Strategic Management-Chapter 06

Corporate-
Level Strategy:
Creating Value
through
Diversification
chapter 6
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Learning Objectives
6-2
After reading this chapter, you should have a good

understanding of:
LO6.1 The reasons for the failure of many
diversification efforts.
LO6.2 How managers can create value through
diversification initiatives.
LO6.3 How corporations can use related
diversification to achieve synergistic benefits
through economies of scope and market power.
Learning Objectives
6-3
LO6.4 How corporations can use unrelated

diversification to attain synergistic benefits through
corporate restructuring, parenting, and portfolio
analysis.
LO6.5 The various means of engaging in
diversification – mergers and acquisitions, joint
ventures/strategic alliances, and internal
development.
LO6.6 Managerial behaviors that can erode the
creation of value.
Corporate-Level Strategy
6-4
Consider . . .
What businesses should a corporation compete in?
How can these businesses be managed so they
create “synergy” – that is, create more value by
working together than if they were freestanding
units?
Making Diversification Work
6-5
▪ Diversification initiatives must create value for

shareholders through
▪ Mergers and acquisitions
▪ Strategic alliances
▪ Joint ventures
▪ Internal development
Diversification should create synergy
Business 1 plus Business 2 equals More than
two
Making Diversification Work
6-6
▪ A firm may diversify into related businesses

▪ Benefits derive from horizontal relationships
▪ Sharing intangible resources such as core
competencies in marketing
▪ Sharing tangible resources such as production
facilities, distribution channels via vertical
integration
▪ A firm may diversify into unrelated
businesses
▪ Benefits derive from hierarchical relationships
▪ Value creation derived from the corporate office
▪ Leveraging support activities in the value chain
Related Diversification
6-7
▪ Related diversification enables a firm to

benefit from horizontal relationships across
different businesses
▪ Economies of scope allow businesses to:
▪ Leverage core competencies
▪ Sharing related activities
▪ Enjoy greater revenues, enhance differentiation
▪ Related businesses gain market power by:
▪ Pooled negotiating power
▪ Vertical integration
Question?
6-8
▪ Sharing core competencies is one of the

primary potential advantages of diversification.
In order for diversification to be most successful,
it is important that
A. the similarity required for sharing core
competencies must be in the value chain, not in
the product.
B. the products use similar distribution channels.
C. the target market is the same, even if the
products are very different.
D. the methods of production are the same.
Related Diversification:
Leveraging Core Competencies
6-9
▪ Core competencies reflect the collective

learning in organizations. Can lead to the
creation of value and synergy if…
▪ They create superior customer value
▪ The value chain elements in separate
businesses require similar skills
▪ They are difficult for competitors to imitate or
find substitutes for
Sharing Activities
6-10
▪ Corporations can also achieve synergy by

sharing activities across their business units.
▪ Sharing tangible & value-creating activities can
provide payoffs:
▪ Cost savings through elimination of jobs, facilities
& related expenses, or economies of scale
▪ Revenue enhancements through increased
differentiation & sales growth
Market Power
6-11
▪ Market power can lead to the creation of value

and synergy through…
▪ Pooled negotiating power
▪ Gaining greater bargaining power with suppliers &
customers
▪ Vertical integration - becoming its own
supplier or distributor through
▪ Backward integration
▪ Forward integration
Example: Question?
6-12
▪ Shaw Industries, a giant carpet manufacturer,

increases its control over raw materials by
producing much of its own polypropylene fiber, a
key input into its manufacturing process. This is
an example of
A. leveraging core competencies.
B. pooled negotiating power.
C. vertical integration.
D. sharing activities.
Vertical Integration
6-13
Example: Simplified Stages of Vertical Integration: Shaw Industries

6-14
1. Is the company satisfied with the quality of the value

that its present suppliers & distributors are providing?
2. Are there activities in the industry value chain
presently being outsourced or performed
independently by others that are a viable source of
future profits?
3. Is there a high level of stability in the demand for the
organization’s products?
4. Does the company have the necessary competencies
to execute the vertical integration strategies?
5. Will the vertical integration initiatives have potential
negative impacts on the firm’s stakeholders?
6-15
▪ The transaction cost perspective

▪ Every market transaction involves some
transaction costs:
▪ Search costs
▪ Negotiating costs
▪ Contract costs
▪ Monitoring costs
▪ Enforcement costs
▪ Need for transaction specific investments
▪ Administrative costs
Unrelated Diversification
6-16
▪ Unrelated diversification enables a firm to

benefit from vertical or hierarchical relationships
between the corporate office & individual
business units through…
▪ The corporate parenting advantage
▪ Providing competent central functions
▪ Restructuring to redistribute assets
▪ Asset, capital, & management restructuring
▪ Portfolio management
▪ BCG growth/share matrix
Unrelated Diversification:
Parenting & Restructuring
6-17
▪ Parenting allows the corporate office to create

value through management expertise &
competent central functions
▪ In restructuring the parent intervenes:
▪ Asset restructuring involves the sale of
unproductive assets
▪ Capital restructuring involves changing the debt–
equity mix, adding debt or equity
▪ Management restructuring involves changes in
the top management team, organizational
structure, & reporting relationships
Portfolio Management
6-18
▪ Portfolio management involves a better

understanding of the competitive position of an
overall portfolio or family of businesses by…
▪ Suggesting strategic alternatives for each business
▪ Identifying priorities for the allocation of resources
▪ Using Boston Consulting Group’s (BCG)
growth/share matrix
6-19
Each circle
represents one of
the firm’s business
units. The size of
the circle
represents the
relative size of the
business unit in
terms of revenue.
Exhibit 6.4 The Boston Consulting Group (BCG) Portfolio Matrix

6-20
▪ Limitations of portfolio models:

▪ SBUs are compared on only two dimensions &
each SBU is considered a standalone entity
▪ Are these the only factors that really matter?
▪ Can every unit be accurately compared on that basis?
What about possible synergies?
▪ An oversimplified graphical model substitutes for
managers’ experience
▪ Following strict & simplistic rules for resource
allocation can be detrimental to a firm’s long-term
viability
Example: Goal of Diversification =
Risk Reduction?
6-21
▪ Diversification can reduce variability in

revenues & profits over time. However…
▪ Stockholders can diversify portfolios at a much
lower cost & economic cycles are difficult to
predict, so why diversify?
▪ Example = General Electric’s businesses:
▪ Aircraft engines, power generation equipment,
locomotive trains, large appliances, healthcare
products, financial products, lighting, mining, oil &
gas
▪ Why is GE in so many businesses?
Means of Diversification
6-22
▪ Diversification can be accomplished via

▪ Mergers & acquisitions
▪ And divestment
▪ Pooling resources of other companies with a firm’s
own resource base through
▪ Strategic alliances & joint ventures
▪ Internal Development through
▪ Corporate entrepreneurship
▪ New venture development
Mergers and Acquisitions
6-23
▪ Mergers involve a combination or consolidation

of two firms to form a new legal entity:
▪ Are relatively rare
▪ The two firms are on a relatively equal basis
▪ Acquisitions involve one firm buying another
either through stock purchase, cash, or the
issuance of debt
Mergers and Acquisitions
6-24
Exhibit 6.5 Global Value of Mergers and Acquisitions ($ trillion)

Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis
Mergers and Acquisitions: Motives
6-25
▪ In high-technology & knowledge-intensive

industries, speed is critical: acquiring is faster
than building.
▪ M&A allows a firm to obtain valuable resources
that help it expand its product offerings &
services.
▪ M&A helps a firm develop synergy:
▪ Leveraging core competencies
▪ Sharing activities
▪ Building market power
Mergers and Acquisitions: Motives
6-26
▪ M&A can lead to consolidation within an industry,

forcing other players to merge.
▪ Corporations can also enter new market
segments by way of acquisitions.
Mergers and Acquisitions:
Limitations
6-27
▪ Takeover premiums for acquisitions are typically

very high
▪ Competing firms can imitate advantages
▪ Competing firms can copy synergies
▪ Managers’ egos get in the way of sound business
decisions
▪ Cultural issues may doom the intended benefits
Insights from Executives:
Using an Acquisition Strategy Successfully
6-28
▪ Kenexa, a subsidiary of IBM, provides workforce

management and recruitment service solutions
▪ Starting in 1987, expanded into new product &
geographic markets, now a company with over
2,600 employees, with clients in over 20
countries
▪ Used organic growth, strategic alliances, &
acquisitions to expand
▪ Acquired 7 companies outside the U.S.
▪ Formed a joint venture in China
6-29
▪ Acquisition allowed Kenexa to get access to local

market knowledge & delivery capabilities
▪ Human capital is the most valuable asset they
seek to acquire
▪ Provides a source of growth, innovation, thought
leadership
▪ Challenge is to make sure cultures don’t compete
▪ Get to know the acquired company’s senior
leadership team; don’t depend on CEO
▪ Allow key employees to self-select out
6-30
▪ Drivers of acquisition success:

▪ Make sure acquisition target is tightly aligned with
the firm’s overall strategy
▪ Does the target fit the business unit’s needs?
▪ Get the acquisition price right; understand how
quickly the target must contribute to firm growth
▪ What is the length of the payback period?
▪ Conduct a full due diligence to avoid surprises
▪ Be honest - do the original reasons survive diligence?
▪ Start planning for integration early on
▪ What performance indicators will become future
financial & strategic targets?
Question?
6-31
▪ Divestment can be the common result of an

acquisition. Divesting businesses can
accomplish many different objectives. These
include
A. enabling managers to focus their efforts more
directly on the firm’s core businesses.
B. providing the firm with more resources to
spend on more attractive alternatives.
C. raising cash to help fund existing businesses.
D. all of the above.
Divestment
6-32
▪ Divestment objectives include:

▪ Cutting the financial losses of a failed acquisition
▪ Redirecting focus on the firm’s core businesses
▪ Freeing up resources to spend on more attractive
alternatives
▪ Raising cash to help fund existing businesses
Divestment
6-33
▪ Successful divestiture involves:

▪ Removing emotion from the decision
▪ Knowing the value of the business you’re selling
▪ Timing the deal right
▪ Maintaining a sizable pool of potential buyers
▪ Telling a story about the deal
▪ Running divestitures systematically through a
project office
▪ Communicating clearly and frequently
Strategic Alliances &
Joint Ventures: Motives
6-34
▪ Strategic alliances & joint ventures are

cooperative relationships between two (or more)
firms with potential advantages:
▪ Ability to enter new markets through
▪ Greater financial resources
▪ Greater marketing expertise
▪ Ability to reduce manufacturing or other costs in
the value chain
▪ Ability to develop & diffuse new technologies
Strategic Alliances &
Joint Ventures: Limitations
6-35
▪ Need for the proper partner:

▪ Partners should have complementary strengths
▪ Partner’s strengths should be unique
▪ Uniqueness should create synergies
▪ Synergies should be easily sustained & defended
▪ Partners must be compatible & willing to trust
each other
Internal Development
6-36
▪ Corporate entrepreneurship & new venture

development motives:
▪ No need to share the wealth with alliance
partners
▪ No need to face difficulties associated with
combining activities across the value chains
▪ No need to merge diverse corporate cultures
▪ Limitations:
▪ Time-consuming
▪ Need to continually develop new capabilities
Managerial Motives
6-37
▪ Managerial motives: Managers may act in their

own self interest – eroding rather than enhancing
value creation through
▪ Growth for growth’s sake
▪ Top managers gain more prestige, higher rankings,
greater incomes, more job security
▪ It’s exciting and dramatic!
▪ Excessive egotism
▪ Use of antitakeover tactics
Managerial Motives:
Antitakeover Tactics
6-38
▪ Antitakeover tactics include:

▪ Green mail
▪ Golden parachutes
▪ Poison pills
▪ Can benefit multiple stakeholders – not just
management
▪ Can raise ethical considerations because the
managers of the firm are not acting in the
best interests of the shareholders

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Corporate-

After reading this chapter, you should have a good

LO6.4 How corporations can use unrelated

▪ Diversification initiatives must create value for

▪ A firm may diversify into related businesses

▪ Related diversification enables a firm to

▪ Sharing core competencies is one of the

▪ Core competencies reflect the collective

▪ Corporations can also achieve synergy by

▪ Market power can lead to the creation of value

▪ Shaw Industries, a giant carpet manufacturer,

Example: Simplified Stages of Vertical Integration: Shaw Industries

1. Is the company satisfied with the quality of the value

▪ The transaction cost perspective

▪ Unrelated diversification enables a firm to

▪ Parenting allows the corporate office to create

▪ Portfolio management involves a better

Exhibit 6.4 The Boston Consulting Group (BCG) Portfolio Matrix

▪ Limitations of portfolio models:

▪ Diversification can reduce variability in

▪ Diversification can be accomplished via

▪ Mergers involve a combination or consolidation

Exhibit 6.5 Global Value of Mergers and Acquisitions ($ trillion)

▪ In high-technology & knowledge-intensive

▪ M&A can lead to consolidation within an industry,

▪ Takeover premiums for acquisitions are typically

▪ Kenexa, a subsidiary of IBM, provides workforce

▪ Acquisition allowed Kenexa to get access to local

▪ Drivers of acquisition success:

▪ Divestment can be the common result of an

▪ Divestment objectives include:

▪ Successful divestiture involves:

▪ Strategic alliances & joint ventures are

▪ Need for the proper partner:

▪ Corporate entrepreneurship & new venture

▪ Managerial motives: Managers may act in their

▪ Antitakeover tactics include:

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