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

2. 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

3. 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

4. “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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

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

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

14. 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