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MKT 450 Strategic Management Mishari Alnahedh

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1 MKT 450 Strategic Management Mishari Alnahedh

2 LECTURE 9: DIVERSIFICATION STRATEGY

3 What are the sources of value creation by diversification?
Learning Objectives Mishari Alnahedh Define corporate-level strategy and discuss its importance to the diversified firm. What are the sources of value creation by diversification? What are the limits to diversification? What are potential agency problems? How should organizational structure fit diversification strategies?

4 Three dimensions of scope
Corporate Strategy Mishari Alnahedh Corporate Strategy Corporate strategy is the way a company creates value through the configuration and coordination of its multi-market activities Quest for competitive advantage when competing in multiple industries - Example: Jeffrey Immelt’s initiative in clean-tech and health care industries Three dimensions of scope Industry value chain Products and services Geography Diversification Decision

5 Diversification decisions involve these same two issues:
The Basic Issues in Diversification Decisions Mishari Alnahedh Superior profit derives from two sources: INDUSTRY ATTRACTIVENESS RETURN ON CAPITAL > COST OF CAPITAL COMPETITIVE ADVANTAGE Diversification decisions involve these same two issues: How attractive is the industry to be entered? Can the firm achieve a competitive advantage? © 2013 Robert M. Grant

6 Growth Motivation for Diversification
Mishari Alnahedh Growth Transferring Core Competencies (Leveraging) Developing New Competencies (Stretching) Brand-name that is exportable (e.g., Haagen-Dazs to chocolate candy) R&D and new product development The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco, oil, newspapers) But, growth satisfies managers not shareholders. Diversification in that achieves seeks growth (esp. by acquisition) tends to destroy shareholder value

7 Risk Reduction/Spreading
Motivation for Diversification Mishari Alnahedh Risk Reduction/Spreading Financial Motives internal capital allocation & restructuring risk reduction tax advantages Diversification reduces the variance of profit flows But, doesn’t create value for shareholders—they can hold diversified portfolios of securities. (Capital Asset Pricing Model shows that diversification only lowers unsystematic risk not systematic risk)

8 Profitability/Value Creation
Motivation for Diversification Mishari Alnahedh Profitability/Value Creation Efficient Management Economies of Scope (shared activities to reduce costs) Utilizing excess capacity (e.g., in distribution) Increase market power multi-point competition For diversification to create shareholder value, then bringing and putting different businesses under common ownership must increase their total profitability

9 Motivations that “Devaluate”:
Other Motivations for Diversifications: Mishari Alnahedh Motivations that “Devaluate”: Growth maximization managerial capitalism/agency problem protect against “unemployment risk” maximize management compensation Motivations that are “Value neutral”: Diversification motivated by poor performance in current businesses.

10 Competitive Advantage from Diversification
Mishari Alnahedh Economies of Scope Sharing tangible resources (research labs, distribution systems) across multiple businesses Sharing intangible resources (brands, technology) across multiple businesses Transferring functional capabilities (marketing, product development) across businesses Applying common general management capabilities to different businesses Economies from Internalizing Transactions Economies of scope not a sufficient basis for diversification—must be supported by transaction costs in markets for resources Diversified firm can avoid external transactions by operating internal capital and labor markets Diversified firm has better information on resource characteristics than external markets © 2013 Robert M. Grant

11 Operational relatedness
Relatedness in Diversification Mishari Alnahedh Economies of scope in diversification derive from two types of relatedness: Operational relatedness Synergies from sharing resources across businesses (common distribution facilities, brands, joint R&D) Strategic relatedness Synergies at the corporate level deriving from the ability to apply common management capabilities to different businesses Problem of operational relatedness: The benefits in terms of economies of scope may be dwarfed by the administrative costs involved in their exploitation © 2013 Robert M. Grant

12 Internal development Acquisition Joint venture Licensing
Modes of Diversification Mishari Alnahedh Internal development Acquisition Joint venture Licensing

13 Diversification Issues
Mishari Alnahedh Issue #1: When there is a reduction in managerial (employment) risk, then there is upside and downside effects for stockholders. On the upside, managers will be more willing to learn firm-specific skills that will improve the productivity and long-run success of the company (to the benefit of stockholders). On the downside, top-level managers may have the incentive to diversify to a point that is detrimental to stockholders.

14 Diversification Issues
Mishari Alnahedh Issue #2: There may be no economic value to stockholders in diversification moves since stockholders are free to diversify by holding a portfolio of stocks. No one has shown that investors pay a premium for diversified firms -- in fact, discounts are common. A classic example is Kaiser Industries Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum; and (3) Kaiser Cement. These were independent companies and the stock of each were publicly traded. Kaiser Industries was selling at a discount which vanished when Kaiser industries revealed its plan to sell its holdings. Kaiser Industries was dissolved as a holding company because its diversification apparently subtracted from its value.

15 Diversification and Performance
Mishari Alnahedh

16 Diversification and Performance
Mishari Alnahedh Source: Rothaermel, F (2013) Strategic Management, McGraw-Hill

17 Diversification Costs
Diversification and Performance Mishari Alnahedh Diversification Costs Coordination cost A function of number, size, and types of businesses linked to one another Influence cost Political maneuvering by managers to influence capital and resource allocation

18 Diversification and Performance
Mishari Alnahedh The majority of diversifying acquisitions have destroyed shareholder wealth: the acquisition premiums paid have greatly exceeded the value added by the acquired businesses Conversely, stock market valuations have responded positively to divestments, or even to the anticipation of divestment

19 Managing the Multibusiness Firm

20 Managing the multi-business corporation
Mishari Alnahedh Can value be derived by operating across the different activities and markets in which they are engaged? How should the multi-business company be structured and managed to ensure that these sources of value are exploited more efficiently than under any other type of organizational arrangement?

21 Industry attractiveness
Managing the multi-business corporation Mishari Alnahedh Strategy analysis Allocating resources Formulating business strategy Analyzing portfolio balance Cash flow Growth Setting performance targets Industry attractiveness Market size, market growth, industry profitability, cyclicality, inflation recovery, importance of overseas market Business unit competitive advantage Market position, competitive position, return on sales relative to that of leading competitors

22 Portfolio Planning Models: BCG Growth-Share Matrix
Mishari Alnahedh

23 Among their weaknesses are:
Portfolio Planning Mishari Alnahedh Since the 1980s, portfolio planning matrices have lost their popularity as analytic tools. Among their weaknesses are: Oversimplification The positioning of businesses within the matrix is highly susceptible to measurement choices and market definitions The approach assumes that every business is completely independent

24 Managing Linkages Across Boundaries
Mishari Alnahedh Value from exploiting linkages within the multibusiness firm result mainly from exploiting resource and capability linkages: At the corporate level – Shared corporate services At the business level – Sharing resources, transferring capabilities Michael Porter identifies types of corporate strategy based on the nature and extent of internal linkages: Portfolio management – Parent creates value by operating an internal capital market Restructuring - Parent creates value by acquiring and revitalizing inefficiently-managed businesses Transferring skills - Parent creates value by transferring capabilities between businesses Sharing activities - Parent creates value by sharing resources between businesses © 2013 Robert M. Grant

25 Today’s Main Takeaway Mishari Alnahedh Recognize the central issues of formulating and implementing corporate strategy Deploy the concepts and techniques necessary for making judgments about these issues Evaluate the relationships between the resources and capabilities of the firm, its corporate strategy, and the implementation of the strategy through an appropriate organization structure, management system, and leadership style

26 Case: The Virgin Group in 2012
NEXT CLASS ! Case: The Virgin Group in 2012 This is the last case in this class. No case guideline


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