Chapter 6- Corporate Level Strategy
t/f Diversifying into other product markets or into other businesses can reduce the uncertainty about a firm's future cash flows.
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Activity sharing is risky because ties among a firms businesses create links between outcomes.
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Value is created - either through related diversification or through unrelated diversification - when the strategy allows a business to increase revenues or reduce costs.
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t/f Firms can create operational relatedness by sharing either a primary activity (e.g., inven- tory delivery systems) or a support activity (e.g., purchasing practices)
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A highly diversified firm that has NO relationships between its businesses follows an ...
unrelated diversification strategy
Economies of scope (related diversification) ● Sharing activities ● Transferring core competencies
Economies of scope are COST SAVINGS a firm creates by successfully sharing resources and capabilities or transferring one or more corporate-level core competence that were developed in one of its businesses to another of its businesses. Essentially the cost savings due to sharing activities (resources and capabilities) and transferring core competencies.
Firms using the related constrained diversification strategy SHARE activities in order to create value.
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Value Neutral Diversification
Antitrust regulation Tax laws Low performance Uncertain future cash flows Risk reduction for firm Tangible resources Intangible resources
Corporate-level core competencies
Complex set of resources and capabilities that link businesses, primarily through managerial and technological knowledge, experience, and expertise firms using the related linked diversification strategy can create value by transferring core competencies.
Efficient internal capital market allocation
Corporate office distributes capital to business divisions to create value for overall company In large diversified firms, the corporate headquarters office distributes capital to its businesses to create value for the overall corporation.
Value Reducing Diversification
Diversifying managerial employment risk increasing managerial compensation
Value Creating Diversification
Economies of Scope (related diversification) Market Power (related diversification) Financial Economies (unrelated diversification)
Multipoint Competition
exists when two or more diversified firms simultaneously compete in the same product areas or geographical markets. Through multi-point competition, rival firms often experience pressure to diversify because other firms in their dominant industry segment have made acquisitions to compete in a different market segment. ex: fedex and ups
Both Operational and Corporate relatedness
high operational relatedness and high corporate relatedness ex: Amazon: books, products, groceries, RX, etc.
Primary activites: Inbound logistics, Operations, Outbound logistics, Marketing and Sales, and Services. Support Activity: Procurement, HR, Infrastrcture, Technological Development
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T/F Corporate-level strategies are strategies firms use to diversify their operations from a single business competing in a single market into several product markets.
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T/F Diversified firms VARY according to their level of diversification and the connections between and among their businesses.
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T/F The MORE links among businesses, the more "CONSTRAINED" is the level of diversification.
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t/f As a firm's product line matures or is threatened, diversification may be an important defensive strategy.96 Research also suggests that during a financial downturn, diversifica- tion improves firm performance because external capital markets are costly and internal resource allocation become more important.97 Family firms and companies in mature or maturing industries sometimes find it necessary to diversify for long-term survival of the legacy business.
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t/f Some research shows that low returns are related to greater levels of diversification.92 If high performance eliminates the need for greater diversification, then low performance may provide an incentive for diversification.
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t/f The difference between sharing activities and transferring competencies is based on how sep- arate resources are jointly used to create economies of scope.
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t/f Vertical integration is commonly used in the firm's core business to gain market power over rivals. Market power is gained as the firm develops the ability to save on its operations, avoid sourcing and market costs, improve product quality, possibly protect its technology from imitation by rivals, and potentially exploit underlying capabilities in the marketplace.
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Amazon uses a related diversification strategy to simultaneously create economies of scope through operational and corporate relatedness.
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Firms can foster increased market power through multipoint competition and vertical integration.
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t/f Research evidence and the experience of a num- ber of firms suggest that an overall curvilinear relationship, as illustrated in Figure 6.3, may exist between diversification and performance.
true according to figure 6.3, dominant businesses and Unrelated businesses have lower performance. while related constrained has higher performance.
Unrelated Diversification firms DO NOT seek operational relatedness and corporate relatedness
true unrelated diversification is easy for others to imitate. financial economies are just cost savings realized through improved investments inside or outside the firm.
•Diversification is SUCESSFUL when:
• it REDUCES VARIABILITY (even-out) in the firm's PROFITABILITY as earnings are generated from DIFFERENT businesses. •Provides firms with the FLEXIBILITY to SHIFT their investments to markets where the GREATEST returns are possible rather than being dependent on only one or a few markets
•Product diversification concerns:
•The SCOPE of the markets and industries in which the firm competes •How managers buy, create, and sell different businesses to match skills and strengths with opportunities presented to the firm
Reasons Companies Pursue Diversification
•Value CREATING Reasons •Value NEUTRAL Reasons •Value REDUCING Reasons CNR*
t/f A firm pursuing a low level of diversification uses either a single- or a dominant-business, corporate-level diversification strategy.
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t/f Although low performance can be an incentive to diversify, firms that are more broadly diversified compared to their competitors may have overall lower performance.
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T/F Corporate-level strategy is expected to help the firm earn above-average returns by creating value
t an effective corporate-level strategy creates, across all of a firm's businesses, aggregate returns that exceed what those returns would be without the strategy and contributes to the firm's strategic competitiveness and its ability to earn above-average returns
•Firms can improve their strategic competitiveness when they pursue a level of diversification that is appropriate for:
- their resources (especially financial resources) and core competencies. - Resources that are in possession, can be quickly acquired, or leased. - The opportunities and threats in their country's institutional and competitive environments.
Single Business Diversification Strategy
-95% or more revenue comes from a SINGLE business For example; McIlhenny Company (the maker of tabasco sauce; has maintained its focus on its family's hot sauce products for seven generations.)
Vertical integration is composed of:
-Backwards Integration: a firm produces its own inputs. - Forward Integration: a firm moves into the adjacent line of business that is closer to the end use.
Corporate-level strategy's value
-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. -What businesses should the firm be in? -How should the corporate office manage the group of businesses?
Transferring core competencies is often associated with related linked (or mixed related and unrelated) diversification, although firms pursuing both sharing activities and transferring core competencies can also use the related linked strategy.
Efficiently allocating resources or restructuring a target firm's assets and placing them under rigorous financial controls are two ways to accomplish successful unrelated diversification. Firms using the unrelated diversification strategy focus on cre- ating financial economies to generate value.
financial economies
Financial economies are just COST SAVINGS realized through improved investments inside or outside the firm.
Asset Restructuring
Financial economies can also be created when firms learn how to create value by buying, restructuring, and then selling the restructured companies' assets in the external market.
Diversification is sometimes pursued for value-neutral reasons. Incentives from tax and antitrust government policies, low per- formance, or uncertainties about future cash flow are examples of value-neutral reasons that firms choose to become more diversified.
Managerial motives to diversify (including to increase com- pensation) can lead to overdiversification and a subsequent reduction in a firm's ability to create value. Evidence suggests, however, that many top-level executives seek to be good stew- ards of the firm's assets and avoid diversifying the firm in ways that destroy value.
Unrelated Diversification
LOW operational relatedness and LOW corporate relatedness. ex: Samsung and Newell which owns rubeermaid and coleman
Related Linked Diversification
Low operational relatedness and high corporate relatedness. ex: GE- porfolio. Some linkages.
Sharing activities usually involves sharing tangible resources between businesses. Examples include transferring core com- petencies developed in one business to another business, and transferring competencies between the corporate headquar- ters office and a business unit.
Sharing activities is usually associated with the related con- strained diversification corporate-level strategy. Activity shar- ing is costly to implement and coordinate, may create unequal benefits for the divisions involved in the sharing, and can lead to fewer managerial risk-taking behaviors.
Vertical Integration
Some firms using a related diversification strategy engage in vertical integration to gain market power. Vertical integration exists when a company PRODUCES ITS OWN INPUTS (backward integration) or owns it OWN SOURCE OF OUTPUT DISTRIBUTION (forward integration).
T/F "Unrelated" refers to the ABSCENCE of direct links between businesses.
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Operational Relatedness: Sharing Actvities
- Firms can create operational relatedness by sharing either: 1. A primary activity (ex: inventory delivery systems) 2 A support activity (ex: purchasing practices) Sharing activities are usually associated with the related constrained diversification strategy.
Managerial motives to diversify CAN lead to over diversification and are reduce the firms ability to create value. Managerial tendencies to over diversify may be held in check by:
- Governance Mechanisms (strong board of directors) - Monitoring by owners - Executive compensation practices (stock, salary, both?) - The market for corporate control evidence suggests that many top level executives seek to be a good steward of the firm;s assets and avoid diversifying the firm in ways that destroy value.
A corporate-level strategy:
- Is used as a means to GROW revenues and profits. - Focuses on DIVERSIFICATION -Is expected to HELP the firm EARN ABOVE-AVG returns BY creating value.
Low Levels of Diversification
Single business and Dominant Business
Activity sharing:
- is costly to implement and coordinate - may create unequal benefits for the divisions involved. - can lead to fewer managerial risk-taking behaviors
Dominant Business Diversification Strategy
- the firm generates between 70% and 95% of revenue from a single business For example; United Parcel Service (UPS) uses this strategy.
Firms using the related linked diversification strategy can create value by transferring core competencies in atleast 2 ways"
1. Because the expense of developing a core competence has already been incurred in one of the firm's businesses, transferring it to a second business ELIMINATES the need for that business to allocate resources to develop it. 2 Because INTANGIBLE resources are difficult for competitors to understand and imitate, the unit receiving a transferred corporate-level competence often gains an immediate competitive advantage over its rivals.
An unrelated diversification strategy can create value through 2 types of financial economies:
1. Efficient internal capital market allocation 2. Asset restructuring
Levels (Categories) of Diversification depends on:
1. How much of your overall REVENUE comes from a SINGLE line of business 2. How RELATED are the ACTIVITIES of the various lines of business?
5 categories of businesses according to increasing levels of diversification
1. Single Business 2. Dominant Business 3. Related Constrained 4. Related linked 5. Unrelated *1 & 2: no or relatively low levels of diversification *3-5: more fully diversified firms are classified into related and unrelated categories. A firm is related through its diversification when its businesses share several links. the more links among businesses, the more 'constrained' is the level of diversification.
Reasons for diversification
1. Value Creating Diversification 2. Value Neutral Diversification 3. Value Reducing Diversification
Corporate-level strategies are concerned with 2 key issues:
1.In WHAT product markets and businesses the firm should compete. 2. HOW corporate headquarters should manage those businesses.
Corporate-level strategies
ACTIONS a firm takes to GAIN a competitive advantage by SELECTING and MANAGING a GROUP of DIFFERENT BUSINESSES COMPETING in different product markets.
Related Constrained Diversification
HIGH operational relatedness (sharing activities between businesses) and LOW corporate relatedness (transferring core compentencies into businesses) Ex: P&G (different divisions use SAME techniques and equipment
Diversification is usually attempted with the desire to create value with some type synergy when the combination of business Unit A with business unit B results in 1+1>2
In other words, when we diversify we want to create a value greater than the 2. When we combine businesses they should yield greater value than when they work independently.
Value Reducing Diversification
Managerial motives to diversify and increased compensation are 2 motives for top-level executives to diversify their firm beyond value-creating/neutral reasons. managerial motives to diversify (including to increase compensation) can lead to overdiversification and a subsequent reduction in a firms ability to create value. managers need to consider the firms internal reorganization and its external environment when making decisions about the optimum level of diversification for their company.
Market Power
Market power exists when a firm can SELL its products at prices ABOVE the existing competitive level and/or REDUCES the costs of its primary and support activities below the competitive level. Firms using a related diversification strategy may gain market power when successfully using a related constrained or related linked strategy Competitive advantages are a type of market power.
Synergy
Synergy exists when the value created by business units working together EXCEEDS the value that those same units create working independetely. However, as a firm increases its relatedness among business units, it also increases its risk of corporate failure because synergy produces joint interdependence among businesses that constrains the firm's flexibility to respond. This threat may force two basic decisions: 1. the firm may reduce its level of technological change by operating in environments that are more certain. This behavior may make the firm risk averse and thus uninterested in pursuing new product lines that have potential but are not proven. 2. Alternatively, the firm may constrain its level of activity sharing and forgo potential benefits of synergy. Either or both decisions may lead to further diversification. Operating in environments that are more certain will likely lead to related diversification into industries that lack potential,103 while constraining the level of activity sharing may pro- duce additional, but unrelated, diversification, where the firm lacks expertise. 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.104 However, firms using either a related or an unrelated diversification strategy must understand the consequences of paying large premiums.105 Paying exces- sive acquisition premiums often causes managers to become more risk averse and focus on achieving short-term returns. When this occurs, managers are less likely to be con- cerned about making long-term investments (e.g., developing innovation).
The primary reason a firm uses a corporate-level strategy tobecome more diversified is to create additional value. Using asingle- or dominant-business corporate-level strategy may be preferable to seeking a more diversified strategy, unless a cor- poration can develop economies of scope or financial econo-mies between businesses, or unless it can obtain market power through additional levels of diversification. Economies of scopeand market power are the main sources of value creation whenthe firm uses a corporate-level strategy to achieve moderate to ■ high levels of diversification.
The related diversification corporate-level strategy helps the firm create value by sharing activities or transferring competen- cies between different businesses in the company's portfolio.
Unrelated Diversification
is when less than 70% of revenue comes from the dominant business, and the are NO COMMON LINKS between businesses. AKA KNOWN AS: Conglomerate
Related Constrained
less than 70% of revenue comes from a single business. ALL businesses SHARE product, technological and distribution linkages. A LOT OF LINKS between all the businesses.
Related Linked
less than 70% of revenue comes from the dominant business and there are ONLY LIMITED competency links between businesses related linked firms share fewer resources and assets between their businesses, concentrating instead on transferring knowledge and core competencies between the businesses.
Financial economies are
risk adjusted cost savings realized through improved allocations of financial resources. create value through 2 types of financial economies: 1. efficient internal capital allocations 2. purchase of other corporations and the restructuring of their assets.
Firms seek to create value from economies of scope through two basic kinds of operational economies:
sharing activities (operational relatedness) and transferring corporate-level core competencies (corporate relatedness).
