Corporate-Level Strategy:

Diversification, Integration, Real Options, and Hopscotch

What’s the point of Diversification?

• Diversification initiatives should create value for the stockholders:– Give access to different industries– Provide opportunity to enter the optimal

industries and segments• Diversification should create synergy:

– Businesses should be managed so as to create more value than they would on their own

Related vs. Unrelated Diversification

• Related businesses (horizontal & vertical relationships)– Sharing tangible resources– Sharing intangible resources

• Unrelated businesses (hierarchical relationships)– Value creation derives from corporate office– Leveraging support activities

Related Diversification: Creating Value• Economies of Scope

• Leveraging core competencies – 3M leverages its competencies in adhesives technologies in 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 super-warehouses

• Market Power• 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 (newspapers, TV, online) in multiple markets

• Vertical Integration - Shaw industries, a carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input to its manufacturing process

Related Diversification: 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

Related Diversification: Economies of Scope

• Three criteria (of core competencies) that lead to the creation of value and synergy– Core competencies must enhance competitive

advantage(s) by creating superior customer value

– Different businesses in the firm must be similar in at least one important way related to the core competence

– Core competencies must be difficult for competitors to imitate or find substitutes for

Economies of Scope: Shared 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

Related Diversification: Market Power

• Two principal means to achieve synergy through market power:– Pooled negotiating power– Vertical integration

• Similar businesses working together can have stronger bargaining position relative to:– Suppliers– Customers– Competitors

• Abuse of bargaining power may affect relationships with customers, suppliers and competitors; may also draw government regulation or sanctions

Vertical Integration

• Vertical Integration usually refers to situations where the corporation purchases suppliers or buyers to create greater value

• Purchasing a supplier is called upward or backward integration (as in moving back up stream)

• Purchasing a buyer is called forward or downward integration (moving down the stream to the customer)

• Neither one should be confused with Lateral (or Horizontal) integration, which involves purchasing competitors or substitutes for your product/service

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 from large investments• Possibility of unbalanced capacities along the value chain• Administrative costs of managing a more complex set of

activities

Issues with Vertical Integration1. 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?

5. Do we have the necessary competencies to execute the vertical integration strategies?

6. Will the vertical integration initiative have potential negative impacts on our stakeholders?

Analyzing Vertical Integration: The Transaction Cost Perspective

• Transaction Cost Analysis considers all of the costs associated with a given market transaction

• In the case of Vertical Integration, that would include search costs, contract costs, monitoring costs, negotiation costs, opportunity costs, etc.

• If the savings, control and opportunity benefits resulting from the Integration do not exceed these costs, then it’s not a good strategic move

Unrelated Diversification: Value Creation

Most benefits from unrelated diversification are gained from hierarchical relationships:– Parenting and restructuring of businesses– Allocate resources to optimize

– Profitability– Cash flow– Growth

– Appropriate human resources practices– Financial controls

Corporate Parenting & Restructuring

• Corporate Parenting: creating value within business units

• Experience of the corporate office• Support from the corporate office

• Corporate Restructuring: Find poorly performing units -

• With unrealized potential• On threshold of significant positive change

Making It Work• 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

Portfolio Management

Means of 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

Strategic Alliances and Joint Ventures

• Strategic Alliance can assist the company in taking a successful product into a new market when it:

• 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

• Join other firms to reduce manufacturing (or other) costs in the value chain:

• Pool capital• Pool value-creating activities• Pool facilities

Unmet Expectations: When Strategic Alliances and Joint Ventures Fail

• 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

Managerial Motives Can Erode Value Creation

• Growth for growth’s sake• Egotism• Antitakeover tactics

– Greenmail– Golden parachute– Poison pills

Before We Go Today: