Corporate-Level Strategy: Creating Value Through Diversification PDF

Because learning changes everything.® CHAPTER 6 Corporate-Level Strategy: Creating Value through Diversification © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Anatoli Styf/Shutterstock  Learning Ob...

Because learning changes everything.® CHAPTER 6 Corporate-Level Strategy: Creating Value through Diversification © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Anatoli Styf/Shutterstock  Learning Objectives After reading this chapter, you should be able to: 1. Identify the reasons for the failure of many diversification efforts. 2. Explain how managers can create value through diversification initiatives. 3. Explain how corporations can use related diversification to achieve synergistic benefits through economies of scope and market power. 4. Explain how corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis. 5. Describe various means of engaging in diversification – mergers and acquisitions, joint ventures/strategic alliances, and internal development. 6. Identify managerial behaviors that can erode the creation of value. © McGraw Hill LLC.  Looking Ahead Making Diversification Work: An Overview. Related Diversification: Economies of Scope and Revenue Enhancement. Enhancing Revenue and Differentiation. Related Diversification: Market Power. Unrelated Diversification: Financial Synergies and Parenting. The Means to Achieve Diversification. How Managerial Motives Can Erode Value Creation. © McGraw Hill LLC.  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? © McGraw Hill LLC.  Reasons for Diversification Failures Acquisitions can destroy value by: Paying a premium for the target firm. Failing to integrate the activities of the newly acquired businesses into the corporate family. Undertaking diversification initiatives that are too easily imitated by the competition. © McGraw Hill LLC.  Making Diversification Work 1 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. © McGraw Hill LLC.  Making Diversification Work 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. © McGraw Hill LLC.  Related Diversification Related diversification enables a firm to benefit from horizontal relationships across different businesses. Economies of scope allow businesses to: Leverage core competencies. Sharing related activities. Enjoy greater revenues, enhance differentiation. Related businesses gain market power by: Pooled negotiating power. Vertical integration. © McGraw Hill LLC.  Question 1 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. © McGraw Hill LLC.  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. © McGraw Hill LLC.  Related Diversification: Sharing Activities Corporations can also achieve synergy by sharing activities across their business units. Sharing tangible and value-creating activities can provide payoffs. Cost savings through elimination of jobs, facilities and related expenses, or economies of scale. Revenue enhancements through increased differentiation and sales growth. © McGraw Hill LLC.  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 and customers. Vertical integration: a firm becomes its own supplier or distributor through: Backward integration. Forward integration. © McGraw Hill LLC.  Example: Question Costco, the warehouse retailer, purchased Innovel Solutions to improve its last-mile capabilities. Innovel provides Costco with 15 distribution and fulfillment centers and over 100 last-mile docking facilities where goods are transferred to delivery trucks. This is an example of: A. leveraging core competencies. B. pooled negotiating power. C. vertical integration. D. sharing activities. © McGraw Hill LLC.  Related Diversification: Vertical Integration, Issues Is the company satisfied with the quality of the value that its present suppliers and 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? © McGraw Hill LLC.  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. © McGraw Hill LLC.  Unrelated Diversification Unrelated diversification enables a firm to benefit from vertical or hierarchical relationships between the corporate office and individual business units through: The corporate parenting advantage. Providing competent central functions. Restructuring to redistribute assets. Asset, capital, and management restructuring. Portfolio management. BCG growth/share matrix. © McGraw Hill LLC.  Unrelated Diversification: Parenting and Restructuring Parenting allows the corporate office to create value through management expertise and 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, and reporting relationships. © McGraw Hill LLC.  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. © McGraw Hill LLC.  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 6.5 The Boston Consulting Group (BCG) Portfolio Matrix Access the text alternative for slide images. © McGraw Hill LLC.  Unrelated Diversification: Portfolio Management, Limitations Limitations of portfolio models: SBUs are compared on only two dimensions and 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 and simplistic rules for resource allocation can be detrimental to a firm’s long-term viability. © McGraw Hill LLC.  Goal of Diversification = Risk Reduction? Diversification can reduce variability in revenues and profits over time. However, Stockholders can diversify portfolios at a much lower cost. Stockholders don’t have to worry about integrating the acquisition into their portfolio. Economic cycles are difficult to predict, so why diversify? Choice to diversify must be part of an overall diversification strategy. © McGraw Hill LLC.  Means of Diversification Diversification can be accomplished via: Mergers and acquisitions. Divestments. Pooling resources of other companies with a firm’s own resource base through strategic alliances and joint ventures. Internal development through corporate entrepreneurship or new venture development. © McGraw Hill LLC.  Mergers and Acquisitions Mergers involve a combination or consolidation of two firms to form a new legal entity. On a relatively equal basis. Are relatively rare. Acquisitions involve one firm buying another either through stock purchase, cash, or the issuance of debt. © McGraw Hill LLC.  Mergers and Acquisitions: Motives Acquiring is faster than building. Acquiring valuable resources can expand product offerings and services and/or enter new market segments. Mergers and acquisitions help a firm develop synergy. Leveraging core competencies. Sharing activities. Building market power. Can consolidate an industry, forcing other players to merge. © McGraw Hill LLC.  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. © McGraw Hill LLC.  Question 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 these are correct. © McGraw Hill LLC.  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. © McGraw Hill LLC.  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. © McGraw Hill LLC.  Strategic Alliances and Joint Ventures: Motives Strategic alliances and 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 and diffuse new technologies. © McGraw Hill LLC.  Strategic Alliances and 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 and defended. Partners must be compatible and willing to trust each other. © McGraw Hill LLC.  Internal Development Corporate entrepreneurship and 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. © McGraw Hill LLC.  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. © McGraw Hill LLC.  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. © McGraw Hill LLC.  Reflecting on Career Implications This chapter focuses on how firms can create value through diversification. Consider how you can develop core competencies that apply in different settings and how you can leverage those skills in different value chain activities or units in your firms. Corporate-Level Strategy. Core Competencies. Sharing Infrastructures. Diversification. © McGraw Hill LLC. 34  End of Main Content Because learning changes everything. ® www.mheducation.com © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Accessibility Content: Text Alternatives for Images © McGraw Hill LLC. 36  Unrelated Diversification: Portfolio Management, B C G, Text Alternative The graphic is divided into four sections: stars, question marks, cash cows, and dogs. The y axis is industry growth rate divided into percentages from 2 to 22. The x axis is the relative market share 10 x to 0.1 x. There are circles in each section representing B C G’s business units. The size of the circle represents the relative size of the business unit in terms of revenues. In stars there are two medium-sized units and one small unit. First unit is at 10 percent growth rate and 3 x relative market share. Second is at 15 percent growth rate and 1.5 x share. The smallest unit is at 21 percent growth rate and 1x share. In question marks, one unit, a medium-sized unit is at 14 percent growth rate and 0.3 x market share. A smaller unit at 16 percent growth rate and.25 x share. And the smallest question mark unit is at 16 percent growth rate and 1 x share. There are three small dog units. One at.15 x share and 4 percent growth rate, one at 0.3 x share and 7 percent growth rate, and one at 8 percent growth rate and almost to 0.1 x share. The largest units are in the cash cows quadrant. The largest is at 4 percent growth rate and 4 x share. A medium 4 percent growth rate and 2 x share, and a medium-sized unit at 8 percent growth rate and 1.5 x share. As the text says, market share is central to the B C G matrix. This is because high relative market share leads to unit cost reduction due to experience and learning curve effects and, consequently, superior competitive position. Return to parent-slide containing images. © McGraw Hill LLC. 37