Learning Objectives
Studying this chapter should provide you with
the strategic management knowledge needed to:
1. Define corporate-level strategy and discuss its purpose.
2. Describe different levels of diversification achieved using different
corporate-level strategies.
3. Explain three primary reasons firms diversify.
4. Describe how firms can create value by using a related diversification
strategy.
5. Explain the two ways value can be created with an unrelated
diversification strategy.
6. Discuss the incentives and resources that encourage diversification.
7. Describe motives that can encourage managers to over diversify
a firm.
6–1
Two Strategy Levels
• Business-level Strategy (Competitive)
– Each business unit in a diversified firm chooses a
business-level strategy as its means of competing in
its individual product markets.
• Corporate-level Strategy (Companywide)
– Specifies actions taken by the firm to gain a
competitive advantage by selecting and managing a
group of different businesses competing in different
product markets.
– Value orientation
6–2
Corporate-Level Strategy:
Key Questions
• Corporate-level Strategy’s Value
– The degree to which the businesses in the portfolio
are worth more under the management of the firm
than they would be under other ownership.
– What businesses should
the firm be in?
– How should the corporate
office manage the
group of businesses?
Business Units
6–3
The Role of Diversification
• Diversification strategies play a major role in the
behavior of large firms.
• Product diversification concerns:
– the scope of the industries and markets in which the
firm competes.
– how managers buy, create and sell different
businesses to match skills and strengths with
opportunities presented to the firm.
6–4
Levels of Diversification: Low Level
• Dominant Business
– Between 70% and 95% of revenue
comes from a singe business A
– Ex. UPS
• Single Business
– 95% or more revenue
comes from a single business
– Ex. McIlhenny’s Tobasco
A
B
6–5
Surgeon
Father Radiologist Related
(Architect)
Constrained
Medicine Diversification
Pharmacy
Surgeon
Father Civil Engineer Related Linked
(Architect) Diversification
MBA
Journalism
1–6
Business-man
Father Athlete
(Architect)
Artist
Freelancer
Unrelated
Diversification
1–7
Levels of Diversification: Moderate
to High
Related Constrained Related Linked (mixed
related and unrelated
– Less than 70% of revenue – Less than 70% of revenue
comes from a single business comes from the dominant
and all businesses share business, and there are only
product, technological and limited links between
distribution linkages. businesses. Shared
– Ex. Publicis competence.
– Ex. GE
A A
B C B C
6–8
Levels of Diversification:
Very High Levels
• Unrelated Diversification
– Less than 70% of revenue comes from the dominant
business, and there are no common links between
businesses.
– Ex. Tata
A
B C
6–9
Levels of Diversification
6–10
Reasons for Diversification
6–11
Value Creating Strategies: Operational
and Corporate
6–12
Related Diversification
• Firms create value by building upon or
extending:
– resources
– capabilities
– core competencies
• Economies of Scope
– Cost savings that occur when a firm transfers
capabilities and competencies developed in one of its
businesses to another of its businesses.
6–13
Related Diversification:
Economies of Scope
• Value is created from economies of scope
through:
– operational relatedness in sharing activities.
– corporate relatedness in transferring skills or
corporate core competencies among units.
• The difference between sharing activities and
transferring competencies is based on how the
resources are jointly used to create economies
of scope.
6–14
Sharing Activities
• Operational Relatedness
– Created by sharing either a primary activity such as
inventory delivery systems, or a support activity such
as purchasing.
– Activity sharing requires sharing strategic control over
business units.
– Activity sharing may create risk because business-
unit ties create links between outcomes.
6–15
Transferring Corporate Competencies
• Corporate Relatedness
– Using complex sets of resources and capabilities to
link different businesses through managerial and
technological knowledge, experience, and expertise.
6–16
Corporate Relatedness
• Creates value in two ways:
– eliminates resource duplication in the need to allocate
resources for a second unit to develop a competence
that already exists in another unit.
– provides intangible resources (resource intangibility)
that are difficult for competitors to understand and
imitate.
• A transferred intangible resource gives the unit receiving it an
immediate competitive advantage over its rivals.
6–17
Related Diversification: Market Power
• Market power exists when a firm can:
– sell its products above the existing competitive level
and/or
– reduce the costs of its primary and support activities
below the competitive level.
– Ex. 3G Capital partners (Heinz, Burger King, Tim
Hortons) backed by Berkshire
6–18
Related Diversification:
Market Power (cont’d)
• Multipoint Competition
– Two or more diversified firms simultaneously compete
in the same product areas or geographic markets.
– Zomato/Swiggy, Pepsi/Coca-cola
• Vertical Integration
– Backward integration — a firm produces its own
inputs.
– Forward integration — a firm operates its own
distribution system for delivering its outputs.
6–19
Related Diversification: Complexity
• Simultaneous Operational Relatedness and
Corporate Relatedness
– Involves managing two sources of knowledge
simultaneously
• Operational forms of economies of scope
• Corporate forms of economies of scope
– Many such efforts often fail because of
implementation difficulties.
– Ex. Disney (parks, resorts, media network, consumer
products)
6–20
Unrelated Diversification
• Financial Economies:
– are cost savings realized through improved
allocations of financial resources.
• Based on investments inside or outside the firm
– create value through two types of financial
economies:
• Efficient internal capital allocations
• Purchase of other corporations and the restructuring their
assets
6–21
Unrelated Diversification (cont’d)
• Efficient Internal Capital Market Allocation
– Corporate office distributes capital to business
divisions to create value for overall company.
• Corporate office gains access to information about those
businesses’ actual and prospective performance.
– Conglomerate life cycles are fairly short life cycle
because financial economies are more easily
duplicated by competitors than are gains from
operational and corporate relatedness.
6–22
Unrelated Diversification: Restructuring
• Restructuring creates financial economies
– A firm creates value by buying and selling other firms’
assets in the external market.
• Resource allocation decisions may become
complex, so success often requires:
– focus on mature, low-technology businesses.
– focus on businesses not reliant on a client orientation.
6–23
External Incentives to Diversify
Anti-trust • Antitrust laws in 1960s and 1970s
Legislation discouraged mergers that created
increased market power (vertical or
horizontal integration.
• Mergers in the 1960s and 1970s thus
tended to be unrelated.
• Relaxation of antitrust enforcement
results in more and larger horizontal
mergers.
• Early 2000: antitrust concerns seem to
be emerging and mergers are now
more closely scrutinized.
6–24
External Incentives to Diversify (cont’d)
Anti-trust • High tax rates on dividends cause
Legislation a corporate shift from dividends to
buying and building companies in
high-performance industries.
Tax Laws
• 1986 Tax Reform Act
– Reduced individual ordinary
income tax rate from 50 to 28
percent.
– Treated capital gains as
ordinary income.
– Created incentive for
shareholders to prefer dividends
to acquisition investments.
6–25
Internal Incentives to Diversify
Low • High performance eliminates the need
Performance for greater diversification.
• Low performance acts as incentive for
diversification.
• Firms plagued by poor performance
often take higher risks (diversification
is risky).
6–26
Internal Incentives to Diversify
Low
Performance • Diversification may be defensive
strategy if:
Uncertain – product line matures.
Future Cash
Flows – product line is threatened.
– firm is small and is in mature or
maturing industry.
6–27
Internal Incentives to Diversify
Low • Synergy exists when the value created
Performance by businesses working together
exceeds the value created by them
Uncertain working independently.
Future Cash • But synergy creates joint
Flows
interdependence between business
Synergy and units.
Firm Risk • A firm may become risk averse and
Reduction constrain its level of activity sharing.
• A firm may reduce level of technological
change by operating in more certain
environments.
6–28
• Tata Steel, one of India’s largest steel producers,
acquired Corus, a British-Dutch steel company, for $12.9
billion. The deal was meant to give Tata access to
European markets and advanced technology (Sub-prime
crisis, high debt)
• Quaker Oats, known for its oatmeal and Gatorade,
purchased Snapple, a trendy bottled tea and juice
company, for $1.7 billion. The idea was to replicate
Gatorade’s success by leveraging its existing distribution
network. (High competition, Overpriced)
• Before the acquisition, Disney was struggling with its animated
movies, while Pixar (which had made hits like Toy Story, Finding
Nemo, and The Incredibles) was dominating the industry. Disney
wanted to regain its leadership in animation, and Pixar needed
Disney’s distribution and marketing power.
• Hindustan Unilever (HUL), India’s largest FMCG company, acquired
GSK Consumer Healthcare India (makers of Horlicks, Boost,
and other health food drinks) for ₹31,700 crore ($4.2 billion) .
The deal was aimed at strengthening HUL’s presence in the health
and wellness segment, which was a growing market in India.
Resources and Diversification
• A firm must have both:
– Incentives to diversify
– The resources required to create value through
diversification—cash and tangible resources (e.g., plant
and equipment)
• Value creation is determined more by appropriate
use of resources than by incentives to diversify.
• Strategic competitiveness is improved when the
level of diversification is appropriate for the level
of available resources.
6–33
Value-Reducing Diversification:
Managerial Motives to Diversify
• Managerial motives to diversify
– Managerial risk reduction
– Desire for increased compensation
– Build personal performance reputation
• Effects of inadequate internal firm governance
– Diversification fails to earn even average returns
– Threat of hostile takeover
– Self-interest actions of entrenched management
© 2017Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitt 6–34
ed in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Relationship between Diversification
and Firm Performance
6–35
