Corporate-Level Strategy: Creating Value Through Diversification Chapter 6 Corporate-Level Strategy: Creating Value Through Diversification McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.

After studying this chapter, you should have a good understanding of: Learning Objectives After studying this chapter, you should have a good understanding of: How managers can create value through diversification The reasons why many diversification efforts fail How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis The various means of engaging in diversification—mergers and acquisitions, joint ventures/strategic alliances, and internal development Managerial behaviors that can erode the creation of value

Diversification and Corporate Performance: A Disappointing History Exhibit 6.1 (adapted) Diversification and Corporate Performance: A Disappointing History A study conducted by Business Week and Mercer Management Consulting, Inc., analyzed 150 acquisitions that took place between July 1990 and July 1995. Based on total stock returns from three months before, and up to three years after, the announcement: 30 percent substantially eroded shareholder returns. 20 percent eroded some returns. 33 percent created only marginal returns. 17 percent created substantial returns. A study by Salomon Smith Barney of U.S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquiring firms have, on average, under-performed the S&P stock index by 14 percentage points and under-performed their peer group by four percentage points after the deals were announced. Sources: Lipin, S. & Deogun, N. 2000. Big merges of the 90’s prove disappointing to shareholders. Wall Street Journal, October 30: C1; A study by Dr. G. William Schwert, University of Rochester, cited in Pare, T. P. 1994. The new merger boom. Fortune, November 28:96; and Porter, M.E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3):43.

Creating Value through Related Diversification Exhibit 6.2 (adapted) Economies of Scope (Efficiencies of operating two or more businesses within the same firm) Leveraging Core Competences 3M leverages its competences in adhesives technologies to many industries, including automotive, construction, and telecommunications Sharing Activities McKesson, a large distribution company, sells many product lines such as pharmaceuticals and liquor through its super warehouses

Creating Value through Related Diversification Exhibit 6.2 (adapted) Creating Value through Related Diversification Market Power Pooled Negotiating Power The Times Mirror Company increases its power over customers by providing “one-stop shopping” for advertisers to reach customers through multiple media in several huge markets Vertical Integration Shaw Industries, a carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, one of its key inputs

Creating Value through Unrelated Diversification Exhibit 6.2 (adapted) Corporate Restructuring and Parenting Cooper Industries adds value to its acquired businesses by performing such activities as auditing their manufacturing operations, improving their accounting activities, and centralizing union negotiations Portfolio Analysis Novartis uses portfolio analysis to improve many key activities, including resource allocation as well as reward and evaluation systems. Creating Synergy Across the Business Units Richard Branson creates synergy across various unrelated and largely independent businesses by linking them through branding (Virgin).

Simplified Stages of Vertical Integration: Shaw Industries Exhibit 6.3 Polypropylene Fiber Production Carpet Manufacturing Retail Stores Raw Materials Manufacturing of final product Distribution Backward Integration Forward Integration

The Benefits and Risks of Vertical Integration Secures a source of raw materials or distribution channels Costs associated with increased overhead and capital expenditures Protection and control over valuable assets Loss of flexibility resulting from large investments Access to new business opportunities Problems associated with unbalanced capacities along the value chain Simplified procurement and administrative procedures Additional costs associated with more complex activities

The BCG Portfolio Matrix Exhibit 6.5 0.1X 0.5X 0.4X 0.3X 0.2X 2X 1.5X 1X 10X 4X 18% 16% 10% 22% 2% 4% 6% 8% 20% 14% 12% Business Growth Rate Stars Cash Cows Dogs Question Marks Relative Market Share Notes: 1. Each circle represents one of the corporation’s business units. The size of the circle represents the relative size of the business unit in terms of revenues. 2. Relative market share is plotted as a logarithmic scale to be consistent with experience curve effects. This is very similar to learning curves and central to the BCG growth share matrix. 3. Relative market share is measured by the ratio of the business unit’s size to that of its largest competitor.

The top ten mergers Exhibit 6.6 Below are the world’s biggest mergers. Listed are the partners, each deal’s status or date of completion, and values in billions. Partners Date Value ($ billions) 1. Vodafone AirTouch PLC-Mannesmann AG April 12, 2000 $161 2. Pfizer Inc.-Warner-Lambert Co. June 19, 2000 $116 3. America Online-Time Warner January 11, 2001 $111 4. Exxon Corp.-Mobil Corp. Nov. 30, 1999 $81 5. (tie) Glaxo Wellcome PLC-SmithKline Beecham PLC December 27, 2000 $72 5. (tie) SBC Communications Inc.-Ameritech Oct. 8, 1999 7. Vodafone Group PLC-Airtouch Communications Inc. June 30, 1999 $69 8. Bell Atlantic Corp.-GTE Corp. (now Verizon) May 30, 2000 $60 9. Total Fina-Elf Aquitaine (now Total Fina Elf S.A.) Feb. 9, 2000 $54 10. Viacom Inc.-CBS Corp. May 4, 2000 $50 Sources: Thomson Financial Securities Data; AP Wire Reports