Corporate-Level Strategy: Creating Value through Diversification

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

2. Learning Objectives 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.

3. Learning Objectives 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.

4. Corporate-Level Strategy 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?

5. Making Diversification Work • Diversification initiatives must create value for shareholders through • Mergers and acquisitions • Strategic alliances • Joint ventures • Internal development • Diversification should create synergy

6. Making Diversification Work • 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 • 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

7. Related Diversification • Related diversification enables a firm to benefit from horizontal relationships across different businesses • Economies of scope allow businesses to: • Leverage core competencies • Share related activities • Enjoy greater revenues • Related businesses gain market power by: • Pooled negotiating power • Vertical integration

8. Question? • Sharing core competencies is one of the primary potential advantages of diversification. In order for diversification to be most successful, it is important that • the similarity required for sharing core competencies must be in the value chain, not in the product. • the products use similar distribution channels. • the target market is the same, even if the products are very different. • the methods of production are the same.

9. Related Diversification: Leveraging Core Competencies • 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

10. Related Diversification: Sharing Activities • 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

11. Related Diversification: Market Power • 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

12. Example: Question? • 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 • leveraging core competencies. • pooled negotiating power. • vertical integration. • sharing activities.

13. Related Diversification: Vertical Integration Exhibit 6.3 Simplified Stages of Vertical Integration: Shaw Industries

14. Related Diversification: Vertical Integration • It is the company satisfied with the quality of the value that its present suppliers & distributors are providing? • Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? • Is there a high level of stability in the demand for the organization’s products? • Does the company have the necessary competencies to execute the vertical integration strategies? • Will the vertical integration initiatives have potential negative impacts on the firm’s stakeholders?

15. Related Diversification: Vertical Integration • 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

16. Unrelated Diversification • 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

17. Unrelated Diversification: Parenting & Restructuring • 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

18. Unrelated Diversification: Portfolio Management • 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

19. Unrelated Diversification: Portfolio Management 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 6.5 The Boston Consulting Group (BCG) Portfolio Matrix

20. Unrelated Diversification: Portfolio Management • 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

21. Example: Goal of Diversification = Risk Reduction? • 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?

22. Means of Diversification • 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

23. Mergers and Acquisitions • 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

24. Mergers and Acquisitions Exhibit 6.6 Global Value of Mergers and Acquisitions ($ trillion) Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis

25. Mergers and Acquisitions: Motives • 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

26. Mergers and Acquisitions: Motives • 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.

27. Mergers and Acquisitions: Limitations • 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

28. Question? • Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These include • enabling managers to focus their efforts more directly on the firm’s core businesses. • providing the firm with more resources to spend on more attractive alternatives. • raising cash to help fund existing businesses. • all of the above.

29. Mergers and Acquisitions: Divestment • 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

30. Mergers and Acquisitions: Divestment • 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

31. Strategic Alliances & Joint Ventures: Motives • Strategic alliances & joint ventures are cooperative relationships 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

32. Strategic Alliances & Joint Ventures: Limitations • 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

33. Internal Development • 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

34. Managerial Motives • 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

35. Managerial Motives: Antitakeover Tactics • 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