LEVELS OF DIVERSIFICATION: LOW LEVEL

SM CHAPTER 6
CORPORATE-LEVEL STRATEGY - Dominant Business
➢ Between 70% and 95% of
revenue comes from a single
The Role of Diversification business.
- Diversification strategies play a major - Single Business
role in the behavior of large firms. ➢ 95% or more revenue
- Product diversification concerns: comes from a single business
➢ the scope of the industries and LEVELS OF DIVERSIFICATION: MODERATE TO
markets in which the firm HIGH
competes.
➢ how managers buy, create - Related Constrained
and sell different businesses to ➢ Less than 70% of revenue
match skills and strengths with comes from a single business
opportunities presented to the and all businesses share
firm. product, technological and
distribution linkages.
TWO STRATEGY LEVELS: - Related Linked (mixed related and
- Business-level Strategy (Competitive) unrelated
➢ Each business unit in a ➢ Less than 70% of revenue
diversified firm chooses a comes from the dominant
business-level strategy as its business, and there are only
means of competing in its limited links between
individual product markets. businesses.
- Corporate-level Strategy
(Companywide) LEVELS OF DIVERSIFICATION: VERY HIGH
➢ Specifies actions taken by the LEVELS
firm to gain a competitive - Unrelated Diversification
advantage by selecting and ➢ Less than 70% of revenue
managing a group of different comes from the dominant
businesses competing in business, and there are no
different product markets. common links between
CORPORATE-LEVEL STRATEGY: KEY businesses.
QUESTIONS
- 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?
 ➢ corporate relatedness in
transferring skills or corporate
core competencies among
units.
- The difference between sharing
activities and transferring
competencies is based on how the
resources are jointly used to create
economies of scope.
SHARING ACTIVITIES
- Operational Relatedness
➢ Created by sharing either a
primary activity such as
inventory delivery systems, or a
support activity such as
purchasing.
➢ Activity sharing requires sharing
strategic control over business
units.
➢ Activity sharing may create risk
because business-unit ties
create links between
outcomes.
TRANSFERRING CORPORATE COMPETENCIES
RELATED DIVERSIFICATION
- Corporate Relatedness
- Firms create value by building upon ➢ Using complex sets of resources
or extending: and capabilities to link different
➢ resources businesses through managerial
➢ capabilities and technological knowledge,
➢ core competencies experience, and expertise.
- Economies of Scope
CORPORATE RELATEDNESS
➢ Cost savings that occur when a
firm transfers capabilities and - Creates value in two ways:
competencies developed in ➢ eliminates resource duplication
one of its businesses to another in the need to allocate
of its businesses. resources for a second unit to
develop a competence that
RELATED DIVERSIFICATION: ECONOMIES OF
already exists in another unit.
SCOPE
➢ provides intangible resources
- Value is created from economies of (resource intangibility) that are
scope through: difficult for competitors to
➢ operational relatedness in understand and imitate.
sharing activities.
 ▪ A transferred intangible UNRELATED DIVERSIFICATION
resource gives the unit
- Financial Economies:
receiving it an
➢ are cost savings realized
immediate competitive
through improved allocations
advantage over its rivals.
of financial resources.
RELATED DIVERSIFICATION: MARKET POWER ▪ Based on investments
inside or outside the firm
- Market power exists when a firm can:
➢ create value through two types
➢ sell its products above the
of financial economies:
existing competitive level
▪ Efficient internal capital
and/or
allocations.
➢ reduce the costs of its primary
▪ Purchase of other
and support activities below
corporations and the
the competitive level.
restructuring their assets.
- Multipoint Competition
- Efficient Internal Capital Market
➢ Two or more diversified firms Allocation
simultaneously compete in the
same product areas or ➢ Corporate office distributes
geographic markets. capital to business divisions to
create value for overall
- Vertical Integration
company.
➢ Backward integration — a firm
produces its own inputs. ▪ Corporate office gains
access to information
➢ Forward integration — a firm
operates its own distribution about those businesses’
system for delivering its outputs. actual and prospective
performance.
RELATED DIVERSIFICATION: COMPLEXITY
➢ Conglomerate life cycles are
- Simultaneous Operational
fairly short life cycle because
Relatedness and Corporate
financial economies are more
Relatedness
easily duplicated by
➢ Involves managing two sources
competitors than are gains
of knowledge simultaneously
from operational and
▪ Operational forms of
corporate relatedness.
economies of scope
▪ Corporate forms of UNRELATED DIVERSIFICATION:
economies of scope RESTRUCTURING
➢ Many such efforts often fail
- Restructuring creates financial
because of implementation
economies
difficulties.
➢ A firm creates value by buying
and selling other firms’ assets in
the external market.
 - Resource allocation decisions may INTERNAL INCENTIVES TO DIVERSIFY
become complex, so success often
Low Performance
requires:
- High performance eliminates the
➢ focus on mature, low-
need for greater diversification.
technology businesses.
- Low performance acts as incentive
➢ focus on businesses not reliant for diversification.
on a client orientation. - Firms plagued by poor performance
often take higher risks (diversification
EXTERNAL INCENTIVES TO DIVERSIFY
is risky).
Anti-trust Legislation
- Antitrust laws in 1960s and 1970s Uncertain Future Cash Flows
discouraged mergers that created
- Diversification may be defensive
increased market power (vertical or
strategy if:
horizontal integration.
- Mergers in the 1960s and 1970s thus ➢ product line matures.
tended to be unrelated.
➢ product line is threatened.
- Relaxation of antitrust enforcement
results in more and larger horizontal ➢ firm is small and is in mature or
mergers. maturing industry.
- Early 2000: antitrust concerns seem to
be emerging and mergers are now
more closely scrutinized. RELATIONSHIP BETWEEN DIVERSIFICATION
AND PERFORMANCE
Tax Laws
- High tax rates on dividends cause
a corporate shift from dividends to
buying and building companies in
high-performance industries.
- 1986 Tax Reform Act
➢ Reduced individual ordinary
income tax rate from 50 to 28
percent.
➢ Treated capital gains as
ordinary income. Synergy and Firm Risk Reduction
➢ Created incentive for - Synergy exists when the value
shareholders to prefer created by businesses working
dividends to acquisition together exceeds the value created
investments. by them working independently.
- But synergy creates joint
interdependence between business
units.
 - A firm may become risk averse and
constrain its level of activity sharing.
- A firm may reduce level of
technological change by operating RELATIONSHIP BETWEEN DIVERSIFICATION
in more certain environments. AND FIRM PERFORMANCE

RESOURCES AND DIVERSIFICATION

- A firm must have both:
➢ Incentives to diversify
➢ The resources required to
create value through
diversification—cash and
tangible resources (e.g., plant
and equipment)
- Value creation is determined more by
appropriate use of resources than by
incentives to diversify.
- Strategic competitiveness is
improved when the level of
diversification is appropriate for the
level of available resources.
Value-Reducing Diversification:
Managerial Motives to Diversify
- Managerial motives to diversify
➢ Managerial risk reduction
➢ Desire for increased
compensation
➢ Build personal performance
reputation
- Effects of inadequate internal firm
governance
➢ Diversification fails to earn
even average returns
➢ Threat of hostile takeover
➢ Self-interest actions of
entrenched management