STRATEGIC MANAGEMENT

5th WEEK

TAU - BUSINESS ADMINISTRATION

Copyright © 2006 by McGraw-Hill Ryerson, Inc. All rights reserved. 6-1
 Canadian
Strategic Management: Edition

Creating Competitive Advantages

Gregory G. Dess
G. T. Lumpkin
Theodore Peridis
Part 2: Strategic
Formulation

Chapter 6
Corporate-Level Strategy:
Creating Value through
Diversification
STRATEGIC MANAGEMENT
McGraw-Hill Ryerson Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Corporate-level strategy:

a strategy that focuses on gaining long-term

revenue, profits, and market value through
managing operations in multiple businesses.

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 Making Diversification Work

• What businesses should a corporation

compete in?
• How should these businesses be
managed to jointly create more value
than if they were freestanding units?
• Diversification: the process of firms
expanding their operations by entering
new businesses.

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 Making Diversification Work
• Diversification initiatives must create value for
shareholders
• Mergers and acquisitions
• Strategic alliances
• Joint ventures
• Internal development
• Diversification should create synergy

Business Business
1 2

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 Key issues corporate versus business
strategy

CORPORATE STRATEGY: How to create a competitive advantage

for the whole company
• What businesses should we be in?
• How should these be managed?
• How to create value for the corporation as a whole?
BUSINESS STRATEGY: How to create a competitive advantage in
specific, individual product markets
• Which customers to serve (who?) – segmentation
• Which customers needs to satisfy (what?) – differentiation
• Resources and value chain activities necessary to satisfying customer
needs (how?) – “core competencies”

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 Synergy
• Related businesses (horizontal
relationships)
• Sharing tangible resources
• Sharing intangible resources
Manufacturing Specialized Patents,
facilities skills copyrights, etc.

Production Distribution Favorable

facilities channels reputation

Business Business
1 2

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 Synergy
• Unrelated businesses (hierarchical
relationships)
• Value creation derives from corporate office
• Leveraging support activities
Business
Human Firm 2
resource mgmt infrastructure

Technology Information
Procurement
development systems
Business
1

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 Creating Value
Related Diversification
Leveraging core competencies
• 3M leverages it competencies in adhesives technologies to many
industries, including automotive, construction, and telecommunications
Sharing activities
• McKesson, a large distribution company, sells many product lines,
such as pharmaceuticals and liquor, through its superwarehouses
Pooled negotiating power
• The Times Mirror Company increases its power over customers by providing “one-stop
shopping” for advertisers to reach customers through multiple media—television and
newspapers—in several huge markets such as New York and Chicago
Vertical integration
• Shaw industries, a giant carpet manufacturer, increases its control over raw materials by
producing much of its own polypropylene fiber, a key input to its manufacturing process

Exhibit 6.1 Creating Value through Related and Unrelated Diversification

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 Creating Value
Unrelated Diversification: Parenting, Restructuring, and
Financial Synergies
Corporate restructuring and parenting
• The corporate office of Cooper Industries adds value to its acquired
businesses by performing such activities as auditing their
manufacturing operations, improving their accounting activities, and
centralizing union negotiations
Portfolio management
• Novartis, formerly Ciba-Geigy, uses portfolio management to improve
many key activities, including resource allocation and reward and
evaluation systems

Exhibit 6.1 Creating Value through Related and Unrelated Diversification

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 Related Diversification: Economies of
Scope and Revenue Enhancement

• Economies of scope
• Cost savings from leveraging core
competencies or sharing related activities
among businesses in the corporation
• Leverage or reuse key resources
 Favorable reputation
 Expert staff

 Management skills

 Efficient purchasing operations

 Existing manufacturing facilities

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 Leveraging Core Competencies

• Core competencies
• The glue that binds existing businesses
together
• Engine that fuels new business growth
• Collective learning in a firm
 How to coordinate diverse production skills
 How to integrate multiple streams of technologies

 How to market diverse products and services

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 Three Criteria of Core Competencies
• Three criteria (of core competencies)
Superior
Customer
that lead to the creation of value and
value synergy
• Core competencies must enhance
competitive advantage(s) by creating
superior customer value
• Develop strengths relative to
competitors
• Build on skills and innovations
• Appeal to customers

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 Three Criteria of Core Competencies
• Three criteria (of core competencies)
Superior
Customer
that lead to the creation of value and
value synergy
• Different businesses in the firm must
Businesses be similar in at least one important
similar in way way related to the core competence
related to core
competency
• Not essential that products or
services themselves be similar
• Is essential that one or more
elements in the value chain
require similar essential skills
• Brand image is an example
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 Three Criteria of Core Competencies
• Three criteria (of core competencies)
Superior
Customer
that lead to the creation of value and
value synergy
• Core competencies must be difficult
Businesses for competitors to imitate or find
similar in way substitutes for
related to core
competency
• Easily imitated or replicated core
competencies are not a sound
basis for sustainable advantages
Difficult to
imitate or find
• Specialized technical skills
substitutes for acquired only in company work
experience are an example

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 Sharing Activities

• Corporations can also achieve synergy by

sharing tangible and value-creating activities
across their business units
• Common manufacturing facilities
• Distribution channels
• Sales forces
• Sharing activities provide two payoffs
• Cost savings
• Revenue enhancements

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 Cost Savings through Sharing Activities

• Most common type of synergy

• Savings obtained through
• Eliminating duplicate jobs
• Eliminating duplicate facilities
• Eliminating related expenses
• Savings may be offset by
• Greater costs of coordinating shared activities
• Costs of compromising design or performance of a
shared activity

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 Enhancing Revenue through Sharing
Activities

• Acquiring firm and its target may achieve a

higher level of sales growth together than either
could have achieved on its own
• Combined distribution channels can escalate sales
of the acquiring company’s products
• Enhanced effectiveness of differentiation strategies
• Can have a negative effect on a given
business’s differentiation

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 Pooled Negotiating Power
• Similar businesses
working together can
have stronger bargaining
Bargaining position relative to
Bargaining Bargaining
powerpower
power • Suppliers
• Customers
• Competitors
Business Business
1 2 • Abuse of bargaining
power may affect
relationships with
customers, suppliers and
competitors

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 Vertical Integration
• Benefits
Dependency • Secure source of supply of
• Suppliers raw materials
• Customers
• Secure distribution
Business
channels
2
Dependency • Protection and control over
assets and services
Dependency
• Suppliers • Access to new business
• Customers opportunities and
Business technologies
1 • Simplified procurement
and administrative
procedures

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 Vertical Integration
• Risks
• Costs and expenses
associated with increased
overhead and capital
Business expenditures
2 • Loss of flexibility resulting
Dependency from inability to respond
quickly to changes in the
external environment
• Problems associated with
Business unbalanced’ capacities or
1 unfilled demand along the
value chain
• Additional administrative
costs

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 Vertical Integration: Benefits and Risks

Benefits
• A secure source of raw materials or distribution channels.
• Protection of and control over valuable assets.
• Access to new business opportunities
• Simplified procurement and administrative procedures.
Risks
• Costs and expenses associated with increased overhead and capital
expenditures
• Loss of flexibility resulting from large investments.
• Problems associated with unbalanced capacities along the value chain.
• Additional administrative costs associated with managing a more complex
set of activities.

Exhibit 6.3 Benefits and Risks of Vertical Integration

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 Vertical Integration

In making decisions associated with vertical integration,

four issues should be considered
1. Are we satisfied with the quality of the value that our present
suppliers and distributors are providing?
2. Are there activities in our industry value chain presently being
outsourced or performed independently by others that are a
viable source of future profits?
3. Is there a high level of stability in the demand for the
organization’s products?
4. How high is the proportion of additional production capacity
actually absorbed by existing products or by the prospects of
new and similar products?

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 Analyzing Vertical Integration: The
Transaction Cost Perspective

Negotiating
Search costs
costs

Negotiating
Search costs
Market costs
transaction

Costs of
Enforcement
written
costs
Monitoring contract
costs

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 Unrelated Diversification: Financial
Synergies and Parenting

• Most benefits from unrelated diversification

are gained from vertical (hierarchical)
relationships
• Parenting and restructuring of businesses
• Allocate resources to optimize
 Profitability
 cash flow

 Growth

• Appropriate human resources practices

• Financial controls
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 Corporate Parenting
• Parenting—creating
Corporate value within business
office units
• Experience of the
• Plans corporate office
• Budgets
• Procurement • Support of the corporate
• Legal functions office
• Financial functions
• Human resource management

Business Business Business

unit unit unit

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 Corporate Restructuring

• Find poorly performing

Corporate
office
firms
• With unrealized
• Sell off parts potential
• Reduce payroll
• Change strategies • On threshold of
• Change management significant positive
• Infuse new technologies
• Reduce unnecessary expenses change

Business
Business Business
Business Business
Business
unitunit unit
unit unitunit

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 Corporate Restructuring

• Corporate management must

• Have insight to detect undervalued companies or
businesses with high potential for transformation
• Have requisite skills and resources to turn the
businesses around
• Restructuring can involve changes in
• Assets
• Capital structure
• management

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 Portfolio Management

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

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 The Boston Consulting Group (BCG) Portfolio Matrix

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 Portfolio Management
• Creation of synergies and shareholder
value by portfolio management and the
corporate office
• Allocate resources (cash cows to stars and
some question marks)
• Expertise of corporate office in locating
attractive firms to acquire

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 Portfolio Management
• Creation of synergies and shareholder
value by portfolio management and the
corporate office
• Provide financial resources to business units
on favorable terms reflecting the
corporation’s overall ability to raise funds
• Provide high quality review and coaching for
units
• Provide a basis for developing strategic
goals and reward/evaluation systems

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 Means to Achieve Diversification

• Acquisitions or mergers
• Pooling resources of other companies with a
firm’s own resource base
• Joint venture
• strategic alliance
• Internal development
• New products
• New markets
• New technology

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 Mergers and Acquisitions
Value Created Value Destroyed
Deal Year Since Combination Since
Combination
Manulife/John Hancock 2003 $ 12.7 billion _____

AOL/Time Warner 2001_____$148 billion

Vodafone/Mannesmann2000 _____ $299 billion
Pfizer/Warner-Lambert 2000 _____$78 billion
Glaxo/SmithKline 2000 _____$40 billion
Chase/J. P. Morgan 2000 _____$26 billion
Exxon/Mobil 1999 $ 8 billion _____
SBC/Ameritech 1999 _____$68 billion
WorldCom/MCI 1998 _____$94 billion
Travelers/Citicorp 1998 $109 billion _____
Daimler/Chrysler 1991 _____$36 billion
Source: K. H. Hammonds, “The Numbers Don’t Lie,” Fast Company, September 2002, p. 80. and Thomson Datatream

Exhibit 6.2 Ten Biggest Mergers and Acquisitions of All Time and Their Effect on Shareholder Wealth
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 Benefits & Limitations of Mergers and
Acquisitions

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 Strategic Alliances and Joint Ventures

Entering new
• Introduce successful product
markets or service into a new market
• Lacks requisite marketing
expertise
 Doesn’t understand customer
needs
 Doesn’t know how to promote the
product
 Doesn’t have access to proper
distribution channels

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 Strategic Alliances and Joint Ventures

Entering new
• Join other firms to reduce
markets manufacturing (or other) costs
in the value chain
Reducing
• Pool capital
costs in value • Pool value-creating activities
chain
• Pool facilities
• Economies of scale

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 Strategic Alliances and Joint Ventures

Entering new
• Develop or diffuse new
markets technologies
• Use expertise of two or more
companies
Reducing
costs in value • Develop products
chain technologically beyond the
capability of the companies
Developing acting independently
diffusing new
technology

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 Unmet Expectations: Strategic Alliances
and Joint Ventures

• Improper partner
• Each partner must bring desired
complementary strengths to partnership
• Strengths contributed by each should be
unique
• Partners must be compatible
• Partners must trust one another

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 Managerial Motives Can Erode Value
Creation

• Growth for growth’s sake: managers’ actions to grow

the size of their firms not to increase long-term

profitability but to serve managerial self-interest.

• Egotism: managers’ actions to shape their firms’

strategies to serve their selfish interests rather than to
maximize longterm shareholder value.

• Antitakeover tactics: managers’ actions to avoid

losing wealth or power as a result of a hostile takeover

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 Managerial Motives Can Erode Value
Creation

Greenmail: a payment by a firm to a hostile party for the

firm’s stock at a premium, made when the firm’s management
feels that the hostile party is about to make a tender offer.

Golden parachute: a prearranged contract with managers

specifying that, in the event of a hostile takeover, the target
firm’s managers will be paid a significant severance package.

Poison pills: used by a company to give shareholders certain

rights in the event of takeover by another firm.

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 “WASSALAM”

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