CORPORATE-LEVEL STRATEGY: RELATED AND UNRELATED DIVERSIFICATION Chapter 10 CORPORATE-LEVEL STRATEGY: RELATED AND UNRELATED DIVERSIFICATION

Learning Objectives Differentiate between models based on related/unrelated diversification Explain ways diversification can create profitability Discuss conditions that lead managers to pursue related/unrelated diversification & why Describe methods used to enter new industries Discuss advantages/disadvantages of each method 10-2 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Diversified Company “...makes and sells products in two or more different or distinct industries…”

Free Cash Flow “...cash in excess of that required to fund investments in the company’s existing industry...” 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Diversify? When company is generating free cash flow with resources in excess of those needed to maintain competitive advantage.

Corporate-Level Strategy Allow company to perform value creation functions at lower cost or in way allowing differentiation & premium price. Used to identify: Businesses/industries in which company should compete Value creation activities company should perform in those businesses Method to enter or leave businesses or industries in order to maximize its long-run profitability

Strategy of Diversification Types of diversification: Related diversification Unrelated diversification Methods to implement diversification strategy: Internal new ventures Acquisitions Joint ventures

Enables Company to Perform Value Chain Functions Enables Company to Perform At lower cost In way that allows differentiation & gives pricing options Helps manage industry rivalry better

Ways to Diversify = Increase Profitability Transfer competencies Leverage competencies Share Resources & Capabilities Product bundling General organizational competencies

Transferring Competencies Taking a distinctive competency developed in one industry and implanting it in EXISTING business unit in another industry Competencies transferred must involve activities important to establish competitive advantage

Increase profitability when: For strategy to work, the distinctive competency being transferred must have real strategic value. Increase profitability when: Lowers cost structure of one or more business units Enables one or more business units to better differentiate products

Transfer of Competencies at Philip Morris Figure 10.1

Leveraging Competencies Taking a distinctive competency developed by a business in one industry and using it to create a NEW business unit in a different industry

Sharing resources and capabilities across two or more business units in different industries to realize economies of scope. Economies of scope arise when business units effectively pool, share, & utilize expensive resources or capabilities = possible only when significant commonalities between one or more value-chain functions.

Sharing Resources at Procter & Gamble Figure 10.2

Product Bundling Differentiate products/expand product lines to satisfy customers’ needs for package of related products. Allows customers to reduce suppliers for convenience & cost savings Examples Telecommunications Medical equipment

General Organizational Competencies Skills transcend individual functions or business units. Capabilities help business unit perform at higher level than operated as individual: Entrepreneurial – encourage risk taking Organizational design – create structure, culture, & control systems Superior strategic management – effectively manage managers of business units

Types of Diversification Related - entry into new business in different industry: Related to company’s existing business/activities Has commonalities between one or more components of each activity’s value chain Based on transferring/leveraging competencies, sharing resources, & bundling products Unrelated - entry into industries with no connection to any of company’s activities in present industry or industries Based on only general organizational competencies to increase profitability of all business units

Commonalities Between Value Chains of 3 Business Units Figure 10.3

Disadvantages/Limits of Diversification Conditions = diversification disadvantageous: Changes in Industry/Company Unpredictable future Willing to divest business units Diversification for the Wrong Reasons Clear vision of how value will be created. Extensive diversification can reduce profitability. Bureaucratic Costs of Diversification Costs are function of number of business units portfolio Extent coordination is required to gain benefits.

Factors Ignored in Pooling Diversification Risk Stockholders can diversify own portfolio Business cycles of different industries are difficult to predict – economic downturn affects all

Coordination Among Related Business Units Figure 10.4

May pursue both strategies simultaneously Choosing Strategy Depends on comparison of benefits of each strategy versus cost of pursuing it: Related Competencies can be applied across greater number of industries Superior capabilities to control bureaucratic costs Unrelated Functional competencies have few uses across industries Organizational design skills to build competencies May pursue both strategies simultaneously

Sony’s Web of Corporate-Level Strategy Figure 10.5

Internal New Ventures Pitfalls: Scale of Entry Commercialization Process of transferring/creating new business unit/division in new industry. Pitfalls: Scale of Entry Commercialization Poor Implementation

Scale of Entry Versus Profitability Figure 10.6

Successful Internal New Venturing Place funding for research in hand of business unit managers Effective use of R & D competency Foster close links between R & D and marketing Large-scale entry leads to greater long-term profits

Attractions of Acquisitions Principle strategy to start horizontal integration: Lack of distinctive competencies Need to move quickly Perceived as less risky than internal new ventures Attractive way to enter new industry protected by high barriers to entry

Acquisition Pitfalls Integrating the acquired company Overestimating economic benefits Expense of acquisitions Inadequate preacquisition screening

Guidelines for Successful Acquisition Identification and screening Bidding strategy Integration Learning from experience

Joint Ventures Attractions: Pitfalls: Avoid risks/costs of building new operation Sharing complementary skills/assets increase probability of success Pitfalls: Sharing profits if new business succeeds Venture partners must share control – conflicts can cause failure Risk of giving know-how away to joint venture partner

Restructuring Why Restructure? Process of divesting businesses and exiting industries to focus on core distinctive competencies to increase company profitability. Why Restructure? Diversification discount- investors see highly diversified companies as less attractive Response to failed acquisitions Innovations in strategic management have diminished advantages of vertical integration or diversification

“Growth does not always lead a business to build on success “Growth does not always lead a business to build on success. All too often it converts a highly successful business into a mediocre large business.” - Richard Branson “The corporate strategies of most companies have dissipated instead of created shareholder value.” - Michael Porter