The Multi-Business, Diversified
Firm
MANEC 387
Economics of Strategy
David J. Bryce
David J. Bryce © 2002
Corporate vs. Business Unit
Strategy
• Business Unit Strategy
– To whom will we sell, for what price?
– How will we source, manufacture, distribute, etc.
our product?
• Corporate Strategy
– What business(es) should we be in?
– How will we get in (or out) of them?
– How will we coordinate or integrate businesses to
create value?
David J. Bryce © 2002
Adapted from M. Porter, 2001, HBR
Corporate-Level Strategy and the
Multi-business Firm
• Corporate strategy is action taken to gain competitive
advantage through multiple business units
• Value is created through the configuration and
coordination of multi-business activities
David J. Bryce © 2002
Scope of the Firm
“Horizontal Integration”
output-products
Prod./Ind. A
Prod./Ind. B
Prod./Ind. C
Sales
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Manuf.
Manuf.
...
Input-products
“Vertical
Integration”
Vertical Scope
Horizontal Scope
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Manuf.
Manuf.
...
David J. Bryce © 2002
Sales
Wal-mart
Prod./Ind. A
Prod./Ind. B
Prod./Ind. C
Sales
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Manuf.
Manuf.
...
Input-products
Vertical Scope
output-products
Horizontal Scope
Sales
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Manuf.
Manuf.
...
David J. Bryce © 2002
GE
Horizontal Scope
Aircraft Engines
Prod./Ind. C
Sales
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Compressors
Sales
Manuf.
Manuf.
Sales
Sales
Distrib
Distrib
Distrib
Manuf.
Manuf.
Manuf.
Input-products
Vertical Scope
output-products
Refrigerators
...
...
David J. Bryce © 2002
Why Diversify?
• Secure Market Power
– Cross-subsidization, mutual forbearance, reciprocal
buying
– Shown to be an incomplete, if not an incorrect
view
• Mitigate Business (Cycle) Risk
– Perspective from finance
– Few firms are just “portfolio” investors
David J. Bryce © 2002
Why Diversify?
• Achieve Efficiency (or “Synergy”)
– Pursue related or complementary activities
– Most common type of diversification
– Associated with higher levels of performance than previous two
types
• Dynamic Learning
– Related to the efficiency motivation
– Firms invest in activities that leverage existing skills and
knowledge
– Firms introduce new activities to build skills and knowledge
– Objective is to develop a “capabilities portfolio” that is ready for
new opportunities when they emerge
David J. Bryce © 2002
Transaction Costs and
Diversification
• Hierarchical organization (as within a firm) is
a governance mechanism that reduces the
costs of transactions that would otherwise
occur across markets or not at all
– E.g. Complex contracting environments (recall our
discussions on Hold-up)
– Contracting for specific assets
– Certain types of knowledge assets
David J. Bryce © 2002
How to Choose Industries/Products for
Expansion
1. Strategically Important
2. Strategically Related; i.e. commonality
in one of the following:
1.
2.
3.
4.
5.
Customers
Channels
Inputs
Processes
Market Knowledge
David J. Bryce © 2002
Evaluating Diversification
• How can diversification create value?
– Economies of scope
– Learning
• How can diversification dissipate value?
– Bureaucratic costs – information overload, coordination
limitations
– Over-extension for management know-how,
financial, or other resources
– Empire building without incremental value-add
David J. Bryce © 2002
Sequential Entry and Dynamic
Learning: Example
Texas
Texas Instruments
Instruments
Semiconductors
(3674)
Electronic
Computers (3571)
Software (7372)
Search &
Navigation (3812)
Electronic
Computers (3571)
IBM
IBM
Computer
Storage
Devices (3572)
Computer
Terminals (3575)
Computer
Peripherals (3577)
Source: COMPUSTAT Business Segment Files, 1977-1996
David J. Bryce © 2002
Software (7372)
Semi-conductors
(3674)
Patterns of Historic Entry in Industries
Related to Semiconductors, 1977-1996
Process Control
Instruments
(3823)
Electronic
Capacitors
(3675)
***
(*)
*** (*)
Search &
Navigation Equip.
(3812)
** (*)
*
Radio/TV
Communication
Equip
(3663)
* p<0.10
**p<0.005
***p<0.001
David J. Bryce © 2002
*
*
Electronic
Computers
(3571)
*
*
Printed Circuit
Boards
(3672)
*
Computer Storage
Devices
(3572)
*** (*)
(*)
Electronic
Components
(3679)
***
(***)
*
*
*
Semiconductors
(3674)
*
Engineering
Services
(8711)
*
Computer
Peripherals
(3577)
Special Industries
Machinery
(3559)
Instruments to
Measure Electricity
(3825)
Patent Owners &
Lessors
(6794)
Summary and Takeaways
• Corporate Strategy is about structuring a
portfolio of businesses that hang together
and make strategic sense
• It is sometimes motivated by economizing on
transaction costs
• Other (strategic) motivations include dynamic
learning, efficiency, or sometimes market
power and risk management
• Diversification is not a fail-proof strategy
David J. Bryce © 2002