Chapter 10: Corporate Level Strategy: Related and Unrelated Diversification

Types of Diversification

- Related diversification - Unrelated diversification

Several ways to improve performance of an acquired company

- Replace top managers of the acquired company with a more aggressive top management team. Sell off expensive assets and terminate managers and employees to reduce cost structure. Work to devise new strategies to improve performance of the operations of the acquired company. Set challenging goals at all levels (stretch goals). Offer bonuses to motivate managers and employees.

Diversification increases profitability by:

- Transferring Competencies - Leveraging Competencies - Sharing Resources and Capabilities - Utilizing Product Bundling - Utilizing General Organizational Competencies (GOCs)

Methods to implement diversification strategy

-Internal new ventures -Acquisitions -Joint ventures

Corporate Level Strategy: Used to Identify

1) Businesses/industries in which company should compete 2) Value creation activities company should perform in those businesses 3) Method to enter or leave businesses or industries in order to maximize its long-run profitability

Entry Modes for Entering New Industries

1) Internal New Venturing 2) Acquisitions / Mergers 3) Joint Ventures / Strategic Alliances

Joint Ventures (cont)

Advantage of Joint Ventures: Share the risks and costs associated with establishing a business unit in the new industry Share complementary skills or distinctive competencies

Corporate Level Strategy

Allows company to perform value creation functions at a lower cost or allows differentiation & premium price.

Limits/Disadvantages of Diversification

Bureaucratic Costs of Diversification: ++ Bureaucratic costs are the costs associated with solving the transaction difficulties that arise between a company's business unit and between the business unit and corporate headquarters, as the company attempts to obtain the benefits from transferring, sharing, and leveraging competencies. The greater the number of business units, the more difficult it is for corporate managers to remain informed about each business. When employing a diversification strategy, there is an enormous amount of cost arising from managerial time and effort required to accurately measure the performance and unique profit contribution of a business unit sharing resources.

Limits/Disadvantages of Diversification

Changes in the Industry or Company: When the managers who possess hard-to-define skills leave, they often take their unique capabilities with them. A company's new leader may lack the competency or commitment necessary to pursue diversification successfully over time. The environment often changes rapidly and unpredictably over time. The future success of any business is hard to predict when using diversification.

Unrelated Diversification (cont)

Companies pursuing this strategy are often called conglomerates; that is, business organizations that operate in many diverse industries. In unrelated diversification there is no transfer or leverage of value chain functions. +++ Value is created by use of GOCs

Why should a company diversify?

Companies should diversify when diversification allows them to better differentiate their products or to achieve a cost leadership position or when they are convinced they have superior general organizational competencies (GOCs)

Transferring Competencies CONT

Companies that base their diversification strategy on transferring competencies tend to acquire new businesses related to their existing business activities. A commonality is some kind of skill or attribute, which, when it is shared or used by two or more business units allows both businesses to operate more effectively and efficiently, and create more value for customers. To increase profitability, the competencies transferred must involve value-chain activities that gives the business unit competitive advantage in the future.

Why diversify?

Company is generating free cash flow in excess of that needed to maintain competitive advantage in current businesses.

Unrelated Diversification

Corporate-level strategy based on a multi-business model with a goal to increase profitability through the use of General Organizational Competencies (GOCs), and to increase the performance of all the company's business units.

Related Diversification

Corporate-level strategy that is based on the goal of establishing a business unit in a new industry that is RELATED to a company's existing business units by some form of commonality or linkage between value-chain functions of the existing and new business units.

Joint Ventures (cont)

Disadvantages of entering a joint venture: Must share the profits The partner with more valuable skills will "give away" profits to the other partner in a 50/50 agreement. Problems caused by conflicting business models Risk of giving away important company-specific knowledge to partner.

Why Restructure?

Diversification discount - investors see highly diversified companies as less attractive Response to failed acquisitions Innovations in strategic management have diminished advantages of vertical integration or diversification

Limits/Disadvantages of Diversification

Diversification for the Wrong Reasons: Although they know they should divest unprofitable businesses, managers "make up" reasons why they should keep their businesses together. In the past, one widely used (and false) justification for diversification was that the strategy would allow a company to obtain the benefits of risk pooling. When a company's core business is in trouble, some think diversification will rescue it and lead to long-term growth and profitability.

Sharing Resources and Capabilities

Economies of scope arise when one or more of a diversified company's business units are able to realize cost-saving or differentiation synergies. Companies can increase profitability by more effectively pooling, sharing, and utilizing expensive resources or capabilities. Sharing resources or capabilities across business units lowers a companies cost structure compared to companies that operate in only one industry.

Superior Strategic Management Capabilities

For diversification to increase profitability, a company's top managers must have superior capabilities in strategic management: - They must possess the intangible skills that are required to manage different business units in a way that enables these units to perform better than they would if they were independent companies. - These skills are a rare and valuable capability.

Acquisitions

Guidelines for successful acquisitions: Strategic target identification Preacquisition screening Bidding strategy Integration Learning from experience

Product Bundling

In search of new ways to differentiate products, more and more companies are entering into industries that provide customers with new products connected or related to existing products. Product bundling allows a company to expand the range of products it produces to provide customers a complete package of related products. The goal is to bundle products to offer customers lower prices and/or a superior product or service.

Joint Ventures

Involve two or more companies agreeing to pool their resources to create new businesses.

Organizational Design Capabilities

Organizational design skills are a result of a manager's ability to create effective structure, control systems, and culture. - Effective organizational structure and controls create incentives that encourage business unit managers to maximize efficiency and effectiveness of their units. - Good organizational design helps prevent missing out on profitable new opportunities.

Restructuring

Process of divesting businesses and exiting industries to focus on core distinctive competencies to increase company profitability.

Acquisitions

Reasons acquisitions fail: Management problems Overestimating the potential economic benefits Poor screening - not identifying major problems

Internal New Venturing

Reasons given to explain the high failure rate (33% to 60%) of internal new ventures include: 1) Market entry on too small a scale. 2) Poor commercialization of the new-venture product. 3) Poor corporate management of the new venture division. Steps taken to ensure good science ends with good, commercially viable products: 1) Put research in the hands of skilled managers. 2) Encourage managers to work with R&D scientists. 3) Foster a close link between R&D and marketing.

Choosing a Diversification Strategy

Related diversification is preferred when: 1) The company's distinctive competencies can be applied across a greater number of industries, and 2) The company has superior strategic capabilities that allow it to keep bureaucratic costs under control. Unrelated diversification is preferred when: 1) Top managers are skilled at raising the profitability of a poorly run business, and 2) Superior management is able to keep costs under control.

Utilizing General Organizational Competencies (GOCs)

Result of the skills of top managers and functional experts in three areas: 1) Entrepreneurial Capabilities 2) Organizational Design Capabilities 3) Superior Strategic Management Capabilities

Leveraging Competencies

Taking a distinctive competency developed by a business unit in one industry and using it to create a NEW business unit or division in a different unit.

Transferring Competencies

Taking a distinctive competency developed by a new business unit in one industry and implanting it into an EXISTING business unit operating in another industry.

Related Diversification (Cont)

The greater the number of linkages that can be formed among business units, the greater the potential to realize the profit-enhancing benefits of diversifying. Diversification allows a company to use its GOCs to increase the overall performance of all its different divisions in multiple industries.

Diversification

The process of entering new industries, distinct from a company's core or original industry, in order to make new kinds of products that can be sold profitably.

Internal New Venturing

The process of transferring resources to and creating a new business unit or division in a new industry. May be used to enter newly emerging or embryonic industry

Entrepreneurial Capabilities

To promote entrepreneurship, a company must: 1) Encourage managers to take risks 2) Give them the time and resources to pursue novel ideas 3) Not punish managers when a new idea fails 4) Not pursue too many risky new ventures that have a low probability of generating a profit

Acquisitions

Why firms use acquisitions as an entry strategy: Firm needs to move fast to establish a presence in an industry. Perceived as being less risky than internal new ventures because they involve less commercial uncertainty. +++ To enter an industry that is protected by high barriers to entry.

Product Bundling

allows a company to expand the range of products it produces to provide customers a complete package of related products.

Economies of Scope

arise when or more of a diversified company's business units are able to realize cost saving or differentiation synergies

Difference between Transferring and Leveraging competencies

leveraging competencies means a NEW business is being created. Transferring competencies involves the sharing of competencies between two EXISTING businesses.

Diverified Company

makes and sells products in two or more different or distinct industries