Corporate Diversification

Corporate DiversificationCorporate Diversification

Corporate Level Strategies

Detail actions taken to gain a competitive advantage through the selection

and management of a mix of businesses competing in several industries

or product markets.

Relevant questions:

• What business should the firm be in?

• How should the corporate office manage its group of businesses?


Levels and Types of Diversification Single-business firm - 100% of revenue comes from a single business unit.

Dominant firm - 70% - 95% of revenue comes from a single business unit.

Related-Constrained - <70% of revenues from dominant business; all businesses share product, technological and distribution linkages.

Related-Linked – More than 30% but less than 70% of revenues come from outside the core business.

Unrelated-Diversified (conglomerate) - More than 70% of firm sales come from outside the core business.

IncentivesIncentives

ResourcesResources

ManagerialManagerialMotivesMotives

DiversificationDiversification

Rationales for Diversification



Incentives to Diversify

Anti-trust and tax laws.

• Cellar-Kefauver Act - Firms cannot acquire firms in related businesses.

• Tax rate differences

- Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions.

- After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments


Incentives to Diversify

Low profitability or poor industry outlook.

Uncertainty regarding future cash flows.

Firm risk reduction – unsystematic business specific risk.

RiskRisk

Level of DiversificationLevel of Diversification

DominantBusiness

UnrelatedBusiness

RelatedConstrained

SingleBusiness

RelatedLinked

Firm risk reduction – unsystematic business specific risk.


Resources

Despite incentives, managers need the resources to diversify.

Value creation is determined more by the appropriate use of resources than by incentives.

Managerial Motives

Diversification increases firm size, size is positively correlated with compensation.

Diversification reduces employment risk.


Types of Diversification

Why do large diversified companies have different approaches to diversification?

- Financial economies – Internal capital market.

- Vertical economies – Value chain activities.

- Synergistic economies – Exploit interrelationships across business units.

• May be due to different economic rationales for diversifying.

• May be due to distinctive competencies

• Concept of synergy

MultidivisionalMultidivisionalStructureStructure(M-form)(M-form)

Strategic Business-UnitStrategic Business-Unit(SBU) Form(SBU) Form

CooperativeCooperativeFormForm

CompetitiveCompetitiveFormForm


Types of Diversification and Variations

Vertical integrationRelated constrained

Related linked

Unrelated or conglomerate



Vertical integration strategies

Full integration

• Generally a dominant business.

• Firm enters into one or more businesses necessary to the manufacture and distribution of its own products.

• Forward and/or backward integration.

• Different degrees of integration

Partial integration

• Benefits?

GovernmentGovernmentAffairsAffairs

LegalLegalAffairsAffairs

CorporateCorporateR&D LabR&D Lab

StrategicStrategicPlanningPlanning

CorporateCorporateHumanHuman

ResourcesResources

CorporateCorporateMarketingMarketing

CorporateCorporateFinanceFinance

ProductProductDivisionDivision



PresidentPresident

Vertical economies

Vertical Integration



Horizontal diversification strategies

• Subset of related-constrained strategy.

• Firm acquires another firm in the same industry.

• Benefits?

- Decreases competition

- Facilitates market power and economies of scale

• Examples: Continental - Eastern, Compaq – HP.



Related constrained strategies

Sharing activities often lowers costs or raises differentiationSharing activities often lowers costs or raises differentiation.

Sharing activities can lower costs if it:Sharing activities can lower costs if it:

- achieves economies of scale.- achieves economies of scale. - boosts efficiency of utilization. - boosts efficiency of utilization. - helps move more rapidly down the learning curve- helps move more rapidly down the learning curve.

• Sharing activities:

Sharing activities can enhance potential for or reduce the Sharing activities can enhance potential for or reduce the cost of differentiation.cost of differentiation.

Must involve activities that are crucial to competitive advantage.Must involve activities that are crucial to competitive advantage.




Exploits interrelationships among divisionsExploits interrelationships among divisions.

Start with value chain analysis

- identify ability to transfer skills or expertise among similar value chains. - exploit ability to transfer activities

• Transferring core competencies:

Transferring core competencies leads to competitive advantage only if the similarities among business units meet the following conditions:




- activities involved in the businesses are similar enough that - activities involved in the businesses are similar enough that sharing sharing expertise is meaningful.expertise is meaningful.

- transfer of skills involves activities which are important transfer of skills involves activities which are important toto competitive advantage.competitive advantage.

- the skills transferred represent significant sources of the skills transferred represent significant sources of competitivecompetitive advantage for the receiving unitadvantage for the receiving unit




Tangible interrelationships: Tangible interrelationships:

• Synergies based on interrelationships:

* * Marketing* Production* Technological (R&D)* Procurement* Infrastructure.

- Sources of tangible interrelationships- Sources of tangible interrelationships

- Costs of achieving tangible interrelationships

* Coordination* Compromise* Inflexibility




Intangible interrelationships: Intangible interrelationships:

• Synergies based on interrelationships:

- Sharing of know-how, or transferring of skills that have already Sharing of know-how, or transferring of skills that have already been paid for.been paid for.- Same generic strategy- Same generic strategy- Same type of buyer- Same type of buyer- Similar configuration of value chain- Similar configuration of value chain- Similar important value activity- Similar important value activity- Example: Phillip Morris acquisition of Kraft and Miller Brewing.- Example: Phillip Morris acquisition of Kraft and Miller Brewing.

GovernmentGovernmentAffairsAffairs




CorporateCorporateHumanHuman

ResourcesResources






PresidentPresident

Related Constrained Strategy

Synergistic economies



Related linked strategies

• Very similar to related constrained except larger and more diversified.

• Related businesses are grouped into Strategic Business Units (SBUs).

Facilitates the realization of synergies within related units and across unrelated ones.

Allows integration of selected businesses as opposed to all businesses in a related constrained firm.

PresidentPresident



CorporateCorporateHRMHRM



DivisionDivision

DivisionDivisionDivisionDivision

SBUSBU SBUSBU SBUSBU

DivisionDivision


DivisionDivision


Vertical & Synergistic economiesFinancial economies

Related Linked Strategy



Unrelated diversified strategies

Firms using this strategy frequently use acquisitions.

• Efficient internal capital market

- acquire sound, attractive companies.- acquired units are autonomous.- acquiring corporation supplies needed capital.- portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs.- add professional management & control to sub-units.- sub-unit managers compensation based on unit results.



Unrelated diversified strategies

Scope of operating divisions.

• Efficient internal capital market

- Comparable in terms of performance criteria- Don’t overly concentrate in one business- Buy market leaders- Use wholly owned approach

Acquisition / divestment policies- Be able to maintain control -- Avoid high tech

and service- Avoid unfriendly acquisitions- Divest rather than turnaround- Don’t get into businesses that are difficult to

unload- If problems develop unload early

Unrelated Diversification Strategy

PresidentPresident


FinanceFinance AuditingAuditing

DivisionDivision DivisionDivision DivisionDivision DivisionDivision

Financial economies

Documents

Corporate Diversification