Chapter 7 - Corporate Diversification [PDF]

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Strategic Management & Competitive Advantage: Concepts and Cases Sixth Edition, Global Edition



Chapter 7 Corporate Diversification



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Learning Objectives (1 of 2) 7.1 Define corporate diversification and describe five types of corporate diversification. 7.2 Specify the two conditions that a corporate diversification strategy must meet to create economic value. a. Define the concept of “economies of scope” and identify nine potential economies of scope a diversified firm might try to exploit. b. Identify which of these economies of scope a firm’s outside equity investors can realize on their own at low cost. Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Learning Objectives (2 of 2) 7.3 Specify the circumstances under which a firm’s diversification strategy will be a source of sustained competitive advantage. a. Explain which of the economies of scope identified in this chapter are more likely to be subject to low-cost imitation and which are less likely to be subject to lowcost imitation. b. Identify two potential substitutes for corporate diversification.



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The Strategic Management Process



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Logic of Corporate Level Strategy Corporate level strategy should create value: 1. such that businesses forming the corporate whole are worth more than they would be under independent ownership 2. that equity holders cannot create through portfolio investing • Therefore, ‒ a corporate level strategy must create synergies ▪ economies of scope—diversification



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Integration and Diversification Integration



Forward



Backward



Diversification Other Businesses



No Links



Other Businesses



Current Businesses Unrelated



Related



Many Links



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Types of Corporate Diversification (1 of 2) At a general level… • Product Diversification: – operating in multiple industries • Geographic-Market Diversification: – operating in multiple geographic markets • Product-Market Diversification: – operating in multiple industries in multiple geographic markets



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Types of Corporate Diversification (2 of 2) When a firm chooses to diversify, it faces a decision as to how related the new business(es) is(are) to the existing businesses of the firm At a more specific level… • Limited Diversification – single business: >95% of sales in single business – dominant business: 70–95% in single business



• Related Diversification – related constrained: all businesses related on most dimensions (Pepsico) – related linked: some businesses related on some dimensions (Disney) • Unrelated Diversification – businesses are not related (General Electric) Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Types of Corporate Diversification Limited Diversification 1. Single business: > 95% of sales in single business: A single-business firm is technically not diversified because it gets 95 percent or more of its total revenues from one business.



2. Dominant business: 70% to 95% in single business: A dominant-business firm is different in that it has moved beyond a complete focus on one business by obtaining revenues from other businesses. However, it is still largely dependent upon one industry.



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Types of Corporate Diversification Related Diversification 3. Related-constrained: when all the businesses in which a firm operates share a significant number of inputs, production technologies, distribution channels, similar customers, etc. (most dimensions). Example : Bic, PepsiCo 4. Related-linked: when the different businesses that a single firm pursues are linked on only a couple of dimensions, or if different sets of businesses are linked along very different dimensions. Example : Disney Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Types of Corporate Diversification Unrelated Diversification 5. Businesses are not related An



unrelated diversified firm (called a conglomerate) owns businesses in its portfolio that share few, if any, common attributes. The management approach in such firms is to regard each business as a stand-alone entity.



Example: General Electric Transportation/energy/healthcare/ lighting



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Types of Corporate Diversification



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Product and Geographic Diversification • Possibilities: – single business in one geographic area – single business in multiple geographic areas – related constrained in one or multiple geographic areas – related linked in one or multiple geographic areas – unrelated in one or multiple geographic areas • Note: – Relatedness usually refers to products.



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Competitive Advantage If a diversification strategy meets the VRIO criteria… Is it Valuable? Is it Rare? Is it costly to Imitate? Is the firm Organized to exploit it? …it may create competitive advantage.



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Value of Diversification Two Criteria: for corporate diversification to be economically valuable, TWO conditions must hold



1) There must be some economy of scope (Economies of scope exist in a firm when the value of the products or services it sells increases as a function of the number of businesses in which that firm operates. The term scope refers to the range of businesses in which a diversified firm operates). 2) The focal firm must have a cost advantage over outside equity holders in exploiting any economies of scope Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Value of Diversification (2 of 2)



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Economies of Scope (1 of 7) Types



1. Operational Economies of Scope 2. Financial Economies of Scope



3. Anticompetitive Economies of Scope 4. Managerialism (employee & stakeholder incentive for diversification)



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Economies of Scope (2 of 7) 1. Operational Economies of Scope 1.1 Sharing Activities – exploiting efficiencies of sharing business activities - Increase revenue (product bundles and positive reputations) Example: IBM, HP, GM 1.2 Spreading Core Competencies ‒ exploiting core competencies in other businesses ‒ competency must be strategically relevant Example: Orbitz Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Economies of Scope A Hypothetical Firm Sharing Activities Among Three Businesses



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Economies of Scope (3 of 7) 2- Financial Economies of Scope 2.1 Internal Capital Market – Premise: insiders can allocate capital across divisions more efficiently than the external capital market. ▪ works only if managers have detailed and accurate information about the actual performance of the business.



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Economies of Scope (4 of 7) 2.2 Risk Reduction – counter cyclical businesses may provide decreased overall risk However, individual investors can usually do this more efficiently than a firm 2.3 Tax Advantages – Diversified firms may also benefit from tax advantages. Losses in one business can offset profits in others . – Tax advantages of diversification can be especially important in the international context. Because of differing tax rates across borders. Example: Ireland



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Economies of Scope (6 of 7) 3- Anticompetitive Economies of Scope • Multipoint Competition – mutual forbearance ▪ a firm chooses not to compete aggressively in one market to avoid competition in another market Example: P&G and Unilever : American Airlines and Delta • Market Power ‒ using profits from one business to compete in another business ‒ using buying power in one business to obtain advantage in another business Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Economies of Scope (7 of 7) 4- Firm Size and Employee Incentives to Diversify – Managers of larger firms receive more compensation (larger scope = more compensation). – Therefore, managers have an incentive to acquire other firms and become ever larger. • Recently, the traditional relationship between firm size and management compensation has begun to break down. More and more, the compensation of senior managers is being tied to the firm’s economic performance. Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Equity Holders and Economies of Scope • Most economies of scope cannot be captured by equity holders. – Risk reduction can be captured by equity holders. • Managers should consider whether corporate diversification will generate economies of scope that equity holders can capture. – If a corporate diversification move is unlikely to generate valuable economies of scope, managers should avoid it.



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Rareness of Diversification Diversification per se is not rare. • Underlying economies of scope may be rare. – Relationships that allow an economy of scope to be exploited may be rare. – An economy of scope may be rare because it is naturally or economically limited.



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Imitability of Diversification (1 of 2) Duplication of Economies of Scope Less Costly-to-Duplicate



Costly-to-Duplicate



Shared Activities*



Core Competencies



Tax Advantages



Internal Capital Allocation



Risk Reduction



Multipoint Competition



Employee Compensation



Exploiting Market Power



(codified/tangible)



(tacit/intangible)



*may be costly depending on relationships



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Imitability of Diversification (2 of 2) Substitution of Economies of Scope • Internal Development • start a new business under the corporate whole



• avoids potential cross-firm integration issues • Strategic Alliances • find a partner with the desired complementary assets



• less costly than acquiring a firm Competitors may use these strategies to arrive at a position of diversification without buying another firm. Copyright © 2019 Pearson Education, Ltd. All Rights Reserved



Summary (1 of 2) • Corporate Strategy: In what businesses should the firm operate? – An understanding of diversification helps managers answer that question. Two Criteria: 1. economies of scope must exist 2. must create value that outside equity holders cannot create on their own



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Summary (2 of 2) Economies of Scope – a case of synergy—combined activities generate greater value than independent activities – may generate competitive advantage if they meet the VRIO criteria Firms should pursue diversification only if careful analysis shows that competitive advantage is likely!



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