Corporate Diversification

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. Relevant questions:

What business should the firm be in? How should the corporate office manage its group of businesses?

Corporate Diversification
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 - <70% of revenues from dominant business; all businesses share product, technological and distribution linkages. Related-Linked More than 30% but less than 70% of revenues come from outside the core business. Unrelated-Diversified (conglomerate) - More than 70% of firm sales come from outside the core business.

Corporate Diversification
Rationales for Diversification

Incentives

Resources

Diversification

Managerial Motives

Corporate Diversification
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 spending retained earnings on acquisitions.
- After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments

Corporate Diversification
Incentives to Diversify

Low profitability or poor industry outlook. Uncertainty regarding future cash flows. Firm risk reduction unsystematic business specific risk.

 Firm risk reduction unsystematic business specific risk.

Risk

Single Business

Dominant Business

Related Constrained

Related Linked

Unrelated Business

Level of Diversification

Corporate Diversification
Resources

Despite incentives, managers need the resources to diversify. Value creation is determined more by the appropriate use of resources than by incentives.

Managerial Motives

Diversification increases firm size, size is positively correlated with compensation. Diversification reduces employment risk.

Corporate Diversification
Types of Diversification

Why do large diversified companies have different approaches to diversification?

May be due to different economic rationales for diversifying. May be due to distinctive competencies Concept of synergy - Financial economies Internal capital market. - Vertical economies Value chain activities. - Synergistic economies Exploit interrelationships across business units.

Corporate Diversification
Types of Diversification and Variations

Multidivisional Structure (M-form)

Unrelated or conglomerate

Cooperative Form

Competitive Form

Vertical integration Related constrained

Strategic Business-Unit (SBU) Form

Related linked

Corporate Diversification
Types of Diversification

Vertical integration strategies

Generally a dominant business. Firm enters into one or more businesses necessary to the manufacture and distribution of its own products. Forward and/or backward integration. Different degrees of integration Full integration Benefits? Partial integration

Vertical Integration

President Government Affairs Legal Affairs

Corporate R&D Lab

Strategic Planning

Corporate Human Resources Product Division

Vertical economies

Corporate Marketing

Corporate Finance

Product Division

Product Division

Corporate Diversification
Types of Diversification

Horizontal diversification strategies

Subset of related-constrained strategy. Firm acquires another firm in the same industry. Examples: Continental - Eastern, Compaq HP. Benefits? - Decreases competition

- Facilitates market power and economies of scale

Corporate Diversification
Types of Diversification

Related constrained strategies

Sharing activities: 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 can enhance potential for or reduce the cost of differentiation.
Must involve activities that are crucial to competitive advantage.

Corporate Diversification
Types of Diversification

Related constrained strategies

Transferring core competencies: Exploits interrelationships among divisions. Start with value chain analysis - identify ability to transfer skills or expertise among similar value chains. - exploit ability to transfer activities

Transferring core competencies leads to competitive advantage only if the similarities among business units meet the following conditions:

Corporate Diversification
Types of Diversification

Related constrained strategies - activities involved in the businesses are similar enough that sharing expertise is meaningful. - transfer of skills involves activities which are important to competitive advantage. - the skills transferred represent significant sources of competitive advantage for the receiving unit

Corporate Diversification
Types of Diversification

Related constrained strategies

Synergies based on interrelationships: Tangible interrelationships: - Sources of tangible interrelationships * * * * * Marketing Production Technological (R&D) Procurement Infrastructure.

- Costs of achieving tangible interrelationships * Coordination * Compromise * Inflexibility

Corporate Diversification
Types of Diversification

Related constrained strategies

Synergies based on interrelationships: Intangible interrelationships: - Sharing of know-how, or transferring of skills that have already been 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.

Related Constrained Strategy

President Government Affairs Legal Affairs

Corporate R&D Lab

Strategic Planning

Corporate Human Resources Product Division

Synergistic economies

Corporate Marketing

Corporate Finance

Product Division

Product Division

Corporate Diversification
Types of Diversification

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 and across unrelated ones. Allows integration of selected businesses as opposed to all businesses in a related constrained firm.

Related Linked Strategy

President

Corporate R&D Lab

Strategic Planning

Corporate HRM

Corporate Marketing

Corporate Finance

SBU
Division Division

SBU
Division Division

SBU
Division Division

Division

Division

Division

Vertical & Synergistic economies

Financial economies

Corporate Diversification
Types of Diversification

Unrelated diversified strategies

Efficient internal capital market Firms using this strategy frequently use acquisitions. 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.

Corporate Diversification
Types of Diversification

Unrelated diversified strategies

Efficient internal capital market Scope of operating divisions. 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

Unrelated Diversification Strategy

President

Legal Affairs

Finance

Auditing

Division
Financial economies

Division

Division

Division