MAN4001 –

S T R AT E G I C
MANAGEMENT

Competitiveness & Globalization

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 UNIT 6:
D I V E R S I F I C AT I O N

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CORPORATE-LEVEL STRATEGY’S VALUE

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”

A corporate-level strategy is expected to help the firm earn above-average returns by creating
value

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CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
DIVERSIFICATION - growing into new business areas either related (similar to existing
business) or unrelated (different from existing business); allows a firm to create value by
productively using excess resources
The diversified firm operates in several different and unique product markets and likely in
several businesses; it forms two types of strategies: corporate-level (or company-wide) and
business-level (or competitive)

For the diversified corporation, a business-level strategy must be selected for each one of its
businesses

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CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
ONE • A single-product market/single geographic
location firm employs one business-level
BUSINESS- strategy and one corporate-level strategy
identifying what or which industry the firm
will compete in
LEVEL
STRATEGY

SEVERAL
• A diversified firm employs a separate
business-level strategy for each product
market area in which it competes and one
BUSINESS- or more corporate-level strategies dealing
with product and/or geographic diversity
LEVEL
STRATEGIES
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LEVELS OF DIVERSIFICATION

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LEVELS OF DIVERSIFICATION

A firm is related through its diversification when its businesses share links across:
o PRODUCTS (goods or services)
o TECHNOLOGIES
o DISTRIBUTION CHANNELS

The more links among businesses, the more “constrained” is the relatedness of diversification

“Unrelated” refers to the absence of direct links between businesses

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REASONS FOR DIVERSIFICATION

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REASONS FOR DIVERSIFICATION – Value Creating

Value-Creating
Diversification Strategies:
Operational and Corporate
Relatedness

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Value Creating Strategies
Value Creating Strategies
FIRM CREATES VALUE BY BUILDING UPON OR EXTENDING:
o Resources
o Capabilities
o Core competencies
PURPOSE: gain market power relative to competitors
ADVANTAGE: ECONOMIES OF SCOPE
Cost savings that occur when a firm transfers capabilities and competencies developed in one of
its businesses to another of its businesses

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Related Strategies
Operational Relatedness: Sharing Activities
Firms can create operational relatedness by sharing either a primary activity (such as inventory
delivery systems) or a support activity (such as purchasing practices)
Firms using the related constrained diversification strategy share activities in order to create value
Example: P&G’s paper towel business and baby diaper business both use paper products as a
primary input to the manufacturing process. The firm’s paper production plant produces inputs for
both businesses and is an example of a shared activity.
Risks:
Not easy, often synergies not realized as planned
Activity sharing is also risky because ties among a firm’s businesses create links between outcomes.
For instance, if demand for one business’s product is reduced, it may not generate sufficient
revenues to cover the fixed costs required to operate the shared facilities.

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Corporate Relatedness: Transferring of Core Competencies

the firm’s intangible resources, such as its know-how, become the foundation of core competencies, over
time.
Corporate-level core competencies are complex sets of resources and capabilities that link different
businesses, primarily through managerial and technological knowledge, experience, and expertise.
Firms seeking to create value through corporate relatedness use the related linked diversification
strategy.
The related linked diversification strategy helps firms to create value in two ways
First, because the expense of developing a core competence has already been incurred in one of the
firm’s businesses, transferring this competence to a second business eliminates the need for that business
to allocate resources to develop it.
Second, Resource intangibility - intangible resources are difficult for competitors to understand and
imitate. Because of this difficulty, the unit receiving a transferred corporate-level competence often
gains an immediate competitive advantage over its rivals
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Corporate Relatedness: Transferring of Core Competencies
Risks:
Managers may be reluctant to transfer key people who have accumulated knowledge and
experience critical to the business’s success.
Too much dependence on outsourcing can lower the usefulness of core competencies and thereby
reduce their useful transferability

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SIMULTANEOUS OPERATIONAL RELATEDNESS AND CORPORATE RELATEDNESS

The ability to simultaneously create economies of scope by sharing activities (operational

relatedness) and transferring core competencies (corporate relatedness) is difficult for
competitors to understand and learn how to imitate
Involves managing two sources of knowledge simultaneously:
o Operational forms of economies of scope
o Corporate forms of economies of scope
Many such efforts often fail because of implementation difficulties
If the cost of realizing both types of relatedness is not offset by the benefits created, the result is
DISECONOMIES because the cost of organization and incentive structure is very expensive

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Unrelated Strategies
Unrelated Diversification Strategy
Involves diversifying into businesses with
o No strategic fit
o No meaningful value chain relationships
o No unifying strategic theme
Approach is to venture into “any business in which we think we can make a profit”
Firms pursuing unrelated diversification are often referred to as conglomerates

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An unrelated diversification strategy can create value through two types of financial economies.
o Efficient Internal Capital Market Allocation
o Restructuring of Assets
Financial economies are cost savings realized through improved allocations of financial
resources based on investments inside or outside the firm.

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Example: General Electric
Operates as an infrastructure and financial services company worldwide.
- 8 segments

• Power and Water • Healthcare

• Oil and Gas • Transportation
• Energy Management • Appliances and Lighting
• Aviation • GE Capital

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Efficient Internal Capital Market Allocation
An internal capital market is where the internally generated cash flows of different divisions are
pooled, allowing a diversified firm to allocate resources to its best use.
In large diversified firms, the corporate headquarters office distributes capital to its businesses to
create value for the overall corporation.
In a market economy, capital markets allocate capital efficiently
● EQUITY - investors take equity positions (ownership) with high expected future cash-flow
values.
● DEBT - debt holders try to improve the value of their investments by taking stakes in
businesses with high growth and profitability prospects

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Restructuring of Assets
Financial economies can also be created when firms buy, restructure, and then sell the
restructured company in the external market.
o As in the real estate business, buying assets at low prices, restructuring them, and selling
them at a price that exceeds their cost generates a positive return on the firm’s invested
capital.
o Not as effective in high-technology businesses are often human-resource dependent; these
people can leave or demand higher pay and thus appropriate or deplete the value of an
acquired firm

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Value Neutral Strategies
Value Neutral Diversification Strategies

Different incentives to diversify sometimes exist, and the quality of the firm’s resources may
permit only diversification that is value neutral rather than value creating.
Incentives to Diversify
o Incentives to diversify come from both the external environment and a firm’s internal
environment. External incentives include antitrust regulations and tax laws.
o Internal incentives include low performance, uncertain future cash flows, and the pursuit of
synergy and reduction of risk for the firm.

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1. Antitrust Regulation and Tax Laws

Antitrust laws prohibit mergers that created increased market power (via either vertical or
horizontal integration)
Antitrust laws also referred to as competition laws ensure that fair competition exists in an open-
market economy.
Tax laws make sure that when a firm diversifies it does not pay less taxes as was the case before
1986.
Therefore, if firms have free cash flow to diversify they do not gain any additional value from it.

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2. Low Performance
Some research shows that low returns are related to greater levels of diversification - high
performance eliminates the need for greater diversification,” then low performance may provide
an incentive for diversification

3. Uncertain Future Cash Flows

As a firm’s product line matures or is threatened, diversification may be an important defensive
strategy. Small firms and companies in mature or maturing industries sometimes find it necessary
to diversify for long-term survival.
For example, auto-industry suppliers have been slowly diversifying into other more promising
businesses such as “green” businesses and medical supplies as the auto industry has declined.

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4. Synergy and Firm Risk Reduction

Diversified firms pursuing economies of scope often have investments that are too inflexible to
realize synergy between business units. As a result, a number of problems may arise. Synergy
exists when the value created by business units working together exceeds the value that those
same units create working independently.
But as a firm increases its relatedness between business units, it also increases its risk of
corporate failure, because synergy produces joint interdependence between businesses that
constrains the firm’s flexibility to respond.

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Value Reducing Strategies
Value Reducing Diversification Strategies

Managerial motives to diversify can exist independent of value-neutral reasons (i.e., incentives
and resources) and value-creating reasons (e.g., economies of scope).
The desire for increased compensation and reduced managerial risk are two motives for top-level
executives to diversify their firm beyond value-creating and value-neutral levels.
Top-level executives may diversify a firm in order to diversify their own employment risk, as
long as profitability does not suffer excessively - as firm size increases, so does executive
compensation

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 THE END!

Next class: Unit 7 – Mergers and

Acquisitions

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