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Unit 6 - Diversification

The document discusses corporate-level strategy and diversification, outlining its purpose, types, and value creation methods. It explains related and unrelated diversification strategies, the reasons firms diversify, and the potential risks and incentives associated with these strategies. Additionally, it highlights the managerial motives that may lead to overdiversification and the implications for firm performance.

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rojay burton
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Unit 6 - Diversification

The document discusses corporate-level strategy and diversification, outlining its purpose, types, and value creation methods. It explains related and unrelated diversification strategies, the reasons firms diversify, and the potential risks and incentives associated with these strategies. Additionally, it highlights the managerial motives that may lead to overdiversification and the implications for firm performance.

Uploaded by

rojay burton
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 31

MAN4001 –

S T RAT E G I C
MANAGEMENT

Competitiveness &
Globalization

University of Technology - Marie Bradford (2021) 1


Learning Objectives

1. Define corporate-level strategy and discuss


its purpose.
UNIT 6:
2. Describe different levels of diversification
D I V E R S I F I C AT I O N with different corporate level strategies.

3. Explain three primary reasons firms


diversify.

4. Describe how firms can create value by


using a related diversification strategy.

5. Explain the two ways value can be created


with an unrelated diversification strategy

6. Discuss the incentives and resources that


encourage diversification.

7. Describe motives University


that can encourage
of Technology - Marie Bradford (2021) 2

managers to overdiversify a firm.


CORPORATE-LEVEL STRATEGY’S VALUE

Corporate-level strategy’s value is ultimately determined by the degree to


which “the businesses in the portfolio are worth more under the
management of the company than they would be under any other
ownership”

A corporate-level strategy is expected to help the firm earn above-average


returns by creating value

University of Technology - Marie Bradford (2021) 3


CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
DIVERSIFICATION - growing into new business areas either related (similar to
existing business) or unrelated (different from existing business); allows a
firm to create value by productively using excess resources
The diversified firm operates in several different and unique product markets
and likely in several businesses; it forms two types of strategies: corporate-
level (or company-wide) and business-level (or competitive)

For the diversified corporation, a business-level strategy must be selected


for each one of its businesses

University of Technology - Marie Bradford (2021) 4


CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
ONE • A single-product market/single
geographic location firm
BUSINESS- employs one business-level
strategy and one corporate-level
strategy identifying what or
LEVEL which industry the firm will
compete in
STRATEGY

• A diversified firm employs a


SEVERAL separate business-level strategy
for each product market area in
BUSINESS- which it competes and one or
more corporate-level strategies
LEVEL dealing with product and/or
geographic diversity

STRATEGIES
University of Technology - Marie Bradford (2021) 5
LEVELS OF DIVERSIFICATION

University of Technology - Marie Bradford (2021) 6


LEVELS OF DIVERSIFICATION

A firm is related through its diversification when its businesses share links
across:
o PRODUCTS (goods or services)
o TECHNOLOGIES
o DISTRIBUTION CHANNELS

The more links among businesses, the more “constrained” is the relatedness
of diversification

“Unrelated” refers to the absence of direct links between businesses

University of Technology - Marie Bradford (2021) 7


REASONS FOR DIVERSIFICATION

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REASONS FOR DIVERSIFICATION – Value Creating

Value-Creating
Diversification
Strategies: Operational
and Corporate
Relatedness

University of Technology - Marie Bradford (2021) 9


Value Creating Strategies
Value Creating Strategies
FIRM CREATES VALUE BY BUILDING UPON OR EXTENDING:
o Resources
o Capabilities
o Core competencies
PURPOSE: gain market power relative to competitors
ADVANTAGE: ECONOMIES OF SCOPE
Cost savings that occur when a firm transfers capabilities and competencies
developed in one of its businesses to another of its businesses

University of Technology - Marie Bradford (2021) 11


Related Strategies
Operational Relatedness: Sharing Activities
Firms can create operational relatedness by sharing either a primary activity (such as
inventory delivery systems) or a support activity (such as purchasing practices)
Firms using the related constrained diversification strategy share activities in order to
create value
Example: P&G’s paper towel business and baby diaper business both use paper
products as a primary input to the manufacturing process. The firm’s paper production
plant produces inputs for both businesses and is an example of a shared activity.
Risks:
Not easy, often synergies not realized as planned
Activity sharing is also risky because ties among a firm’s businesses create links
between outcomes.
For instance, if demand for one business’s product is reduced, it may not generate
sufficient revenues to cover the fixed costs required to operate the shared facilities.

University of Technology - Marie Bradford (2021) 13


Corporate Relatedness: Transferring of Core Competencies

the firm’s intangible resources, such as its know-how, become the foundation of core
competencies, over time.
Corporate-level core competencies are complex sets of resources and capabilities that link
different businesses, primarily through managerial and technological knowledge,
experience, and expertise.
Firms seeking to create value through corporate relatedness use the related linked
diversification strategy.
The related linked diversification strategy helps firms to create value in two ways
First, because the expense of developing a core competence has already been incurred in
one of the firm’s businesses, transferring this competence to a second business eliminates
the need for that business to allocate resources to develop it.
Second, Resource intangibility - intangible resources are difficult for competitors to
understand and imitate. Because of this difficulty, the unit receiving a transferred
corporate-level competence often gains an immediate competitive advantage over its
rivals University of Technology - Marie Bradford (2021) 14
Corporate Relatedness: Transferring of Core Competencies

Risks:
Managers may be reluctant to transfer key people who have accumulated
knowledge and experience critical to the business’s success.
Too much dependence on outsourcing can lower the usefulness of core
competencies and thereby reduce their useful transferability

University of Technology - Marie Bradford (2021) 15


SIMULTANEOUS OPERATIONAL RELATEDNESS AND CORPORATE RELATEDNESS

The ability to simultaneously create economies of scope by sharing activities


(operational relatedness) and transferring core competencies (corporate
relatedness) is difficult for competitors to understand and learn how to
imitate
Involves managing two sources of knowledge simultaneously:
o Operational forms of economies of scope
o Corporate forms of economies of scope
Many such efforts often fail because of implementation difficulties
If the cost of realizing both types of relatedness is not offset by the benefits
created, the result is DISECONOMIES because the cost of organization and
incentive structure is very expensive
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Unrelated Strategies
Unrelated Diversification Strategy
Involves diversifying into businesses with
o No strategic fit
o No meaningful value chain relationships
o No unifying strategic theme
Approach is to venture into “any business in which we think we can make a
profit”
Firms pursuing unrelated diversification are often referred to as
conglomerates

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An unrelated diversification strategy can create value through two types of
financial economies.
o Efficient Internal Capital Market Allocation
o Restructuring of Assets
Financial economies are cost savings realized through improved allocations of
financial resources based on investments inside or outside the firm.

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Example: General Electric
Operates as an infrastructure and financial services company worldwide.
- 8 segments

• Power and Water • Healthcare


• Oil and Gas • Transportation
• Energy Management • Appliances and Lighting
• Aviation • GE Capital

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Efficient Internal Capital Market Allocation
An internal capital market is where the internally generated cash flows of
different divisions are pooled, allowing a diversified firm to allocate resources
to its best use.
In large diversified firms, the corporate headquarters office distributes capital
to its businesses to create value for the overall corporation.
In a market economy, capital markets allocate capital efficiently
● EQUITY - investors take equity positions (ownership) with high expected
future cash-flow values.
● DEBT - debt holders try to improve the value of their investments by taking
stakes in businesses with high growth and profitability prospects

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Restructuring of Assets
Financial economies can also be created when firms buy, restructure, and
then sell the restructured company in the external market.
o As in the real estate business, buying assets at low prices, restructuring
them, and selling them at a price that exceeds their cost generates a
positive return on the firm’s invested capital.
o Not as effective in high-technology businesses are often human-resource
dependent; these people can leave or demand higher pay and thus
appropriate or deplete the value of an acquired firm

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Value Neutral Strategies
Value Neutral Diversification Strategies

Different incentives to diversify sometimes exist, and the quality of the firm’s
resources may permit only diversification that is value neutral rather than
value creating.
Incentives to Diversify
o Incentives to diversify come from both the external environment and a
firm’s internal environment. External incentives include antitrust
regulations and tax laws.
o Internal incentives include low performance, uncertain future cash flows,
and the pursuit of synergy and reduction of risk for the firm.

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1. Antitrust Regulation and Tax Laws

Antitrust laws prohibit mergers that created increased market power (via
either vertical or horizontal integration)
Antitrust laws also referred to as competition laws ensure that fair
competition exists in an open-market economy.
Tax laws make sure that when a firm diversifies it does not pay less taxes as
was the case before 1986.
Therefore, if firms have free cash flow to diversify they do not gain any
additional value from it.

University of Technology - Marie Bradford (2021) 25


2. Low Performance
Some research shows that low returns are related to greater levels of
diversification - high performance eliminates the need for greater
diversification,” then low performance may provide an incentive for
diversification

3. Uncertain Future Cash Flows


As a firm’s product line matures or is threatened, diversification may be an
important defensive strategy. Small firms and companies in mature or
maturing industries sometimes find it necessary to diversify for long-term
survival.
For example, auto-industry suppliers have been slowly diversifying into other
more promising businesses such as “green” businesses and medical supplies
University of Technology - Marie Bradford (2021) 26
as the auto industry has declined.
4. Synergy and Firm Risk Reduction

Diversified firms pursuing economies of scope often have investments that


are too inflexible to realize synergy between business units. As a result, a
number of problems may arise. Synergy exists when the value created by
business units working together exceeds the value that those same units
create working independently.
But as a firm increases its relatedness between business units, it also
increases its risk of corporate failure, because synergy produces joint
interdependence between businesses that constrains the firm’s flexibility to
respond.

University of Technology - Marie Bradford (2021) 27


Value Reducing Strategies
Value Reducing Diversification Strategies

Managerial motives to diversify can exist independent of value-neutral


reasons (i.e., incentives and resources) and value-creating reasons (e.g.,
economies of scope).
The desire for increased compensation and reduced managerial risk are two
motives for top-level executives to diversify their firm beyond value-creating
and value-neutral levels.
Top-level executives may diversify a firm in order to diversify their own
employment risk, as long as profitability does not suffer excessively - as firm
size increases, so does executive compensation

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University of Technology - Marie Bradford (2021) 30
THE END!

Next class:
Unit 7 – Mergers and
Acquisitions

University of Technology - Marie Bradford (2021) 31

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