The Multi-Business, Diversified Firm MANEC 387 Economics of Strategy David J. Bryce David J. Bryce © 2002

Corporate vs. Business Unit Strategy To whom will we sell, for what price? How will we source, manufacture, distribute, etc. our product? Corporate Strategy What business(es) should we be in? How will we get in (or out) of them? How will we coordinate or integrate businesses to create value? David J. Bryce © 2002 Adapted from M. Porter, 2001, HBR

Corporate-Level Strategy and the Multi-business Firm Corporate strategy is action taken to gain competitive advantage through multiple business units Value is created through the configuration and coordination of multi-business activities David J. Bryce © 2002

“Vertical Integration” Scope of the Firm Horizontal Scope “Horizontal Integration” Prod./Ind. A Prod./Ind. B Prod./Ind. C Sales Sales Sales output-products Distrib Distrib Distrib Manuf. Manuf. Manuf. Vertical Scope . . . “Vertical Integration” Sales Sales Sales Distrib Distrib Distrib Input-products Manuf. Manuf. Manuf. . . . David J. Bryce © 2002

Wal-mart . . . . . . Horizontal Scope Prod./Ind. A Prod./Ind. B Prod./Ind. C Sales Sales Sales output-products Distrib Distrib Distrib Manuf. Manuf. Manuf. . . . Sales Sales Sales Vertical Scope Distrib Distrib Distrib Input-products Manuf. Manuf. Manuf. . . . David J. Bryce © 2002

GE . . . . . . Horizontal Scope Refrigerators Prod./Ind. C Sales Sales Aircraft Engines Prod./Ind. C Sales Sales Sales output-products Distrib Distrib Distrib Manuf. Manuf. Manuf. . . . Compressors Sales Sales Sales Vertical Scope Distrib Distrib Distrib Input-products Manuf. Manuf. Manuf. . . . David J. Bryce © 2002

Why Diversify? Secure Market Power Mitigate Business (Cycle) Risk Cross-subsidization, mutual forbearance, reciprocal buying Shown to be an incomplete, if not an incorrect view Mitigate Business (Cycle) Risk Perspective from finance Few firms are just “portfolio” investors David J. Bryce © 2002

Why Diversify? Achieve Efficiency (or “Synergy”) Dynamic Learning Pursue related or complementary activities Most common type of diversification Associated with higher levels of performance than previous two types Dynamic Learning Related to the efficiency motivation Firms invest in activities that leverage existing skills and knowledge Firms introduce new activities to build skills and knowledge Objective is to develop a “capabilities portfolio” that is ready for new opportunities when they emerge David J. Bryce © 2002

Transaction Costs and Diversification Hierarchical organization (as within a firm) is a governance mechanism that reduces the costs of transactions that would otherwise occur across markets or not at all E.g. Complex contracting environments (recall our discussions on Hold-up) Contracting for specific assets Certain types of knowledge assets David J. Bryce © 2002

How to Choose Industries/Products for Expansion Strategically Important Strategically Related; i.e. commonality in one of the following: Customers Channels Inputs Processes Market Knowledge David J. Bryce © 2002

Evaluating Diversification How can diversification create value? Economies of scope Learning How can diversification dissipate value? Bureaucratic costs – information overload, coordination limitations Over-extension for management know-how, financial, or other resources Empire building without incremental value-add David J. Bryce © 2002

Sequential Entry and Dynamic Learning: Example Source: COMPUSTAT Business Segment Files, 1977-1996 David J. Bryce © 2002

Patterns of Historic Entry in Industries Related to Semiconductors, 1977-1996 David J. Bryce © 2002

Summary and Takeaways Corporate Strategy is about structuring a portfolio of businesses that hang together and make strategic sense It is sometimes motivated by economizing on transaction costs Other (strategic) motivations include dynamic learning, efficiency, or sometimes market power and risk management Diversification is not a fail-proof strategy David J. Bryce © 2002