1. Corporate-Level Strategy: Creating Value through Diversification
Chapter Six
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives
After reading this chapter, you should have a good understanding of: LO6.1 The reasons for the failure of many diversification efforts. LO6.2 How managers can create value through diversification initiatives. LO6.3 How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.

3. Learning Objectives (cont.)
LO6.4 How corporations can use unrelated diversification to attain synergistic benefits trough corporate restructuring, parenting, and portfolio analysis.
LO6.5 The various means of engaging in diversification-mergers and acquisitions, joint ventures/strategic alliances, and internal development.
LO6.6 Managerial behaviors that can erode the creation of value.

4. Making Diversification Work
the process of firms expanding their operations by entering new businesses.

5. Making Diversification Work
What businesses should a corporation compete in?
How should these businesses be managed to jointly create more value than if they were freestanding units?

6. Making Diversification Work
Diversification initiatives must create value for shareholders
Mergers and acquisitions
Strategic alliances
Joint ventures
Internal development
Diversification should be synergistic

7. Making Diversification Work
Related businesses (horizontal relationships)
Sharing tangible resources
Sharing intangible resources
Unrelated businesses (hierarchical relationships)
Value creation derives from corporate office
Leveraging support activities

8. Related Diversification
a firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power.

9. Related Diversification
Economies of scope
cost savings from leveraging core competencies or sharing related activities among businesses in a corporation.
Leverage or reuse key resources
Favorable reputation
Expert staff
Management skills
Efficient purchasing operations
Existing manufacturing facilities 9

10. QUESTION
McKesson, a large distribution company, sells many product lines such as pharmaceuticals and liquor through its super warehouses. This is an example of 
Achieving economies of scope through related diversification
Achieving market power through related diversification
Attaining the benefits of restructuring through unrelated diversification
Attaining the benefits of parenting through unrelated diversification
Answer: A. Achieving economies of scope through related diversification 10

11. Leveraging Core Competencies
a firm’s strategic resources that reflect the collective learning in the organization.

12. Leveraging Core Competencies
Core competencies reflect the collective learning in a firm:
How to coordinate diverse production skills
How to integrate multiple streams of technologies
How to market diverse products and services

13. Three Criteria of Core Competencies
Core competencies must enhance competitive advantages by creating superior customer value
Different businesses in the firm must be similar in at least one important way related to the core competence
Core competencies must be difficult for competitors to imitate or find substitutes for
Core competencies must enhance competitive advantages by creating superior customer value
Develop strengths relative to competitors
Build on skills and innovations
Appeal to customers
Different businesses in the firm must be similar in at least one important way related to the core competence
Not essential that products or services themselves be similar
Is essential that one or more elements in the value chain require similar essential skills
Brand image is an example
Core competencies must be difficult for competitors to imitate or find substitutes for
Easily imitated or replicated core competencies are not a sound basis for sustainable advantages
Specialized technical skills acquired only in company work experience are an example 13

14. QUESTION
Philip Morris bought Miller Brewing and used its marketing expertise to improve Miller's market share. This justification for diversification is best described as 
Utilizing common infrastructures
Capitalizing on core competencies
Reducing corporate risk
Using portfolio analysis
Answer: B. Capitalizing on core competencies 14

15. Sharing Activities
Corporations can also achieve synergy by sharing tangible and value-creating activities across their business units
Common manufacturing facilities
Distribution channels
Sales forces
sharing activities
having activities of two or more businesses’ value chains done by one of the businesses. 15

16. Sharing Activities Sharing activities provide two payoffs Cost savings
Revenue enhancements

17. Market Power Market power
firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment.

18. Market Power Pooled negotiating power Vertical integration
The improvement in bargaining position relative to suppliers and customers.
Vertical integration
an expansion or extension of the firm by integrating preceding or successive production processes.

19. Pooled Negotiating Power
Similar businesses working together can have stronger bargaining position relative to
Suppliers
Customers
Competitors
Abuse of bargaining power may affect relationships with customers, suppliers and competitors

20. Vertical Integration
Exhibit 6.3

21. Vertical Integration Benefits
A secure source of raw materials or distribution channels.
Protection of and control over valuable assets.
Access to new business opportunities.
Simplified procurement and administrative procedures.
Vertical integration occurs when a firm becomes its own supplier or distributor. That is,
it represents an expansion or extension of the firm by integrating preceding or successive
production processes.

22. Vertical Integration Risks
Costs and expenses associated with increased overhead and capital expenditures.
Loss of flexibility resulting from large investments.
Problems associated with unbalanced capacities along the value chain.
Additional administrative costs associated with managing a more complex set of activities.

23. Making Vertical Integration Decisions
Is the company satisfied with the quality of the value that our present suppliers and distributors are providing?
Are there activities in our industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?
Is there a high level of stability in the demand for the organization’s products?

24. Making Vertical Integration Decisions (cont.)
Do we have the necessary competencies to execute the vertical integration strategies?
Will the vertical integration initiative have potential negative impacts on our stakeholders?

25. Transaction Cost Perspective
the choice of a transaction’s governance structure, is influenced by transaction costs, such as search, negotiating, contracting, monitoring, and enforcement costs

26. Unrelated Diversification
a firm entering a different business that has little horizontal interaction with other businesses of a firm.

27. Corporate Parenting and Restructuring
Parenting advantage
the positive contributions of the corporate office to a new business as a result of expertise and support provided

28. Corporate Parenting and Restructuring
The intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management
restructuring the
intervention of the
corporate office
in a new business
that substantially
changes the assets,
capital structure,
and/or management,
including selling
off parts of the
business, changing
the management,
reducing payroll
and unnecessary
sources of expenses,
changing strategies,
and infusing the
new business with
new technologies,
processes, and
reward systems.

29. Corporate Restructuring
Corporate management must
Have insight to detect undervalued companies or businesses with high potential for transformation
Have requisite skills and resources to turn the businesses around
Can involve changes in
Assets
Capital
Management
Asset Restructuring: The sale of unproductive assets, or even whole lines of businesses,
that are peripheral.
Capital Restructuring: Changing the debt-equity mix, or the mix between different
classes of debt or equity.
Management Restructuring: Changes in the composition of the top management team,
organization structure, and reporting relationships. 29

30. Portfolio Management Portfolio management
assessing the competitive position of a portfolio of businesses within a corporation,
suggesting strategic alternatives for each business
identifying priorities for the allocation of resources across the businesses.

31. BCG Portfolio Matrix Key
Each circle represents one of the firm’s business units
Size of circle represents the relative size of the business unit in terms of revenue

32. Example
Church & Dwight has a well balanced portfolio of products, which includes
Arm & Hammer
Trojan condoms
Oxi Clean
AIM toothpastes
First Response
Nair
Xtra laundry detergent
Brillo
Source:

33. Limitations of Portfolio Management
SBUs compared on only two dimensions
SBUs viewed as stand-alone entities
Process becomes largely mechanical
Reliance on “strict rules” regarding resource allocation across SBUs can be detrimental
they compare SBUs on only two dimensions, making the implicit
but erroneous assumption that (1) those are the only factors that really matter and (2) every
unit can be accurately compared on that basis. Second, the approach views each SBU as a
stand-alone entity, ignoring common core business practices and value-creating activities
that may hold promise for synergies across business units. Third, unless care is exercised,
the process becomes largely mechanical, substituting an oversimplified graphical model
for the important contributions of the CEO’s (and other corporate managers') experience
and judgment. Fourth, the reliance on “strict rules” regarding resource allocation across
SBUs can be detrimental to a firm’s long-term viability. For example, according to one
study, over one-half of all the businesses that should have been cash users (based on the
BCG matrix) were instead cash providers. 41 Finally, while colorful and easy to comprehend,
the imagery of the BCG matrix can lead to some troublesome and overly simplistic
prescriptions 33

34. Means to Achieve Diversification
Acquisitions or mergers
Pooling resources of other companies with a firm’s own resource base
Joint venture
Strategic alliance
Internal development
Corporate entrepreneurship

35. Mergers and Acquisitions
Can be a means of obtaining valuable resources that can help an organization expand its product offerings and services
Can lead to consolidation within an industry and can force other players to merge
Corporations can also enter new market segments by way of acquisitions
Can be a means of obtaining valuable resources that can help an organization expand its product offerings and services
Can provide the opportunity for firms to attain the three bases of synergy—leveraging core competencies, sharing activities, and building market power
Can lead to consolidation within an industry and can force other players to merge
Corporations can also enter new market segments by way of acquisitions

36. Limitations
Competing firms often can imitate any advantages realized or copy synergies that result from the M&A.
There can be many cultural issues that may doom the intended benefits from M&A endeavors.
The takeover premium that is paid for an acquisition typically is very high
Competing firms often can imitate any advantages realized or copy synergies that result from the M&A.
Managers’ credibility and ego can sometimes get in the way of sound business decisions.
There can be many cultural issues that may doom the intended benefits from M&A endeavors.

37. Strategic Alliances and Joint Ventures
Introduce successful product or service into a new market
Lacks requisite marketing expertise
Join other firms to reduce manufacturing (or other) costs in the value chain
Pool capital, value-creating activities, facilities

38. Strategic Alliances and Joint Ventures
Develop or diffuse new technologies
Use expertise of two or more companies
Develop products technologically beyond the capability of the companies acting independently

39. Unmet Expectations: Strategic Alliances and Joint Ventures
Improper partner
Each partner must bring desired complementary strengths to partnership
Strengths contributed by each should be unique
Partners must be compatible
Partners must trust one another

40. Managerial Motives Can Erode Value Creation
Growth for growth’s sake
Egotism
Antitakeover tactics
Greenmail
Golden parachute
Poison pills
greenmail a
payment by a firm to a hostile party for the firm’s stock at a premium, made when the firm’s
management feels that the hostile party is about to make a tender offer.
golden parachute
a prearranged contract with managers specifying that, in the event of a hostile takeover,
the target firms managers will be paid a significant severance package 40