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Corporate-Level Strategy: Creating Value through Diversification
Chapter Six McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
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Making Diversification Work
the process of firms expanding their operations by entering new businesses. 6-2
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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? 6-3
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Making Diversification Work
Diversification initiatives must create value for shareholders Mergers and acquisitions Strategic alliances Joint ventures Internal development Diversification should be synergistic 6-4
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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 6-5
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Related Diversification
a firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power. 6-6
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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 6-7 7
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Leveraging Core Competencies
a firm’s strategic resources that reflect the collective learning in the organization. 6-8
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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 6-9
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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 6-10 10
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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 A. Utilizing common infrastructures B. Capitalizing on core competencies C. Reducing corporate risk D. Using portfolio analysis Answer: B. Capitalizing on core competencies 6-11 11
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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. 6-12 12
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Market Power Market power
firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment. 6-13
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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. 6-14
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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 6-15
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Vertical Integration 6-16
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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. 6-17
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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. 6-18
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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? 6-19
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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? 6-20
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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 6-21
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Unrelated Diversification
a firm entering a different business that has little horizontal interaction with other businesses of a firm. 6-22
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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 6-23
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Corporate Parenting and Restructuring
Corporate Restructuring The intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management 6-24
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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. 6-25 25
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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. 6-26
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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 6-27
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Portfolio Management Allocate resources
Expertise of corporate office in locating attractive firms to acquire Provide financial resources to business units on favorable terms reflecting the corporation’s overall ability to raise funds Provide high quality review and coaching for units Provide a basis for developing strategic goals and reward/evaluation systems 6-28
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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’s) 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 6-29 29
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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 6-30
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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 6-31
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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. 6-32
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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 6-33
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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 6-34
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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 6-35
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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 6-36 36
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