Strategic Management Corporate Diversification

© Lucas Wenger 2018
Strategic Management
Corporate Diversification
© Lucas Wenger 2018
Where Are We in the SM Process?
Mission Objectives
External
Analysis
Internal
Analysis
Strategic
Choice
Strategy
Implementation
Competitive
Advantage
Business Level
Strategy
Corporate Level
Strategy
How to Position a
Business
in the Market?
Which Businesses
to Enter?
•Vertical Integration
•Diversification
© Lucas Wenger 2018
Strategies used as a means to avoid or be
better than competitors
• Module 3:
– Vertical Integration (8)
– Corporate Diversification (9) & organizing for
diversification (10)
• Module 4:
– Collusion (7)
– Strategic Alliances (10)
– Mergers and Acquisitions (11)
© Lucas Wenger 2018
Ethics & Strategy
• Diversification contributes to increasing firm size,
and facilitates the growth of MNEs
• Protests against the WTO, the Occupy Movement,
and more recently a populist discontent for free trade
agreements (i.e. NAFTA & TPP)
• Why? Globalization increases the total value created
in the world economy & accelerates growth (which is
largely unchallenged throughout the political
spectrum)
• How can we respond?
© Lucas Wenger 2018
Logic of Corporate Level Strategy
Corporate level strategy should create value:
2) such that businesses forming the corporate whole
are worth more than they would be under
independent ownership
3) that equity holders cannot create through
portfolio investing
• A corporate level strategy should create
synergies that are not available in equity
markets
– In this pursuit, diversification potentially creates
economies of scope
1) such that the value of the corporate whole increases
© Lucas Wenger 2018
What are economies of scope?
• Increases in the net value of products or
services offered as a function of the number of
businesses in which a firm operates
© Lucas Wenger 2018
What is Corporate Diversification?
Operation in multiple industries or
markets simultaneously
à2 Categories (not mutually exclusive)
© Lucas Wenger 2018
Integration and Diversification
Integration
Diversification
Backward Forward
Current
Businesses
No
Links
Many
Links
Unrelated Related
Other
Businesses
Other
Businesses
© Lucas Wenger 2018
Categories of Corporate Diversification
Product Diversification:
Geographic Market Diversification:
Product-Market Diversification
• operating in multiple industries
• operating in multiple geographic markets
• operating in multiple industries in multiple
geographic markets
At a general level… Examples?
Darden Restaurants
Starbucks
Pollo Campero
© Lucas Wenger 2018
Typology of Corporate Diversification
Limited Diversification
Related Diversification
Unrelated Diversification
• single business: > 95% of sales in single business
• dominant business: 70% to 95% in single business
• related-constrained: all businesses related on most
dimensions
• related-linked: some businesses related on some
dimensions
• businesses are not related
© Lucas Wenger 2018
Product and Geographic Diversification
Possibilities:
• single-business in multiple geographic areas
• single-business in one geographic area
• related-constrained in one or multiple geographic areas
• related-linked in one or multiple geographic areas
• unrelated in one or multiple geographic areas
Note:
• relatedness usually refers to products
• seemingly unrelated products may be related on
other dimensions
© Lucas Wenger 2018
Examples of Corporate Diversification
Limited Diversification
Related Diversification
Unrelated Diversification
Example
• related-constrained:
PepsiCo
• related-linked:
Disney
•GE
© Lucas Wenger 2018
Value of Diversification
Two Criteria
1) There must be some economy of scope
2) The focal firm must have a cost advantage over
outside equity holders in exploiting any
economies of scope
© Lucas Wenger 2018
Economies of Scope
Business X Business Y Business Z
Independent: equity holder could buy shares of each firm
Value
Business X
Business Y
Business Z
Focal Firm
Value
+ +
Economies
Of
Scope
Combined: equity holder buys shares in one firm
© Lucas Wenger 2018
Economies of Scope
Four Types
Operational
Financial
Anticompetitive
Managerialism
© Lucas Wenger 2018
Economies of Scope
Operational Economies of Scope
Sharing Activities
• exploiting efficiencies of sharing business
activities
Example: 3M J&J
Spreading Core Competencies
• exploiting core competencies in other businesses
Example: Frito-Lay’s Trucking
• competency must be strategically relevant
© Lucas Wenger 2018
What are core competencies?
• “The collective learning in the organization,
especially how to coordinate diverse
production skills and integrate multiple
streams of technologies”
• May be generated through logical
consideration of pre-diversified firms’
resources/ capabilities or may emerge naturally
• May entail shared activates or may not/
© Lucas Wenger 2018
Economies of Scope
Financial Economies of Scope
Internal Capital Market
• premise: insiders can allocate capital across
divisions more efficiently than the external capital
market
• works only if managers have better information
• may protect proprietary information
• may suffer from escalating commitment
Example: Hanson Trust, PLC
© Lucas Wenger 2018
Economies of Scope
Financial Economies of Scope
Risk Reduction
• counter cyclical businesses may provide
decreased overall risk
Example: Snow Skiis & Water Skiis
• individual investors can usually do this more
efficiently than a firm
however,
© Lucas Wenger 2018
Economies of Scope
Financial Economies of Scope
Tax Advantages
• transfer pricing policy allows profits in one
division to be offset by losses in another division
• this is especially true internationally
Example: Ireland (Apple, among others)
• can be used to ‘smooth’ income
Why is it potentially beneficial to smooth
income (under tax code accounting rules?
© Lucas Wenger 2018
Economies of Scope
• Which of these is realizable by investors
without diversification in the focal firm (within
financial economies of scope)?
© Lucas Wenger 2018
Anticompetitive Economies of Scope
Multipoint Competition
• mutual forbearance
• a firm chooses not to compete aggressively
in one market to avoid competition in another
market
Example: American Airlines & Delta: Dallas & Atlanta
Market Power
• using profits from one business to compete in
another business
• using buying power in one business
to obtain advantage in another business
© Lucas Wenger 2018
Economies of Scope
Managerialism
• an economy of scope that accrues to managers
at the expense of equity holders
• managers of larger firms receive more compensation
(larger scope = more compensation)
• therefore, managers have an incentive to
acquire other firms and become ever larger
• even though the incentive is there, it is difficult
to know if managerialism is the reason for an
acquisition
• What is different between managerialism &
operational/financial/anticompetitive economies of scope?
The locus of value capture –firm (flowing/ principals vs. agents)
© Lucas Wenger 2018
Rareness of Diversification
Diversification per se is not rare
Underlying economies of scope may be rare
• relationships that allow an economy of scope
to be exploited may be rare
• an economy of scope may be rare because
it is naturally or economically limited
• a soft drink bottler buys the only source of
spring water available
• a hotel in a resort town creates a large water park,
there are only enough customers to support one park
© Lucas Wenger 2018
Imitability of Diversification
Less Costly-to-Duplicate Costly-to-Duplicate
Employee Compensation
Tax Advantages
Risk Reduction
Shared Activities*
Core Competencies
Internal Capital Allocation
Multipoint Competition
Exploiting Market Power
(codified/tangible) (tacit/intangible)
*may be costly depending on relationships
© Lucas Wenger 2018
But companies can succeed in Corporate
Strategy .. With proper analysis
• The Porter Test
• The 4 Poles Test
• The Combined Acid Test
© Lucas Wenger 2018
Basis of
Value Creation
Parenting Skills
Scope
Modification
Internal
Organization
The Poles of Corporate Strategy
• What businesses is this
company in?
• How is value created to these
businesses? (if at all)
• Why is this value superior to
that created by other HQs or
stand alone business? (if at all)
• What kind of
systems/structures/processes
have been put in place to
achieve the target value?
• Are the 4 poles consistent?
© Lucas Wenger 2018
Porter’s Test
• The attractiveness test
• The cost of entry test
• The better off test
© Lucas Wenger 2018
The Combined Acid Test for
Diversification
• Taking a Resource View:
• Do we have valuable and rare resources and capabilities that could be
transferred to (or from) or shared with the new unit?
• How valuable are these to the new/old unit?
• Do we have the Parenting Skills/Internal Organization needed for the
transfer?
• Can we build/acquire the valuable (complementary) skills that we are
lacking?
• Taking a Market View:
• Can we overcome the barriers to entry?
• Is this industry attractive?
Costs Versus Benefits
© Lucas Wenger 2018
Diversification Based on Activities
Sharing: The Acid Test
• Taking a Resource View:
• Do we have activities that can be shared among the units?
• Will activity sharing reduce costs or differentiation costs?
• Could we outsource this activity? Impact on Flexibility?
• Do we have the Parenting Skills/Internal Organization needed for effective
activities sharing?
• Can we build/acquire the valuable (complementary) resources that we are
lacking?
• Taking a Market View:
• Can we overcome the barriers to entry?
• Is this industry attractive?
Costs Versus Benefits


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