Management of Strategy Concepts International Edition 10th Edition Ireland Solutions Manual Download

Chapter 6: Corporate-Level Strategy
Management of Strategy Concepts

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Chapter 5
Chapter 6
Corporate-Level Strategy
KNOWLEDGE OBJECTIVES
1. Define corporate-level strategy and discuss its purpose.

2. Describe different levels of diversification with 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 overdiversify a firm.
CHAPTER OUTLINE
Opening Case General Electric: The Quintessential Diversified Firm
LEVELS OF DIVERSIFICATION
Low Levels of Diversification
Strategic Focus Relatedness Among Business Bears Fruit at the Publicis Groupe
Moderate and High Levels of Diversification
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REASONS FOR DIVERSIFICATION
VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND
RELATED LINKED DIVERSIFICATION
Operational Relatedness: Sharing Activities
Corporate Relatedness: Transferring of Core Competencies
Market Power
Strategic Focus The Economic Power of Google and the Competitive Derivatives
Simultaneous Operational Relatedness and Corporate Relatedness
UNRELATED DIVERSIFICATION
Efficient Internal Capital Market Allocation
Restructuring of Assets
Strategic Focus Danaher and ITW: Serial Acquirers of Diversified Industrial
Manufacturing Businesses
VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES
Incentives to Diversify
Resources and Diversification
VALUE-REDUCING DIVERSIFICATION: MANAGERIAL MOTIVES TO
DIVERSIFY
SUMMARY
REVIEW QUESTIONS
EXPERIENTIAL EXERCISES
VIDEO CASE
NOTES
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LECTURE NOTES
Chapter Introduction: Chapters 4 and 5 looked at strategy at the level of the

business and focused on the factors and approaches that can lead to
competitive advantage and superior performance. Chapter 6 takes this a step
further by standing back to consider strategy at a higher level—corporate
strategy. The concern here is for the performance benefits that are derived
from putting together an effective “portfolio of businesses”—that is, putting
businesses together in a way that makes sense and can generate synergies
between units. The discussion of this chapter builds toward a summary
presented in Figure 6.4. It might be helpful to review that figure carefully
before starting into the material of the chapter.
OPENING CASE
General Electric: The Quintessential Diversified Firm
General Electric is a diversified company with a storied past. It currently competes in 16

different industries. These businesses are grouped into four GE divisions: GE Capital, GE
Energy, GE Technology Infrastructure, and GE Home & Business Solutions. In recent
years, however, more than 50 percent of GE’s annual revenue came from the GE Capital
division. Though it has encountered problems throughout its history, it is at a critical
point at present. GE appears to be placing large bets on its green energy business and
only time will tell if these investments pay off.
Teachng Note: GE has encountered numerous problems during its

history but it is at a critical juncture now. GE management capability has
been called into question and its future is anything but certain. GE’s stock
has gone from around $60 per share in 2000 to around $16 in late 2011.
Its exposure to European debt is tremendous and if the euro collapses,
GE would be severely crippled, if it survived at all. For reasons that are not
at all obvious, CEO Immelt remains the helm despite GE’s awful
performance record over the past decade. Ask students to evaluate GE’s
mix of businesses. Does this combination make sense? Ask students how
GE’s board should evaluate management performance.
1 Define corporate-level strategy and discuss its purpose.
Remember that in Chapters 4 and 5 the discussion centered around selecting and
implementing a business-level or competitive strategy—actions a firm should take to
compete in a single industry or product market—and the actions and responses that affect the
competitive dynamics of a single industry or product market.
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In contrast, when a firm diversifies its operations by operating business in several industries,
corporate-level strategy becomes a primary focus. This means that a diversified firm has two
levels of strategy: business-level (or competitive) and corporate-level (or company-wide), the
latter of which entails selecting a strategy that focuses on the selection and management of a
mix of businesses.
Teaching Note: Students sometimes have a difficult time grasping the

concept of levels of strategy. One useful way of explaining this is to draw their
attention to PepsiCo and its portfolio of businesses prior to the 1997 spin-off
of Tricon Global Restaurants, Inc., which later changed its name to Yum!
Brands Inc. Yum controls Pizza Hut, Taco Bell, and KFC, all of which were
part of PepsiCo at one time. Students are very familiar with these products,
which is why the illustration works so well. PepsiCo’s strategy was at the
corporate level, whereas the soft drink business, Pizza Hut, Taco Bell, and
KFC each have separate, and very different, business-level strategies. It is
easy to help students to see that PepsiCo’s corporate-level strategy was to
generate synergies among the businesses (e.g., selling the firm’s soft drinks
in all the restaurants). But they can also readily see the differences in
business-level strategies for soft drinks (integrated cost/differentiation), at
Pizza Hut (differentiated product), Taco Bell (cost leadership), and KFC
(perhaps somewhere in between). The illustration can also be used to help
students understand other levels of strategy (e.g., functional, operational, and
enterprise).
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. Primary concerns of corporate-level strategy are:
What businesses should the firm be in?
How should the corporate office manage its group of businesses?
How can the corporation as a whole add up to more than the sum of its business parts?
The ultimate measure of the value of a firm’s corporate-level strategy is that the businesses in
the firm’s portfolio are worth more under current management (and by following the firm’s
corporate-level strategy) than they would be under different ownership or management.
Teaching Note: Indicate to students that the unique organizational structure

that is required by this strategy is discussed in Chapter 11.
LEVELS OF DIVERSIFICATION
Diversified firms vary according to two factors:

The level of diversification
Connection or linkages between and among business units
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Figure Note: Five levels of diversification are listed and each is defined in
Figure 6.1. It is recommended that you refer students to Figure 6.1 as you
begin to discuss levels of diversification in more detail.
FIGURE 6.1
Levels and Types of Diversification
Figure 6.1 should be used as a reference point during your discussion of diversification
types. Students’ attention should be directed to inter-unit linkages depicted on the right side
of Figure 6.1.
Levels and types of diversification defined in Figure 6.1 and discussed in more detail in the
next sections of this chapter are:
Low levels of diversification

Single business
Dominant business
Moderate to high levels of diversification

Related-constrained diversification
Related-linked diversification (mixed related and unrelated)
Very high levels of diversification

Unrelated diversification
Describe different levels of diversification with different

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corporate-level strategies.
Low Levels of Diversification
Firms that follow single- or dominant-business strategies have low levels of diversification.
A single business is a firm where more than 95 percent of its revenues are generated by the
dominant business.
Firms such as the Wrigley Co. are examples of single-business firms. Wrigley Co. has
dominated the global gum-related industry as the largest manufacturer of chewing gum,
specialty gums, and gum bases. Its brands, Doublemint, Spearmint, and Juicy Fruit, led the
market.
Teaching Note: Wrigley has chosen to focus its attention on its historic (since
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1915) core business. It competes effectively (and successfully) against large
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diversified firms, including RJR Nabisco (Beechnut and Carefree) and

Warner-Lambert (Trident and Dentyne). Focusing on its core business has
enabled Wrigley’s top-level managers to maintain strategic control of the
business. As a result, Wrigley maintains a clear, strategic focus and is highly
competitive in its core business (though it is beginning to diversify somewhat
in recent years).
A dominant business is a firm that generates between 70 and 95 percent of its sales within a
single business area.
Teaching Note: UPS is an example of a dominant business firm because,

although 22 percent of revenue comes from international operations, it
generates 60 percent of its revenue from its US package delivery service.
STRATEGIC FOCUS
Relatedness Among Business Bears Fruit at the Publicis Groupe
Publicis Groupe. the third largest communications company in the world, uses a related
constrained diversified strategy. It has three primary business groups—advertising, media,
and digital. Clear threads run through these business groups. Despite challenging global
economic conditions, Publicis has been able to grow (significantly) its revenues and earnings.
One of its key strategic decisions was the early move to digital technology, which allows it to
efficiently customize messages for specific customers. It also put an emphasis on emerging
market growth. In addition, Publicis helps companies learn how to use social media to get
their message out. Though the company may not be a household name, it has managed to
land General Motors as a client.
Teaching Note: Publicis Groupe has been able to grow its business through a
solid mix of related businesses. These businesses can help each other improve
offerings, provide a greater breadth of services, and reduce costs. Early decisions
(digital technology and emerging market focus) show the Publicis was not
constrained by old business models or industry convention. Ask students to
identify other diversified firms in which the business portfolio improves the
organization’s overall performance.
Moderate and High Levels of Diversification
A related-diversified firm is one that earns at least 30 percent of its revenues from sources
outside the dominant business and whose units are related to each other—e.g., by the sharing
of resources and by product, technological, and distribution linkages.
Related-constrained firms also earn at least 30 percent of their revenues from the dominant
business, and all business units share product, technological, and distribution linkages, as
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illustrated in Figure 6.1. Kodak, Procter & Gamble, and Campbell’s Soup Company are
related-constrained firms.
Related linked (mixed related and unrelated) firms, such as Campbell Soup and P&G,
generate at least 30 percent of their total revenues from the dominant business, but there are
few linkages between key value-creating activities.
Unrelated-diversified (or highly diversified) firms do not share resources or linkages, as

illustrated in Figure 6.1. Firms that pursue unrelated diversification strategies—often known
as conglomerates—include United Technologies, Samsung, and Textron.
Though there are more unrelated diversified firms in the US than in most other countries,
conglomerates (firms following unrelated diversification strategies) dominate the private
sector economy in Latin America and in several emerging economies (such as China, South
Korea, and India).
Teaching Note: Many firms that have at one time pursued unrelated
diversification strategies are restructuring to focus on a less diversified mix of
businesses, a move that may reflect:
An inability to manage high levels of diversification
Recognition that a lower level of diversification would improve the match
between the firm’s core competencies and environmental opportunities and
threats
3 Explain three primary reasons firms diversify.
REASONS FOR DIVERSIFICATION
Teaching Note: The content of this section of the chapter generally is limited
to a discussion of Table 6.1, which provides some of the reasons that firms
implement diversification strategies. The various value-related motives for
diversification are discussed in more detail in the remainder of the chapter as
specific diversification strategies are discussed.
Firms may implement diversification strategies to enhance or increase the strategic

competitiveness of the overall organization, and thus the value of the firm increases.
Value can be created through either related or unrelated diversification if the strategies
enable the firm’s mix of businesses to increase revenues and/or decrease costs when
implementing business-level strategies.
Firms may implement diversification strategies that are either value neutral or result in
devaluation of the firm. They may attempt to diversify:
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To neutralize a competitor’s market power

To reduce managers’ employment risk (i.e., risk of the CEO being unemployed when a
dominant-business firm fails as compared to this risk when a single business fails when it
is only one part of a diversified firm)
To increase managerial compensation because of the positive relationships between
diversification, firm size, and compensation
Table Note: Reasons or motives for implementing diversification strategies

are presented in Table 6.1. They are discussed in the following chapter
sections.
TABLE 6.1
Reasons for Diversification
Firms follow diversification strategies for many reasons. These can be grouped into three
broad sets of motives:
Motives to create value:

Economies of scope (related diversification) through activity-sharing and the transfer of
core competencies
Market power motives (related diversification) by vertical integration or blocking
competitors via multipoint competition
Financial economies motives (unrelated diversification) to improve efficiency of capital
allocation through an internal capital market or by restructuring the portfolio of
businesses
Motives that are value-neutral with respect to strategic competitiveness:

To avoid violations of antitrust regulations
To take advantage of tax incentives
To overcome low performance
To reduce the uncertainty of future cash flows
To reduce overall firm risk
To exploit tangible resources
To exploit intangible resources
Managerial or value-reducing motives:

To diversify managerial employment risk
To increase managerial compensation
Figure Note: As illustrated in Figure 6.2, firms seek to create value by

sharing activities and transferring skills or corporate core competencies. This
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figure can help students organize their thoughts about the options firms have
to exploit various forms of relatedness.
FIGURE 6.2
Value-Creating Strategies of Diversification: Operational and Corporate Relatedness
Firms seek to create value from economies of scope through two basic kinds of operational
economies: sharing activities and transferring skills (corporate core competencies).
However, the levels of the two will lead to different corporate strategies with different
advantages associated with each.
Combinations of Economies Resulting Strategy Economies for Advantage
High operational/ Vertical integration Market power

Low corporate
Low operational/ Unrelated diversification Financial economies
Low corporate
High operational/ Both operational and Rare capability and can create
High corporate relatedness diseconomies of scope
High operational/ Related-linked Economies of scope
High corporate diversification
VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND

RELATED LINKED DIVERSIFICATION
Firms implement related diversification strategies in order to achieve and exploit economies
of scope and build a competitive advantage by building on existing resources, capabilities,
and core competencies.
For firms that operate in multiple industries or product markets, economies of scope
represent cost savings attributed to entering an additional business and sharing activities or
using capabilities and core competencies developed in another business that can be
transferred to a new business without significant additional costs.
The difference between activity sharing and core competence sharing is based on how
different resources are used jointly to create economies of scope:
To create economies of scope, tangible resources such as plant and equipment or other
business-unit physical assets often must be shared. Less tangible resources, such as
manufacturing know-how, also can be shared.
Know-how transferred between separate activities with no physical or tangible resource
involved is a transfer of a corporate-level core competence, not an operational sharing of
activities.
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A key to creating value through sharing essentially separate activities is to share know-how
or skills rather than physical or tangible resources.
Operational Relatedness: Sharing Activities
Because all of its businesses share product and technological and distribution linkages,
activity sharing is common among related-constrained diversified firms, such as Procter &
Gamble.
P&G’s paper towel and disposable diaper units can share many activities due to their
common characteristics:
Each business uses paper products as a key input, so they are likely to share key facets of
procurement and inbound logistics, as well as primary manufacturing activities.
Because all three businesses produce consumer products that are sold in similar (if not the
same) outlets, they will likely share outbound logistics, distribution channels, and possibly
sales forces.
Firms also must recognize that although activity sharing is intended to reduce costs through
achieving economies of scope, there are incremental costs related to sharing activities (costs
that are created by sharing). These costs must be recognized and taken into account when
planning activity sharing or scope economies may not result.
Activity sharing can also result in new risks since closer linkages between business units
create tighter interrelationships and/or interdependencies. For example, if two business units
share production facilities and sales in one unit’s products decline to the point that revenues
no longer cover the costs of shared production, then each business unit’s ability to achieve
strategic competitiveness may be adversely affected.
Regardless of the risks that accompany activity sharing, research indicates that activity
sharing—or the potential for activity sharing—can increase the value of the firm. Some
findings are summarized here:
Acquiring firms in the same industry—a horizontal acquisition—where sharing of
activities and resources is implemented results in improved performance and higher
returns to shareholders.
Selling off units where resource sharing is a possible source of economies of scope results
in lower returns to shareholders than does selling off business units unrelated to the firm’s
core business.
Firms with more related units have less risk.
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Describe how firms can create value by using a related

4
diversification strategy.
Corporate Relatedness: Transferring of Core Competencies
Over time, most firms develop intangible resources that can become a foundation for
corporate-level core competencies that are competitively valuable. In diversified firms, these
core competencies generally are made up of managerial and technical knowledge,
experiences, and expertise.
There are at least two ways the related linked diversification strategy helps firms create
value:
Any costs related to developing the competence have already been incurred
Competencies based on intangible resources, such as marketing know-how, are less visible
and therefore are more difficult for competitors to understand and imitate
Teaching Note: As an example, Philip Morris acquired Miller Brewing at a
time when competition in the brewing industry was focused on establishing
efficient operations.
Philip Morris used marketing competencies coming from the competitive
cigarette industry.
No brewing firm used marketing capabilities as a source of competitive
advantage.
By transferring its marketing competence to Miller, Philip Morris introduced
marketing as a source of competitive advantage to the brewing industry.
Because its primary competitor, Anheuser-Busch, was unable to develop
the capability to respond for several years, Miller’s strategic action (mostly
effective advertising campaigns) let Miller achieve a temporary competitive
advantage and earn above-average returns.
Other firms have focused on transferring a variety or resources/capabilities across businesses

in their control.
Virgin has transferred its marketing skills across travel, cosmetics, music, drinks, and
other retail businesses.
Thermo Electron has employed its entrepreneurial skills in starting up a number of new
ventures and maintaining a new venture network.
Honda has developed and transferred across its businesses its expertise in small and now
larger engines for a number of vehicle types—from motorcycles and lawnmowers to its
range of automotive products.
One way that firms can facilitate the transfer of competencies between or among business
units is to move key personnel into new management positions in the receiving unit.
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However, research suggests that transferring expertise often does not lead to performance
improvement.
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Teaching Note: It is good to help students understand the human

dimensions of strategic decisions—e.g., expertise transfers may be difficult or
costly because of the following:
A business-unit manager of an older division may be reluctant to transfer
key people who have accumulated knowledge and experience critical to
the business unit’s success.
Managers able to facilitate the transfer of core competencies may come at
a premium.
The key people involved may not want to transfer.
The top-level managers from the transferring division may not want the
competencies transferred to a new division to fulfill the firm’s diversification
objectives.
Market Power
Firms also may implement related diversification strategies in an attempt to gain market
power.
Market power exists when a firm is able to sell its products at prices above the existing
competitive level or decrease the costs of its primary activities below the competitive
level, or both.
Market power through diversification may be gained through multipoint competition, a
condition where two or more diversified firms compete in the same product areas or
geographic markets.
Firms also might gain market power by following a vertical integration strategy, which exists
when a company produces its own inputs (backward integration) or owns its own distribution
system (forward integration).
A vertical integration strategy may be motivated by a firm’s desire to strengthen its position
in its core business relative to competitors by increasing its market power.
Vertical integration enables a firm to increase market power by:

Developing the ability to save on its operations
Avoiding market costs
Improving product quality
Protecting its technology from imitation by rivals
Having strong ties between their assets for which no market prices exist
Note: establishing a market price would result in high search and transaction costs, so firms
seek to vertically integrate rather than remain separate businesses.
Teaching Note: As an example of vertical integration, CVS, a Walgreen’s

competitor, recently merged with Caremark, a pharmaceutical benefits
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manager. This represents a vertical move for CVS from a retail-only firm to
broader-based health care. However, CVS risks alienating Walgreen’s, which
may then choose to align with another benefits manager.
However, like other strategies that create value and aid the firm in achieving strategic
competitiveness, vertical integration may not be the perfect answer because of risks and costs
that accompany it.
Outside suppliers may be able to provide inputs at a lower cost (and, possibly also of a
higher quality).
The costs of coordinating vertically integrated activities may exceed the value of the
control realized.
Vertical integration may result in the firm losing strategic competitiveness if the internal
unit does not keep up with changes in technology.
To vertically integrate, the firm may need to build a facility with capacity that exceeds the
ability of its internal units to absorb, forcing the selling unit to sell to outside users in
order to achieve scale economies.
Many manufacturing firms no longer pursue vertical integration. In fact, deintegration is the
focus of most manufacturing firms, such as Intel and Dell, and even among large automobile
companies, such as Ford and General Motors, as they develop independent supplier
networks. Solectron Corp., a contract manufacturer, represents a new breed of large contract
manufacturers that is helping to foster this revolution in supply-chain management. Such
firms often manage their customers’ entire product lines, and offer services ranging from
inventory management to delivery and after-sales service.
E-commerce allows vertical integration to turn into ―virtual integration,‖ permitting closer
relationships with suppliers and customers through electronic means of integration. This lets
firms reduce transaction costs while boosting supply-chain management skills and tightening
inventory control.
STRATEGIC FOCUS
The Economic Power of Google and the Competitive Derivatives
Google is a very formidable competitor with deep pockets. Around 96 percent of its annual
revenue comes from advertisements on its search engine. However, Google is looking to
reduce this level of reliance on its core business. With its huge cash reserves, Google is
investing a large amount in R&D to develop products/services that will allow it to enter new
markets. In addition to organic growth, Google is also looking for acquisition targets that
align with its strategic thrusts. Google’s push toward related-linked diversification will create
multipoint competition with large, established rivals (such as Apple, Microsoft, Netflix,
Yahoo!, AOL, Groupon, and Facebook). Google’s diversification away from its reliance on
its core business has potential competitors taking note.
Teaching Note: Google’s attempts to diversify operations so it is less reliant on

its dominant business make a lot of sense. Its execution of these efforts will be
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critical because it will be engaging in multipoint competition with some of the best
companies in the world. Ask students to speculate about the types of competitive
responses that rivals will take as a result of Google’s actions. Do they believe that
Google will be able to compete on several fronts against these established, well-
run companies? Ask students to evaluate Google’s business portfolio as it is
outlined in the Strategic Focus. Do they think this mix of businesses makes sense
or do they think Google is moving too fast and in too many directions?
Simultaneous Operational and Corporate Relatedness
As Figure 6.2 suggests, some firms simultaneously seek operational and corporate
relatedness to create economies of scope. Because simultaneously managing two sources of
knowledge is very difficult, such efforts often fail, creating diseconomies of scope.
A Bit of Disney History: A Mini-Case
By using operational relatedness and corporate relatedness, Disney made $3 billion

on the 150 products that were marketed with its movie, The Lion King. Sony’s Men in
Black was a super hit at the box office and earned $600 million, but box office and
video revenues were practically the entire success story. Disney was able to
accomplish its great success by sharing activities regarding The Lion King theme
within its movie, theme park, music, and retail products divisions, while at the same
time transferring knowledge into these same divisions, creating a music CD, Rhythm
of the Pride Lands, and producing a video, Simba’s Pride. In addition, there were
Lion King themes at Disney resorts and Animal Kingdom parks. However, it is
difficult for analysts from outside the firm to fully assess the value-creating potential
of the firm pursuing both operational relatedness and corporate relatedness. As such,
Disney’s assets as well as other media firms such as AOL Time Warner have been
discounted somewhat because ―the biggest lingering questions is whether multiple
revenue streams will outpace multiple-platform overhead.‖
Explain the two ways value can be created with an unrelated

5
diversification strategy.
UNRELATED DIVERSIFICATION
Firms implementing unrelated diversification strategies hope to create value by realizing

financial economies, which are cost savings realized through improved allocations of
financial resources based on investments inside or outside the firm.
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Financial economies are realized through internal capital allocations (that are more efficient
than market-based allocations) and by purchasing other companies and then restructuring
their assets.
Efficient Internal Capital Market Allocation
Although capital generally is efficiently distributed in a market economy through the capital
markets, large diversified firms may be able to distribute capital more efficiently to divisions
and thus create value for the overall organization. This generally is possible because:
Corporate offices have more detailed and accurate information on actual division
performance and future prospects.
Investors have limited access to internal information and generally can only estimate
division performance.
One implication of increased access to information is that the internal capital market may be
able to allocate resources between investment opportunities more accurately (and at more
adequate levels) than the external capital market. There are several reasons for this:
Information disclosed to capital markets through annual reports may not fully disclose
negative information, reporting only positive prospects while meeting all regulatory
disclosure requirements.
External capital sources have limited knowledge of what is taking place within large,
complex firms.
While owners have access to information, full and complete disclosure is not guaranteed.
An internal capital market may enable the firm to safeguard information related to its
sources of competitive advantage that otherwise might have to be disclosed. Through
disclosure, the information could become available to competitors who might use the
information to duplicate or imitate the firm’s sources of competitive advantage.
Other advantages of internal capital markets:

Corrective actions may be more efficiently structured and underperforming management
can be more effectively disciplined through the internal capital market than through
external capital market mechanisms. Thus, the internal capital market is more capable of
taking specific, finely tuned corrective actions compared to the external market.
If external intervention is required, only drastic alternatives generally are available, such
as forcing the firm into bankruptcy or forcing the removal of top-level managers.
With an internal capital market, the corporate office can adjust managerial incentives or
can suggest strategic changes to make the desired corrections.
Research suggests that in efficient capital markets, the unrelated diversification strategy may
be discounted. Stock markets have applied what some have called a ―conglomerate discount‖
reflected in the valuation of diversified manufacturing conglomerates at 20 percent less, on
average, than the value of the sum of their parts.
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The Achilles heel of the unrelated diversification strategy is that conglomerates in developed
economies have a fairly short life cycle because financial economies are more easily
duplicated than are the gains derived from operational relatedness and corporate relatedness.
This is less of a problem in emerging economies, where the absence of a ―soft infrastructure‖
(e.g., effective financial intermediaries, sound regulations, and contract laws) supports and
encourages use of the unrelated diversification strategy. In fact, in emerging economies such
as those in India and China, diversification increases performance of firms from large
diversified business groups.
Restructuring of Assets
A restructuring approach to creating value in an unrelated diversified firm involves the

buying and selling of other companies (and their assets) in the external market.
Following the asset sale and layoffs, underperforming divisions (those acquired in the
purchase) are sold to other firms and remaining divisions are placed under strict budgetary
controls accompanied by the reporting of cash inflows and outflows to the corporate office.
Tyco International: A Question of Ethics

Under former CEO Dennis L. Kozlowski, Tyco International, Ltd. excelled at
exploiting financial economies through restructuring. Tyco focused on two types of
acquisitions: platform, which represented new bases for future acquisitions, and add-
on, in markets where Tyco currently had a major presence. As with many unrelated
diversified firms, Tyco acquired mature product lines. However, completing large
numbers of complex transactions resulted in accounting practices that aren’t as
transparent as stakeholders now demand. In fact, many of Tyco’s top executives,
including Kozlowski, were arrested for fraud, and the new CEO, Edward Breen, has
been restructuring the firm’s businesses to overcome ―the flagrant accounting, ethical,
and governance abuses of his predecessor.‖ Actions being taken in firms such as Tyco
suggest that firms creating value through financial economies are responding to the
demand for greater transparency in their practices. Responding in this manner will
provide the information the market needs to more accurately estimate the value the
diversified firm is creating when using the unrelated diversification strategy.
Success in implementing unrelated diversification strategies usually requires that firms:

Focus on firms in mature, low technology industries
Avoid service businesses because of their client- or sales-orientation
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Discuss the incentives and resources that encourage

6
diversification.
VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES
As mentioned earlier, not all firms diversify to increase the value of the overall firm. Some
attempts at diversification are implemented to prevent the value of the firm from decreasing.
Incentives to Diversify
In most instances managers have a choice regarding the level of diversification that their firm
should implement. In addition, both the external and internal environments are sources of
incentives or reasons that managers might use to justify diversification choices.
Antitrust Regulation and Tax Laws
In the 1960s and 1970s, government policies—in the form of antitrust enforcement and tax
laws—provided US firms with incentives to diversify the mix of businesses controlled by the
firm. As a result of these policies, the vast majority of mergers during the period represented
unrelated diversification. They were classified as conglomerate mergers.
Conglomerate mergers (unrelated diversification) were encouraged in large part by the

Celler-Kefauver Act, which discouraged horizontal and vertical mergers. That is, federal
legislation (and enforcement by the US Department of Justice) discouraged market power
boosting via related diversification. As one measure of the effectiveness of official
―discouragement,‖ almost 80 percent of mergers during the 1973–1977 period were
conglomerate mergers.
During the 1980s, enforcement of antitrust laws slackened and firms chose to implement
horizontal merger strategies (or mergers with firms in the same [or a related] line of
business).
At the same time, investment bankers aggressively promoted merger and acquisition activity
to the extent that many acquisitions were classified as unfriendly or hostile takeovers.
Firms that had diversified (in an unrelated fashion) in the 1960s and 1970s began to
implement strategies to refocus their firms, and an era of restructuring began.
When firms generate more cash than they are able to profitably reinvest in the firm’s primary
activities, the excess funds, or ―free cash flows,‖ should be returned to shareholders in the
form of dividends. However, during the 1960s and 1970s, dividends were taxed more heavily
than ordinary personal income. (Dividends are taxed twice: once when the firm pays taxes on
its operating income and a second time when net income is paid out to shareholders in the
6-19
form of dividends as shareholders pay a tax on dividends received at their personal income
tax rate.)
In 1986, the perspective shifted once again, as the Tax Reform Act of 1986 reduced the top
personal income tax rate from 50 percent to 28 percent. Capital gains rules were changed so
that capital gains would be taxed at the ordinary personal income tax rate, and personal
interest deductibility was eliminated.
These changes in federal tax laws that affected individual tax rates for dividends and capital
gains (with the former decreasing and the latter increasing), have created an incentive for
shareholders to favor reduced levels of diversification (after 1986) unless funded by tax-
deductible debt.
The recent changes recommended by the Financial Accounting Standards Board (FASB),
regarding the elimination of the ―pooling of interests‖ method for accounting for the acquired
firm’s assets and the elimination of the write-off for research and development in process,
reduce some of the incentives to make acquisitions, especially related acquisitions in high-
technology industries.
Although there was a loosening of federal regulations in the 1980s and a retightening in the
late 1990s, a number of industries have experienced increased merger activity due to
industry-specific deregulation activity, including banking, telecommunications, oil and gas,
and electric utilities.
Low Performance
When firms are able to earn above-average or superior returns in a single business, they have
little incentive to diversify (as previously discussed in the Wrigley Co. example).
However, low performance may provide an incentive for diversification as a low-performing

firm may become more risk-seeking in an effort to improve overall firm performance.
In response to low returns (or poor performance), firms often choose to seek greater levels of
diversification. At some point, however, poor performance slows the pace of diversification,
often resulting in restructuring divestitures of businesses to lower the level of firm
diversification.
Figure Note: The relationship between level of performance and

diversification (for firms that already have diversified) is illustrated in Figure
6.3.
FIGURE 6.3
The Curvilinear Relationship Between Diversification and Performance
6-20
As Figure 6.3 illustrates, firms exhibiting low performance in their dominant businesses
often implement related-constrained diversification strategies that, to a certain point, result in
increased performance.
In search of even higher performance, related-diversified firms may continue to diversify, but
elect to acquire unrelated businesses.
When a firm’s core competencies do not create value in unrelated businesses, firm
performance decreases.
Teaching Note: DaimlerChrysler had to deal with the challenges that were
created partly by its failed diversification efforts. The firm faced the task of
reversing this strategy, which started with the sale of its electronics operation,
divesting a 34 percent stake in Cap Gemini (a French software services
company), and liquidating Fokker (a Dutch aircraft manufacturer). The firm
also eliminated a layer of upper-level executives and shaped a culture of
responsibility and entrepreneurship, with innovation (using cross-functional
project teams) as the force supporting the new culture.
Uncertain Future Cash Flows
Firms also may implement diversification strategies when their products reach maturity (in
the product life cycle) or are threatened by external factors that the firm cannot overcome.
Thus, firms may view diversification as a survival strategy.
In the 1960s and 1970s, railroads diversified because of the threat from the trucking industry
to reduce demand for rail transportation.
Uncertainty can be derived from supply, demand, and distribution sources. For example, at
one time PepsiCo acquired Quaker Oats to fortify its growth with Gatorade and healthy
snacks, on the projection that these products would experience greater growth rates than
Pepsi’s soft drinks.
Teaching Note: Uncertainty can derive from supply sources or demand

conditions.
ENEL, Italy’s state-owned electricity company, has diversified broadly in
recent years to cope with anticipated deregulation across Europe, which
may mean that ENEL will have to cede 30 percent of its generating
capacity to new rivals with cheaper electricity production. Thus, since
ENEL’s future sources of revenue are threatened, ENEL is using
corporate-level diversification to compete in multiple segments of the utility
market.
To adapt to decreases in government defense spending in Russia, Reuben
Central Design Bureau (the celebrated submarine designer) used a
6-21
diversification strategy. With its world class design engineers, it continued

its marine business while expanding into other areas—e.g., developing a
high-speed rail system, a floating sea launch for rocket companies, real
estate development, a restaurant chain, and a tea business, among others.
The Bureau’s diversification strategy has allowed it to survive in the chaotic
Russian economic environment.
Synergy and Firm Risk Reduction
As you will recall from the discussion earlier in this chapter, firms that diversify in pursuit of
economies of scope take advantage of linkages between primary value-creating activities to
realize synergy from sharing.
Synergy exists when the value created by business units working together exceeds the value
the units create when working independently.
These linkages—and the inter-relatedness or interdependencies that result—produce joint

profitability between business units, and the flexibility of the firm to respond may be
constrained, increasing the risk of failure.
To eliminate this risk, firms may do one of two things:

Operate in more certain environments to reduce the level of technological change and
choose not to pursue potentially profitable, yet unproven product lines
Constrain or reduce the level of activity sharing, thus forgoing the potential benefits of
synergy
However, these decisions could lead to further diversification

To diversify into industries where more certainty exists
To additional, but unrelated diversification
Research suggests that a firm using a related diversification strategy is more careful in
bidding for new businesses, whereas a firm pursuing an unrelated diversification strategy
may be more likely to overprice its bid, because an unrelated bidder may not have full
information about the acquired firm. However, firms using either a related or an unrelated
diversification strategy must understand the consequences of paying large premiums.
Resources and Diversification
In addition to having incentives to diversify, a firm also must possess the correct mix of
resources—tangible, intangible, or financial—that makes diversification feasible.
However, remember that resources create value when they are rare, valuable, costly to
imitate, and nonsubstitutable. In other words, resources that do not have these
characteristics can be more easily duplicated (or acquired) by competitors. Thus, it may
not be possible to create value using such resources.
6-22
The excess capacity of tangible resources may be used to justify diversification, especially
when the firm sees opportunities for activity sharing. However, value-creation may be
possible only in related diversification. Remember, using tangible resources also creates
interrelationships through its activity linkages in production, marketing, procurement, and
technology, and these interdependencies often reduce firm flexibility and may, in fact,
increase the risk of failure.
Ideally, as discussed earlier, a firm’s intangible resources—because they are less visible and
less understood by competitors—should be used to facilitate and create value from
diversification.
Describe motives that can encourage managers to

7
overdiversify a firm.
VALUE-REDUCING DIVERSIFICATION: MANAGERIAL MOTIVES TO

DIVERSIFY
Some managers may be motivated to diversify their firms even if there are no incentives, and
a lack of resources can constrain inclinations toward diversification. Managers’ motives for
diversification include the following:
Diversification may enable managers to reduce employment risk (the risks related to the
loss of their jobs or a reduction in compensation) because by diversifying the firm (i.e., by
adding a number of additional businesses), managers may be able to diversify their
employment risk, as long as profitability does not decline greatly as a result of the
diversification.
Diversification allows managers to increase their compensation because of positive
correlations between diversification, firm size, and executive compensation (based on the
logic that large firms are more difficult to manage).
Teaching Note: Indicate to students that corporate governance is covered in

much greater detail in Chapter 10. The discussion in this chapter is
introductory in nature.
If properly structured and used, governance structures—such as the firm’s board of directors,
performance monitoring, executive compensation limits, and the market for corporate
control—may provide the means to exert control over managers’ tendencies to overdiversify
because of self-interest motives.
However, if a firm’s internal governance structure is not strong (or functions imperfectly),
managers may diversify the firm beyond the optimal level. As a result, the overall firm may
fail to earn average returns (illustrated by Figure 6.3).
6-23
When the internal governance structure fails to restrain managers from overdiversifying (and
performance declines), external governance mechanisms, such as the takeover market, may
come into play.
In the takeover market (also known as the market for corporate control), improved levels of
diversification (and improved performance) are achieved by replacing incumbent or current
managers and restructuring the firm. However, managers may be able to avoid takeovers
through defensive tactics, such as golden parachutes, poison pills, greenmail, or increasing
the firm’s leverage ratio.
In spite of the preceding comments, most managers take positive strategic actions (such as
those related to diversification) that result in overall firm profitability and contribute to the
strategic competitiveness of the firm.
In addition to the internal and external governance mechanisms discussed, managers also
may be provided with incentives to limit firm diversification to optimal levels by a concern
for their personal reputations in the labor market and the related market for managerial talent
(also known as the market for managers).
One signal that the firm may be overdiversified is when operating diversified businesses
reduces, rather than improves, the overall performance of the firm.
Figure Note: It is useful to note that two factors appearing in Figure 6.4 are
discussed in greater detail in future chapters. Governance structures are
discussed in Chapter 10 and strategy implementation is covered in Chapter
11. The overall relationship between reasons for diversification, governance,
and firm performance is provided in Figure 6.4.
FIGURE 6.4
Summary Model of the Relationship Between Diversification and Firm Performance
As shown in Figure 6.4, a firm’s diversification strategy is determined by several inter-

related factors,
Value-creating influences (economies of scope, market power, financial economics)
Value-neutral influences (resources and incentives)
Value-reducing influences (managerial motives to diversify)
Internal governance
Capital market intervention and the market for managerial talent
In turn, the relationship between diversification strategy and firm performance is moderated
by:
Capital market intervention and the market for managerial talent with which the
diversification strategy is implemented
6-24
As noted in this chapter, diversification strategies can be used to enhance a firm’s strategic
competitiveness and enable it to earn above-average returns. However, positive outcomes
from diversification are possible only when the firm achieves the appropriate level of
diversification, given its resources, capabilities, and core competencies, and taking into
account the external environmental opportunities and threats.
— ANSWERS TO REVIEW QUESTIONS
1. What is corporate-level strategy and why is it important? (pp. 148–149)
Corporate-level strategies are strategies that detail actions taken to gain a competitive
advantage through the selection and management of a mix of businesses competing in
different product markets. They are concerned with what businesses the firm should be in
and how the corporate office should manage its group of businesses.
Corporate-level strategies are important to the diversified firm because developing and
implementing multibusiness strategies is necessary for effective utilization of resources,
capabilities, and core competencies across multiple businesses to create value. In the final
analysis, a corporate-level strategy’s value is ultimately determined by the degree to which
the businesses in the portfolio are worth more under the management of the company than
they would be under any other ownership.
2. What are the different levels of diversification firms can pursue by using different
corporate-level strategies? (pp. 149–152)
Low levels of diversification. Single- and dominant-business firms represent those for which
at least 95 percent and 70 percent of total sales, respectively, come from a single business.
Several advantages accrue to these firms. For example, managers of single- and dominant-
business firms may be more capable of understanding the competitive dynamics of the
smaller number of industries in which their business(es) compete. Furthermore, managers in
these firms can develop more specialized skills, concentrating on formulating and
implementing a narrower range of business-level strategies and managing synergies between
businesses that may be easier to identify and master. However, these firms must also
overcome a number of disadvantages. For example, single- and dominant-business firms are
affected more negatively by an economic downturn that affects their single or dominant
industry. Also, by focusing their operations, these firms cannot enjoy the advantages that are
realized only by diversified firms
Moderate to high levels of diversification. A firm generating more than 30 percent of its
revenue outside a dominant business and whose businesses are related to each other in some
manner uses a related diversification corporate-level strategy. When the links between the
6-25
diversified firm’s businesses are rather direct, a related constrained diversification strategy is
being used.
6-26
The diversified company with a portfolio of businesses with only a few links between them is
called a mixed related and unrelated firm and is using the related linked diversification
strategy. Compared with related constrained firms, related linked firms share fewer resources
and assets between their businesses, concentrating instead on transferring knowledge and
core competencies between the businesses. As with firms using each type of diversification
strategy, companies implementing the related linked strategy constantly adjust the mix in
their portfolio of businesses as well as make decisions about how to manage their businesses.
Very high levels of diversification. A highly diversified firm that has no relationships
between its businesses follows an unrelated diversification strategy. These businesses are not
related to each other, and the firm makes no effort to share activities or to transfer core
competencies between or among them.
3. What are three reasons firms choose to diversify their operations? (pp. 152–154)
Firms may chose to move from a single- or dominant-business position to a more diversified
position for three general reasons. First (value-creating), they do this to enhance strategic
competitiveness via increased economies of scope (e.g., by sharing activities and transferring
core competencies), market power (e.g., by blocking competitors through multipoint
competition or implementing vertical integration), and financial economies (e.g., from
efficient internal capital allocations and business restructuring). Second (value-neutral), firms
may diversify in response to incentives. For example, they may do so to respond to
advantages from tax law, to overcome a low performance trend, or to balance out uncertain
future cash flows. Finally (value-reducing), unrelated acquisitions also may be made for
managerial reasons (either to diversify managerial employment risk or to increase managerial
compensation). It is important to note that diversification is not always pursued in an effort to
enhance the firm’s strategic competitiveness; in fact, diversification may have neutral or even
negative effects on firm performance.
4. How do firms create value when using a related diversification strategy? (pp. 154–
159)
Activity sharing and transferring core competencies are used to obtain economies of scope
while pursuing a related diversification strategy because cost savings are attributed to
entering an additional related business using capabilities and competencies developed in one
business that can be transferred to another business without significant additional costs. In
other words, it may be possible for related firms to share production facilities or distribution
networks, or a core competency such as marketing expertise might be transferred between
related business units. However, related firms also must take into account the costs related to
activity sharing and core competency transfers, namely the cost of coordination and sharing
of control created by the interdependencies that result or the savings imputed to economies of
scope may not be realized.
6-27
Firms using a related diversification strategy may gain market power when successfully
using their related constrained or related linked strategy. Market power exists when a firm is
able to sell its products above the existing competitive level or to reduce the costs of its
primary and support activities below the competitive level, or both.
Some firms using a related diversification strategy engage in vertical integration to gain
market power. Vertical integration exists when a company produces its own inputs
(backward integration) or owns its own source of output distribution (forward integration).
5. What are the two ways to obtain financial economies when using an unrelated
diversification strategy? (pp. 159–161)
Two ways to obtain financial economies when pursuing an unrelated diversification strategy
are by establishing an efficient internal capital market and by restructuring the assets of
purchased businesses.
Financial economies can be achieved by establishing an efficient internal capital market that
enables corporate managers—because they have access to more detailed and more accurate
(or more relevant) information—to make better (more value-enhancing) capital allocation
decisions relative to those made by the market. Restructuring focuses exclusively on buying
and selling other firms’ assets in the external market. This usually entails selling off
corporate headquarters facilities, laying off corporate staff, selling underperforming divisions
to other firms that may be able to enhance the division’s strategic competitiveness, and
managing the remaining business units to maximize net cash flow.
6. What incentives and resources encourage diversification? (pp. 162–165)

Incentives that encourage diversification include antitrust regulation, tax laws, low firm
performance, uncertain future cash flows, and opportunities to reduce overall firm risk.
Resources that encourage diversification include both tangible and intangible resources such
as plant and equipment (excess productive capacity) and financial resources (free cash flows)
for which no attractive (positive) investment opportunities are available as the firm is
currently structured.
7. What motives might encourage managers to overdiversify their firm? (pp. 166–167)
Managers might be encouraged to push a firm toward a more diversified position to reduce
the risk of job loss by diversifying employment risk (so long as profitability does not suffer
excessively) or to increase their compensation. Increased levels of diversification are strongly
correlated with firm size, and firm size in turn is strongly correlated with managerial
compensation because of the increased complexity that results from increases in firm size
and diversification level.
6-28
INSTRUCTOR'S NOTES FOR EXPERIENTIAL

—
EXERCISES
EXERCISE 1: COMPARISON OF DIVERSIFICATION STRATEGIES
The goals of this exercise are two-fold: first, to understand how diversification strategies
differ across firms in an industry, and second, to gain more experience in collecting
company information. In Part One, teams collect business segment data for two firms
that are competing in the same industry.
For an example of the data that is to be collected, a search of pharmaceutical firms yields
a number of companies, including Merck and Schering Plough. Data on revenues and
profits from the 10-K reports filed in February of 2009 for each firm are as follows:
Merck data (in millions)
2008 2007 2006 2008 2007 2006

Segment Revenues Revenues Revenues Profit Profit Profit
Pharmaceutical 19382.9 19617.6 20374.8 12400.4 13430.6 13649.4

Vaccines 4237.0 4321.5 1705.5 2798.9 2625.0 892.8
Other 81.8 162.0 555.7 419.3 452.7 -8320.8
Total 23701.7 24101.1 22636.0 15618.6 16508.3 6221.4
Schering Plough data (in millions)
2008 2007 2006 2008 2007 2006

Segment Revenues Revenues Revenues Profit Profit Profit
Pharmaceuticals 14253.0 10173.0 8561.0 2725.0 -1206.0 1394.0

Consumer Health 1276.0 1266.0 1123.0 271.0 275.0 228.0
Animal Health 2973.0 1251.0 910.0 186.0 -582.0 120.0
Other -1133.0 298.0 -259.0
Total 18502.0 12690.0 10594.0 2049.0 -1215.0 1483.0
6-29
Both firms draw the vast majority of their revenues from the pharmaceutical segment,
although with differing intensity: About ninety percent of revenues come from
pharmaceuticals for Merck, while the figure is around eighty percent for Schering
Plough. A review of the product lines for these two firms is also helpful in discussing
how closely these two firms compete with one another.
Both firms compete in other drug-related business: Merck primarily in vaccines, and
Schering Plough in Consumer Health Products and Animal Health. A closer look at the
SP Consumer division reveals that this includes both prescription and over-the-counter
(OTC) products. Additionally, SP sells many other goods, such as Dr. Scholl's (foot
care) and Coppertone (sunscreen).
Trend data and profit patterns also differ for these two competitors.
For a more pronounced comparison, Proctor & Gamble is also considered a competitor in
the pharmaceutical industry. P&G has a much broader portfolio of goods, including
beauty products, household goods, as well as the Duracell, Braun, and Gillette product
lines.
Drawing on their independent analysis, ask the students to prepare a short PowerPoint
summary of their findings. The findings should describe the nature and extent of
diversification used at each firm, and assess which had a more effective approach to
diversification.
Typically, there is not enough time to review and discuss PowerPoint presentations for all
teams. As such, it often works well to use this as a homework or other graded
assignment. Then, the instructor can select a subset of teams to make in-class
presentations.
EXERCISE 2: HOW DOES THE FIRM’S PORTFOLIO STACK UP?
This is a fairly straight forward exercise for the instructor but the student learning should
be powerful as this will bring into focus many of the concepts studied to this point. In
particular, students will need to identify not only the category of each business unit (dog,
cash cow, etc) but also its potential for market growth. To do these students will need to
consult data bases such as Mint Global, DataMonitor, Gartner Group etc.
A good exercise for the students would be to have them create a poster in the spirit of the
original BCG matrix. In this way the instructor could place the posters strategically
around the room to promote discussion.
To prepare students for this exercise the instructor might pick a firm like Textron, which
is a highly diversified firm and identify its main segments from the firm’s annual reports.
In the annual reports one will find the percentage breakdowns for each business unit.
6-30
Another good conversation can also revolve around the firm’s strategy going forward. If
there are dogs indentified, should the division be sold off, should dogs just fund stars and
questions marks? This can lead to a nice conversation about core competencies and
sustainable competitive advantage.
— INSTRUCTOR'S NOTES FOR VIDEO EXERCISES
Title: THE ROAD TO DIVERSIFICATION: BARRY DILLER/SENIOR

EXECUTIVE/IAC
RT: 5:38
Topic Key: Corporate-level strategy, Levels of diversification, Value-creating
diversification, Operational and corporate relatedness, Related and
unrelated diversification, Motivations to overdiversify
In an interview with Leslie Stahl, Barry Diller, once Paramount CEO, reflected on seeing
this primitive interactivity of computers, televisions, and phones and how it seized his
curiosity. Diller saw a future where most shopping would be done by interacting with a
screen. Even his wife indicated they were intrigued by this entire new world. She said
Barry Diller can see something way before you can see anything. In the interview, Diller
concurs that most of the public considered him to be losing his mind with the purchase of
QVC and trading the glamour of Hollywood away. In Westchester, PA, Barry Diller
made his first fortune as his own boss. But in a string of setbacks, he involved himself in
a bidding war to buy Paramount only to make a mistake by not making the last bid.
Learning from his mistakes and making other deals, he ended up losing QVC. Despite
this, his gut feeling told him that interactive commerce would catch on so he purchased
QVC’s competitor HSN. In the interview, Diller confirms that the public’s perception of
his company is correct as a hodge podge but it’s an interactive conglomerate operating in
financial services and flirt services.
Diller says that the development of his company has been a journey and they are figuring
it out along the way. He says he knows now that many of his businesses are related to one
another and has united all his brands under one new corporate headquarters. He wanted to
give his company, IAC, the same cache as other big Internet companies. In comparison to
Google, Barry Diller says that IAC is an endless multiproduct company and his desire
would be to be like Procter & Gamble one day. With a personal fortune of well over a
billion, Diller’s wife says he is driven by the vision. Shown in business meetings, Diller
makes decisions quickly and his employees say that his ability to grasp new and difficult
concepts is uncanny. With 20,000 employees, Diller runs intense meetings and he is the
ultimate decider who controls the votes in the company.
Also check out http://www.fastcompany.com/1767926/barry-diller-iac-launch-social-

network-for-nostalgic-seniors
6-31
Suggested Discussion Questions and Answers

Describe Diller’s corporate-level strategy.
o Text: A corporate-level strategy specifies actions a firm takes to gain a
competitive advantage by selecting and managing a group of different
businesses competing in different product markets.
o Diller’s: To be an endless interactive conglomerate of multiproducts similar to
Procter & Gamble—presently all activities for creating financial to flirt
services.
Describe IAC’s level of diversification.
o IAC is considered related linked diversification signifying a moderate to high
level of diversification. IAC appears to share resources and products and
services, technologies, and distribution channels.
What do you think was Diller’s reason to diversify?
o Reduce managerial risk would be an estimate but really he appears to be
diversifying based on what he sees and likes.
Is Diller’s approach value-creating diversification? Why or Why not?
o Yes, the expansion of IAC has brought economies of scope, sharing of some
activities with the interactive nature of many of the businesses, core
competencies can be transferred into other ventures, and overall market power
has increased. At some point, it appears that Diller was attempting to block
competitors through multipoint competition, especially when he lost QVC.
Explain how IAC businesses and brands are related. Related diversification?
o All IAC businesses and brands use an interactive computer component.
Corporate relatedness is high whereas operational relatedness is low
Is Diller in a position to overdiversify?
o Diller is likely to overdiversify due his consideration that IAC is just ―figuring
it out.‖ In other words, he appears to have no real plan for businesses to add
and chooses fresh and new ideas because he likes them, which could produce
a lot of different and related companies with each failing to impact overall
market share. His vision without a plan may only result in too many
companies.
— ADDITIONAL QUESTIONS AND EXERCISES
The following questions and exercises can be presented for in-class discussion or assigned as
homework.
Application Discussion Questions
1. This chapter suggests that there is a curvilinear relationship between diversification and
performance. Ask students how this relationship can be modified so that the negative
6-32
relationship between performance and diversification is reduced and the downward curve
has less slope or begins at a higher level of diversification.
2. The Fortune 500 firms are very large, and many of them have significant product
diversification. Ask students if they believe these large firms are overdiversified. Do they
experience lower performance than they should?
3. What is the primary reason for overdiversification? Is it industrial policies, such as taxes
and antitrust regulation, or do firms overdiversify because managers pursue their own
self-interest through increased compensation, and a reduced risk of job loss? Why? Have
students explain.
4. One rationale for pursuing related diversification is to obtain market power. In the United
States, however, too much market power may result in a challenge by the US Justice
Department (because it may be perceived as anticompetitive). Ask students in what
situations related diversification might be considered unfair competition.
5. Tell students they have two job offers, one from a dominant-business firm and one from
an unrelated diversified firm (suppose the beginning salaries are virtually identical).
Which offer would they accept and why?
6. Ask students if they believe that by the year 2015 large firms will be more or less
diversified than they are today. Why? Will the trends regarding diversification be
identical in Europe, the United States, and Japan? Explain.
7. Will the Internet make it easier for firms to diversify? Why or why not?
Ethics Questions
1. Propose the following statement: ―Those managing an unrelated diversified firm face far
more difficult ethical challenges than do those managing a dominant-business firm.‖
Based on their reading of this chapter, do the students this statement true or false? Why?
2. Is it ethical for managers to diversify a firm rather than return excess earnings to
shareholders? Have students provide their reasoning in support of their answers.
3. What unethical practices might occur when a firm restructures? Explain.
4. Ask students if they believe that ethical managers are unaffected by the managerial
motives to diversify discussed in this chapter. If so, why? In addition, do they believe that
ethical managers should help their peers learn how to avoid making diversification
decisions on the basis of the managerial motives to diversify? Why or why not?
Internet Exercise
Search the websites of CMGI (http://www.cmgi.com), Cisco Systems

(http://www.cisco.com), EMC (http://www.emc.com), and ICG
(http://www.internetcapital.com).
Compare their business models, and explain the type of strategy and level of diversification
that describes each one. In the extremely fast-cycle Internet economy, these companies run
exceptional risks. Track the success of each company’s stocks over the past six months. Can
you pinpoint changes within the industry that have affected the rise and fall of stock prices?
What advancements in information technology and electronic commerce have had the
6-33
greatest effect on the continuing strategies of these companies? Does this type of
collaboration amongst Internet companies foster growth and value within the industry?
*e-project: In January 2000, Hyundai (http://www.hyundai.com), Samsung

(http://www.samsung.com), and LG Group (http://www.lg.co.kr) were fined for illegally
allocating funds to their failing subsidiaries. Using the information provided on the
company websites, choose one of these companies and provide alternative strategies for it
to better compete in international markets.
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1. Define corporate-level strategy and discuss its purpose.

Chapter Introduction: Chapters 4 and 5 looked at strategy at the level of the

General Electric is a diversified company with a storied past. It currently competes in 16

Teachng Note: GE has encountered numerous problems during its

1 Define corporate-level strategy and discuss its purpose.

Teaching Note: Students sometimes have a difficult time grasping the

Teaching Note: Indicate to students that the unique organizational structure

Diversified firms vary according to two factors:

Low levels of diversification

Moderate to high levels of diversification

Very high levels of diversification

Describe different levels of diversification with different

Low Levels of Diversification

diversified firms, including RJR Nabisco (Beechnut and Carefree) and

Teaching Note: UPS is an example of a dominant business firm because,

Moderate and High Levels of Diversification

Unrelated-diversified (or highly diversified) firms do not share resources or linkages, as

3 Explain three primary reasons firms diversify.

REASONS FOR DIVERSIFICATION

Firms may implement diversification strategies to enhance or increase the strategic

To neutralize a competitor’s market power

Table Note: Reasons or motives for implementing diversification strategies

Motives to create value:

Motives that are value-neutral with respect to strategic competitiveness:

Managerial or value-reducing motives:

Figure Note: As illustrated in Figure 6.2, firms seek to create value by

Combinations of Economies Resulting Strategy Economies for Advantage

High operational/ Vertical integration Market power

VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND

Operational Relatedness: Sharing Activities

Describe how firms can create value by using a related

Corporate Relatedness: Transferring of Core Competencies

Other firms have focused on transferring a variety or resources/capabilities across businesses

Teaching Note: It is good to help students understand the human

Vertical integration enables a firm to increase market power by:

Teaching Note: As an example of vertical integration, CVS, a Walgreen’s

Teaching Note: Google’s attempts to diversify operations so it is less reliant on

Simultaneous Operational and Corporate Relatedness

A Bit of Disney History: A Mini-Case

By using operational relatedness and corporate relatedness, Disney made $3 billion

Explain the two ways value can be created with an unrelated

Firms implementing unrelated diversification strategies hope to create value by realizing

Efficient Internal Capital Market Allocation

Other advantages of internal capital markets:

A restructuring approach to creating value in an unrelated diversified firm involves the

Tyco International: A Question of Ethics

Success in implementing unrelated diversification strategies usually requires that firms:

Discuss the incentives and resources that encourage

VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES

Antitrust Regulation and Tax Laws

Conglomerate mergers (unrelated diversification) were encouraged in large part by the

However, low performance may provide an incentive for diversification as a low-performing

Figure Note: The relationship between level of performance and

Uncertain Future Cash Flows

Teaching Note: Uncertainty can derive from supply sources or demand

diversification strategy. With its world class design engineers, it continued

Synergy and Firm Risk Reduction

These linkages—and the inter-relatedness or interdependencies that result—produce joint

To eliminate this risk, firms may do one of two things:

However, these decisions could lead to further diversification