6Corporate-Level Chapter Strategy TRUE/FALSE 1. In 2005, Gillette was acquired by Proctor & Gamble (P&G).

This is an example of business level strategic action initiated by P&G. ANS: F 2. A business-level strategy indicates product markets and businesses in which the firm should compete. ANS: F 3. If the businesses in the corporate portfolio are not worth more under the management of the corporation than they would be under any other ownership, then the corporate-level strategy has failed. ANS: T 4. A major advantage of diversification is that overall monitoring costs are reduced, since each separate business comes under the control of corporate headquarters. ANS: F 5. Successful product diversification is expected to increase the variability in the firms profitability, since the earnings are generated from several different business units. ANS: F 6. All of Krispy Kremes revenues come from its one main product, doughnuts. It can be considered a classic example of a firm following a constrained strategy. ANS: F 7. Revenues for United Parcel Service (UPS) are derived from the following business segments: 74 percent from U.S. package delivery operations, 17 percent from international package delivery, and 9 percent from non-packaging operations. The best description of the corporate level strategy of UPS is unrelated diversification. ANS: F 8. Related linked firms share more resources and assets between their businesses than do related constrained firms. ANS: F 9. Lapworth Industries diversifies by buying companies in unrelated industries. Lapworth probably has a strategy to create value through organizational synergy. ANS: F PTS: 1 DIF: Medium REF: 157 10. A high number of opportunities to share activities among companies in a diversified organization is called high operational relatedness. ANS: T 11. Blocking competitors through multipoint competition is a strategy used by related diversified firms to create value. ANS: T 12. PepsiCo uses its own distribution system to deliver multiple Pepsi branded beverage products. Pepsi recently acquired Gatorade and delivers these products using the Pepsi distribution system. This use of Pepsis outbound logistics is an example of activity sharing. ANS: T 13. P&G acquired Gillette Co. and created the Crest Pro-Health label by combining P&Gs Crest with Gillettes Oral-B brands. This is an example of achieving synergies through sharing activities. ANS: T 14. Economies of scope are cost savings resulting from a firm successfully leveraging, either through sharing or transferring, some of its capabilities and competencies developed in one business to another business. ANS: T 15. In a money-making effort, a small private university has decided to institute consulting services using its business faculty as consultants whose services would be sold to clients. This university is attempting to use its faculty to gain economies of scope. ANS: T

16. When firms share activities across units, they are often able to achieve increased value. ANS: T 17. Corporate level core competencies are resources and capabilities held within specific business units within the corporate portfolio. ANS: F 18. Market power exists when a firm is able to sell its products above the existing competitive level or decrease the costs of its primary and support activities below the competitive level, or both. ANS: T 19. Equator, a U.S. manufacturer of pharmaceuticals, has acquired a firm in the same industry in Ireland. It plans to move one of its key managers from its plant in St. Louis to Ireland. This can be considered a method of transferring corporate-level core competencies. ANS: T 20. As product markets become worldwide, we can expect that multipoint competition will decrease. ANS: F 21. Vertical integration exists when a company produces its own inputs (forward integration) or owns its own source of output distribution (backward integration). ANS: 22. Partial vertical integration is not practical because it involves excessive levels of coordination between internal company units and outside contractors. ANS: 23. Many manufacturing firms are de-integrating and moving to independent supplier networks. ANS: T 24. Contract manufacturers who manage their customers entire product line, and offer services ranging from inventory management to delivery and after-sales services are prime examples of vertical integration. ANS: F 25. Contract manufacturers who manage their customers entire product line, and offer services ranging from inventory management to delivery and after-sales services are prime examples of virtual integration. ANS: T 26. Virtual integration tends to erode the relationships between suppliers and customers as personal contacts are replaced with impersonal electronic communications. ANS: F 27. A company that tries to balance both operational and corporate relatedness and fails risks incurring diseconomies of scope. ANS: T 28. Firms with both operational and corporate relatedness are favorites of investment analysts because the transparency and clarity of their financial statements clearly show the value-creation resulting from the combination of multiple businesses. ANS: F 29. An unrelated diversification strategy can create value through two types of financial economies, (1) efficient internal capital allocations and (2) purchasing other firms, restructuring their assets, and selling them. ANS: T 30. A significant benefit of an internal capital market is limiting competitors access to information about the performance of the individual businesses within the corporation. ANS: 31. In a diversified firm, capital allocation can be adjusted according to more specific criteria than is possible with external market allocation of capital. ANS: T

32. Unrelated diversification has been the norm for the most successful firms in many industrialized countries such as Germany, Italy, and France. ANS: T 33. One limitation of an unrelated diversification strategy is that synergies gained from internal financial economies can be matched in all markets, both developed and developing. ANS: F 34. Companies in emerging markets prefer to use related constrained diversification because it allows the firm to concentrate on a few core competencies which it can share among the sister organizations. ANS: F 35. When implementing a restructuring strategy a company would do best by focusing on mature, lowtechnology businesses. ANS: T 36. Since the 1950s, U.S. government policy regarding antitrust concerns has remained constant. ANS: F 37. Corporate tax laws, rather than tax laws affecting individuals, have had the most impact on the firms use of free cash flows for investment in acquisitions. ANS: F 38. Low performance is associated with increased diversification. ANS: T 39. Performance continues to increase as diversification increases from single business to unrelated diversification. ANS: F 40. Synergy exists when the value created by business units working together exceeds the value that those same units create working independently. ANS: T 41. Related diversification by a firm tends to reduce a managers executive compensation, whereas unrelated diversification tends to increase it because the firm has moved into new industries. ANS: F 42. If managers diversify a firm in a way that does not produce value, the firm risks capital market intervention. ANS: T 43. Golden parachutes protect managers from the negative consequences of over-diversifying a firm. ANS: T 44. Without strict governance mechanisms, the majority of executives will act in their own self-interest rather than acting as positive stewards of firm resources. ANS: F 45. Boards of directors have been shown to be ineffective governance mechanisms and are being replaced by the market for corporate control. ANS: F MULTIPLE CHOICE 1. In 2005, P&G, whose products include Crest toothpaste and Tide laundry detergent, purchased Gillette. Gillette itself had multiple businesses, including a range of products including electric toothbrushes, razors and batteries. Which of the following reflects the acquisition? a. It is unrelated diversification for P&G because Gillette consists of more than one business unit. b. It is unrelated diversification for Gillette because P&G consists of more than one business unit. c. It is related diversification for P&G because the product lines for both firms are consumer products sold through similar channels.

d. It is related diversification for Gillette because the product lines for both firms are consumer products sold through similar channels. ANS: 2. Brinker International operates restaurants in several different segments of the casual dining market. Their brands include Chilis Grill & Bar, Romanos Macaroni Grill, and On the Border. Brinkers corporate level strategy is best described as a. a relatively high level of diversification. b. an example of product diversification. c. an example of unrelated diversification. d. an example of a corporate entity that should manage its firms using the efficient internal capital market allocation approach. ANS: B 3. On the most basic level, corporate-level strategy is concerned with ____ and how to manage these businesses. a. whether the firm should invest in global or domestic businesses b. what product markets and businesses the firm should be in c. whether the portfolio of businesses should generate immediate above-average returns or should be troubled businesses which will create above-average returns only after restructuring d. whether to integrate backward or forward. ANS: B 4. The ultimate test of the value of a corporate-level strategy is whether the a. corporation earns a great deal of money. b. top management team is satisfied with the corporation's performance. c. businesses in the portfolio are worth more under the management of the company in question than they would be under any other ownership. d. businesses in the portfolio increase the firms financial returns. ANS: C 5. The more constrained the relatedness of diversification, a. the fewer the linkages between the businesses within the portfolio owned by the firm. b. the wider the variation in the portfolio of businesses owned by the firm. c. the more links there are among the businesses owned by an organization. d. the lower the proportion of total organizational revenue derived from the dominant-business. ANS: C 6. Wm. Wrigley Jr. Company once made only chewing gum. When Wrigley bought Life Savers (a line of candy mints) and Altoids (a line of breadth mints) from Kraft, chewing gum then constituted less than 95 percent of revenues. Thus, Wrigley a. was moving away from its traditional single-business strategy toward a dominant strategy. b. was moving away from its traditional dominant strategy toward a related-linked strategy. c. became a conglomerate since Life Savers and Altoids are unrelated businesses. d. probably planned to restructure these companies and sell them off. ANS: A 7. Usually a company is classified as a single business firm when revenues generated by the dominant business are greater than ____ percent. a. 99 b. 95 c. 90 d. 70 ANS: B

8. The more direct connections among businesses, the more ____ is the relatedness of the diversification. a. linked b. constrained c. integrated d. intense ANS: 9. A firm that earns less than 70% of revenue from its dominant business and has direct connections between its businesses is engaging in ____ diversification. a. unrelated b. related constrained c. related linked d. dominant-business ANS: B 10. Revenues for United Parcel Service (UPS) come from the following business segments: 74 percent from U.S. package delivery operations, 17 percent from international package delivery, and 9 percent from non-packaging operations. Which best describes the corporate level strategy of UPS? a. Single-business b. Dominant business c. Related-constrained d. Related-linked ANS: B 11. Which acquisition would be considered the LEAST related? a. a candy manufacturer purchases a chemical laboratory specializing in food flavorings b. a chain of garden centers acquires a landscape architecture firm c. a hospital acquires a long-term care nursing home d. an upscale white-tablecloth restaurant chain acquires a travel agency ANS: D 12. The lowest level of diversification is the ____ level. a. single business b. dominant-business c. related constrained d. unrelated ANS: A 13. The main difference between the related constrained level of diversification and the related linked level of diversification is a. the percentage of total organizational profitability that comes from the dominant business. b. the level of resources and activities shared among the businesses. c. whether the diversification is vertical or horizontal. d. whether the diversification is value-creating or value-neutral. ANS: B 14. The term conglomerates refers to firms using the ____ diversification strategy. a. unrelated b. related constrained c. related linked d. global ANS: A 15. GE has recently reorganized from eleven businesses down to six core businesses. The purpose of this reorganization is to transfer core competencies in different types of technologies among GEs businesses. This is an example of a. increasing market power through vertical integration. b. efficient internal capital allocation.

c. a focus on financial economies. d. increasing corporate relatedness. ANS: D 16. Which of the following reasons for diversification is most likely to increase the firms value? a. increasing managerial compensation b. reducing costs through business restructuring c. taking advantage of changes in tax laws d. conforming to antitrust regulation ANS: B 17. Which of the following is a value-reducing reason for diversification? a. enhancing the strategic competitiveness of the entire company b. expanding the business portfolio in order to reduce managerial employment risk c. gaining market power relative to competitors d. conforming to antitrust regulation ANS: B 18. An office management firm has developed a system for efficiently organizing small medical and dental practices both through proprietary software and through unique training programs for staff. It has recently acquired a firm specializing in providing management services for veterinary practices. The office management firm is hoping to a. achieve economies of scope. b. implement vertical integration. c. achieve financial economies through an unrelated acquisition. d. acquire specialized talent from the veterinary management company. ANS: A 19. Firms that have selected a related diversification corporate-level strategy seek to exploit a. control shared among business-unit managers. b. economies of scope between business units. c. the favorable demand of buyers. d. market power. ANS: B 20. Firms seek to create value from economies of scope through all of the following EXCEPT a. activity sharing. b. skill transfers. c. transfers of corporate core competencies. d. de-integration. ANS: D 21. The basic types of operational economies through which firms seek value from economies of scope are a. synergies between internal and external capital markets. b. the leveraging of individual tangible resources. c. the sharing of primary and support activities. d. joint ventures and outsourcing. ANS: C 22. Operational relatedness is created by ____ activities within the ____. a. sharing; value chain b. sharing; value chain c. transferring; value chain d. transferring; capabilities ANS: B 23. The acquisition of Gillette Co. by Procter & Gamble will probably result in activity sharing because P&G has a reputation for technology transfer: the ability to take technology used in one brand and apply it to another brand. This is an example of a. operational relatedness.

b. corporate relatedness. c. vertical integration. d. virtual integration. ANS: A 24. Which of the following is TRUE? a. Conglomerates no longer exist in the U.S. business scene, but are common in emerging markets. b. Unrelated diversified firms seek to create value through economies of scope. c. The sharing of intangible resources, such as know-how, between firms is a type of operational sharing in related diversifications. d. Related linked firms share more tangible resources and activities between businesses than do related constrained firms. ANS: 25. Research has shown that horizontal acquisitions a. tend to have disappointing financial results in the long run. b. are being replaced by virtual acquisitions. c. result in lower levels of performance than unrelated acquisitions. d. are able to use activity sharing to successfully create economies of scope. ANS: 26. A noted professional art academy has founded an artists and friends travel company specializing in tours for artists to scenic locales, using its faculty as traveling teachers. In addition, the art academy has purchased a framing company to both make frames for academy art works, but also to sell museum-quality framing services to the public. The art academy is engaging in diversification based on ____ relatedness. a. operational b. corporate c. intellectual d. constrained ANS: A 27. Dragonfly Publishers of childrens books has purchased White Rabbit, another publisher of childrens books. Both companies books are sold to the same retail stores and schools. Their content is different, since Dragonfly produces childrens literature, whereas White Rabbit focuses on childlevel scientific and nature topics. Which of the following statements is probably TRUE about this acquisition? a. This is a horizontal acquisition. b. This is an example of virtual integration. c. Dragonfly is beginning to build a conglomerate. d. Economies of scope are unlikely to result from this acquisition. ANS: A 28. The purchasing of firms in the same industry is called: a. unrelated diversification. b. vertical integration. c. networking the organization. d. horizontal acquisition. ANS: D 29. In related linked diversified firms, ____ are a complex set of resources that link the different businesses through managerial and technological knowledge, experience, and expertise. a. corporate core competencies b. strategies c. support activities d. intangible assets ANS: A

30. The drawbacks to transferring competencies by moving key people into new management positions include all EXCEPT a. the people involved may not want to move. b. managerial competencies are not easily transferable to different organizational cultures. c. managers with these skills are expensive. d. top-level managers may resist having these key people transferred. ANS: B 31. Multipoint competition occurs when a. firms have multiple retail outlets. b. firms have multiple products in their primary industry. c. diversified firms compete against each other in several markets. d. firms have diversified portfolios of companies. ANS: C 32. One method of facilitating the transfer of competencies between firms is to a. virtually integrate the two firms. b. transfer key people into new management positions. c. share support activities, such as purchasing practices. d. restructure the weaker firm to mirror the structure of the more successful firm. ANS: B 33. Xanadu, a U.S. manufacturer of pharmaceuticals, has acquired a firm in the same industry in Ireland. It plans to transfer one of its key managers from its plant in St. Louis to Ireland. What is the major threat to Xanadus plan to transfer competencies from itself to the Irish firm? a. The St. Louis manager may quit Xanadu in order to remain in St. Louis. . American pharmaceutical manufacturing techniques may not transfer to Ireland. c. Irish managers will refuse to take direction from a foreign executive. d. The cost of transferring U.S. managers overseas is usually not cost-effective. ANS: A 34. Acquisitions to increase market power require that the firm have a ____ diversification strategy. a. unrelated b. related c. dominant-business d. single business ANS: B 35. When diversification results in two companies, such as UPS and FedEx, simultaneously competing in numerous markets, this is called ____ competition. a. multiple b. multiportal c. multipoint d. mutiplicit ANS: C 36. Cendant Corporation owns real estate brokerages, relocation services, lodging franchises and online travel services. It follows a ____ corporate strategy. a. dominant-business b. related constrained diversification c. related linked diversification d. unrelated diversification ANS: C 37. Historically, steel manufacturers in the U.S. have been involved in multiple facets of steel production. This was centered on the actual mill where steel was produced. Most large steel producers also owned the iron ore and coal mines, which are essential raw materials, and railroads needed to bring the raw materials to the mill and the finished goods to distribution centers. Steel manufactures were

a. historically integrated b. horizontally integrated c. vertically integrated d... virtually integrated. ANS: C 38. Whirlpool and Maytag have similar product lines. By acquiring Maytag, Whirlpool sought to a. engage in multipoint competition. b. increase scale. c. vertically integrate. d. virtually integrate. ANS: B 39. Backward integration occurs when a company a. produces its own inputs. b. owns its own source of distribution of outputs. c. is concentrated in a single industry. d. is divesting unrelated businesses. ANS: A 40. PorkPride Foods produces hams and other meat products. It owns hog raising operations. This is an example of a ____ business. a. de-integrated b. vertically integrated c. totally integrated d. horizontally integrated ANS: B 41. A company pursuing vertical integration can gain market power over its competitors through all of the following EXCEPT a. improved process innovation. b. savings on operations costs. c. improved product quality. d. avoidance of market costs. ANS: A 42. Which of the following is NOT a limit directly relating to vertical integration? a. bureaucratic b. costs the loss of flexibility through investment in specific technologies c. capacity balance and coordination problems from changes in demand d. imitation of core technology by potential competitors ANS: D 43. Specialty Steel, Inc., needs a particular type of brick to line its kilns in order to safely achieve the high temperatures needed for the unusually strong steel it produces. The clay to make this brick is very rare and only two brick plants in the U.S. make this type of brick. Specialty Steel has decided to buy one of these brick plants. This is an example of a. backward integration. b. forward integration. c. horizontal integration. d. virtual integration. ANS: A 44. Specialty Steel, Inc., needs a particular type of brick to line its kilns in order to safely achieve the high temperatures needed for the unusually strong steel it produces. The clay to make this brick is very rare and only two brick plants in the U.S. make this type of brick. Specialty Steel owns one of these brick plants and buys all of its production. The other brick manufacturer has recently developed an inexpensive new technology whereby ordinary clay can be used to make this fire brick. This significantly reduces the production cost of this type of brick.

a. Specialty Steel has less flexibility now than if it were not vertically integrated. b. This is an example of a capacity balance problem. c. This is a result of conflicts of interest between the managers of the brick plant and the executives of Specialty Steel. d. The market power of Specialty Steel has been de-integrated. ANS: A 45. The use of e-commerce to allow firms to reduce the costs of processing transactions while improving their supply-chain management skills and tightening the control of their inventories is beginning to replace a. outsourcing. b. unrelated diversification. c. de-integration. d. vertical integration. ANS: D 46. Disney has been successful both in the sharing of activities among divisions and in the transfer of knowledge among divisions. Disney can be said to have created a. dynamic stability. b. inimitable competencies. c. cross-fertilization. d. synthesis. ANS: B 47. The value of the assets of a firm using a diversification strategy to create both operational and corporate relatedness tend to be a. discounted by investors. b. inflated by investors. c. completely ignored by investors. d. highly valued by investors. ANS: A 48. Firms are increasingly moving away from ____ integration and toward ____ integration. a. virtual; vertical b. virtual; virtuous c. virtuous; vertical d. vertical; virtual ANS: D 49. When a firm simultaneously practices operational relatedness and corporate relatedness, a. it is difficult for investors to observe the value created by the firm. b. the firm is likely to be overvalued by investors. c. the firm will suffer from diseconomies of scope which outweigh cost savings generated. d. the firm is seeking to create value through financial economies. ANS: A 50. Which type of diversification is most likely to create value through financial economies? a. related constrained b. operational and corporate relatedness c. unrelated d. related linked. ANS: C 51. Luxottica is a sunglass manufacturer which has traditionally served the fashion segment. Luxottica recently purchased Oakley, Inc., a manufacturer of sunglasses in the sportswear segment. The potential synergies from this acquisition include a. Operational relatedness. b. Corporate relatedness. c. Both operational and corporate relatedness.

d. Neither operational nor corporate relatedness. ANS: C 52. An ability to efficiently allocate capital through an internal market may help the firm protect the competitive advantages it develops a. through reduced disclosure to outside parties. b. by the ability to not report losses to investors. c. by the ability to increase pay to managers without shareholders being aware. d. through the ability to reinvest cash in dividends to shareholders. ANS: A 53. A firm practicing unrelated diversification can make better capital allocations to its subsidiary businesses than the external capital market can for all the following reasons EXCEPT a. corporate headquarters can change managerial incentives. b. corporate headquarters has more complete information about the subsidiary businesses than the external capital market. c. the firm can acquire other firms with innovative products instead of allocating capital to research and development. d. the firm can make strategic changes in its subsidiary businesses. ANS: C 54. Stock markets apply a conglomerate discount of 20% on unrelated diversified firms. This means that investors a. understand that the financial efficiencies of this strategy automatically make these stocks worth 20% more than their current market valuation. b. believe that the value of conglomerates is 20% less than the value of the sum of their parts. c. discount the expected future earnings of conglomerates by 20%. d. have found that over time, conglomerates earn 20% more than the component companies would have earned independently. ANS: B 55. Successful unrelated diversification through restructuring is typically accomplished by a. focusing on mature, low-technology businesses. b. a random walk of good luck in picking firms to buy. c. seeking out high technology firms in high growth industries. d. a top management team that is not constrained by pre-established ideas of how the firms portfolio should be developed. ANS: A 56. The risk for firms that follow the unrelated diversification strategy in developed economies is that a. external investors tend to dump the stocks of conglomerates during economic downturns. b. conglomerates are typically owned by one powerful entrepreneur and do not survive his/her retirement or death. c. government regulations, especially in Europe, have periodically forced the dissolution of conglomerates. d. competitors can imitate financial economies more easily than they imitate economies of scope. ANS: D 57. What is the similarity between high-technology firms and service-based firms that makes them risky as restructuring candidates? a. They are human-resource dependent. b. They have few tangible assets. c. Both types of firm rely on financial economies. d. The demand for their products is highly sensitive to economic downturns. ANS: A 58. Which of the following firms would be the most likely to be a successful candidate for acquisition and restructuring?

a. a medical practice b. a management consulting firm that has a tradition of long term client-consultant relationships c. a tire manufacturer established in 1910 d. a start-up communications technology firm ANS: C 59. External incentives to diversify include a. the fact that other firms in an industry are diversifying. b. pressure from stockholders who are demanding that the firm diversify. c. changes in antitrust regulations and tax laws. d. a firms low performance. ANS: C 60. All of the following are internal firm incentives to diversify EXCEPT a. overall firm risk reduction. b. uncertain future cash flows. c. stricter interpretation of antitrust laws. d. low performance. ANS: C 61. The trend among conglomerates is to a. further increase their level of diversification. b. decrease their level of diversification. c. maintain their level of diversification. d. none of the above are correct. ANS: B 62. Because of the tax laws of the 1960s and 1970s, when dividends were taxed more heavily than capital gains, shareholders preferred that corporations a. pay dividends annually. b. keep free cash flows for investment in acquisitions. c. distribute capital gains regularly. d. increase managerial salaries. ANS: B 63. Free cash flows are a. liquid financial assets for which investments in current businesses are no longer economically viable. b. liquid financial assets that for tax purposes must be reinvested in the firm if not distributed as dividends to shareholders. c. the profits resulting after a restructured firm has been sold. d. dividends that have been distributed to shareholders that are taxed as capital gains. ANS: A 64. Industry-specific deregulation has affected each of the following industries EXCEPT a. banking. b. telecommunication. c. grocery stores. d. electric utilities. ANS: C 65. The curvilinear relationship of corporate performance and diversification indicates that a. dominant-business corporate strategies tend to be higher performing than related constrained or unrelated business strategies. b. the highest performing business strategy is related constrained diversification. c. the less related the businesses acquired, the higher performing the organization. d. none of the strategies consistently outperforms the others. ANS: B

66. As the threat of corporate failure increases due to relatedness between a firms business units, firms may decide to a. increase the firms level of retained resources. b. diversify into less risky environments. c. reduce the level of diversity in its investments. d. pursue unproven product lines. ANS: B 67. Synergy exists when a. cost savings are realized through improved allocations of financial resources based on investments inside or outside the firm. b. two units create value by utilizing market power in their respective industries. c. firms utilize constrained related diversification to build an attractive portfolio of businesses. d. the value created by business units working together exceeds the value the units create when working independently. ANS: D 68. The downside of synergy in a diversified firm is a. increasing independence of businesses. b. the reduction of activity sharing. c. excessive focus on risky innovation. d. the loss of flexibility. ANS: D 69. The Cherrywood Fine Furniture Company finds itself with excess capacity in its plant and equipment for furniture manufacturing. This excess capacity will be useful in a. unrelated diversification. b. related diversification projects. c. corporate restructuring. d. multipoint competition ANS: B 70. Intangible resources a. allow greater synergy for firms than do tangible assets. b. are more flexible than tangible assets. c. are value-neutral assets. d. discourage diversification. ANS: B 71. Compared with diversification based on intangible resources, diversification based on financial resources is a. less imitable and less likely to create value on a long-term basis. b. more imitable and less likely to create value on a long-term basis c. less imitable and more likely to create value on a long-term basis d. more imitable and more likely to create value on a long-term basis ANS: B 72. Personal motives for managers to seek diversification include a desire to a. improve their marketability to other firms. b. effectively use corporate resources. c. provide higher returns to corporate stakeholders. d. increase their compensation. ANS: D 73. Isidore Crocker, CEO of Gotham Engines, is strongly in favor of acquiring Carolina Textiles, a firm in an unrelated industry. Some members of the board of directors are questioning Crockers motives for the acquisition. They argue that it is not uncommon for CEOs to push for acquisitions because a. a successful acquisition will increase the CEOs power over the board of directors.

b. making an acquisition is an easier route to increased firm value than is improving the firms core competencies. c. higher CEO pay is related to larger organization size. d. CEOs nearing retirement seek to create empires to continue their legacy. ANS: C 74. During the 1990s top executives of Titanic, Inc., followed a pattern of aggressive acquisitions and diversification. Now, Titanic is performing poorly and earning below average returns. Lusitania, a large conglomerate firm, is in the final stages of purchasing Titanic. Lusitania has announced that it will fire Titanics current top executives. The Titanic executives may not be worried about their impending job loss if they a. plan to take poison pills. b. have golden parachutes. c. have silver handcuffs. d. have ironclad contracts. ANS: B 75. Which of the following is NOT a governance mechanism that may limit managerial tendencies to over-diversify? a. the market for corporate control b. the Board of Directors c. surveillance technologies d. monitoring by owners ANS: C 76. Which of a firms resources is the most flexible and should have the strongest relationship to the extent of diversification? a. financial b. human c. intangible d. property, plant and equipment ANS: A 77. The trend in diversification is a(an) a. increase in related diversification. b. decrease in restructuring. c. increase in unrelated diversification. d. increase in firms using a dominant-business strategy. ANS: A ESSAY 1. Differentiate between corporate-level and business-level strategies and give examples of each. ANS: A business-level strategy determines how a firm will compete in a single industry or product market. When a firm diversifies beyond a single industry it uses a corporate-level strategy. A diversified company has two levels of strategy: business-level and corporate-level. Each business unit has a business level strategy. The corporate strategy is concerned with: 1) what businesses the firm should be in and 2) how the corporate office should manage the group of businesses. The top management of diversified companies views the firms businesses as a portfolio of core competencies that will generate above-average returns by creating value. An example of a business-level strategy would be the pricing of one of its products. An example of a corporate-level strategy would be whether the firm should sell off a poorly performing subsidiary 2. What are the five categories of businesses based on level of diversification? ANS: The five categories of businesses determined by level of diversification are as follows: (1) Single business (more than 95% of revenues from a single business),

(2) Dominant business (between 70% and 95% of revenue from a single business), (3) Related constrained (a diversified organization earning less than 70% of revenue from the dominant business, and all the component businesses share product, technological, and distribution linkages), (4) Related linked (a diversified organization earning less than 70% of revenues from the dominant business with only limited links among the component businesses), and (5) Unrelated (diversified organizations earning less than 70% of revenues from the dominant business with no common links among the businesses). 3. Describe the primary reasons a firm pursues increased diversification. ANS: Firms typically diversity to increase the firms value by improving its overall performance. Value-creating diversification occurs through related or unrelated diversification when the strategy allows the companys business units to increase revenues or reduce costs while implementing business level strategies. Alternatively, a firm may diversify to gain market power over competitors. Value-neutral diversification may occur in response to governmental policies, firm performance problems, or uncertainties about future cash flows. Finally, managers may have selfish motives to diversify, such as increased compensation or personal reduced employment risk. These selfish motivations may actually erode the firms competitiveness, and can be value-reducing diversifications. 4. Describe how diversified firms can use activity sharing and transfer of core competencies to create value. ANS: In related diversification, a firm seeks to exploit economies of scope between its business units. Economies of scope are cost savings created by transferring some of its capabilities and competencies developed in another business to a new business. Firms create value through economies of scope two ways: the sharing of activities (operational relatedness) and the transferring of core competencies (corporate relatedness). Both primary and support activities may be shared, including marketing and production. This activity sharing can result in cost reductions and improve financial returns. The sharing of core competencies allows the firm to create value two ways: 1) it eliminates the need for the second unit to allocate resources to develop the competence, and 2) transferring intangible resources internally makes it hard for competitors to understand and to imitate the resource. 5. What are the two ways that an unrelated diversification strategy can create value? ANS: Unrelated diversification can create value through two types of financial economies (cost savings). 1) Unrelated diversified firms can more efficiently allocate capital among the component businesses than can the external financial market. This is possible because the corporate-level management has more complete information about the performance of the component businesses and it can also discipline under-performing management teams. 2) Unrelated diversified firms can also create value by purchasing other businesses at low prices, restructuring them, and reselling them at a higher price. This practice is most successful with mature, low-technology businesses, rather than high-technology or service businesses, which are more dependent on employees who may leave. 6. What is the effect of a firms low performance on the pursuit of diversification? ANS: High corporate performance eliminates the need for diversification. Some research shows that low returns are related to greater levels of diversification. Firms plagued by poor performance often diversify in an effort to become more profitable. But, continued poor performance following diversification may slow the pace of diversification and may lead to divestitures and a focus on the core business. Figure 6.2 shows that the related constrained diversification strategy is the highest performing strategy. So poor performing firms that intend to diversify should look at purchasing businesses that would be suitable for this strategy rather than moving into unrelated diversification or retaining a dominant business strategy.

7. What are the managerial motives to diversify? ANS: A top-level manager may be motivated to pursue diversification because diversification leads to greater job security for executives. In general, greater amounts of diversification reduce managerial risk because if a particular business fails, the top executive remains employed by the corporation. In addition, diversification increases firm size, and firm size has a direct effect on executive compensation. Moreover, managing a highly diversified firm is more difficult; thus, managerial compensation is generally higher in such a firm. Consequently, executives may have selfish motives to diversify the company in ways which may actually reduce corporate competitiveness. PTS: 1 DIF: Medium REF: 172-174 OBJ: 06-07 NOT: AACSB: Business Knowledge & Analytical Skills | Management: Leadership Principles | Dierdorff & Rubin: Managing decision-making processes