Chapter 7

Corporate Diversification

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

The Strategic Management ProcessExternal Analysis Strategic Choice

Mission

Objectives

Strategy Implementation

Competitive Advantage

Internal Analysis

Which Businesses to Enter? Corporate Level Strategy

Vertical Integration Diversification

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Corporate Diversification Corporate Diversification

Logic of Corporate Level StrategyCorporate level strategy should create value:1) such that businesses forming the corporate whole are worth more than they would be under independent ownership2) that equity holders cannot create through portfolio investing

Therefore, a corporate level strategy must create synergies economies of scope - diversificationCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Integration and DiversificationIntegration

Backward

Forward

DiversificationOther Businesses Current Businesses Unrelated Other Businesses

No Links

Related

Many Links7-4 4

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Corporate Diversification Corporate Diversification

Types of Corporate DiversificationAt a general level Product Diversification: operating in multiple industries

Geographic Market Diversification: operating in multiple geographic markets

Product-Market Diversification operating in multiple industries in multiple geographic marketsCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Types of Corporate DiversificationAt a more specific levelLimited Diversification single business: > 95% of sales in single business dominant business: 70% to 95% in single business

Related Diversification related-constrained: all businesses related on most dimensions related-linked: some businesses related on some dimensions

Unrelated Diversification businesses are not relatedCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Product and Geographic DiversificationPossibilities: single-business in one geographic area

single-business in multiple geographic areas related-constrained in one or multiple geographic areas related-linked in one or multiple geographic areas unrelated in one or multiple geographic areas

Note: relatedness usually refers to products seemingly unrelated products may be related on other dimensionsCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Competitive AdvantageIf a diversification strategy meets the VRIO criteria Is it Valuable? Is it Rare? Is it costly to Imitate? Is the firm Organized to exploit it?

it may create competitive advantage.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Value of DiversificationTwo Criteria1) There must be some economy of scope

2) The focal firm must have a cost advantage over outside equity holders in exploiting any economies of scope

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Value of DiversificationBusiness X + Business Y + Business Z

Value

Independent: equity holder could buy shares of each firm

Focal Firm

Business XEconomies Of Scope

Business Y Business Z

Value

Combined: equity holder buys shares in one firmCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Economies of ScopeFour Types Operational Financial Anticompetitive Managerialism

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Economies of ScopeOperational Economies of ScopeSharing Activities exploiting efficiencies of sharing business activities Example: Frito-Lays Trucking

Spreading Core Competencies exploiting core competencies in other businesses competency must be strategically relevant Example: OrbitzCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Economies of ScopeFinancial Economies of ScopeInternal Capital Market premise: insiders can allocate capital across divisions more efficiently than the external capital market works only if managers have better information

may protect proprietary information may suffer from escalating commitment Example: Hanson Trust, PLCCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Economies of ScopeFinancial Economies of ScopeRisk Reduction counter cyclical businesses may provide decreased overall risk

however, individual investors can usually do this more efficiently than a firm Example: Snow Skiis & Water Skiis

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Corporate Diversification Corporate Diversification

Economies of ScopeFinancial Economies of ScopeTax Advantages transfer pricing policy allows profits in one division to be offset by losses in another division

this is especially true internationally can be used to smooth income Example: Ireland

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Corporate Diversification Corporate Diversification

Economies of ScopeAnticompetitive Economies of ScopeMultipoint Competition mutual forbearance a firm chooses not to compete aggressively in one market to avoid competition in another market Example: American Airlines & Delta: Dallas & Atlanta

Market Power using profits from one business to compete in another business using buying power in one business to obtain advantage in another businessCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Economies of ScopeManagerialism an economy of scope that accrues to managers at the expense of equity holders managers of larger firms receive more compensation (larger scope = more compensation) therefore, managers have an incentive to acquire other firms and become ever larger even though the incentive is there, it is difficult to know if managerialism is the reason for an acquisitionCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Equity Holders and Economies of ScopeMost economies of scope cannot be captured by equity holders risk reduction can be captured by equity holders

Managers should consider whether corporate diversification will generate economies of scope that equity holders can capture if a corporate diversification move is unlikely to generate valuable economies of scope, managers should avoid itCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Rareness of DiversificationDiversification per se is not rare

Underlying economies of scope may be rare relationships that allow an economy of scope to be exploited may be rare an economy of scope may be rare because it is naturally or economically limited a soft drink bottler buys the only source of spring water available a hotel in a resort town creates a large water park, there are only enough customers to support one parkCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Imitability of DiversificationDuplication of Economies of ScopeLess Costly-to-Duplicate Costly-to-Duplicate Core Competencies Internal Capital Allocation Multipoint Competition Exploiting Market Power (tacit/intangible)

Employee CompensationTax Advantages Risk Reduction Shared Activities* (codified/tangible)

*may be costly depending on relationshipsCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

Imitability of DiversificationSubstitution of Economies of ScopeInternal Development start a new business under the corporate whole avoids potential crossfirm integration issues

Strategic Alliances find a partner with the desired complementary assets less costly than acquiring a firm

Competitors may use these strategies to arrive at a position of diversification without buying another firmCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

SummaryCorporate Strategy: In what businesses should the firm operate? an understanding of diversification helps managers answer that question

Two Criteria:1) economies of scope must exist 2) must create value that outside equity holders cannot create on their own

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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Corporate Diversification Corporate Diversification

SummaryEconomies of Scope a case of synergycombined activities generate greater value than independent activities may generate competitive advantage if they meet the VRIO criteria

Firms should pursue diversification only if careful analysis shows that competitive advantage is likely!

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Corporate Diversification Corporate Diversification

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Copyright 2012 Pearson Education, Inc. publishing as Prentice HallCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall.

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