-level strategy
specifies actions a firm takes to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets
Dominant-business diversification strategy
the firm generates between 70 and 95 percent of its total revenue within a single business area
Value-neutral diversification
• Antitrust regulation • Tax laws • Low performance • Uncertain future cash flows • Risk reduction for firm • Tangible resources • Intangible resources
Value-reducing diversification
• Diversifying managerial employment risk • Increasing managerial compensation
Value-creating diversification
• Economies of scope (related diversification) --- Sharing activities --- Transferring core competencies • Market power (related diversification) --- Blocking competitors through multipoint competition --- Vertical integration • Financial economies (unrelated diversification) --- Efficient internal capital allocation --- Business restructuring
