Corporate Strategy: Diversification

1. Corporate Strategy:Diversification Learning Objectives: To identify types of diversification and when this strategy can create value to the firm and generate sustained competitive advantage Have any of you experienced corporate diversification with your employers ?

2. Means to Achieve Diversification

3. Corporate Diversification:According to J. Barney … using a corporate diversification strategy, a firm operates in multiple industries or markets simultaneously … • Types of corporate diversification • Limited • Related • Unrelated How are these types different ? Why are these differences important ?

4. Types of Corporate Diversification

5. Corporate Diversification andCompetitive Advantage • Analyze corporate diversification from VRIO perspective • Two conditions must hold for this strategy to produce value: • Valuable economies of scope • Stockholders cannot achieve these economies at a lesser-cost by themselves What do we mean by economies of scope ?

6. Operational economies of scope Shared activities Core competencies Financial economies of scope Internal capital allocation Risk reduction Tax advantages Anticompetitive economies of scope Multipoint competition Exploiting market power Common Types of Economies of Scope(motivations for corporate diversification)

7. Operational Economies of Scope … operational economies come from shared activities or core competencies … • Shared activities Examples of shared activities ? • Core competencies Definition of core competencies ? Are these the same as ‘synergies’, the most abused word in corporate diversification lingo ?

8. Financial Economies of Scope … financial economies come from internal capital allocation, risk reduction and possible tax advantages … • Internal capital allocation Do firms get better information ? Are decision makers subject to escalation of commitment ? • Risk reduction How well can shareholders do this themselves ? • Tax advantages – use losses to offset other gains Are these powerful arguments for corporate diversification ?

9. Anticompetitive Economies of Scope … anticompetitive tactics are most often noticed when a firm experiences multipoint competition with another firm, or seeks to exploit market power … • Multipoint competition Examples of multipoint competition ? • Exploiting market power Examples of exploiting market power ? Legality and ethics of tacit collusion and predatory pricing ?

10. Managerial Incentives to Diversify • Management compensation is more likely related to firm size (sales revenue) than to economic performance Implications: build sales quickly, M & A activity Is this a fair criticism of CEOs in corporate America ?

11. Corporate Diversification and VRIO Framework … if these economies of scope provide value, they must still pass other hurdles in the VRIO framework … • Rarity of diversification is based on the resulting economies of scope, not diversification per se • Imitability of diversification is also based on the resulting economies of scope

12. Economies that are less-costly-to-duplicate: Shared activities Risk reduction Tax advantages Economies that are more-costly-to-duplicate Core competencies Internal capital allocation Multipoint competition Exploiting market power Imitability of Diversification What criteria makes these more or less costly to duplicate ? Substitutes for diversification ?

13. Examples of Corporate Diversification • Apple Computer introduces an I-Pod MD3 Player with a larger memory. • General Electric borrows money from BankAmerica at 3% interest and then makes capital available to its jet engine subsidiary at 8% interest. • A venture capital firm invests in a firm in the bio-technology industry and a firm in the entertainment industry. • Another venture capital firm invests in two firms in the bio-technology industry. For each example, Identify the type of economy of scope.