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Chapter 8

Chapter 8. Corporate-Level Strategy. The Role of Diversification. Product Diversification concerns: The Scope of the industries and markets in which our firm competes.

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Chapter 8

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  1. Chapter 8 Corporate-Level Strategy

  2. The Role of Diversification Product Diversification concerns: The Scope of the industries and markets in which our firm competes. How managers Buy, Create and Sell different Businesses to match our Skills and Strengths with our Opportunities .

  3. Two Strategy Levels Business-level Strategy(Competitive) Each Business Unit in a diversified firm chooses a Business-Level Strategy for competing in individual product markets. Corporate-level Strategy(Companywide) The firm’s efforts to gain competitive advantage by Selecting and Managing a group of Different Businesses competing in different industries and product markets.

  4. Corporate-Level Strategy Corporate-Level Strategy’s Value: Are the businesses in our “Portfolio” Worth More under the management of our company than they would be under other ownership?

  5. Corporate-Level Strategy: Key Questions • What Businessesshould our firm be in? • How should the Corporate Office Managethe group of businesses?

  6. Dominant Business Between 70% and 95% of revenue comes from a single business. A A B Levels of Diversification: Low Level Single Business More than 95% of revenue comes from a single business.

  7. Related Constrained Less than 70% of revenue comes from a single business and all businesses share product, technological and distribution linkages. Related Linked (mixed related and unrelated) Less than 70% of revenue comes from the dominant business, and there are only limited links between businesses. A A C C B B Levels of Diversification: Moderate to High

  8. A C B Levels of Diversification: Very High Levels • Unrelated Diversification • Less than 70% of revenue comes from the dominant business, and there are no common links between businesses.

  9. Levels and Types of Diversification Figure 6.1

  10. Reasons for Diversification Value-Creating Diversification: •Economies of Scope(Related Diversification)Sharing ActivitiesTransferring Core Competencies • Market Power(Related Diversification)Blocking Competitors through Multipoint Competition Vertical Integration •Financial Economies(Unrelated Diversification)Efficient Internal Capital AllocationBusiness Restructuring Table 8.1a

  11. Reasons for Diversification (cont’d) • Value-Neutral Diversification: • Antitrust Regulations • Tax Laws • Low Performance • Uncertain Future Cash Flows • Risk Reduction for firm • Tangible Resources • Intangible Resources Table 8.1b

  12. Reasons for Diversification (cont’d) • Value-Reducing Diversification • Diversifying Managerial Employment Risk • Increasing Managerial Compensation Table 8.1c

  13. Related Constrained Diversification Vertical Integration (Market Power) Related Linked Diversification (Economies of Scope) UnrelatedDiversification (Financial Economies) Both Operational and Corporate Relatedness(Rare capability that creates diseconomies of scope) Value-Creating Strategies of Diversification Operational and Corporate Relatedness High Operational Relatedness:Sharing Activities between Businesses Low Low High Corporate Relatedness:Transferring Skills into Businesses through Corporate Headquarters

  14. Organizational Controls • Organizational Controls • guide the Use of Strategy • How to Compare Actual Results with Expected Results? • What Corrective Actions to take when the difference between actual and expected results is unacceptable?

  15. Two Types of Organizational Controls • Strategic Controls • Financial Controls

  16. Strategic Controls Organizational Controls: Strategic Controls • SubjectiveCriteria • Examining the Fit between: • what the firm Might Do (Opportunities in the External Environment) • what it Can Do (based on its Competitive Advantages) • Is the firm using Appropriate Strategy for its Opportunities and Strengths?

  17. Financial Controls Strategic Controls Organizational Controls: Financial Controls • ObjectiveCriteria • Measure Performance againstQuantitative Standards • Accounting-BasedMeasures, e.g.: • Return on Investment • Return on Assets • Market-BasedMeasures, e.g.: • Economic Value Added

  18. Matching Control to Strategy • Relative Use of Controls Varies by Type of Strategy: • Large Diversified firms using the Cost Leadership Strategy emphasize Financial Controls • Companies and Business Units using the Differentiation Strategy emphasize Strategic Controls

  19. Multi-DivisionalStructure • Strategic Control • Operating Divisions • Each Division is Separate Business or profit center • Top Corporate Officer Delegates Responsibilities to Division Managers: • for Day-to-Day Operations • for Business-Unit Strategy • Appropriate when the Firm Diversifies

  20. Multi-Divisional Structure • 3 Major Benefits: • Corporate Officers able to more accurately Monitor the performance of each business, which Simplifies the problem of Control. • Facilitates Comparisons between Divisions, which Improves Resource Allocation. • StimulatesManagers of poorly performing divisions to Improve Performance.

  21. Multi-Divisional Structure (M-Form) Cooperative Form Competitive Form Strategic Business-Unit (SBU) Form 3 Variations of the Multi-DivisionalStructure

  22. Related Diversification Firm creates value by building on (or extending): • Resources • Capabilities • Core Competencies • Economies of Scope • Cost Savingsthat occur when a firmTransfers Capabilities and Competenciesdeveloped in one of its businesses to another of its businesses.

  23. Related Diversification: Economies of Scope Economies of Scope create Value through: • Operational Relatednessin Sharing Activities • Corporate Relatednessin Transferring Skills or corporate Core Competencies among units

  24. Sharing Activities Operational Relatedness • Created by Sharing either a primary activity such as inventory delivery systems, or a support activity such as purchasing. • Activity Sharing requires sharing strategic Control over business units. • Activity sharing may create risk because business-unit ties create links between outcomes.

  25. President Government Affairs Legal Affairs Corporate R&D Lab Strategic Planning Corporate Human Resources Corporate Marketing Corporate Finance Product Division Product Division Product Division Product Division Product Division Cooperative Form of Multi-Divisional Structure: Related-Constrained Strategy Headquarters Office

  26. Cooperative Form of Multi-Divisional Structure: Related-Constrained Strategy • Structural Integration devices create Tight Links Among all Divisions • Corporate Centralized strategic Planning, HR, and Marketing to foster Cooperation between Divisions • R&D is likely to be Centralized • Rewards are Subjective and tend to Emphasize overall Corporate Performance, in addition to Divisional Performance • Culture Emphasizes Cooperative Sharing

  27. Transferring Corporate Competencies Corporate Relatedness • Using Resources and Capabilities to link different businesses through managerial and technological knowledge, experience, and expertise.

  28. Corporate Relatedness Creates Value in 2 Ways: • Eliminates Resource Duplication: No need to allocate resources for one unit to develop a competence that already exists in another unit. • Provides Intangible Resources that are difficult for competitors to understand and imitate. • A Transferred Intangible Resource gives the unit receiving it an Immediate Competitive Advantage over its rivals.

  29. President Corporate R&D Lab Strategic Planning Corporate HRM Corporate Marketing Corporate Finance Division Division Division Division Division Division Division Division Division SBU SBU SBU SBU Form of Multi-Divisional Structure: Related-Linked Strategy Headquarters Office

  30. SBU Form of Multi-Divisional Structure: Related-Linked Strategy • Within each SBU: • Divisions are Related to each other. • Divisions with Similar Products and/or Technologies are organized to achieve Synergy.

  31. SBU Form of Multi-Divisional Structure: Related-Linked Strategy • SBU groups are Unrelated to each other. • SBUs treated as Profit Centers, controlled by Corporate HQ. • Corporate HQ focuses on Strategic Planning, rather than Operational Control.

  32. Related Diversification: Market Power Market Powerexists when a firm can: • Sell its products above the existing competitive Price level and/or • Reduce the costs of its primary and support activities below the competitive Cost level.

  33. Related Diversification: Market Power Multi-point Competition • Two or more diversified firms simultaneously compete in the same product areas or geographic markets (UPS vs. FedEx) Vertical Integration • BackwardIntegration: firm produces its own inputs • ForwardIntegration—a firm operates its own distribution system for delivering its outputs

  34. Related Diversification: Complexity Simultaneous Operational Relatedness and Corporate Relatedness • Involves managing two sources of knowledge simultaneously: • Operational forms of economies of scope • Corporate forms of economies of scope • These efforts often fail because of implementation difficulties.

  35. Unrelated Diversification Financial Economies • Cost Savings realized through improved Allocations of financial resources • Based on investments inside or outside the firm • Create value through 2 types of financial economies: • Efficient Internal Capital Allocations • Purchasing other corporations and Restructuring their assets

  36. Unrelated Diversification (cont’d) Efficient Internal Capital Market Allocation • Corporate office Distributes Capital among business divisions to create value for overall company. • “Conglomerates” have a fairly short life cycle because financial economies are more easily duplicated by competitors than are gains from operational and corporate relatedness.

  37. Unrelated Diversification: Restructuring • Restructuring creates Financial Economies • A firm creates value by Buying and Selling other firms’ assets in the external market. • Success often requires: • Focus on Mature, Low-Tech businesses • Focus on businesses not reliant on a “client orientation”.

  38. President Legal Affairs Finance Auditing Division Division Division Division Division Division Competitive Form of Multi-Divisional Structure: Unrelated Diversification Strategy Headquarters Office

  39. Competitive Form of Multi-Divisional Structure: Unrelated Diversification Strategy • Corporate Headquarters has a Small Staff. • Finance and Auditing are the most Prominent Functions in Headquarters to Manage Cash Flow and ensure Accuracy of Divisions’ Performance Data. • Legal Affairs function is Important when the firm Acquires or Divests assets.

  40. Competitive Form of Multi-Divisional Structure: Unrelated Diversification Strategy • Divisions are Independent and Separate for Financial Evaluation purposes. • Divisions retain Strategic Control, but Cashis Managed by the Corporate office. • Divisions Compete for Corporate Resources.

  41. Characteristics of Various Structural Forms Structural Characteristics Cooperative M-Form Competitive M-Form SBU M-Form Unrelated Diversification Type of Strategy Related- Constrained Related- Linked Degree of Centralization Centralized at Corporate Office Partially Centralized in SBUs Decentralized to Divisions Use of Integrating Mechanisms Extensive Moderate Nonexistent

  42. Characteristics of Various Structural Forms Structural Characteristics Cooperative M-Form Competitive M-Form SBU M-Form Objective Financial Criteria Divisional Performance Appraisal Subjective Strategic Criteria Strategic & Financial Criteria Linked to Corporate, SBU, and Division Performance Divisional Incentive Compensation Linked to Corporate Performance Linked to Divisional Performance

  43. Anti-Trust Legislation External Incentives to Diversify • Antitrust laws in 1960s and 1970sDiscouraged mergers that created “Market Power” (Vertical or Horizontal Integration). • Mergers in the 1960s and 1970s thus tended to be Unrelated. • Relaxation of antitrust enforcement resulted in More and Larger “Related” Mergers. • Now, Antitrust Concerns are Emerging again, and mergers are more closely scrutinized.

  44. Anti-trust Legislation Tax Laws External Incentives to Diversify (cont’d) • High Tax Rates on Dividends in the 1960s and 70s caused a corporate shift from dividends to buying and building companies in high-performance industries. • 1986 Tax Reform Act: • Reduced individual ordinary income tax rate from 50 to 28 percent • Treated capital gains as ordinary income • Thus created incentive for shareholders to prefer dividends to acquisition investments

  45. Low Performance Internal Incentives to Diversify • High Performance eliminates the need for greater diversification. • Low performance acts as incentive for diversification. • Firms plagued by poor performance often take higher risks (Diversification is Risky!).

  46. Curvilinear Relationship between Diversification and Performance Figure 6.3

  47. Low Performance Uncertain Future Cash Flows Internal Incentives to Diversify (cont’d) • Diversification may be a defensive strategy if: • Product Line Matures • Product Line is Threatened • Firm is Small and is in a Mature (or maturing) Industry

  48. Low Performance Uncertain Future Cash Flows Synergy and Risk Reduction Internal Incentives to Diversify • Synergy - the value created by businesses working togetherexceeds the value created by them working independently. • … but synergy creates joint interdependence between business units. • A firm may become risk averse and constrain its level of activity sharing.

  49. Resources and Diversification • A firm must have both: • Incentivesto Diversify, and • Resourcesto create value through diversification • Cash • Tangible Resources(e.g., plant and equipment) • Value Creation is determined more by appropriate use of resources than by incentives to diversify.

  50. Managerial Motives to Diversify:Value-Reducing Diversification Managerial Risk Reduction Desire for Increased Compensation

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