Chapter 6: Corporate-Level Strategy

Chapter 6 Corporate-Level Strategy

KNOWLEDGE OBJECTIVES 1. 2. 3. 4. 5. 6. 7. Define corporate-level strategy and discuss its purpose. Describe different levels of diversification with different corporate-level strategies. Explain three primary reasons firms diversify. Describe how firms can create value by using a related diversification strategy. Explain the two ways value can be created with an unrelated diversification strategy. Discuss the incentives and resources that encourage diversification. Describe motives that can encourage managers to overdiversify a firm.

CHAPTER OUTLINE Opening Case Procter and Gambles Diversification Strategy LEVELS OF DIVERSIFICATION Low Levels of Diversification Moderate and High Levels of Diversification REASONS FOR DIVERSIFICATION VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION Operational Relatedness: Sharing Activities Corporate Relatedness: Transferring of Core Competencies Market Power Simultaneous Operational Relatedness and Corporate Relatedness UNRELATED DIVERSIFICATION Strategic Focus Operational and Corporate Relatedness: Smith & Wesson and Luxottica Efficient Internal Capital Market Allocation Restructuring of Assets VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES Incentives to Diversify Strategic Focus Revival of the Unrelated Strategy (Conglomerate): Small Firms Acquire Castoffs from Large Firms and Seek to Improve Their Value Resources and Diversification VALUE-REDUCING DIVERSIFICATION: MANAGERIAL MOTIVES TO DIVERSIFY SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES NOTES

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Chapter 6: Corporate-Level Strategy LECTURE NOTES Chapter Introduction: Chapters 4 and 5 looked at strategy at the level of the business and focused on the factors and approaches that can lead to competitive advantage and superior performance. Chapter 6 takes this a step further by standing back to consider strategy at a higher levelcorporate strategy. The concern here is for the performance benefits that are derived from putting together an effective portfolio of businessesthat is, putting businesses together in a way that makes sense and can generate synergies between units. The discussion of this chapter builds toward a summary presented in Figure 6.4. It might be helpful to review that figure carefully before starting into the material of the chapter. OPENING CASE Procter and Gambles Diversification Strategy This opening case focuses on establishing and maintaining economies of scope. Economies of scope are cost savings that a firm creates by successfully sharing some of its resources and capabilities or transferring one or more corporate-level core competencies from one of its businesses to another. After reading this case, youll begin to develop an appreciation for difficulties regarding diversification, bundling, consolidating corporate families, and the blending of corporate cultures. In 2005, Procter & Gamble Companies acquired the Gillette Company with high expectations to create synergies between these businesses. Because Gillettes consumer health care products were focused mainly on masculine market areas and P&G had more female beauty and baby care products, management saw complementary opportunities between these two corporations. One area in which they sought to create the potential synergy was combining the toothbrush and toothpaste businesses. Procter and Gamble (Crest) had recently lost its lead in toothpaste market-share to Colgate. In order to regain its top position, P&G decided on a bundling strategy of packaging a tube of Crest Toothpaste with an Oral-B Toothbrush under a new Pro-Health label. Retailers welcomed this new bundling concept as it freed up precious shelf space previously used for two separate products in two separate areas. P&Gs new oral-health bundling strategy resembles hair care and skin care products that are usually located together. While various bundling strategies across the P&G and Gillette product lines appeared to have real potential, the feasibility of sharing activities between the two businesses (operational readiness) was not without obstacles. Prior to P&Gs acquisition of Gillette, the two firms had been competitors in some markets. Top management of both firms decided to commingle the employees in one place. Accordingly, they moved basic operations to Cincinnati, Ohio, near P&Gs headquarters. In the process, however, many of the Boston-area Gillette employees decided not to move, leading to an exit of talent. Secondly, P&G and Gillette had different ways of making business decisions. Gillette had established a strong empowerment environment, whereas the culture of P&G was more of a consensus-seeking process in making major decisions. The business cultures never truly united. The combination of the research unit in charge of providing new products for the Pro-Health project proceeded much better than the combination of the production and marketing personnel in Ohio. The most likely reason is that the research unit employees were able to stay in their general locations and collaborate through conferences and electronic means. Despite the difficulties, in 2007 the combined P&G brands overtook Colgate in market share with 35 percent to Colgates 32 percent. As this case illustrates, merging two diverse firms to create operational relatedness or synergy between products can be more difficult to achieve than is apparent in the design phase. Remind students that corporate culture is driven from the top downward. Although there is limited information given in this case, do students see possible solutions to the apparent culture-gap? The two companies had been competitors prior to P&Gs acquisition. Does the fact that they

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Chapter 6: Corporate-Level Strategy competed in some markets prior to the formal acquisition affect the likelihood of successfully blending their different cultures? Is it necessary to blend the cultures? Discuss the pros and cons of building a common culture.

Define corporate-level strategy and discuss its purpose.

Remember that in Chapters 4 and 5 the discussion centered around selecting and implementing a business-level or competitive strategyactions a firm should take to compete in a single industry or product marketand the actions and responses that affect the competitive dynamics of a single industry or product market. In contrast, when a firm diversifies its operations by operating business in several industries, corporate level strategy becomes a primary focus. This means that a diversified firm has two levels of strategy: business-level (or competitive) and corporate-level (or company-wide), the latter of which entails selecting a strategy that focuses on the selection and management of a mix of businesses. Teaching Note: Students sometimes have a difficult time grasping the concept of levels of strategy. One useful way of explaining this is to draw their attention to PepsiCo and its portfolio of businesses prior to the 1997 spin-off of Tricon Global Restaurants, Inc., which later changed its name to Yum! Brands Inc. Yum controls Pizza Hut, Taco Bell, and KFC, all of which were part of PepsiCo at one time. The students are very familiar with these products, which is why the illustration works so well with them. PepsiCos strategy was at the corporate level, whereas Pizza Hut, Taco Bell, and KFC each have separate, and very different, business-level strategies. It is easy to help students to see that PepsiCos corporate-level strategy was to generate synergies among the businesses (e.g., selling the firms soft drinks in all the restaurants). But they can also readily see the differences in business-level strategies at Pizza Hut (differentiated product), Taco Bell (cost leadership), and KFC (perhaps somewhere in between). The illustration can also be used to help students understand other levels of strategy (e.g., functional, operational, and enterprise). Corporate-level strategies detail actions taken to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets. Primary concerns of corporate-level strategy are: What businesses should the firm be in? How should the corporate office manage its group of businesses? How can the corporation as a whole add up to more than the sum of its business parts? The ultimate measure of the value of a firms corporate-level strategy is that the businesses in the firms portfolio are worth more under current management (and by following the firms corporate-level strategy) than they would be under different ownership or management. Teaching Note: Indicate to students that the unique organizational structure that is required by this strategy will be discussed in Chapter 11. LEVELS OF DIVERSIFICATION Diversified firms vary according to two factors: the level of diversification connection or linkages between and among business units

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Figure Note: Five levels of diversification are listed and each is defined in Figure 6.1. It is recommended that you refer students to Figure 6.1 as you begin to discuss levels of diversification in more detail. FIGURE 6.1 Levels and Types of Diversification Figure 6.1 should be used by students as a reference point during your discussion of diversification types. Students attention should be directed to inter-unit linkages depicted on the right side of Figure 6.1. Levels and types of diversification defined in Figure 6.1 and discussed in more detail in the next sections of this chapter are: Low levels of diversification Single business Dominant business Moderate to high levels of diversification Related-constrained diversification Related-linked diversification (mixed related and unrelated) Very high levels of diversification Unrelated diversification

Describe different levels of diversification with different corporatelevel strategies.

Low Levels of Diversification Firms that follow single- or dominant-business strategies have low levels of diversification. A single business is a firm where more than 95 percent of its revenues are generated by the dominant business. Firms such as the Wrigley Co. are examples of single-business firms. Wrigley Co. has dominated the global gum-related industry as the largest manufacturer of chewing gum, specialty gums, and gum bases. Its brands, Doublemint, Spearmint and Juicy Fruit, led the market. Teaching Note: Wrigley has chosen to focus its attention on its historic (since 1915) core business. It competes effectively (and successfully) against large diversified firms, including RJR Nabisco (Beechnut and Carefree) and Warner-Lambert (Trident and Dentyne). Focusing on its core business has enabled Wrigleys top-level managers to maintain strategic control of the business. As a result, Wrigley maintains a clear, strategic focus and is highly competitive in its core business (though it is beginning to diversify somewhat in recent years). A dominant business is a firm that generates between 70 and 95 percent of its sales within a single business area.

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Chapter 6: Corporate-Level Strategy Teaching Note: Hershey Foods Corp. is an example of a dominant business firm because, although it manufactures other food products, the bulk of the firms revenues are earned through its dominant confectionery business. Moderate and High Levels of Diversification A related-diversified firm is one that earns at least 30 percent of its revenues from sources outside of the dominant business and whose units are related to each othere.g., by the sharing of resources and by product, technological, and distribution linkages. Related-constrained firms also earn at least 30 percent of their revenues from the dominant business, and all business units share product, technological, and distribution linkages, as illustrated in Figure 6.1. Kodak, Procter & Gamble, and Campbells Soup Company are related-constrained firms. Mixed related and unrelated or related-linked firms, such as Johnson and Johnson and General Electric, generate at least 30 percent of their total revenues from the dominant business, but there are few linkages between key value-creating activities. Unrelated-diversified (or highly diversified) firms do not share resources or linkages, as illustrated in Figure 6.1. Firms that pursue unrelated diversification strategiesoften known as conglomeratesinclude United Technologies, Samsung, and Textron. While there are more unrelated diversified firms in the U.S. than in most other countries, conglomerates (firms following unrelated diversification strategies) dominate the private sector economy in Latin America and in several emerging economies (such as China, South Korea, and India). Teaching Note: Many firms that have at one time pursued unrelated diversification strategies are restructuring to focus on a less diversified mix of businesses, a move that may reflect: an inability to manage high levels of diversification recognition that a lower level of diversification would improve the match between the firms core competencies and environmental opportunities and threats

Explain three primary reasons firms diversify.

REASONS FOR DIVERSIFICATION Teaching Note: The content of this section of the chapter generally is limited to a discussion of Table 6.1, which provides some of the reasons that firms implement diversification strategies. The various value-related motives for diversification will be discussed in more detail in the remainder of the chapter as specific diversification strategies are discussed. Firms may implement diversification strategies to enhance or increase the strategic competitiveness of the overall organization, and thus the value of the firm increases. Value can be created through either related or unrelated diversification if the strategies enable the firms mix of businesses to increase revenues and/or decrease costs when implementing business-level strategies. Firms may implement diversification strategies that are either value neutral or result in devaluation of the firm. They may attempt to diversify to neutralize a competitors market power

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Chapter 6: Corporate-Level Strategy to reduce managers employment risk (i.e., risk of the CEO being unemployed when a dominant-business firm fails as compared to this risk when a single business fails when it is only one part of a diversified firm) to increase managerial compensation because of the positive relationships between diversification, firm size, and compensation Table Note: Reasons or motives for implementing diversification strategies are presented in Table 6.1. These will be discussed in the following chapter sections.

TABLE 6.1 Reasons for Diversification Firms follow diversification strategies for many reasons. These can be grouped into three broad sets of motives: Motives to enhance strategic competitiveness: economies of scope (related diversification) through activity-sharing and the transfer core competencies market power motives (related diversification) by vertical integration or blocking competitors via multipoint competition financial economies motives (unrelated diversification) to improve efficiency of capital allocation through an internal capital market or by restructuring the portfolio of businesses Motives that are value-neutral with respect to strategic competitiveness: to avoid violations of antitrust regulations to take advantage of tax incentives to overcome low performance to reduce the uncertainty of future cash flows to reduce overall firm risk to exploit tangible resources to exploit intangible resources Managerial or value-reduction motives: to diversify managerial employment risk to increase managerial compensation

Figure Note: As illustrated in Figure 6.2, firms seek to create value by sharing activities and transferring skills or corporate core competencies. This figure can help students organize their thoughts about the options firms have to exploit various forms of relatedness.

FIGURE 6.2 Value-creating Strategies of Diversification: Operational and Corporate Relatedness Firms seek to create value from economies of scope through two basic kinds of operational economies: sharing activities and transferring skills (corporate core competencies). However, the levels of the two of these will lead to different corporate strategies with different advantages associated with each. Combinations of economies Resulting Strategy Economies for advantage

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Chapter 6: Corporate-Level Strategy High operational/low corporate Low operational/low corporate High operational/high corporate High operational/high corporate Vertical integration Unrelated diversification Market power Financial economies

Both operational and relatedness Rare capability and can create diseconomies of scope Related-linked diversification Economies of scope

VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION Firms implement related diversification strategies in order to achieve and exploit economies of scope and build a competitive advantage by building on existing resources, capabilities, and core competencies. For firms that operate in multiple industries or product markets, economies of scope represent cost savings attributed to entering an additional business and sharing activities or using capabilities and core competencies developed in another business that can be transferred to a new business without significant additional costs. The difference between activity sharing and core competence sharing is based on how different resources are used jointly to create economies of scope: To create economies of scope, tangible resources, such as plant and equipment or other business-unit physical assets, often must be shared. Less tangible resources, such as manufacturing know-how, also can be shared. Know-how transferred between separate activities with no physical or tangible resource involved, is a transfer of a corporate-level core competence, not an operational sharing of activities. A key to creating value through sharing essentially separate activities is to share know-how or skills rather than physical or tangible resources. Operational Relatedness: Sharing Activities Because all of its businesses share product, technological, and distribution linkages, activity sharing is common among related-constrained diversified firms, such as Procter & Gamble. P&Gs paper towel and disposable diaper units can share many activities due to their common characteristics: Each business uses paper products as a key input, so they are likely to share key facets of procurement and inbound logistics, as well as primary manufacturing activities. Because all three businesses produce consumer products that are sold in similar (if not the same) outlets, they will likely share outbound logistics, distribution channels, and possibly sales forces. Teaching Note: Recall from the discussion of the primary and support activities in a firms value chain in Chapter 3 that primary activities (such as inbound logistics, outbound logistics, and operations) might have several shared activities. Firms that are able to develop core competencies through effective (and efficient) sharing of primary activities will achieve a competitive advantage. Examples of activity sharing may include the following: Inbound logistics: inventory delivery systems, warehouse facilities, quality assurance Operations: assembly facilities, quality control systems, maintenance operations Outbound logistics: sales force and service management Support activities: procurement, technology development

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Firms also must recognize that, while activity sharing is intended to reduce costs through achieving economies of scope, there are incremental costs related to sharing activities (costs that are created by sharing). These costs must be recognized and taken into account when planning activity sharing or scope economies may not result. Activity sharing can also result in new risks since closer linkages between business units create tighter interrelationships and/or interdependencies. For example, if two business units share production facilities and sales in one units products decline to the point that revenues no longer cover the costs of shared production, then each business units ability to achieve strategic competitiveness may be adversely affected. Regardless of the risks that accompany activity sharing, research indicates that activity sharingor the potential for activity sharingcan increase the value of the firm. Some findings are summarized here: Acquiring firms in the same industrya horizontal acquisitionwhere sharing of activities and resources is implemented results in improved performance and higher returns to shareholders. Selling off units where resource sharing is a possible source of economies of scope results in lower returns to shareholders than does selling off business units unrelated to the firms core business. Firms with more related units have less risk.

Describe how firms can create value by using a related diversification strategy.

Corporate Relatedness: Transferring of Core Competencies Over time, most firms develop intangible resources that can become a foundation for core competencies that are competitively valuable. In diversified firms, these core competencies generally are made up of managerial and technical knowledge, experiences, and expertise. There are at least two ways the related linked diversification strategy helps firms to create value: any costs related to developing the competence have already been incurred competencies based on intangible resources, such as marketing know-how, are less visible and therefore are more difficult for competitors to understand and imitate Teaching Note: As an example, Philip Morris acquired Miller Brewing at a time when competition in the brewing industry was focused on establishing efficient operations. Philip Morris used marketing competencies coming from the competitive cigarette industry. No brewing firm used marketing capabilities as a source of competitive advantage. By transferring its marketing competence to Miller, Philip Morris introduced marketing as a source of competitive advantage to the brewing industry. Because its primary competitor, Anheuser-Busch, was unable to develop the capability to respond for several years, Millers strategic action (mostly effective advertising campaigns) let Miller achieve a temporary competitive advantage and earn above-average returns. Other firms have focused on transferring a variety or resources/capabilities across businesses in their control. Virgin has transferred its marketing skills across travel, cosmetics, music, drinks, and other retail businesses. Thermo Electron has employed its entrepreneurial skills in starting up a number of new ventures and maintaining a new venture network. Honda has developed and transferred across its businesses its expertise in small and now larger engines for a number of vehicle typesfrom motorcycles and lawnmowers to its range of automotive products.

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Chapter 6: Corporate-Level Strategy One way that firms can facilitate the transfer of competencies between or among business units is to move key personnel into new management positions in the receiving unit. However, research suggests that transferring expertise often does not lead to performance improvement. Teaching Note: It is good to help students understand the human dimensions of strategic decisionse.g., expertise transfers may be difficult or costly because of the following: A business-unit manager of an older division may be reluctant to transfer key people who have accumulated knowledge and experience critical to the business units success. Managers able to facilitate the transfer of core competencies may come at a premium. The key people involved may not want to transfer. The top-level managers from the transferring division may not want the competencies transferred to a new division to fulfill the firms diversification objectives. Market Power Firms also may implement related diversification strategies in an attempt to gain market power. Market power exists when a firm is able to sell its products at prices above the existing competitive level or decrease the costs of its primary activities below the competitive level, or both. Market power through diversification may be gained through multipoint competition, a condition where two or more diversified firms compete in the same product areas or geographic markets. Firms also might gain market power by following a vertical integration strategy, which exists when a company produces its own inputs (backward integration) or owns its own distribution system (forward integration). A vertical integration strategy may be motivated by a firms desire to strengthen its position in its core business relative to competitors by increasing its market power. Vertical integration enables a firm to increase market power by: developing the ability to save on its operations avoiding market costs improving product quality protecting its technology from imitation by rivals having strong ties between their assets for which no market prices exist Note: establishing a market price would result in high search and transaction costs, so firms seek to vertically integrate rather than remain separate businesses. Teaching Note: As an example of vertical integration, CVS, a Walgreens competitor, recently merged with Caremark, a pharmaceutical benefits manager. This represents a vertical move for CVS from a retail-only firm to broader-based health care. However, CVS risks alienating Walgreens, which may then choose to align with another benefits manager. However, like other strategies that create value and aid the firm in achieving strategic competitiveness, vertical integration may not be the perfect answer because of risks and costs that accompany it. Outside suppliers may be able to provide inputs at a lower cost (and, possibly also of a higher quality). The costs of coordinating vertically integrated activities may exceed the value of the control realized. Vertical integration may result in the firm losing strategic competitiveness if the internal unit does not keep up with changes in technology. To vertically integrate, the firm may need to build a facility with capacity that exceeds the ability of its internal units to absorb, forcing the selling unit to sell to outside users in order to achieve scale economies.

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Chapter 6: Corporate-Level Strategy Many manufacturing firms no longer pursue vertical integration. In fact, deintegration is the focus of most manufacturing firms, such as Intel and Dell, and even among large automobile companies, such as Ford and General Motors, as they develop independent supplier networks. Solectron Corp., a contract manufacturer, represents a new breed of large contract manufacturers that is helping to foster this revolution in supply-chain management. Such firms often manage their customers entire product lines, and offer services ranging from inventory management to delivery and after-sales service. E-commerce allows vertical integration to turn into virtual integration, permitting closer relationships with suppliers and customers through electronic means of integration. This lets firms reduce transaction costs while boosting supply-chain management skills and tightening inventory control. Simultaneous Operational and Corporate Relatedness As Figure 6.2 suggests, some firms simultaneously seek operational and corporate relatedness to create economies of scope. Because simultaneously managing two sources of knowledge is very difficult, such efforts often fail, creating diseconomies of scope.

A Bit of Disney History: A Mini-Case By using operational relatedness and corporate relatedness, Disney made $3 billion on the 150 products that were marketed with its movie, The Lion King. Sonys Men in Black was a super hit at the box office and earned $600 million, but box-office and video revenues were practically the entire success story. Disney was able to accomplish its great success by sharing activities regarding the Lion King theme within its movie, theme park, music, and retail products divisions, while at the same time transferring knowledge into these same divisions, creating a music CD, Rhythm of the Pride Lands, and producing a video, Simbas Pride. In addition, there were Lion King themes at Disney resorts and Animal Kingdom parks. However, it is difficult for analysts from outside the firm to fully assess the value-creating potential of the firm pursuing both operational relatedness and corporate relatedness. As such, Disneys assets as well as other media firms such as AOL Time Warner have been discounted somewhat because the biggest lingering questions is whether multiple revenue streams will outpace multiple-platform overhead.

Explain the two ways value can be created with an unrelated diversification strategy.

UNRELATED DIVERSIFICATION Firms implementing unrelated diversification strategies hope to create value by realizing financial economies, which are cost savings realized through improved allocations of financial resources based on investments inside or outside the firm. Financial economies are realized through internal capital allocations (that are more efficient than market-based allocations) and by purchasing other companies and then restructuring their assets.

STRATEGIC FOCUS Operational and Corporate Relatedness: Smith & Wesson and Luxottica Smith & Wesson, a traditional handgun manufacturer, has been pursuing the combined operational and corporate relatedness strategy. Interestingly, until a short time ago Smith & Wesson had not ventured into

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Chapter 6: Corporate-Level Strategy other weapons-related products besides handguns. Recently it moved beyond its traditional handgun market into producing shotguns and rifles. In 2004, Michael F. Golden took over as CEO of Smith & Wesson and initiated an operationally related diversification strategy by purchasing Thompson/Center Arms Company, a shotgun and rifle manufacturer. Thompsons expertise in the long-barrel market has facilitated Smith & Wessons move into this market. Its interesting to note that Goldens background had not been in the weapons, but rather in marketing tools for Black & Decker. In addition to pushing into the long-barrel market, Golden developed a corporate relatedness effort by Smith & Wesson using its highly reputed name by licensees in their advertisements. Its licensing revenues rose 17 percent in the second quarter of 2007. With its dual diversification strategy (using both operational and corporate relatedness), Smith & Wesson expects sales gains of 40 percent or more for fiscal 2007 and 2008. In addition, Smith & Wesson will continue to introduce new handguns such as its recently announced .45 calibersized handgun with both military and law enforcement applications. In a similar move, Luxottica moved from a focus on fashion to sports brand sunglasses. To make this shift, Luxottica acquired Oakley, Inc., which is primarily focused in the sports eyewear segment. Operationally, due to synergies between these two businesses, Luxottica expects to see proposed savings over three years equivalent to $932 million due to opportunities for operational relatedness: higher than the premium paid of $663 million for Oakley. The big question is whether it can manage the brand change from fashion to sports using a corporate relatedness strategy given its image as a fashion sunglass manufacturer. Another concern is that the acquisition will make Luxottica 80 percent focused on retail markets in the United States. It had signaled earlier that it would like to expand its retail outlets in more affluent markets. Thus, it has risked being overly focused in the U.S. market. In summary, both Smith & Wesson and Luxottica are examples of firms that are pursuing both operational and corporate relatedness as they diversify to increase their opportunities for growth. Market power is one of the forces driving Smith & Wessons acquisition of Thompson and Luxotticas acquisition of Oakley. This is a common strategy. Size, after all, can help to boost economies of scale, market reach, and general formidability in an industry. However, there are drawbacks to acquisition strategies as a means of gaining strength in the market. For example, integrating newlycombined operations can prove challenging, especially when turf wars and other managerial machinations create complications. As explained, Smith & Wesson recently expanded its market scope into long barreled weapons in order to achieve leverage in the marketplace off its reputation in handguns. Will this effort capture synergies between businesses? What are the drawbacks to this approach? Efficient Internal Capital Market Allocation Although capital generally is efficiently distributed in a market economy through the capital markets, large diversified firms may be able to distribute capital more efficiently to divisions and thus create value for the overall organization. This generally is possible because: Corporate offices have more detailed and accurate information on actual division performance and future prospects. Investors have limited access to internal information and generally can only estimate division performance. One implication of increased access to information is that the internal capital market may be able to allocate resources between investment opportunities more accurately (and at more adequate levels) than the external capital market. There are several reasons for this: Information disclosed to capital markets through annual reports may not fully disclose negative information, reporting only positive prospects while meeting all regulatory disclosure requirements. External capital sources have limited knowledge of what is taking place within large, complex firms. While owners have access to information, full and complete disclosure is not guaranteed. An internal capital market may enable the firm to safeguard information related to its sources of competitive advantage that otherwise might have to be disclosed. Through disclosure, the information could become

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Chapter 6: Corporate-Level Strategy available to competitors who might use the information to duplicate or imitate the firms sources of competitive advantage. Other advantages of internal capital markets: Corrective actions may be more efficiently structured and underperforming management can be more effectively disciplined through the internal capital market than through external capital market mechanisms. Thus, the internal capital market is more capable of taking specific, finely-tuned corrective actions compared to the external market. If external intervention is required, only drastic alternatives generally are available, such as forcing the firm into bankruptcy or forcing the removal of top-level managers. With an internal capital market, the corporate office can adjust managerial incentives or can suggest strategic changes to make the desired corrections. Research suggests that in efficient capital markets, the unrelated diversification strategy may be discounted. Stock markets have applied what some have called a conglomerate discount reflected in the valuation of diversified manufacturing conglomerates at 20 percent less, on average, than the value of the sum of their parts. The Achilles heel of the unrelated diversification strategy is that conglomerates in developed economies have a fairly short life cycle because financial economies are more easily duplicated than are the gains derived from operational relatedness and corporate relatedness. This is less of a problem in emerging economies, where the absence of a soft infrastructure (e.g., effective financial intermediaries, sound regulations, and contract laws) supports and encourages use of the unrelated diversification strategy. In fact, in emerging economies such as those in India and China, diversification increases performance of firms from large diversified business groups. Restructuring of Assets A restructuring approach to creating value in an unrelated diversified firm involves the buying and selling of other companies (and their assets) in the external market. Following the asset sale and layoffs, under-performing divisions (those acquired in the purchase) are sold to other firms and remaining divisions are placed under strict budgetary controls accompanied by the reporting of cash inflows and outflows to the corporate office.

Tyco International: A Question of Ethics Under former CEO Dennis L. Kozlowski, Tyco International, Ltd. excelled at exploiting financial economies through restructuring. Tyco focused on two types of acquisitions: platform, which represented new bases for future acquisitions, and add-on, in markets where Tyco currently had a major presence. As with many unrelated diversified firms, Tyco acquired mature product lines. However, completing large numbers of complex transactions resulted in accounting practices that arent as transparent as stakeholders now demand. In fact, many of Tycos top executives, including Kozlowski, were arrested for fraud, and the new CEO, Edward Breen, has been restructuring the firms businesses to overcome the flagrant accounting, ethical, and governance abuses of his predecessor. Actions being taken in firms such as Tyco suggest that firms creating value through financial economies are responding to the demand for greater transparency in their practices. Responding in this manner will provide the information the market needs to more accurately estimate the value the diversified firm is creating when using the unrelated diversification strategy.

Success in implementing unrelated diversification strategies usually requires that firms: focus on firms in mature, low technology industries

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Chapter 6: Corporate-Level Strategy avoid service businesses because of their client- or sales-orientation

Discuss the incentives and resources that encourage diversification.

VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES As mentioned earlier, not all firms diversify to increase the value of the overall firm. Some attempts at diversification are implemented to prevent the value of the firm from decreasing. Incentives to Diversify In most instances managers have a choice regarding the level of diversification that their firm should implement. In addition, both the external and internal environments are sources of incentives or reasons that managers might use to justify diversification choices.

STRATEGIC FOCUS Revival of the Unrelated Strategy (Conglomerate): Small Firms Acquire Castoffs from Large Firms and Seek to Improve Their Value Many large diversified firms are feeling pressure by major shareholders to focus their portfolios and to divest themselves of entities perceived by shareholders as diversions of corporate resources, such as managerial resources. A number of small, unrelated firms have been anxious to purchase these castoffs. One smaller firm with huge appetites is Jarden Corporation. Jarden Corporation acquired Coleman Camping Goods in 2005 after its previous owner had gone into bankruptcy. Jardens CEO Martin Franklin was able to transact a low price in a friendly takeover of this firm that had otherwise been pressured by competitors. Franklin stated, We look for brands that are market leaders but havent been innovative. Similar acquisitions by Jarden include Ball Canning Jars, Bicycle Playing Cards, and Crock-Pot Cookers. Prestige Brands Holdings, Inc. is also an active player in buying these castoffs. Prestige has been buying castoffs from large consumer product companies, such as Procter & Gamble, Unilever, and ColgatePalmolive, as they sell their underperforming brands such as Sure and Right Guard deodorants, Comet Cleaner, Aqua Net standard products, Pert Plus Shampoo, and Rit Dye. Prestige also sought to revive Cutex Nail Polish Remover and Spic-n-Span cleaner, among other brands. Innovative Brands, in partnership with promotional agent Ten United, bought and revived old brands such as Cloraseptic Sore Throat Treatment and Pert Shampoo. This restructuring strategy is attractive to these firms as less money is required to revive old brands than create new ones.
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This diversification strategy is not only found in consumer product industries, but also in the clothing, hardware, and tool industries. VF Corporation has been transformed from a manufacturer of Lee and Wrangler Jeans and Vanity Fair underwear labels into the largest apparel maker in the world. VF Brands also include Reef, JanSport, Nautica, and John Varvatos. Its interesting that VF Corporation seeks to maintain an entrepreneurial approach by keeping the founders of the business and managers, if possible, and giving them lots of autonomy, but at the same time alerting them that they will be under the tight financial control systems of the corporation to make sure that the entrepreneurs know how things will operate after the acquisition. Illinois Tool Works (ITW) started out as a toolmaker and tripled its size in the past decade to 750 business units worldwide. Its acquisition and diversification strategy focuses on small, low-margin but mature industrial businesses. Examples of its products include screws, auto parts, deli-slicers, and the plastic rings that hold together soft drink cans. It seeks to restructure each business it acquires in order to increase the business units profit margins by focusing on a narrowly defined product range and targeting the most

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Chapter 6: Corporate-Level Strategy lucrative products and customers using the 80/20 concept, where 80 percent of revenues are derived by 20 percent of customers. Most acquisitions are under $100 million, and the price is usually relatively cheap. This Strategic Focus offers instructors a plethora of thought-provoking questions to challenge students. You might ask students why the above examples of acquisitions by smaller companies have proven successful. Are shareholders becoming more vocal with their concerns about diversity? What alternatives did previous owners have other than selling to current owners? Antitrust Regulation and Tax Laws In the 1960s and 1970s, government policiesin the form of antitrust enforcement and tax lawsprovided U.S. firms with incentives to diversify the mix of businesses controlled by the firm. As a result of these policies, the vast majority of mergers during the period represented unrelated diversification. They were classified as conglomerate mergers. Conglomerate mergers (unrelated diversification) were encouraged in large part by the Celler-Kefauver Act which discouraged horizontal and vertical mergers. That is, federal legislation (and enforcement by the U.S. Department of Justice) discouraged market power boosting via related diversification. As one measure of the effectiveness of official discouragement, almost 80 percent of mergers during the 1973-1977 period were conglomerate mergers. During the 1980s, enforcement of antitrust laws slackened and firms chose to implement horizontal merger strategies (or mergers with firms in the same [or a related] line of business). At the same time, investment bankers aggressively promoted merger and acquisition activity to the extent that many acquisitions were classified as unfriendly or as hostile takeovers. Firms that had diversified (in an unrelated fashion) in the 1960s and 1970s began to implement strategies to refocus their firms, and an era of restructuring began. When firms generate more cash than they are able to profitably reinvest in the firms primary activities, the excess funds, or free cash flows, should be returned to shareholders in the form of dividends. However, during the 1960s and 1970s, dividends were taxed more heavily than ordinary personal income. (Dividends are taxed twice: once when the firm pays taxes on its operating income and a second time when net income is paid out to shareholders in the form of dividends as shareholders pay a tax on dividends received at their personal income tax rate). In 1986, the perspective shifted once again, as the Tax Reform Act of 1986 reduced the top personal income tax rate from 50 percent to 28 percent. Capital gains rules were changed so that capital gains would be taxed at the ordinary personal income tax rate, and personal interest deductibility was eliminated. These changes in federal tax laws, which affected individual tax rates for dividends and capital gains (with the former decreasing and the latter increasing), have created an incentive for shareholders to favor reduced levels of diversification (after 1986) unless funded by tax-deductible debt. The recent changes recommended by the Financial Accounting Standards Board (FASB), regarding the elimination of the pooling of interests method for accounting for the acquired firms assets and the elimination of the write-off for research and development in process, reduce some of the incentives to make acquisitions, especially related acquisitions in high-technology industries. Although there was a loosening of federal regulations in the 1980s and a retightening in the late 1990s, a number of industries have experienced increased merger activity due to industry-specific deregulation activity, including banking, telecommunications, oil and gas, and electric utilities.

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Chapter 6: Corporate-Level Strategy Low Performance When firms are able to earn above-average or superior returns in a single business, they have little incentive to diversify (as previously discussed in the Wrigley Co. example). However, low performance may provide an incentive for diversification as a low-performing firm may become more risk-seeking in an effort to improve overall firm performance. In response to low returns (or poor performance), firms often choose to seek greater levels of diversification. At some point, however, poor performance slows the pace of diversification, often resulting in restructuring divestitures of businesses to lower the level of firm diversification. Figure Note: The relationship between level of performance and diversification (for firms that already have diversified) is illustrated by Figure 6.3. FIGURE 6.3 The Curvilinear Relationship between Diversification and Performance As Figure 6.3 illustrates, firms exhibiting low performance in their dominant businesses often implement related-constrained diversification strategies which, to some point, result in increased performance. In search of even higher performance, related-diversified firms may continue to diversify, but elect to acquire unrelated businesses. When a firms core competencies do not create value in unrelated businesses, firm performance decreases. Teaching Note: DaimlerChrysler had to deal with the challenges that were created partly by its failed diversification efforts. The firm faced the task of reversing this strategy, which started with the sale of its electronics operation, divesting a 34 percent stake in Cap Gemini (a French software services company), and liquidating Fokker (a Dutch aircraft manufacturer). The firm also eliminated a layer of upper-level executives and shaped a culture of responsibility and entrepreneurship, with innovation (using cross-functional project teams) as the force supporting the new culture. Uncertain Future Cash Flows Firms also may implement diversification strategies when their products reach maturity (in the product life cycle) or are threatened by external factors that the firm cannot overcome. Thus, firms may view diversification as a survival strategy. In the 1960s and 1970s, railroads diversified because of the threat from the trucking industry to reduce demand for rail transportation. Uncertainty can be derived from supply, demand, and distribution sources. For example, at one time PepsiCo acquired Quaker Oats to fortify its growth with Gatorade and healthy snacks, on the projection that these products would experience greater growth rates than Pepsis soft drinks. Teaching Note: Uncertainty can derive from supply sources or demand conditions. ENEL, Italys state-owned electricity company, has diversified broadly in recent years to cope with anticipated deregulation across Europe, which may mean that ENEL will have to cede 30 percent of its generating capacity to new rivals with cheaper electricity production.

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Chapter 6: Corporate-Level Strategy Thus, since ENELs future sources of revenue are threatened, ENEL is using corporatelevel diversification to compete in multiple segments of the utility market. To adapt to decreases in government defense spending in Russia, Reuben Central Design Bureau (the celebrated submarine designer) used a diversification strategy. With its world class design engineers, it continued its marine business while expanding into other arease.g., developing a high-speed rail system, a floating sea launch for rocket companies, real estate development, a restaurant chain, and a tea business, among others. The Bureaus diversification strategy has allowed it to survive in the chaotic Russian economic environment. Synergy and Firm Risk Reduction As you will recall from the discussion earlier in this chapter, firms that diversify in pursuit of economies of scope take advantage of linkages between primary value-creating activities to realize synergy from sharing. Synergy exists when the value created by business units working together exceeds the value the units create when working independently. These linkagesand the inter-relatedness or interdependencies that resultproduce joint profitability between business units, and the flexibility of the firm to respond may be constrained, increasing the risk of failure. To eliminate this risk, firms may do one of two things: operate in more certain environments to reduce the level of technological change and choose not to pursue potentially profitable, yet unproven product lines constrain or reduce the level of activity-sharing, thus foregoing the potential benefits of synergy However, these decisions could lead to further diversification to diversify into industries where more certainty exists to additional, but unrelated diversification Research suggests that a firm using a related diversification strategy is more careful in bidding for new businesses, whereas a firm pursuing an unrelated diversification strategy may be more likely to overprice its bid, because an unrelated bidder may not have full information about the acquired firm. However, firms using either a related or an unrelated diversification strategy must understand the consequences of paying large premiums. Resources and Diversification In addition to having incentives to diversify, a firm also must possess the correct mix of resourcestangible, intangible, or financialthat makes diversification feasible. However, remember that resources create value when they are rare, valuable, costly to imitate, and nonsubstitutable. In other words, resources that do not have these characteristics can be more easily duplicated (or acquired) by competitors. Thus, it may not be possible to create value using such resources. Teaching Note: This implies that acquisitions purchased at market prices using a firms free cash flow, such as Anheuser-Buschs purchase of the St. Louis Cardinals baseball team, acquisition of the Campbell Taggarts bakery business, and $400 million investment in the development and operation of Eagle Snacks, were not likely to create value exceeding average returns because of the flexibility (or mobility) and common nature of liquid assets. As a result of poor performance, Anheuser-Busch sold off Campbell Taggart and closed its

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Chapter 6: Corporate-Level Strategy Eagle Snacks business. However, it continues to use its free cash flows to support some of its other businesses. The excess capacity of tangible resources may be used to justify diversification, especially when the firm sees opportunities for activity sharing. However, value-creation may be possible only in related diversification. Remember, using tangible resources also creates interrelationships through its activity linkages in production, marketing, procurement, and technology, and these interdependencies often reduce firm flexibility and may, in fact, increase the risk of failure. Ideally, as discussed earlier, a firms intangible resourcesbecause they are less visible and less understood by competitorsshould be used to facilitate and create value from diversification. Describe motives that can encourage managers to overdiversify a firm.

VALUE-REDUCING DIVERSIFICATION: MANAGERIAL MOTIVES TO DIVERSIFY Some managers may be motivated to diversify their firms even if there are no incentives, and a lack of resources can constrain inclinations toward diversification. Managers motives for diversification include the following: Diversification may enable managers to reduce employment risk (the risks related to the loss of their jobs or a reduction in compensation) because by diversifying the firm (i.e., by adding a number of additional businesses), managers may be able to diversify their employment risk, as long as profitability does not decline greatly as a result of the diversification. Diversification allows managers to increase their compensation because of positive correlations between diversification, firm size, and executive compensation (which is based on the logic that large firms are more difficult to manage). Teaching Note: Indicate to students that corporate governance is covered in much greater detail in Chapter 10. The discussion in this chapter is introductory in nature. If properly structured and used, governance structuressuch as the firms board of directors, performance monitoring, executive compensation limits, and the market for corporate controlmay provide the means to exert control over managers tendencies to overdiversify because of self-interest motives. However, if a firms internal governance structure is not strong (or functions imperfectly), managers may diversify the firm beyond the optimal level. As a result, the overall firm may fail to earn average returns (illustrated by Figure 6.3). When the internal governance structure fails to restrain managers from over-diversifying (and performance declines), external governance mechanisms, such as the takeover market, may come into play. In the takeover market (also known as the market for corporate control), improved levels of diversification (and improved performance) are achieved by replacing incumbent or current managers and restructuring the firm. However, managers may be able to avoid takeovers through defensive tactics, such as golden parachutes, poison pills, greenmail, or increasing the firms leverage ratio. In spite of the preceding comments, most managers take positive strategic actions (such as those related to diversification) that result in overall firm profitability and contribute to the strategic competitiveness of the firm.

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Chapter 6: Corporate-Level Strategy In addition to the internal and external governance mechanisms discussed, managers also may be provided with incentives to limit firm diversification to optimal levels by a concern for their personal reputations in the labor market and the related market for managerial talent (also known as the market for managers). One signal that the firm may be overdiversified is when operating diversified businesses reduces, rather than improves, the overall performance of the firm. Figure Note: It is useful to note that two factors appearing in Figure 6.4 will be discussed in greater detail in future chapters. Governance structures will be discussed in Chapter 10 and strategy implementation is covered in Chapter 11. The overall relationship between reasons for diversification, governance, and firm performance is provided in Figure 6.4. FIGURE 6.4 Summary Model of the Relationship between Firm Performance and Diversification As shown in Figure 6.4, a firms diversification strategy is determined by three inter-related factors, economies of scope resources and incentives managerial motives In turn, the relationship between diversification strategy and firm performance is moderated by: external governance mechanisms internal governance mechanisms the success with which the diversification strategy is implemented

As noted in this chapter, diversification strategies can be used to enhance a firms strategic competitiveness and enable it to earn above-average returns. However, positive outcomes from diversification are possible only when the firm achieves the appropriate level of diversification, given its resources, capabilities, and core competencies, and taking into account the external environmental opportunities and threats.

ANSWERS TO REVIEW QUESTIONS

1. What is corporate-level strategy and why is it important? (pp. 154-155)

Corporate-level strategies are strategies that detail actions taken to gain a competitive advantage through the selection and management of a mix of businesses competing in different product markets. They are concerned with what businesses the firm should be in and how the corporate office should manage its group of businesses. Corporate-level strategies are important to the diversified firm because developing and implementing multibusiness strategies is necessary for effective utilization of resources, capabilities, and core competencies across multiple businesses to create value. In the final analysis, a corporate-level strategys 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. 2. What are the levels of diversification firms can pursue by using different corporate-level strategies? (pp. 155-157) Low levels of diversification. Single- and dominant-business firms represent those for which at least 95 percent and 70 percent of total sales, respectively, come from a single business. Several advantages accrue to these

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Chapter 6: Corporate-Level Strategy firms. For example, managers of single- and dominant-business firms may be more capable of understanding the competitive dynamics of the smaller number of industries in which their business(es) compete. Furthermore, managers in these firms can develop more specialized skills, concentrating on formulating and implementing a narrower range of business-level strategies and managing synergies between businesses that may be easier to identify and master. However, these firms must also overcome a number of disadvantages. For example, single- and dominant-business firms are affected more negatively by an economic downturn that affects their single or dominant industry. Also, by focusing their operations, these firms cannot enjoy the advantages that are realized only by diversified firms Moderate to high levels of diversification. A firm generating more than 30 percent of its revenue outside a dominant business and whose businesses are related to each other in some manner uses a related diversification corporate-level strategy. When the links between the diversified firms businesses are rather direct, a related constrained diversification strategy is being used. The diversified company with a portfolio of businesses with only a few links between them is called a mixed related and unrelated firm and is using the related linked diversification strategy . Compared with related constrained firms, related linked firms share fewer resources and assets between their businesses, concentrating instead on transferring knowledge and core competencies between the businesses. As with firms using each type of diversification strategy, companies implementing the related linked strategy constantly adjust the mix in their portfolio of businesses as well as make decisions about how to manage their businesses. Very high levels of diversification. A highly diversified firm that has no relationships between its businesses follows an unrelated diversification strategy. These businesses are not related to each other, and the firm makes no efforts to share activities or to transfer core competencies between or among them. 3. What are three reasons causing firms choose to diversify their operations? (pp. 157-174)

Firms may chose to move from a single- or dominant-business position to a more diversified position for three general reasons. First (value-creating), they do this to enhance strategic competitiveness via increased economies of scope (e.g., by sharing activities and transferring core competencies), market power (e.g., by blocking competitors through multipoint competition or implementing vertical integration), and financial economies (e.g., from efficient internal capital allocations and business restructuring). Second (value-neutral), firms may diversify in response to incentives. For example, they may do so to respond to advantages from tax law, to overcome a low performance trend, or to balance out uncertain future cash flows. Finally (valuereducing), unrelated acquisitions also may be made for managerial reasons (either to diversify managerial employment risk or to increase managerial compensation). It is important to note that diversification is not always pursued in an effort to enhance the firms strategic competitiveness; in fact, diversification may have neutral or even negative effects on firm performance. 4. How do firms create value when using a related diversification strategy? (pp. 159-163)

Activity sharing and transferring core competencies are used to obtain economies of scope while pursuing a related diversification strategy because cost savings are attributed to entering an additional related business using capabilities and competencies developed in one business that can be transferred to another business without significant additional costs. In other words, it may be possible for related firms to share production facilities or distribution networks, or a core competency such as marketing expertise might be transferred between related business units. However, related firms also must take into account the costs related to activity sharing and core competency transfers, namely the cost of coordination and sharing of control created by the interdependencies that result or the savings imputed to economies of scope may not be realized. Firms using a related diversification strategy may gain market power when successfully using their related constrained or related linked strategy. Market power exists when a firm is able to sell its products above the existing competitive level or to reduce the costs of its primary and support activities below the competitive level, or both.

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Chapter 6: Corporate-Level Strategy Some firms using a related diversification strategy engage in vertical integration to gain market power. Vertical integration exists when a company produces its own inputs (backward integration) or owns its own source of output distribution (forward integration). 5. What are the two ways to obtain financial economies when using an unrelated diversification strategy? (pp. 163-166) Two ways to obtain financial economies when pursuing an unrelated diversification strategy are by establishing an efficient internal capital market and by restructuring the assets of purchased businesses. Financial economies can be achieved by establishing an efficient internal capital market which enables corporate managersbecause they have access to more detailed and more accurate (or more relevant) informationto make better (more value-enhancing) capital allocation decisions relative to those made by the market. Restructuring focuses exclusively on buying and selling other firms assets in the external market. This usually entails selling off corporate headquarters facilities, laying off corporate staff, selling underperforming divisions to other firms that may be able to enhance the divisions strategic competitiveness, and managing the remaining business units to maximize net cash flow. 6. What incentives and resources encourage diversification? (pp. 166-172)

Incentives that encourage diversification include antitrust regulation, tax laws, low firm performance, uncertain future cash flows, and opportunities to reduce overall firm risk. Resources that encourage diversification include both tangible and intangible resources such as plant and equipment (excess productive capacity) and financial resources (free cash flows) for which no attractive (positive) investment opportunities are available as the firm is currently structured. 7. What motives might encourage managers to overdiversify their firm? (pp. 172-174)

Managers might be encouraged to push a firm towards a more diversified position to reduce the risk of job loss by diversifying employment risk (so long as profitability does not suffer excessively) or to increase their compensation. Increased levels of diversification are strongly correlated with firm size, and firm size in turn is strongly correlated with managerial compensation because of the increased complexity that results from increases in firm size and diversification level.

EXPERIENTIAL EXERCISES
Exercise 1: Comparison of Diversification Strategies The use of diversification varies both across and within industries. In some industries, most firms may follow a single- or dominant-product approach. Other industries are characterized by a mix of both singleproduct and heavily diversified firms. The purpose of this exercise is to learn how the use of diversification varies across firms in an industry, and the implications of such use. Part One Working in small teams of four to seven persons, choose an industry to research. You will then select two firms in that industry for further analysis. Many resources can aid in identifying specific firms in an industry for analysis. One option is to visit the Web site of the New York Stock Exchange (http://www.nyse.com), which has an option to screen firms by industry group. A second option is http://www.hoovers.com, which offers similar listings. Identify two public firms based in the United States. (Note that Hoovers includes some private firms, and the NYSE includes some foreign firms. Data for the exercise are often unavailable for foreign or private companies.)

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Chapter 6: Corporate-Level Strategy Once a target firm is identified, you will need to collect business segment data for each company. Segment data break down the companys revenues and net income by major lines of business. These data are reported in the firms SEC 10-K filing, and may also be reported in the annual report. Both the annual report and 10-K are usually found on the companys Website; both the Hoovers and NYSE listings include company homepage information. For the most recent three-year period available, calculate the following: Percentage growth in segment sales Net profit margin by segment Bonus item: compare profitability to industry averages (Industry Norms and Key Business Ratios publishes profit norms by major industry segment.) Next, based on your reading of the company filings and these statistics, determine whether the firm is best classified as: Single product Dominant product Related diversified Unrelated diversified Part Two Prepare a brief PowerPoint presentation for use in class discussion. Address the following in the presentation: Describe the extent and nature of diversification used at each firm. Can you provide a motive for the firm's diversification strategy, given the rationales for diversification put forth in the chapter? Which firms diversification strategy appears to be more effective? Try to justify your answer by explaining why you think one firms strategy is more effective than the other. Exercise 2: Corporate Juggling What are the implications for managers when their firm shifts from competing in a single product segment to multiple segments? Additionally, how is the managers role affected by the similarity or dissimilarity of these segments? This exercise will be completed in class. The instructor will assign students randomly to two different types of teams: part of the class will be assigned to teams of five to seven persons, and the remainder of the class will be assigned to teams of ten to fourteen persons. Each team will assign one person to serve as a facilitator. The instructor will give each facilitator a bag of objects. The goal is for each team to juggle as many objects as possible. The team will start with one object, which should be tossed from person to person. When the group is ready, ask the facilitator for a second object. Continue to add objects up to your groups ability.

INSTRUCTOR'S NOTES FOR

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EXPERIENTIAL EXERCISES
Exercise 1: Comparison of Diversification Strategies The goals of this exercise are two-fold: first, to understand how diversification strategies differ across firms in an industry, and second, to gain more experience in collecting company information. In Part One, teams collect business segment data for two firms that are competing in the same industry. For an example of the data that is to be collected, a search of pharmaceutical firms yields a number of companies, including Merck and Schering Plough. Data on revenues and profits from the 10-K reports filed in February of 2007 for each firm are as follows: Merck data (in millions) 2006 Revenues 20374.8 1705.5 555.7 22636 2005 Revenues 20678.8 984.2 348.9 22011.9 2004 Revenues 21591 972.8 409 22978.2 2006 Profit 13649.4 892.8 -8320.8 6221.4 2005 Profit 13157.9 767 -6561 7363.9 2004 Profit 13560.3 881.4 -6438.9 8002.8

Segment Pharmaceutical Vaccines Other Total

Schering Plough data (in millions) 2006 Revenues 8561 1123 910 2005 Revenues 7564 1093 851 2004 Revenues 6417 1085 770 2006 Profit 1394 228 120 -259 1483 2005 Profit 733 235 120 -591 497 2004 Profit 13 234 88 -503 -168

Segment Pharmaceuticals Consumer Health Animal Health Other Total

10594

9508

8272

Both firms draw the vast majority of their revenues from the pharmaceutical segment, although with differing intensity: About ninety percent of revenues come from pharmaceuticals for Merck, while the figure is around eighty percent for Schering Plough. A review of the product lines for these two firms is also helpful in discussing how closely these two firms compete with one another. Both firms compete in other drug-related business: Merck primarily in vaccines, and Schering Plough in Consumer Health Products and Animal Health. A closer look at the SP Consumer division reveals that this includes both prescription and over-the-counter (OTC) products. Additionally, SP sells many other goods, such as Dr. Scholl's (foot care) and Coppertone (sunscreen). Trend data and profit patterns also differ for these two competitors.

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Chapter 6: Corporate-Level Strategy For a more pronounced comparison, Proctor & Gamble is also considered a competitor in the pharmaceutical industry. P&G has a much broader portfolio of goods, including beauty products, household goods, as well as the Duracell, Braun, and Gillette product lines. Drawing on their independent analysis, ask the students to prepare a short PowerPoint summary of their findings. The findings should describe the nature and extent of diversification used at each firm, and assess which had a more effective approach to diversification. Typically, there is not enough time to review and discuss PowerPoint presentations for all teams. As such, it often works well to use this as a homework or other graded assignment. Then, the instructor can select a subset of teams to make in-class presentations. Exercise 2: Corporate Juggling The corporate juggling exercise is very different from prior activities used in the textbook. The main differences are (a) that it is physical, and (b) it will require that the instructor invest in a set of props to conduct the exercise. However, this exercise is often welcomed by students, as it gets them out for their seats for part of the class period. The exercise also offers a highly visual metaphor that makes the concepts of diversification and complexity far more tangible. To run the exercise, you will divide the class into two types of groups: small teams (five to seven persons) and large teams (ten to fourteen persons). You will need to assemble one bag of resources for each team. For example, with a class enrollment of 40, you might have two large teams, and three to four small teams. Part One Each team gets a bag of items to be juggled. The items should be lightweight enough so that no one is hurt. Each bag should contain just one type of object, and the items should vary from team to team. Sample objects can include ping pong balls, tennis balls, used film canisters (ask at photo processing shops), balled socks, and even crumpled pieces of butcher pad paper. You should have at least as many objects in the bag as there are team members. Give the bags to the team facilitators, and allow them to practice for ten minutes. Then, ask the following questions: How did group size affect your process and outcomes? How did the nature of the objects being tossed affect your process and outcomes? Part Two After the discussion of these two questions, trade objects so that each team has a mix of different items. For example, a small team might have a couple of ping pong balls, one tennis ball, a sock, and a paper ball. Have the team repeat the juggling process using this diverse set of resources. Then, ask: How did the variability in inputs affect your process and outcomes? So far, the discussion has focused on team processes versus diversification. To sharpen the focus on the chapter, ask students How are elements of the exercise similar to topics in Chapter 6? Mentioning some of the following may help in stimulating further conversation: How easy or hard was it to process multiple objects? How does a CEO manage many different business segments concurrently?

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How important was the dissimilarity between objects in your teams effectiveness? How does that relate to a firms ability in managing dissimilar business units? What strategies did the team use to create value (i.e., keep more objects in the air at one time)? Teams may use very different approaches to maximize their output: e.g., switching facilitators, creating rules for adding more objects into play, building structures and processes to handling more capacity.

ADDITIONAL QUESTIONS AND EXERCISES

The following questions and exercises can be presented for in-class discussion or assigned as homework. Application Discussion Questions 1. This chapter suggests that there is a curvilinear relationship between diversification and performance. Ask the students how this relationship can be modified so that the negative relationship between performance and diversification is reduced and the downward curve has less slope or begins at a higher level of diversification? The Fortune 500 firms are very large, and many of them have significant product diversification. Ask the students if they believe these large firms are overdiversified? Do they experience lower performance than they should? What is the primary reason for overdiversification? Is it industrial policies, such as taxes and antitrust regulation, or do firms overdiversify because managers pursue their own self-interest through increased compensation, and a reduced risk of job loss? Why? Have the students explain. One rationale for pursuing related diversification is to obtain market power. In the United States, however, too much market power may result in a challenge by the U.S. Justice Department (because it may be perceived as anticompetitive). Ask the students in what situations related diversification might be considered unfair competition? Tell the students they have two job offers, one from a dominant-business firm and one from an unrelated diversified firm (suppose the beginning salaries are virtually identical). Which offer would they accept and why? Ask the students if they believe that by the year 2015 large firms will be more or less diversified than they are today. Why? Will the trends regarding diversification be identical in Europe, the United States, and Japan? Explain. Will the Internet make it easier for firms to diversify? Why or why not?

2. 3. 4.

5. 6. 7.

Ethics Questions 1. 2. 3. 4. Propose the following statement: Those managing an unrelated diversified firm face far more difficult ethical challenges than do those managing a dominant-business firm. Based on their reading of this chapter, do the students this statement true or false? Why? Is it ethical for managers to diversify a firm rather than return excess earnings to shareholders? Have the students provide their reasoning in support of their answers. What unethical practices might occur when a firm restructures? Explain. Ask the students if they believe that ethical managers are unaffected by the managerial motives to diversify discussed in this chapter? If so, why? In addition, do they believe that ethical managers should help their peers learn how to avoid making diversification decisions on the basis of the managerial motives to diversify? Why or why not?

Internet Exercise Search the Websites of CMGI (http://www.cmgi.com), Cisco Systems (http://www.cisco.com), EMC (http://www.emc.com), and ICG (http://www.internetcapital.com). Compare their business models, and explain

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Chapter 6: Corporate-Level Strategy the type of strategy and level of diversification that describes each one. In the extremely fast-cycle Internet economy, these companies run exceptional risks. Track the success of each companys stocks over the past six months. Can you pinpoint changes within the industry that have affected the rise and fall of stock prices? What advancements in information technology and electronic commerce have had the greatest effect on the continuing strategies of these companies? Does this type of collaboration amongst Internet companies foster growth and value within the industry? *e-project: In January 2000, Hyundai (http://www.hyundai.com), Samsung (http://www.samsung.com), and LG Group (http://www.lg.co.kr) were fined for illegally allocating funds to their failing subsidiaries. Using the information provided on the company Websites, choose one of these companies, and provide alternative strategies for it to better compete in international markets.

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