Corporate-Level Strategy: Creating Value through Diversification

1. Chapter 6 Corporate-Level Strategy: Creating Value through Diversification

2. Discussion Objectives 1. How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power. 2. How corporations can use unrelated diversification to attain synergistic benefits 3. The various means of engaging in diversification 4. Managerial behaviors that can erode the creation of value.

3. Does Diversification Make Sense Research indicates that diversification is generally a bad idea: Between 33% and 50% of corporate diversification efforts end up as divestitures. Companies typically pay 30% to 40% premiums to acquire target companies. All of us can diversify our own portfolios very easily and efficiently

4. Key Questions Corporate level strategy is concerned with two key questions: What businesses should a corporation compete in? How should these businesses be managed to jointly create more value than if they were freestanding units (synergy)?

5. Diversification Efforts Diversification initiatives must create value for shareholders Mergers and acquisitions Strategic alliances Joint ventures Internal development Diversification should create synergy Shared value

6. Synergy Related businesses - Horizontal relationships Sharing intangible resources Sharing tangible resources Pooled negotiating power Vertical integration Unrelated businesses. Hierarchical relationships - value creation derived from the corporate office. Leveraging support activities in the value chain

7. Related Diversification – Economies of Scope Economies of scope - Cost savings from leveraging core competencies or sharing related activities among businesses in the corporation Leverage or reuse key resources Favorable reputation Expert staff Management skills Efficient purchasing operations

8. RD – Leveraging Core Competencies. Leveraging Core competencies Core competencies reflect the collective learning in organizations How to coordinate diverse production skills, integrate multiple streams of technologies, and market and merchandise diverse products and services. Examples?

9. RD – Leveraging Cont. Core competencies must meet three criteria 1. The core competence must enhance competitive advantage(s) by creating superior customer value. 2. Different businesses in the corporation must be similar in at least one important way related to the core competence. 3. The core competencies must be difficult for competitors to imitate or find substitutes for.

10. RD - Sharing Activities Sharing Activities - Corporations can also achieve synergy by sharing tangible and value-creating activities across their business units Common manufacturing facilities Distribution channels Sales forces Sharing activities provide two payoffs Cost savings Revenue enhancements Why do shared activities not lead to these benefits?

11. RD – Pooled Negotiating Power Pooled negotiating power - Similar businesses working together can have stronger bargaining position relative to Suppliers Customers Competitors Abuse of bargaining power may affect relationships with customers, suppliers and competitors What are some other downsides to pooled negotiating power??

12. RD - Vertical Integration. Benefits Secure source of supply of raw materials Secure distribution channels Protection and control over assets and services Access to new business opportunities and technologies Simplified procurement and administrative procedures

13. RD – Vertical Integration Cont. Risks Costs and expenses associated with increased overhead and capital expenditures Loss of flexibility resulting from inability to respond quickly to changes in the external environment Problems associated with unbalanced capacities or unfilled demand along the value chain Additional administrative costs

14. RD – Vertical Integration Cont. Six issues to consider: 1. Are we satisfied with the quality of the value that our present suppliers and distributors are providing? 2. Are there activities in our 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?

15. RD –Vertical Integration Cont. Six Issues to consider 4. How high is the proportion of additional production capacity actually absorbed by existing products or by the prospects of new and similar products? 5. Does the company have the necessary competencies to execute the vertical integration strategies? 6. Will the vertical integration initiative have potential negative impacts on the firm’s stakeholders?

16. RD – Vertical Integration Cont. Transaction Cost Perspective – VI makes sense if the sum of transaction costs to acquire a product are more than the costs of manufacturing it internally. Search costs Negotiation costs Contracting costs Monitoring costs Enforcement costs Transaction Specific Investments Transaction costs versus administrative costs

17. Unrelated Diversification Most benefits from unrelated diversification are gained from vertical (hierarchical) relationships Parenting and restructuring of businesses - Allocate resources to optimize Profitability Cash flow Growth Appropriate human resource practices Financial controls

18. UD – Parenting & Restructuring Corporate management must Have insight to detect undervalued companies or businesses with high potential for transformation Have requisite skills and resources to turn the businesses around Restructuring can involve changes in Assets Capital structure Management

19. UD – Portfolio Management

20. UD – Portfolio MNGT cont. Creation of synergies and shareholder value by portfolio management and the corporate office Allocate resources (cash cows to stars and some question marks) Expertise of corporate office in locating attractive firms to acquire Provide financial resources to business units on favorable terms reflecting the corporation’s overall ability to raise funds Provide high quality review and coaching for units Provide a basis for developing strategic goals and reward/evaluation systems

21. UD – Portfolio MNGT Cont. Risks of the BCG Matrix Compares SBUs on only two dimensions Mechanical Process Views each SBU as a stand alone entity Reliance on strict rules regarding resource allocation across SBUs can be detrimental to a firm’s long-term viability Imagery of the BCG matrix can lead to some troublesome and overly simplistic prescriptions.

22. Mergers and Acquisitions M & A activity in the U.S. increased in recent years for 3 primary reasons: 1. Weak economy 2. Weak dollar 3. More governance regulations

23. M & A Cont. Motives for M & A Activity Speed Access to resources Expand product and service offerings Synergy Force other firms to merge Enter new markets or market segments

24. M & A Cont. Potential drawbacks of M & A activities Take over premium is very high Realized advantages are easily duplicated by competitors Management ego Cultural issues

25. Managerial Motives Growth for growth’s sake Egotism Antitakeover tactics Greenmail Golden parachute Poison pills

26. Discussion Objectives 1. How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power. 2. How corporations can use unrelated diversification to attain synergistic benefits 3. The various means of engaging in diversification 4. Managerial behaviors that can erode the creation of value.