Corporate Diversification503

7/31/2019 Corporate Diversification503

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Corporate Diversification

Corporate Level Strategies

Detail actions taken to gain a competitive advantage through the selectionand management of a mix of businesses competing in several industriesor product markets.

Relevant questions:

What business should the firm be in?

How should the corporate office manage its group of businesses?


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Levels and Types of Diversification

Single-business firm - 100% of revenue comes from a single business unit.

Dominant firm - 70% - 95% of revenue comes from a single business unit.

Related-Constrained -


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Incentives

Resources

Managerial

Motives

Diversification

Rationales for Diversification



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Incentives to Diversify

Anti-trust and tax laws.

Cellar-Kefauver Act - Firms cannot acquire firms in related businesses.

Tax rate differences

- Before 1986, higher taxes on dividends favored spendingretained earnings on acquisitions.

- After 1986, firms made fewer acquisitions with retained earnings,shifting to the use of debt to take advantage of tax deductibleinterest payments


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Incentives to Diversify

Low profitability or poor industry outlook.

Uncertainty regarding future cash flows.

Firm risk reduction unsystematic business specific risk.


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Risk

Level of Diversification

DominantBusiness

UnrelatedBusiness

RelatedConstrained

SingleBusiness

RelatedLinked

Firm risk reduction unsystematic business specific risk.


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Resources

Despite incentives, managers need the resources to diversify.

Value creation is determined more by the appropriate use of resourcesthan by incentives.

Managerial Motives

Diversification increases firm size, size is positively correlatedwith compensation.

Diversification reduces employment risk.


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Types of Diversification

Why do large diversified companies have different approaches todiversification?

- Financial economies Internal capital market.

-Vertical economies Value chain activities.

- Synergistic economies Exploit interrelationships acrossbusiness units.

May be due to different economic rationales for diversifying.

May be due to distinctive competencies

Concept of synergy


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Multidivisional

Structure

(M-form)

Strategic Business-Unit

(SBU) Form

Cooperative

Form

Competitive

Form


Types of Diversification and Variations

Vertical integrationRelated constrained

Related linked

Unrelated or conglomerate


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Vertical integration strategies

Full integration

Generally a dominant business.

Firm enters into one or more businesses necessary to the manufactureand distribution of its own products.

Forward and/or backward integration.

Different degrees of integration

Partial integration

Benefits?


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Government

Affairs

Legal

Affairs

Corporate

R&D Lab

Strategic

Planning

Corporate

Human

Resources

Corporate

Marketing

Corporate

Finance

Product

Division

Product

Division

Product

Division

President

Vertical economies

Vertical Integration


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Horizontal diversification strategies

Subset of related-constrained strategy.

Firm acquires another firm in the same industry.

Benefits?

- Decreases competition

- Facilitates market power and economies of scale

Examples: Continental - Eastern, Compaq HP.


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Related constrained strategies

Sharing activities often lowers costs or raises differentiation.

Sharing activities can lower costs if it:

- achieves economies of scale.- boosts efficiency of utilization.- helps move more rapidly down the learning curve.

Sharing activities:

Sharing activities can enhance potential for or reduce thecost of differentiation.

Must involve activities that are crucial to competitive advantage.


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Exploits interrelationships among divisions.

Start with value chain analysis

- identify ability to transfer skills or expertise among similarvalue chains.

- exploit ability to transfer activities

Transferring core competencies:

Transferring core competencies leads to competitive advantageonly if the similarities among business units meet the followingconditions:


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- activities involved in the businesses are similar enough that sharingexpertise is meaningful.

- transfer of skills involves activities which are important tocompetitive advantage.

- the skills transferred represent significant sources of competitiveadvantage for the receiving unit


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Tangible interrelationships:

Synergies based on interrelationships:

* Marketing* Production* Technological (R&D)* Procurement* Infrastructure.

- Sources of tangible interrelationships

- Costs of achieving tangible interrelationships

* Coordination* Compromise

* Inflexibility


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Intangible interrelationships:

Synergies based on interrelationships:

- Sharing of know-how, or transferring of skills that have alreadybeen paid for.

- Same generic strategy- Same type of buyer- Similar configuration of value chain

- Similar important value activity- Example: Phillip Morris acquisition of Kraft and Miller Brewing.


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Government

Affairs

Legal

Affairs

Corporate

R&D Lab

Strategic

Planning

Corporate

Human

Resources

Corporate

Marketing

Corporate

Finance

Product

Division

Product

Division

Product

Division

President

Related Constrained Strategy

Synergistic economies


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Related linked strategies

Very similar to related constrained except larger and more diversified.

Related businesses are grouped into Strategic Business Units (SBUs).

Facilitates the realization of synergies within related units andacross unrelated ones.

Allows integration of selected businesses as opposed to all

businesses in a related constrained firm.


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President

Corporate

R&D Lab

Strategic

Planning

Corporate

HRM

Corporate

Marketing

Corporate

Finance

Division

DivisionDivision

SBU SBU SBU

Division

DivisionDivision

Division

DivisionDivision

Vertical & Synergistic economies Financial economies

Related Linked Strategy


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Unrelated diversified strategies

Firms using this strategy frequently use acquisitions.

Efficient internal capital market

- acquire sound, attractive companies.- acquired units are autonomous.- acquiring corporation supplies needed capital.- portfolio managers transfer resources from units that

generate cash to those with high growth potential and

substantial cash needs.- add professional management & control to sub-units.- sub-unit managers compensation based on unit results.


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Unrelated diversified strategies

Scope of operating divisions.

Efficient internal capital market

- Comparable in terms of performance criteria- Dont overly concentrate in one business- Buy market leaders- Use wholly owned approach

Acquisition / divestment policies- Be able to maintain control -- Avoid high tech and service- Avoid unfriendly acquisitions- Divest rather than turnaround- Dont get into businesses that are difficult to unload- If problems develop unload early


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Unrelated Diversification Strategy

President

Legal

Affairs Finance Auditing

Division Division Division Division

Financial economies

Corporate Diversification503

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