Strategy at the Corporate Level

(1)

©

©_{2007 Thomson/South}_{2007 Thomson/South}_-_-_Western._Western.

PowerPoint Presentation by Charlie Cook

The University of West Alabama

Strategic Management

Competitiveness and Globalization:

Concepts and Cases

Michael A. Hitt • R. Duane Ireland • Robert E. Hoskisson

Seventh edition

Strategy at the Corporate

Level

Management of Strategy

Concepts and Cases

(2)

K

KNOWLEDGENOWLEDGE OOBJECTIVESBJECTIVES

1.

1. Define corporate-Define corporate-level strategy and discuss its purpose.level strategy and discuss its purpose.

2.

2. Describe different levels of diversification with different corporateDescribe different levels of diversification with different corporate- -level strategies.

level strategies.

3.

3. Explain three primary reasons firms diversify.Explain three primary reasons firms diversify.

4.

4. Describe how firms can create value by using a relatedDescribe how firms can create value by using a related diversification strategy.

diversification strategy.

5.

5. Explain the two ways value can be created with an unrelatedExplain the two ways value can be created with an unrelated diversification strategy.

diversification strategy.

6.

6. Discuss the incentives and resources that encourageDiscuss the incentives and resources that encourage diversification.

diversification.

7.

7. Describe motives that can encourage managers toDescribe motives that can encourage managers to overdiversifyoverdiversify aa firm.

firm.

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The Role of Diversification

•

• Diversification strategies play a major role in the

Diversification strategies play a major role in the

behavior of large firms.

•

• Product diversification concerns:

Product diversification concerns:



The scope of the industries and markets in which theThe scope of the industries and markets in which the firm competes.

firm competes.



How managers buy, create and sell differentHow managers buy, create and sell different businesses to match skills and strengths with businesses to match skills and strengths with opportunities presented to the firm.

(4)

Two Strategy Levels

•

• Business

Business

-

level Strategy (Competitive)



Each business unit in a diversified firm chooses aEach business unit in a diversified firm chooses a business

business--level strategy as its means of competing inlevel strategy as its means of competing in individual product markets.

individual product markets.

•

• Corporate

Corporate

-

level Strategy (Companywide)



Specifies actions taken by the firm to gain aSpecifies actions taken by the firm to gain a

competitive advantage by selecting and managing a competitive advantage by selecting and managing a group of different businesses competing in several group of different businesses competing in several industries and product markets.

(5)

Corporate

-

Level Strategy: Key Questions

•

• Corporate

Corporate

-level Strategy

-

level Strategy

’

s Value



The degree to which the businesses in the portfolioThe degree to which the businesses in the portfolio are worth more under the management of the

are worth more under the management of the

company than they would be under other ownership. company than they would be under other ownership.



What businesses shouldWhat businesses should the firm be in?

the firm be in?



How should the corporateHow should the corporate office manage the

office manage the

group of businesses?

Business Units

(6)

Levels of Diversification: Low Level

Dominant Business

Between 70% and 95% of Between 70% and 95% of

revenue comes from a single revenue comes from a single

business. business.

A

B

Single Business

More than 95% of revenue More than 95% of revenue

(7)

Levels of Diversification: Moderate to High

•

• Related ConstrainedRelated Constrained



 Less than 70% of revenueLess than 70% of revenue comes from a single

comes from a single

business and all

businesses share

product, technological

and distribution linkages.

•

• Related Linked (mixedRelated Linked (mixed related and unrelated)

related and unrelated) 

Less than 70% of revenueLess than 70% of revenue comes from the dominant

comes from the dominant

business, and there are only

limited links between

(8)

Levels of Diversification: Very High Levels

•

• Unrelated Diversification

Unrelated Diversification



Less than 70% of revenue comes from the dominant_{Less than 70% of revenue comes from the dominant} business, and there are no common links between business, and there are no common links between businesses.

businesses.

C

B

(9)

FIGURE

FIGURE 6.16.1 _{Levels and Types of Diversification}_{Levels and Types of Diversification}

(10)

Table

Table 6.16.1 _{Reasons for Diversification}_{Reasons for Diversification}

Value-Creating Diversification • Economies of scope (related

diversification)

• Sharing activities

• Transferring core competencies

• Market power (related diversification)

• Blocking competitors through multipoint competition

• Vertical integration

• Financial economies (unrelated diversification)

• Efficient internal capital allocation

• Business restructuring

Value-Neutral Diversification • Antitrust regulation

• Tax laws

• Low performance

• Uncertain future cash flows

• Risk reduction for firm

• Tangible resources

• Intangible resources

Value-Reducing Diversification

• Diversifying managerial employment risk

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High Low

Value

-

Creating Strategies of Diversification

Operational and Corporate Relatedness

Corporate Relatedness: Transferring Skills into Businesses through Corporate Headquarters Operational

(Economies of Scope)

Both Operational and

Corporate Relatedness

(Rare capability that creates

diseconomies of scope)

(12)

FIGURE

FIGURE 6.26.2 _Value_Value_-_-_{Creating Diversification Strategies:}_{Creating Diversification Strategies:}

Operational and Corporate Relatedness

(13)

Related Diversification

•

• Firm creates value by building upon or

Firm creates value by building upon or

extending:



ResourcesResources



CapabilitiesCapabilities



Core competenciesCore competencies

•

• Economies of Scope

Economies of Scope



Cost savings that occur when a firm transfersCost savings that occur when a firm transfers

capabilities and competencies developed in one of its capabilities and competencies developed in one of its businesses to another of its businesses.

(14)

Related Diversification: Economies of Scope

•

• Value is created from economies of scope

Value is created from economies of scope

through:



Operational relatedness in sharing activitiesOperational relatedness in sharing activities



Corporate relatedness in transferring skills or_{Corporate relatedness in transferring skills or} corporate core competencies among units. corporate core competencies among units.

•

• The difference between sharing activities and

The difference between sharing activities and

transferring competencies is based on how the

resources are jointly used to create economies

(15)

Sharing Activities

•

• Operational Relatedness

Operational Relatedness



Created by sharing either a primary activity such asCreated by sharing either a primary activity such as inventory delivery systems, or a support activity such inventory delivery systems, or a support activity such as purchasing.

as purchasing.



Activity sharing requires sharing strategic control overActivity sharing requires sharing strategic control over business units.

business units.



Activity sharing may create risk because business-Activity sharing may create risk because business -unit ties create links between outcomes.

(16)

Transferring Corporate Competencies

•

• Corporate Relatedness

Corporate Relatedness



Using complex sets of resources and capabilities to_{Using complex sets of resources and capabilities to} link different businesses through managerial and link different businesses through managerial and

(17)

Corporate Relatedness

•

• Creates value in two ways:

Creates value in two ways:



Eliminates resource duplication in the need to allocateEliminates resource duplication in the need to allocate resources for a second unit to develop a competence resources for a second unit to develop a competence that already exists in another unit.

that already exists in another unit.



Provides intangible resources (resource intangibility)Provides intangible resources (resource intangibility) that are difficult for competitors to understand and that are difficult for competitors to understand and imitate.

imitate.

•

• A transferred intangible resource gives the unit receiving it anA transferred intangible resource gives the unit receiving it an immediate competitive advantage over its rivals.

(18)

Related Diversification: Market Power

•

• Market power exists when a firm can:

Market power exists when a firm can:



Sell its products above the existing competitive level_{Sell its products above the existing competitive level} and/or

and/or



Reduce the costs of its primary and support activitiesReduce the costs of its primary and support activities below the competitive level.

(19)

Related Diversification: Market Power

(cont

’

d)

•

• Multipoint Competition

Multipoint Competition



Two or more diversified firms simultaneously competeTwo or more diversified firms simultaneously compete in the same product areas or geographic markets.

in the same product areas or geographic markets.

•

• Vertical Integration

Vertical Integration



Backward integrationBackward integration——a firm produces its own inputs.a firm produces its own inputs.



(20)

Related Diversification: Complexity

•

• Simultaneous Operational Relatedness and

Simultaneous Operational Relatedness and

Corporate Relatedness



Involves managing two sources of knowledgeInvolves managing two sources of knowledge simultaneously:

simultaneously:

•

• Operational forms of economies of scopeOperational forms of economies of scope

•

• Corporate forms of economies of scopeCorporate forms of economies of scope



Many such efforts often fail because ofMany such efforts often fail because of implementation difficulties.

(21)

Unrelated Diversification

•

• Financial Economies

Financial Economies



Are cost savings realized through improvedAre cost savings realized through improved allocations of financial resources.

allocations of financial resources.

•

• Based on investments inside or outside the firmBased on investments inside or outside the firm



Create value through two types of financialCreate value through two types of financial economies:

economies:

•

• Efficient internal capital allocationsEfficient internal capital allocations

•

• Purchase of other corporations and the restructuring theirPurchase of other corporations and the restructuring their assets

(22)

Unrelated Diversification (cont

’

d)

•

• Efficient Internal Capital Market Allocation

Efficient Internal Capital Market Allocation



Corporate office distributes capital to businessCorporate office distributes capital to business divisions to create value for overall company. divisions to create value for overall company.

•

• Corporate office gains access to information about thoseCorporate office gains access to information about those businesses

businesses’’ actual and prospective performance.actual and prospective performance.



Conglomerates have a fairly short life cycle becauseConglomerates have a fairly short life cycle because financial economies are more easily duplicated by financial economies are more easily duplicated by competitors than are gains from operational and competitors than are gains from operational and corporate relatedness.

(23)

Unrelated Diversification: Restructuring

•

• Restructuring creates financial economies

Restructuring creates financial economies



A firm creates value by buying and selling other firmsA firm creates value by buying and selling other firms’’ assets in the external market.

assets in the external market.

•

• Resource allocation decisions may become

Resource allocation decisions may become

complex, so success often requires:



Focus on mature, lowFocus on mature, low--technology businesses.technology businesses.



Focus on businesses not reliant on a clientFocus on businesses not reliant on a client orientation.

(24)

External Incentives to Diversify

•

• Antitrust laws in 1960s and 1970sAntitrust laws in 1960s and 1970s discouraged mergers that created discouraged mergers that created increased market power (vertical or increased market power (vertical or horizontal integration.

horizontal integration.

•

• Mergers in the 1960s and 1970s thusMergers in the 1960s and 1970s thus tended to be unrelated.

tended to be unrelated.

•

• Relaxation of antitrust enforcementRelaxation of antitrust enforcement results in more and larger horizontal results in more and larger horizontal mergers.

mergers.

•

(25)

External Incentives to Diversify (cont

’

d)

•

• High tax rates on dividends cause aHigh tax rates on dividends cause a corporate shift from dividends to corporate shift from dividends to

buying and building companies in high buying and building companies in high- -performance industries.

performance industries.

•

• 1986 Tax Reform Act1986 Tax Reform Act



 Reduced individual ordinary income taxReduced individual ordinary income tax rate from 50 to 28 percent.

rate from 50 to 28 percent.



 Treated capital gains as ordinaryTreated capital gains as ordinary income.

income.



 Thus created incentive for shareholdersThus created incentive for shareholders to prefer dividends to acquisition

to prefer dividends to acquisition

(26)

Internal Incentives to Diversify

•

• High performance eliminates theHigh performance eliminates the need for greater diversification.

need for greater diversification.

•

• Low performance acts asLow performance acts as incentive for diversification.

incentive for diversification.

•

• Firms plagued by poorFirms plagued by poor

performance often take higher

risks (diversification is risky).

Low

Performance

(27)

FIGURE

FIGURE 6.36.3 The Curvilinear Relationship betweenThe Curvilinear Relationship between

Diversification and Performance

(28)

Internal Incentives to Diversify (cont

’

d)

•

• Diversification may be

Diversification may be

defensive strategy if:



Product line matures.Product line matures.



Product line is threatened.Product line is threatened.



Firm is small and is in matureFirm is small and is in mature or maturing industry.

or maturing industry.

Low Low

Performance Performance

Uncertain

Future Cash

Flows

(29)

Internal Incentives to Diversify (cont

’

d)

•

• Synergy exists when the value createdSynergy exists when the value created by businesses working together

by businesses working together exceeds

exceeds the value created by themthe value created by them working independently

working independently

•

• …… but synergy creates jointbut synergy creates joint

interdependence between business interdependence between business units.

units.

•

• A firm may become risk averse andA firm may become risk averse and constrain its level of activity sharing. constrain its level of activity sharing.

•

• A firm may reduce level of technologicalA firm may reduce level of technological change by operating in more certain

(30)

Resources and Diversification

•

• A firm must have both:

A firm must have both:



Incentives to diversify_{Incentives to diversify}



The resources required to create value throughThe resources required to create value through diversification

diversification——cash and tangible resources (e.g.,cash and tangible resources (e.g., plant and equipment)

plant and equipment)

•

• Value creation is determined more by

Value creation is determined more by

appropriate use of resources than by incentives

to diversify.

•

• Managerial Motives to Diversify

Managerial Motives to Diversify



Managerial risk reductionManagerial risk reduction



(31)

FIGURE

FIGURE 6.46.4

Summary Model of the

Relationship between

Firm Performance and

Diversification