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Education.

Corporate-Level

Strategy: Creating

Value through

Diversificationchapter 6

Learning Objectives6-2

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.

Learning Objectives

LO6.4 How corporations can use unrelated diversification to attain synergistic benefits through 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.

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Corporate-Level Strategy

Consider…

What businesses should a corporation compete in?

How can these businesses be managed so they create “synergy” – that is, create more value by working together than if they were freestanding units?

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Making Diversification Work

Diversification initiatives must create value for shareholders through Mergers and acquisitions Strategic alliances Joint ventures Internal development

Diversification should create synergy

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Making Diversification Work

A firm may diversify into related businesses Benefits derive from horizontal relationships

Sharing intangible resources such as core competencies in marketing

Sharing tangible resources such as production facilities

A firm may diversify into unrelated businesses Benefits derive from hierarchical relationships

Value creation derived from the corporate office Leveraging support activities in the value chain

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Related Diversification

Related diversification enables a firm to benefit from horizontal relationships across different businesses

Economies of scope allow businesses to: Leverage core competencies Share related activities Enjoy greater revenues

Related businesses gain market power by: Pooled negotiating power Vertical integration

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Question?

Sharing core competencies is one of the primary potential advantages of diversification. In order for diversification to be most successful, it is important thatA. the similarity required for sharing core

competencies must be in the value chain, not in the product.

B. the products use similar distribution channels.C. the target market is the same, even if the

products are very different.D. the methods of production are the same.

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Related Diversification: Leveraging Core Competencies

Core competencies reflect the collective learning in organizations. Can lead to the creation of value and synergy if…

They create superior customer value The value chain elements in separate

businesses require similar skills They are difficult for competitors to

imitate or find substitutes for

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Related Diversification: Sharing Activities

Corporations can also achieve synergy by sharing activities across their business units.

Sharing tangible & value-creating activities can provide payoffs: Cost savings through elimination of jobs,

facilities & related expenses, or economies of scale

Revenue enhancements through increased differentiation & sales growth

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Related Diversification: Market Power

Market power can lead to the creation of value and synergy through…

Pooled negotiating power Gaining greater bargaining power with

suppliers & customers

Vertical integration - becoming its own supplier or distributor through Backward integration Forward integration

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Example: Question?

Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input into its manufacturing process. This is an example ofA. leveraging core competencies.B. pooled negotiating power.C. vertical integration.D. sharing activities.

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Related Diversification: Vertical Integration

Exhibit 6.3 Simplified Stages of Vertical Integration: Shaw Industries

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Related Diversification: Vertical Integration

1. It is the company satisfied with the quality of the value that its present suppliers & distributors are providing?

2. Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?

3. Is there a high level of stability in the demand for the organization’s products?

4. Does the company have the necessary competencies to execute the vertical integration strategies?

5. Will the vertical integration initiatives have potential negative impacts on the firm’s stakeholders?

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Related Diversification: Vertical Integration

The transaction cost perspective Every market transaction involves some

transaction costs: Search costs Negotiating costs Contract costs Monitoring costs Enforcement costs Need for transaction specific investments Administrative costs

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Unrelated Diversification

Unrelated diversification enables a firm to benefit from vertical or hierarchical relationships between the corporate office & individual business units through…

The corporate parenting advantage Providing competent central functions

Restructuring to redistribute assets Asset, capital, & management restructuring

Portfolio management BCG growth/share matrix

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Unrelated Diversification: Parenting & Restructuring

Parenting allows the corporate office to create value through management expertise & competent central functions

In restructuring the parent intervenes: Asset restructuring involves the sale of

unproductive assets Capital restructuring involves changing the

debt–equity mix, adding debt or equity Management restructuring involves changes

in the top management team, organizational structure, & reporting relationships

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Unrelated Diversification: Portfolio Management

Portfolio management involves a better understanding of the competitive position of an overall portfolio or family of businesses by… Suggesting strategic alternatives for each

business Identifying priorities for the allocation of

resources Using Boston Consulting Group’s (BCG)

growth/share matrix

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Unrelated Diversification: Portfolio Management

Each circle represents one of the firm’s business units. The size of the circle represents the relative size of the business unit in terms of revenue.

Exhibit 6.5 The Boston Consulting Group (BCG) Portfolio Matrix

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Unrelated Diversification: Portfolio Management

Limitations of portfolio models: SBUs are compared on only two dimensions

& each SBU is considered a standalone entity Are these the only factors that really matter? Can every unit be accurately compared on that

basis? What about possible synergies? An oversimplified graphical model

substitutes for managers’ experience Following strict & simplistic rules for

resource allocation can be detrimental to a firm’s long-term viability

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Example: Goal of Diversification = Risk Reduction?

Diversification can reduce variability in revenues & profits over time. However… Stockholders can diversify portfolios at a

much lower cost & economic cycles are difficult to predict, so why diversify?

Example = General Electric’s businesses: Aircraft engines, power generation

equipment, locomotive trains, large appliances, healthcare products, financial products, lighting, mining, oil & gas

Why is GE in so many businesses?

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Means of Diversification

Diversification can be accomplished via Mergers & acquisitions

And divestment Pooling resources of other companies with

a firm’s own resource base through Strategic alliances & joint ventures

Internal Development through Corporate entrepreneurship

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Mergers and Acquisitions

Mergers involve a combination or consolidation of two firms to form a new legal entity: Are relatively rare The two firms are on a relatively equal

basis Acquisitions involve one firm buying

another either through stock purchase, cash, or the issuance of debt

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Mergers and Acquisitions

Exhibit 6.6 Global Value of Mergers and Acquisitions ($ trillion)Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis

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Mergers and Acquisitions: Motives

In high-technology & knowledge-intensive industries, speed is critical: acquiring is faster than building.

M&A allows a firm to obtain valuable resources that help it expand its product offerings & services.

M&A helps a firm develop synergy: Leveraging core competencies Sharing activities Building market power

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Mergers and Acquisitions: Motives

M&A can lead to consolidation within an industry, forcing other players to merge.

Corporations can also enter new market segments by way of acquisitions.

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Mergers and Acquisitions: Limitations

Takeover premiums for acquisitions are typically very high

Competing firms can imitate advantages Competing firms can copy synergies Managers’ egos get in the way of sound

business decisions Cultural issues may doom the intended

benefits

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Question?

Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These includeA. enabling managers to focus their efforts more

directly on the firm’s core businesses.B. providing the firm with more resources to spend

on more attractive alternatives.C. raising cash to help fund existing businesses.D. all of the above.

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Mergers and Acquisitions: Divestment

Divestment objectives include: Cutting the financial losses of a failed

acquisition Redirecting focus on the firm’s core

businesses Freeing up resources to spend on more

attractive alternatives Raising cash to help fund existing

businesses

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Mergers and Acquisitions: Divestment

Successful divestiture involves: Removing emotion from the decision Knowing the value of the business you’re

selling Timing the deal right Maintaining a sizable pool of potential buyers Telling a story about the deal Running divestitures systematically through a

project office Communicating clearly and frequently

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Strategic Alliances & Joint Ventures: Motives

Strategic alliances & joint ventures are cooperative relationships with potential advantages: Ability to enter new markets through

Greater financial resources Greater marketing expertise

Ability to reduce manufacturing or other costs in the value chain

Ability to develop & diffuse new technologies

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Strategic Alliances & Joint Ventures: Limitations

Need for the proper partner: Partners should have complementary

strengths Partner’s strengths should be unique

Uniqueness should create synergies Synergies should be easily sustained & defended

Partners must be compatible & willing to trust each other

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Internal Development

Corporate entrepreneurship & new venture development motives: No need to share the wealth with alliance

partners No need to face difficulties associated with

combining activities across the value chains No need to merge diverse corporate cultures

Limitations: Time-consuming Need to continually develop new capabilities

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Managerial Motives

Managerial motives: Managers may act in their own self interest – eroding rather than enhancing value creation through Growth for growth’s sake

Top managers gain more prestige, higher rankings, greater incomes, more job security

It’s exciting and dramatic! Excessive egotism Use of antitakeover tactics

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Managerial Motives: Antitakeover Tactics

Antitakeover tactics include: Green mail Golden parachutes Poison pills

Can benefit multiple stakeholders – not just management

Can raise ethical considerations because the managers of the firm are not acting in the best interests of the shareholders

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