Corporate-Level Strategy

Ch6-1

A Diversified Company Has Two Levels of Strategy

1. Business-Level Strategy
(Competitive Strategy)

How to create competitive advantage in each business in which the company competes
- low cost - focused low cost - differentiation - focused differentiation - integrated low cost/differentiation

2. Corporate-Level Strategy

(Companywide Strategy)

How to create value for the corporation as a whole

Ch6-2

Key Questions of Corporate Strategy

1. What businesses should the corporation be in? 2. How should the corporate office manage the array of business units?

Corporate Strategy is what makes the corporate whole add up to more than the sum of its business unit parts
Ch6-3

Levels and Types of Diversification

Low Levels of Diversification
Single business
> 95% of revenues from a single business unit A A B

Dominant business

Between 70% and 95% of revenues from a single business unit

Moderate to High Levels of Diversification

Related constrained
< 70% of revenues from dominant business; all businesses share product, technological and distribution linkages < 70% of revenues from dominant business, and only limited links exist B A B A

A C

Related linked (mixed)

Very High Levels of Diversification

Unrelated-Diversified
Business units not closely related B

Motives, Incentives, and Resources for Diversification

Motives to Enhance Strategic Competitiveness

Resources

Economies of Scope Market Power Financial Economies

Incentives

Managerial Motives
Ch6-5

Motives, Incentives, and Resources for Diversification

Incentives and Resources with Neutral Effects of Strategic Competitiveness
Anti-Trust Regulation Tax Laws Low Performance Uncertain Future Cash Flows Firm Risk Reduction Tangible Resources Intangible Resources
Ch6-6

Resources

Incentives

Managerial Motives

Motives, Incentives, and Resources for Diversification

Resources

Incentives

Managerial Motives Causing Value Reduction

Managerial Motives

Diversifying Managerial Employment Risk

Increasing Managerial Compensation
Ch6-7

Summary Model of the Relationship Between Firm Performance and Diversification

Resources
Diversification Strategy

Incentives

Managerial Motives
Ch6-8

Adding Value by Diversification

Diversification most effectively adds value by either of two mechanisms:
By developing economies of scope between business units in the firms which leads to synergistic benefits By developing market power which leads to greater returns

Ch6-9

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
Ch6-10

Alternative Diversification Strategies

Sharing Activities
Key Characteristics: Sharing Activities often lowers costs or raises differentiation
Example: Using a common physical distribution system and sales force such as Procter & Gambles disposable diaper and paper towel divisions

Sharing Activities can lower costs if it:

Achieves economies of scale Boosts efficiency of utilization Helps move more rapidly down Learning Curve
Example: General Electrics costs to advertise, sell and service major appliances are spread over many different products Ch6-11

Alternative Diversification Strategies

Sharing Activities
Key Characteristics: Sharing Activities can enhance potential for or reduce the cost of differentiation
Example: Shared order processing system may allow new features customers value or make more advanced remote sensing technology available

Must involve activities that are crucial to competitive advantage

Example: Procter & Gambles sharing of sales and physical distribution for disposable diapers and paper towels is effective because these items are so bulky and costly to ship
Ch6-12

Alternative Diversification Strategies

Sharing Activities
Assumptions: Strong sense of corporate identity Clear corporate mission that emphasizes the importance of integrating business units Incentive system that rewards more than just business unit performance

Ch6-13

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
Ch6-14

Alternative Diversification Strategies

Transferring Core Competencies
Key Characteristics:
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

Ch6-15

Alternative Diversification Strategies

Transferring Core Competencies
Assumptions: Transferring Core Competencies leads to competitive advantage only if the similarities among business units meet the following conditions: 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
Ch6-16

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
Ch6-17

Alternative Diversification Strategies

Efficient Internal Capital Market Allocation
Key Characteristics: Firms pursuing this strategy frequently diversify by acquisition: 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
Ch6-18

Alternative Diversification Strategies

Efficient Internal Capital Market Allocation
Assumptions: Managers have more detailed knowledge of firm relative to outside investors

Firm need not risk competitive edge by disclosing sensitive competitive information to investors
Firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own
Ch6-19

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
Ch6-20

Alternative Diversification Strategies

Restructuring
Key Characteristics: Seek out undeveloped, sick or threatened organizations or industries
Parent company (acquirer) intervenes and frequently: - Changes sub-unit management team - Shifts strategy - Infuses firm with new technology - Enhances discipline by changing control systems - Divests part of firm - Makes additional acquisitions to achieve critical mass Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations
Ch6-21

Alternative Diversification Strategies

Restructuring
Assumptions: Requires keen management insight in selecting firms with depressed values or unforeseen potential Must do more than restructure companies

Need to initiate restructuring of industries to create a more attractive environment

Ch6-22

Incentives to Diversify
External Incentives: Relaxation of Anti-Trust regulation allows more related acquisitions than in the past 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 Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns
Ch6-23

Value-creating Strategies of Diversification Operational and Corporate Relatedness

High Sharing: Operational Relatedness Between Business Low Related Constrained Diversification Vertical Integration (Market Power) Both Operational and Corporate Relatedness (Rare Capability and Can Create Diseconomies of Scope)

Unrelated Diversification (Financial Economies)

Related Linked Diversification (Economies of Scope)

Low

High

Corporate Relatedness: Transferring Skills Into Business Through Corporate Headquarters

Ch6-24

Diversification and Firm Performance

Performance

Dominant Business

Related Constrained

Unrelated Business
Ch6-25

Level of Diversification

Incentives to Diversify
Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns Firms may diversify to balance uncertain future cash flows Firm may diversify into different businesses in order to reduce risk Managers often have incentives to diversify in order to increase their compensation and reduce employment risk, although effective governance mechanisms may restrict such abuses
Ch6-26

Summary Model of the Relationship Between Firm Performance and Diversification

Capital Market Intervention and Market for Managerial Talent

Resources

Incentives

Diversification Strategy

Firm Performance

Managerial Motives
Internal Governance Strategy Implementation

Ch6-27