CorporateLevel
Strategy:
Creating Value
through
Diversification
chapter 6
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
.
Learning Objectives
6-2
After reading this chapter, you should have a
good understanding of:
LO6.1 The reasons for the failure of many
diversification efforts.
LO6.2 How managers can create value through
diversification initiatives.
LO6.3 How corporations can use related
diversification to achieve synergistic benefits through
economies of scope and market power.
Learning Objectives
6-3
LO6.4 How corporations can use unrelated
diversification to attain synergistic benefits through
corporate restructuring, parenting, and portfolio
analysis.
LO6.5 The various means of engaging in
diversification – mergers and acquisitions, joint
ventures/strategic alliances, and internal
development.
LO6.6 Managerial behaviors that can erode the
creation of value.
Corporate-Level Strategy
6-4
Consider…
What businesses should a corporation
compete in?
How can these businesses be managed so
they create “synergy” – that is, create more
value by working together than if they were
freestanding units?
Making Diversification Work
6-5
 Diversification
initiatives must create
value for shareholders through
 Mergers
and acquisitions
 Strategic alliances
 Joint ventures
 Internal development
 Diversification
Business
1
should create synergy
Business
2
More
than two
Making Diversification Work
6-6
A
firm may diversify into related businesses
 Benefits
derive from horizontal relationships
 Sharing
intangible resources such as core
competencies in marketing
 Sharing tangible resources such as production
facilities
firm may diversify into unrelated
businesses
A
 Benefits
 Value
derive from hierarchical relationships
creation derived from the corporate office
 Leveraging support activities in the value chain
Related Diversification
6-7
 Related
diversification enables a firm to
benefit from horizontal relationships
across different businesses
 Economies of scope allow businesses to:
 Leverage
core competencies
 Share related activities
 Enjoy greater revenues
 Related
 Pooled
businesses gain market power by:
negotiating power
 Vertical integration
Question?
6-8

Sharing core competencies is one of the primary
potential advantages of diversification. In order
for diversification to be most successful, it is
important that
A.
B.
C.
D.
the similarity required for sharing core
competencies must be in the value chain, not in
the product.
the products use similar distribution channels.
the target market is the same, even if the
products are very different.
the methods of production are the same.
Related Diversification:
Leveraging Core Competencies
6-9
 Core
competencies reflect the collective
learning in organizations. Can lead to the
creation of value and synergy if…
 They
create superior customer value
 The
value chain elements in separate
businesses require similar skills
 They
are difficult for competitors to
imitate or find substitutes for
Related Diversification:
Sharing Activities
6-10
 Corporations
can also achieve synergy by
sharing activities across their business
units.
 Sharing
tangible & value-creating
activities can provide payoffs:
 Cost
savings through elimination of jobs,
facilities & related expenses, or economies of
scale
 Revenue
enhancements through increased
differentiation & sales growth
Related Diversification:
Market Power
6-11
 Market
power can lead to the creation of
value and synergy through…
 Pooled
negotiating power
 Gaining
greater bargaining power with
suppliers & customers
 Vertical
integration - becoming its own
supplier or distributor through
 Backward
 Forward
integration
integration
Example: Question?
6-12

Shaw Industries, a giant carpet manufacturer,
increases its control over raw materials by
producing much of its own polypropylene fiber, a
key input into its manufacturing process. This is
an example of
A.
B.
C.
D.
leveraging core competencies.
pooled negotiating power.
vertical integration.
sharing activities.
Related Diversification:
Vertical Integration
6-13
Exhibit 6.3 Simplified Stages of Vertical Integration: Shaw Industries
Related Diversification:
Vertical Integration
6-14
1.
It is the company satisfied with the quality of the
value that its present suppliers & distributors are
providing?
2.
Are there activities in the industry value chain
presently being outsourced or performed
independently by others that are a viable source of
future profits?
3.
Is there a high level of stability in the demand for the
organization’s products?
Does the company have the necessary competencies
to execute the vertical integration strategies?
4.
5.
Will the vertical integration initiatives have potential
negative impacts on the firm’s stakeholders?
Related Diversification:
Vertical Integration
6-15
 The
transaction cost perspective
 Every market transaction involves some
transaction costs:
 Search
costs
 Negotiating costs
 Contract costs
 Monitoring costs
 Enforcement costs
 Need for transaction specific investments
 Administrative costs
Unrelated Diversification
6-16
 Unrelated
diversification enables a firm to
benefit from vertical or hierarchical
relationships between the corporate office
& individual business units through…
 The corporate parenting advantage
 Providing
competent central functions
 Restructuring
 Asset,
capital, & management restructuring
 Portfolio
 BCG
to redistribute assets
management
growth/share matrix
Unrelated Diversification:
Parenting & Restructuring
6-17
 Parenting
allows the corporate office to
create value through management
expertise & competent central functions
 In restructuring the parent intervenes:
 Asset
restructuring involves the sale of
unproductive assets
 Capital restructuring involves changing the
debt–equity mix, adding debt or equity
 Management restructuring involves changes
in the top management team, organizational
structure, & reporting relationships
Unrelated Diversification:
Portfolio Management
6-18
 Portfolio
management involves a better
understanding of the competitive position
of an overall portfolio or family of
businesses by…
 Suggesting
strategic alternatives for each
business
 Identifying priorities for the allocation of
resources
 Using Boston Consulting Group’s (BCG)
growth/share matrix
Unrelated Diversification:
Portfolio Management
6-19
Each circle
represents one
of the firm’s
business units.
The size of the
circle represents
the relative size
of the business
unit in terms of
revenue.
Exhibit 6.5 The Boston Consulting Group (BCG) Portfolio Matrix
Unrelated Diversification:
Portfolio Management
6-20
 Limitations
of portfolio models:
 SBUs
are compared on only two dimensions
& each SBU is considered a standalone entity
 Are
these the only factors that really matter?
 Can every unit be accurately compared on that
basis? What about possible synergies?
 An
oversimplified graphical model
substitutes for managers’ experience
 Following strict & simplistic rules for
resource allocation can be detrimental to a
firm’s long-term viability
Example: Goal of Diversification =
Risk Reduction?
6-21
 Diversification
can reduce variability in
revenues & profits over time. However…
 Stockholders
can diversify portfolios at a
much lower cost & economic cycles are
difficult to predict, so why diversify?
 Example
 Aircraft
= General Electric’s businesses:
engines, power generation
equipment, locomotive trains, large
appliances, healthcare products, financial
products, lighting, mining, oil & gas
 Why is GE in so many businesses?
Means of Diversification
6-22
 Diversification
 Mergers
 And
can be accomplished via
& acquisitions
divestment
 Pooling
resources of other companies with a
firm’s own resource base through
 Strategic
 Internal
alliances & joint ventures
Development through
 Corporate
entrepreneurship
Mergers and Acquisitions
6-23
 Mergers
involve a combination or
consolidation of two firms to form a new
legal entity:
 Are
relatively rare
 The two firms are on a relatively equal basis
 Acquisitions
involve one firm buying
another either through stock purchase,
cash, or the issuance of debt
Mergers and Acquisitions
6-24
Exhibit 6.6 Global Value of Mergers and Acquisitions ($ trillion)
Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis
Mergers and Acquisitions: Motives
6-25
 In
high-technology & knowledgeintensive industries, speed is critical:
acquiring is faster than building.
 M&A allows a firm to obtain valuable
resources that help it expand its product
offerings & services.
 M&A helps a firm develop synergy:
 Leveraging
core competencies
 Sharing activities
 Building market power
Mergers and Acquisitions: Motives
6-26
 M&A
can lead to consolidation within an
industry, forcing other players to merge.
 Corporations can also enter new market
segments by way of acquisitions.
Mergers and Acquisitions:
Limitations
6-27
 Takeover
premiums for acquisitions are
typically very high
 Competing firms can imitate advantages
 Competing firms can copy synergies
 Managers’ egos get in the way of sound
business decisions
 Cultural issues may doom the intended
benefits
Question?
6-28

Divestment can be the common result of an
acquisition. Divesting businesses can accomplish
many different objectives. These include
A.
B.
C.
D.
enabling managers to focus their efforts more
directly on the firm’s core businesses.
providing the firm with more resources to spend
on more attractive alternatives.
raising cash to help fund existing businesses.
all of the above.
Mergers and Acquisitions:
Divestment
6-29
 Divestment
 Cutting
objectives include:
the financial losses of a failed
acquisition
 Redirecting focus on the firm’s core
businesses
 Freeing up resources to spend on more
attractive alternatives
 Raising cash to help fund existing businesses
Mergers and Acquisitions:
Divestment
6-30
 Successful
 Removing
divestiture involves:
emotion from the decision
 Knowing the value of the business you’re
selling
 Timing the deal right
 Maintaining a sizable pool of potential buyers
 Telling a story about the deal
 Running divestitures systematically through a
project office
 Communicating clearly and frequently
Strategic Alliances &
Joint Ventures: Motives
6-31
 Strategic
alliances & joint ventures are
cooperative relationships with potential
advantages:
 Ability
to enter new markets through
 Greater
financial resources
 Greater marketing expertise
 Ability
to reduce manufacturing or other
costs in the value chain
 Ability to develop & diffuse new technologies
Strategic Alliances &
Joint Ventures: Limitations
6-32
 Need
for the proper partner:
 Partners
should have complementary
strengths
 Partner’s strengths should be unique
 Uniqueness
should create synergies
 Synergies should be easily sustained & defended
 Partners
must be compatible & willing to
trust each other
Internal Development
6-33
 Corporate
entrepreneurship & new
venture development motives:
 No
need to share the wealth with alliance
partners
 No need to face difficulties associated with
combining activities across the value chains
 No need to merge diverse corporate cultures
 Limitations:
 Time-consuming
 Need
to continually develop new capabilities
Managerial Motives
6-34
 Managerial
motives: Managers may act in
their own self interest – eroding rather
than enhancing value creation through
 Growth
for growth’s sake
 Top
managers gain more prestige, higher
rankings, greater incomes, more job security
 It’s exciting and dramatic!
 Excessive
egotism
 Use of antitakeover tactics
Managerial Motives:
Antitakeover Tactics
6-35
 Antitakeover
tactics include:
 Green
mail
 Golden parachutes
 Poison pills
 Can
benefit multiple stakeholders – not
just management
 Can raise ethical considerations because
the managers of the firm are not acting in
the best interests of the shareholders