Ch. 6: Corporate Strategy

Blue Ocean Strategy

-Buzz word: how firms chose lucrative markets -Blue Ocean: no other company competes (Ideal) -Red Ocean: Competition is intense 1. Look across alternative industries (zipcar) 2. " strategic groups, underserved markets (curves) 3. " chain of buyers (Noropen) 4. " complementary Products and services ( Barnes and Noble w/ Starbucks) 5. " functional appeal and emotional appeal to buyers 6. " time

Different Types of Diversification

PIC 20

Reasons for Diversification

PIC 21 • Value Creating Diversification o Economies of scope: Sharing activities Transferring competencies o Market Power: Blocking competitors Vertical integration o Financial economies: Efficient capital allocatioBusiness restructuring • Value Neutral Diversification o Antitrust law o Tax laws o Low performance o Uncertain future cash flows o Risk reduction o Tangible resources o Intangible resources • Value Reducing Diversification o Reducing managerial employment risk o Increasing management compensation

Resources and Diversification

• A firm must have both: o Incentives to diversify o The resources required to create value through diversification—cash and tangible resources (e.g., plant and equipment) • Value creation is determined more by appropriate use of resources than by incentives to diversify. • Strategic competitiveness is improved when the level of diversification is appropriate for the level of available resources.

External Incentives to diversify

• Antitrust Legislation 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. o High tax rates on dividends cause a corporate shift from dividends to buying and building companies in high-performance industries. • 1986 Tax Reform Act o Reduced individual ordinary income tax rate from 50 to 28 percent. o Treated capital gains as ordinary income. o Created incentive for shareholders to prefer dividends to acquisition investments.

BCG Growth-share Matrix Assumptions

• Cash Cows produce enough cash to finance new businesses and cash is invested. • Firm has sufficient management expertise to manage maturing businesses (keeping up with industry process innovations & scale requirements) • Firm has a sufficient entrepreneurial capability to build up new businesses and kill off dogs. • PIC 19

Transferring Corporate Competencies

• Corporate Relatedness o Using complex sets of resources and capabilities to link different businesses through managerial and technological knowledge, experience, and expertise. • Creates value in two ways: 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 comcompetitive advantage over its rivals.

Corporate Strategy

• Corporate level strategy specifies actions a firm takes to gain competitive advantage by selecting and managing a group of different businesses competing in different product markets • Asks the question: what businesses should the firm be competing in and how should the corporate office manage the businesses. • Key issues: o How much to diversify? o Reasons for diversification

Corporate Diversification Expanding Beyond Single Market

• Diversification strategies: o Product diversification • Active in several different product categories o Geographic diversification • Active in several different countries o Product - market diversification • Active in a range of both product and countries

How does diversification impact performance?

• Economies of scale → lower the cost • Economies of scope → increase the value • Reduce cost and increase value simultaneously • Internal capital markets o Source of value creation in a diversification strategy o Allows conglomerate to do a more efficient job of allocating capital • Yet firms can diversify too far • It is often difficult to realize the benefits of diversification • Coordination cost: A function of number, size, and types of businesses linked to one another • Influence cost: Political maneuvering by managers to influence capital and resource allocation • Relationship between Diversification and Firm Performance PIC 22

Blue Ocean Strategy

• Escaping unfavorable industries and exploiting favorable ones

Unrelated Diversification

• Financial Economies: are cost savings realized through improved allocations of financial resources. o Based on investments inside or outside the firm • Create value through two types of financial economies: o Efficient internal capital allocations o Purchase of other corporations and the restructuring their assets • Efficient Internal Capital Market Allocation o 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. o 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. • Restructuring creates financial economies o A firm creates value by buying and selling other firms' assets in the external market. • Resource allocation decisions may become complex, so success often requires: o focus on mature, low-technology businesses. o focus on businesses not reliant on a client orientation.

Related Diversification

• Firms create value by building upon or extending: o Resources o Capabilities o core competencies • Economies of Scope: Cost savings that occur when a firm transfers capabilities and competencies developed in one of its businesses to another of its businesses. • Value is created from economies of scope through: o operational relatedness in sharing activities. o corporate relatedness in transferring skills or corporate core competencies among units. • The difference between sharing activities and transferring competencies is based on how the resources are jointly used to create economies of scope.

Internal Incentives to diversify

• Low Performance o High performance eliminates the need for greater diversification. o Low performance acts as incentive for diversification. o Firms plagued by poor performance often take higher risks (diversification is risky). • Uncertain cash flows o Diversification may be defensive strategy if: o product line matures. o product line is threatened. o firm is small and is in mature or maturing industry. • Synergy and Firm Risk reduction o Synergy exists when the value created by businesses working together exceeds the value created by them working independently. o But 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.

Value-Reducing Diversification: Managerial Motives to Diversify

• Managerial motives to diversify o Managerial risk reduction o Desire for increased compensation o Build personal performance reputation • Effects of inadequate internal firm governance o Diversification fails to earn even average returns o Threat of hostile takeover o Self-interest actions of entrenched management

Related Diversification: Market Power

• Market power exists when a firm can: o sell its products above the existing competitive level and/or o reduce the costs of its primary and support activities below the competitive level. • Multipoint Competition o Two or more diversified firms simultaneously compete in the same product areas or geographic markets. • Vertical Integration o Backward integration — a firm produces its own inputs. o Forward integration — a firm operates its own distribution system for delivering its outputs.

Sharing Activities

• Operational Relatedness 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.

Related Diversification: Complexity

• Simultaneous Operational Relatedness and Corporate Relatedness • Involves managing two sources of knowledge simultaneously o Operational forms of economies of scope o Corporate forms of economies of scope • Many such efforts often fail because of implementation difficulties.