6-1 Chapter 6 – Corporate-Level Strategy

4-2 Five Business- Level Strategies Source: Adapted from Porter, M. E. (1985). “Competitive advantage: Creating and sustaining superior performance”, New York, NY: Free Press.

6-3 Two Strategy Levels Business-level strategy (competitive)  Each business unit in a diversified firm chooses a business-level strategy as its means of competing in individual product markets Corporate-level strategy (company-wide)  Specifies actions taken by the firm to gain a competitive advantage by selecting and managing a group of different businesses competing in several industries and product markets

6-4 Corporate-Level Strategy: Key Questions Corporate-level strategy’s value  The degree to which the businesses in the portfolio are worth more under the management of the company than they would be under other ownership  What businesses should the firm be in?  How should the corporate office manage the group of businesses? Business Units

6-5 Example – Conglomerate Discount GE overall: 70% increase in profits since 2001, but $20bn decrease in market value General Electric’s planned sale of its plastics business to Saudi Basic Industries is double-edged sword:  Unit sold at $11.6bn, in contrast to investors’ valuation of $8bn  Sale unlocked 45% more value for shareholders Many of GE’s assets may have more value than GE’s share price suggests Source: Cox, R. & Cass, D. (2007). “Placing value on GE’s parts”, The Wall Street Journal, Tuesday, May 22: C14.

6-6 The Role of Diversification Diversification strategies play a major role in the behavior of large firms Product diversification concerns:  The scope of the industries and markets in which the firm competes  How managers buy, create, and sell different businesses to match skills and strengths with opportunities presented to the firm

6-7 To Enhance Strategic Competitiveness: 1. Economies of scope (related diversification)  Sharing activities  Transferring core competencies 2. Market power (related diversification)  Blocking competitors by multipoint competition  Vertical integration 3. Financial economies (unrelated diversification)  Efficient internal capital allocation  Business restructuring Motives for Diversification Related Unrelated

6-8 Portfolio Matrix Competitive Position 4High33Medium22Low1 4 High 3 ? Medium 2 Average 2 Low 1 Attractiveness

6-9 Examples Intuitively, which of the following strategies make sense? Why (please explain)? 1.Apple introduces an I-Pod player with a larger memory. 2.PepsiCo distributes Lay’s Potato Chips to the same stores where it sells Pepsi Cola. 3.Head Ski Company introduces a line of tennis rackets.

6-10 Examples – cont’d Intuitively, which of the following strategies make sense? Why (please explain)? 4.General Electric borrows money from Bank of America at 3 percent interest rate and then makes capital available to its jet engine subsidiary at 8 percent interest. 5.A venture capital firm invests in a firm in the biotechnology industry and a firm in the entertainment industry. 6.Another venture capital firm invests in two firms in the biotechnology industry.

6-11 Economies of Scope (EoS) Firm creates value by building upon or extending its:  Resources  Capabilities  Core competencies Definition:  Cost savings that occur when a firm makes use of capabilities and competencies developed in one of its businesses in another of its businesses Related

6-12 Value is created from economies of scope through:  Operational relatedness in sharing activities  Corporate relatedness in transferring skills or corporate core competencies among units The difference between sharing activities and transferring competencies is based on how the resources are jointly used to create economies of scope Economies of Scope (EoS)– cont’d Related

6-13 EoS: 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 strategic control over business units  Activity sharing may create risk because business-unit ties create links between outcomes Related

6-14 EoS: Transferring Competencies Corporate Relatedness  Using complex sets of resources and capabilities to link different businesses through managerial and technological knowledge, experience, and expertise Creates value in two ways:  Eliminates resource duplication in the need to allocate resources for a second unit to develop a competence that already exists in another unit  Provides intangible resources (resource intangibility) 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 Related

6-15 Market Power Market power exists when a firm can:  Sell its products above the existing competitive level and/or  Reduce the costs of its primary and support activities below the competitive level Related

6-16 Market Power – cont’d Multipoint Competition  Two or more diversified firms simultaneously compete in the same product areas or geographic markets Vertical Integration  Backward integration – a firm produces its own inputs  Forward integration – a firm operates its own distribution system for delivering its outputs Related

6-17 Excurse: 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  Many such efforts often fail because of implementation difficulties Related

6-18 Financial Economies Cost savings realized through improved allocations of financial resources  Based on investments inside or outside the firm Create value through two types of financial economies:  Efficient internal capital allocation  Purchasing other corporations and restructuring their assets Unrelated

6-19 Financial Economies – cont’d Efficient Internal Capital Allocation  Corporate office distributes capital to business divisions to create value for overall company Corporate office gains access to information about those businesses’ actual and prospective performance  Conglomerates have a fairly short life cycle because financial economies are more easily duplicated by competitors than are gains from operational and corporate relatedness Example: GE ( Unrelated

6-20 Financial Economics – cont’d Restructuring creates financial economies  A firm creates value by buying and selling other firms’ assets in the external market Resource allocation decisions may become complex, so success often requires:  Focus on mature, low-technology businesses  Focus on businesses not reliant on a client orientation Unrelated

6-21 Agenda 1.Introduction to Corporate Strategy 2.Motives for Diversification a)Motives to Enhance Strategic Competitiveness b)Incentives and Resources with Neutral Effects c)Managerial Motives (Value Reduction) 3.Exercise

6-22 Motives for Diversification Incentives and Resources with Neutral Effects on Strategic Competitiveness:  Antitrust regulation  Tax laws  Low performance  Uncertain future cash flows

6-23 External Incentives to Diversify Antitrust laws in 1960s and 1970s discouraged mergers that created increased market power (vertical or horizontal integration) Mergers in the 1960s and 1970s thus tended to be unrelated Relaxation of antitrust enforcement results in more and larger horizontal mergers Early 2000 antitrust concerns seem to be emerging and mergers now more closely scrutinized Anti-trust Legislation

6-24 External Incentives to Diversify High tax rates on dividends cause 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 Anti-trust Legislation Tax Laws

6-25 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) Low Performance

6-26 Internal Incentives to Diversify Diversification may be defensive strategy if:  Product line matures  Product line is threatened  Firm is small and is in mature or maturing industry Low Performance Uncertain Future Cash Flows

6-27 Agenda 1.Introduction to Corporate Strategy 2.Motives for Diversification a)Motives to Enhance Strategic Competitiveness b)Incentives and Resources with Neutral Effects c)Managerial Motives (Value Reduction) 3.Exercise

6-28 Motives for Diversification Managerial Motives (Value Reduction)  Diversifying managerial employment risk  Increasing managerial compensation