CHAPTER 6

Corporate-Level
Strategy: Creating
Value through
Diversification

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 Learning Objectives

After reading this chapter, you should have a good understanding of:
6-1 The reasons for the failure of many diversification efforts.
6-2 How managers can create value through diversification initiatives.
6-3 How corporations can use related diversification to achieve
synergistic benefits through economies of scope and market power.
6-4 How corporations can use unrelated diversification to attain
synergistic benefits through corporate restructuring, parenting, and
portfolio analysis.
6-5 The various means of engaging in diversification – mergers and
acquisitions, joint ventures/strategic alliances, and internal
development.
6-6 Managerial behaviors that can erode the creation of value.

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 Corporate-Level Strategy

Consider . . .
What businesses should a corporation compete
in?
How can these businesses be managed so they
create “synergy” – that is, create more value by
working together than if they were freestanding
units?

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 Making Diversification Work
(1 of 2)

Diversification initiatives must create value for

shareholders through
• Mergers and acquisitions

• Strategic alliances

• Joint ventures

• Internal development

Diversification should create synergy.

• Business 1 plus Business 2 equals More than two.

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 Making Diversification Work
(2 of 2)

A firm may diversify into related businesses.

• Benefits derive from horizontal relationships.
• Sharing intangible resources such as core competencies
in marketing
• Sharing tangible resources such as production facilities,
distribution channels via vertical integration

A firm may diversify into unrelated businesses.

• Benefits derive from hierarchical relationships.
• Value creation derived from the corporate office

• Leveraging support activities in the value chain

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 Related Diversification

Related diversification enables a firm to benefit from

horizontal relationships across different businesses.
Economies of scope allow businesses to:
• Leverage core competencies

• Share related activities

• Enjoy greater revenues, enhance differentiation

Related businesses gain market power by:

• Pooled negotiating power

• Vertical integration

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 Question
(1 of 2)

Sharing core competencies is one of the primary

potential advantages of diversification. In order for
diversification to be most successful, it is important
that
A. the similarity required for sharing core
competencies must be in the value chain, not in
the product.
B. the products use similar distribution channels.

C. the target market is the same, even if the

products are very different.
D. the methods of production are the same.
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 Related Diversification:
Leveraging Core Competencies

Core competencies reflect the collective

learning in organizations. Can lead to the creation
of value and synergy if…
They create superior customer value.
The value-chain elements in separate businesses
require similar skills.
They are difficult for competitors to imitate or find
substitutes for.

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 Related Diversification:
Sharing Activities

Corporations can also achieve synergy by sharing

activities across their business units.
Sharing tangible & value-creating activities can
provide payoffs.
• Cost savings through elimination of jobs, facilities
& related expenses, or economies of scale
• Revenue enhancements through increased
differentiation & sales growth

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 Related Diversification:
Market Power

Market power can lead to the creation of value

and synergy through…
Pooled negotiating power
• Gaining greater bargaining power with suppliers &
customers

Vertical integration - becoming its own supplier

or distributor through
• Backward integration
• Forward integration

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 Example: Question

Shaw Industries, a giant carpet manufacturer,

increases its control over raw materials by
producing much of its own polypropylene fiber, a
key input into its manufacturing process. This is
an example of
A. leveraging core competencies.
B. pooled negotiating power.
C. vertical integration.
D. sharing activities.

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 Example: Related Diversification:
Vertical Integration

Example: Simplified Stages of Vertical Integration: Shaw

Industries

©McGraw-Hill Education. Jump to Appendix 1 for long desc

ription
 Related Diversification:
Vertical Integration, Issues

Is the company satisfied with the quality of the value that its
present suppliers & distributors are providing?

Are there activities in the industry value chain presently being

outsourced or performed independently by others that are a
viable source of future profits?

Is there a high level of stability in the demand for the

organization’s products?

Does the company have the necessary competencies to

execute the vertical integration strategies?

Will the vertical integration initiatives have potential

negative impacts on the firm’s stakeholders?

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 Related Diversification:
Vertical Integration, Transaction Costs

Transaction cost perspective

Every market transaction involves some transaction costs.
• Search costs

• Negotiating costs

• Contract costs

• Monitoring costs

• Enforcement costs

• Need for transaction specific investments

• Administrative costs

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 Unrelated Diversification

Unrelated diversification enables a firm to benefit

from vertical or hierarchical relationships between the
corporate office & individual business units through…
The corporate parenting advantage
• Providing competent central functions

Restructuring to redistribute assets

• Asset, capital, & management restructuring

Portfolio management
• BCG growth/share matrix

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 Unrelated Diversification:
Parenting & Restructuring

Parenting allows the corporate office to create

value through management expertise & competent
central functions.
In restructuring the parent intervenes.
• Asset restructuring involves the sale of
unproductive assets.
• Capital restructuring involves changing the debt–
equity mix, adding debt or equity.
• Management restructuring involves changes in the
top management team, organizational structure, &
reporting relationships.
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 Unrelated Diversification:
Portfolio Management

Portfolio management involves a better

understanding of the competitive position of an
overall portfolio or family of businesses by…
• Suggesting strategic alternatives for each business
• Identifying priorities for the allocation of resources
• Using Boston Consulting Group’s (BCG)
growth/share matrix

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 Unrelated Diversification:
Portfolio Management, BCG

Each circle represents

one of the firm’s
business units. The
size of the circle
represents the
relative size of the
business unit in terms
of revenue.

Exhibit 6.4 The Boston Consulting Group (BCG)

Portfolio Matrix
Jump to Appendix 2 for long descri
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 Unrelated Diversification:
Portfolio Management, Limitations

Limitations of portfolio models:

• SBUs are compared on only two dimensions & each
SBU is considered a standalone entity.
• Are these the only factors that really matter?

• Can every unit be accurately compared on that basis?

What about possible synergies?

• An oversimplified graphical model is no substitute for

managers’ experience.
• Following strict & simplistic rules for resource
allocation can be detrimental to a firm’s long-term
viability.
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 Example: Goal of Diversification =
Risk Reduction?

Diversification can reduce variability in revenues

& profits over time. However…
• Stockholders can diversify portfolios at a much
lower cost & economic cycles are difficult to
predict, so why diversify?
Example = General Electric’s businesses:
• Aircraft engines, power generation equipment,
locomotive trains, large appliances, healthcare
products, financial products, lighting, mining, oil &
gas
• Why is GE in so many businesses?

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 Means of Diversification

Diversification can be accomplished via

• Mergers & acquisitions
• And divestment

• Pooling resources of other companies with a firm’s

own resource base through
• Strategic alliances & joint ventures

• Internal Development through

• Corporate entrepreneurship

• New venture development

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 Mergers and Acquisitions

Mergers involve a combination or consolidation

of two firms to form a new legal entity.
• Relatively rare
• On a relatively equal basis

Acquisitions involve one firm buying another

either through stock purchase, cash, or the
issuance of debt.

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 Mergers and Acquisitions: Motives

In high-technology & knowledge-intensive industries, speed is

critical: acquiring is faster than building.
M&A allows a firm to obtain valuable resources that help it
expand its product offerings & services.
M&A helps a firm develop synergy.
• Leveraging core competencies

• Sharing activities

• Building market power

M&A can lead to consolidation within an industry, forcing other

players to merge.
Corporations can also enter new market segments by way of
acquisitions.

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 Mergers and Acquisitions:
Limitations

Takeover premiums for acquisitions are typically

very high.
Competing firms can imitate advantages.
Competing firms can copy synergies.
Managers’ egos get in the way of sound business
decisions
Cultural issues may doom the intended benefits.

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 Question
(2 of 2)

Divestment can be the common result of an

acquisition. Divesting businesses can accomplish
many different objectives. These include
A. enabling managers to focus their efforts more
directly on the firm’s core businesses.
B. providing the firm with more resources to spend
on more attractive alternatives.
C. raising cash to help fund existing businesses.
D. all of the above.

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 Mergers and Acquisitions:
Divestment Objectives

Divestment objectives include:

• Cutting the financial losses of a failed acquisition
• Redirecting focus on the firm’s core businesses
• Freeing up resources to spend on more attractive
alternatives
• Raising cash to help fund existing businesses

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 Mergers and Acquisitions:
Divestment Success

Successful divestiture involves:

• Removing emotion from the decision
• Knowing the value of the business you’re selling
• Timing the deal right
• Maintaining a sizable pool of potential buyers
• Telling a story about the deal
• Running divestitures systematically through a
project office
• Communicating clearly and frequently
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 Strategic Alliances &
Joint Ventures: Motives

Strategic alliances & joint ventures are

cooperative relationships between two (or more)
firms with potential advantages.
• Ability to enter new markets through
• Greater financial resources

• Greater marketing expertise

• Ability to reduce manufacturing or other costs in

the value chain
• Ability to develop & diffuse new technologies

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 Strategic Alliances &
Joint Ventures: Limitations

Need for the proper partner:

• Partners should have complementary strengths.
• Partner’s strengths should be unique.
• Uniqueness should create synergies.

• Synergies should be easily sustained & defended.

• Partners must be compatible & willing to trust each

other.

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 Internal Development

Corporate entrepreneurship & new venture internal

development motives:
• No need to share the wealth with alliance partners.
• No need to face difficulties associated with combining
activities across the value chains.
• No need to merge diverse corporate cultures.
• No need for external funding for new development.

Limitations:
• Time-consuming
• Need to continually develop new capabilities
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 Managerial Motives

Managerial motives: Managers may act in their

own self interest, eroding rather than enhancing
value creation.
• Growth for growth’s sake
• Top managers gain more prestige, higher rankings,
greater incomes, more job security.
• It’s exciting and dramatic!

• Excessive egotism
• Use of antitakeover tactics

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 Managerial Motives:
Antitakeover Tactics

Antitakeover tactics include:

• Greenmail
• Golden parachutes
• Poison pills

Can benefit multiple stakeholders – not just

management
Can raise ethical considerations because the
managers of the firm are not acting in the best
interests of the shareholders

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