Chapter 7 Outline Day 9 Product Diversification
I.
II.
Corporate Level Strategy
a. Corporate Level Strategy should create value:
i. Such that businesses forming the corporate whole are worth more than they
would be under independent ownership.
ii. That equity holders cannot create through portfolio investing
b. Therefore
i. Corporate level strategy must create synergies between divisions that create
value that couldn’t be created by independent ownership
ii. Economies of scope  differentiation
Diversification
a. The difference between integration and diversification:
i. Integration-value chain of current products/ business
ii. Diversification-different products/ businesses
b. Five Types of Corporate Diversification
i. Limited Diversification
1. Single business: > 95% of revenues in single business
2. Dominant business: 70% to 95% in single business
ii. Related Diversification (less than 70% of revenues in single business)
1. Related Constrained: all businesses related on most dimensions
(customers, technology, distribution, brand)
2. Related Link: some businesses related on some dimensions
iii. Unrelated Diversification (less than 70% of revenues in single business)
1. Businesses are not related
c. Value of Diversification
i. If a diversification strategy meets the VRIO criteria
1. Is it Valuable?
2. Is it rare?
3. Is it costly to imitate?
4. Is the firm organized to exploit it?
a. May create competitive advantage
ii. Two Criteria
1. There must be some economy of scope (exist when the value of the
product or service that a firm sales increases as a function of the
number of businesses that a firm operates in by increasing revenue or
decreasing costs
2. The focal firm must have a cost advantage over outside equity holders
in exploiting any economies of scope
d. Economies of Scope- 4 types of Scope
i. Operational Economies of Scope
1. Sharing Activities
a. Exploiting efficiencies of sharing business activities; cost born by
many businesses
2. Spreading core competencies
a. Exploiting core competencies in other businesses
b. Competencies bust be strategically relevant
ii. Financial Economies of Scope
1. Primary reason for conglomerate boom in 60s-70s
2. Financial advantages were
a. Internal capital market
i. Premise: insiders can allocate capital across divisions
more efficiently than the external capital market
ii. Works only if managers have better information
iii. May protect proprietary information
iv. May suffer from escalating commitment
v. However, external capital markets may have more
discipline and avoid escalation of commitment
b. Risk Reduction
i. Counter cyclical businesses may provide decreased
overall risk, and thus more stable returns
ii. However, individual investors can usually do this more
efficiently that a firm risk may also spread
c. Tax Advantages
i. Transfer pricing policy allows profits in one division to
be offset by losses in another division
ii. This is especially true internationally
iii. Can be used to smooth income
iii. Anticompetitive Economies of Scope
1. Multipoint Competition
a. Mutual forbearance—a firm chooses not to compete
aggressively in one market to avoid competition in another
market
2. Market Power
a. Using profits from one business to compete in another business
b. Using buying power in one business to obtain advantage in
another business
iv. Managerialism (Employee Reasons) Economies of Scope
1. An economy of scope that accrues to managers at the expense of equity
holders
2. Managers of larger firms receive more compensation (larger scope/firm
size=more compensation)
3. Therefore, managers have an incentive to acquire other firms become
even larger although difficult to detect.
v. Rareness of Diversification
1. Diversification per se is not rare
2. Underlying economies of scope may be rare
a. Relationships that allow an economy of scope to be exploited
may be rare
b. An economy of scope may be rare because it is naturally or
economically limited
vi. Imitability of Diversification
1. Duplication of Economies of Scope
a. Less likely to duplicate (codified/tangible)
i. Employee compensation
ii. Tax advantages
iii. Risk reductions
iv. Shared activities (may be costly depending on
relationships)
b. Costly to duplicate (tacit/intangible)
i. Core competencies
ii. Internal capital allocation
iii. Multipoint competition
iv. Exploiting market power
2. Substitutions of Economies of Scope
a. Internal Development
i. Start a new business under the corporate whole
ii. Avoids potential cross firm integration issues
b. Strategic Alliances
i. Find a partner with the desired complementary assets
ii. Less costly than acquiring a firm
c. Competitors may use these strategies to arrive at a position of
diversification without buying another firm.