Strategic Management Chapter 6 PDF

Chapter 6 Corporate-Level Strategy Hitt, Hitt, Ireland, Ireland, Hoskisson, Hoskisson, Harrison, Harrison, Strategic...

Chapter 6 Corporate-Level Strategy Hitt, Hitt, Ireland, Ireland, Hoskisson, Hoskisson, Harrison, Harrison, Strategic Strategic Management: Management: Concepts Concepts and and Cases: Cases: Competitiveness Competitiveness andand Globalization, Globalization, 14 14 th Edition. th Edition. © © 2024 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. in part.  Learning Objectives By the end of this chapter, you should be able to: 6.1 Define corporate-level strategy, and discuss its purpose. 6.2 Describe different levels of diversification achieved using different corporate-level strategies. 6.3 Explain the reasons firms diversify. 6.4 Describe how firms can create value by using a related diversification strategy. 6.5 Explain the two ways value can be created with an unrelated diversification strategy. 6.6 Discuss the incentives and resources that encourage value-neutral diversification. 6.7 Describe motives that can encourage managers to diversify a firm too much. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-1 Corporate-Level Strategy and Its Purpose Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Corporate-Level Strategy and Its Purpose (1 of 3) A corporate-level strategy specifies actions a firm takes to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets. A corporate-level strategy: − helps firms diversify their operations from a single business competing in a single market into several product markets and businesses. − helps companies to select new strategic positions—positions that are expected to increase the firm’s value. − is expected to help the firm earn above-average returns by creating value for stakeholders. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Corporate-Level Strategy and Its Purpose (2 of 3) A corporate-level strategy is concerned with two key issues: − In what product markets and businesses the firm should compete − How corporate headquarters should manage those businesses A firm can have more than one type of business-level strategy operating within its portfolio of businesses. An effective corporate-level strategy creates, across all of a firm’s businesses, aggregate returns that exceed what those returns would be without the strategy and contributes to the firm’s strategic competitiveness and its ability to earn above-average returns. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Corporate-Level Strategy and Its Purpose (3 of 3) Product diversification concerns: Diversification: − the scope of the markets and − is successful when it reduces industries in which the firm variability in the firm’s profitability competes. as earnings are generated from − how managers buy, create, and different businesses. sell different businesses to match − provides firms with the flexibility to skills and strengths with shift their investments to markets opportunities presented to the where the greatest returns are firm. possible rather than being dependent on only one or a few markets. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Discussion Activity 6-1 What is corporate-level strategy, and why is it important? Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Discussion Activity 6-1 Debrief What is corporate-level strategy, and why is it important? Corporate-level strategies are strategies firms use to diversify their operations from a single business competing in a single market into several product markets and businesses. A corporate-level strategy specifies actions a firm takes to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets. Corporate-level strategies help companies to select new strategic positions—positions that are expected to increase the firm’s value. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-2 Levels of Diversification Through Corporate-Level Strategies Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Levels of Diversification Through Corporate-Level Strategies Diversified firms vary according to their level of diversification and the connections between and among their businesses. There are five categories of businesses according to increasing levels of diversification: − Single business − Dominant business − Related constrained − Related linked − Unrelated Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 6.1 Levels and Types of Diversification Source: Adapted from R. P. Rumelt, 1974, Strategy, Structure and Economic Performance, Boston: Harvard Business School Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Low Levels of Diversification There are two types of strategies a firm with a low level of diversification can use: − Single-business diversification strategy  The firm generates 95 percent or more of its sales revenue from its core business area. − Dominant-business diversification strategy  The firm generates between 70 and 95 percent of its total revenue within a single business area.  Reflects a small amount of diversification as opposed to the related constrained strategy. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Moderate and High Levels of Diversification (1 of 3) A firm uses a related diversification strategy when: − it generates more than 30 percent of its revenue outside a dominant business. − its businesses are related to each other in some manner. There are two types of related diversification strategies: − Related constrained diversification strategy − Related linked diversification strategy Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Moderate and High Levels of Diversification (2 of 3) Related constrained diversification Related linked diversification strategy strategy − The links between the diversified − The firm’s portfolio of businesses firm’s businesses use similar have only a few links between sourcing, throughput, and them. outbound processes. − A related linked firm concentrates − A related constrained firm shares on transferring knowledge and resources and activities across its core competencies between its businesses. businesses. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Moderate and High Levels of Diversification (3 of 3) A highly diversified firm that has no relationships between its businesses follows an unrelated diversification strategy. − Commonly, firms using this strategy are called conglomerates. − Unrelated firms make no effort to share activities or transfer core competencies between or among their businesses. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Polling Activity 6-2 You own a local ice cream company that uses a unique, small-batch method of making ice cream. You are considering diversifying the company. Which level of diversification does it make sense for you to strive for? a. Single business b. Dominant business c. Related constrained d. Related linked e. Unrelated Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-3 Reasons for Diversification Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 6.1 Reasons for Diversification (1 of 2) Value-Creating Diversification Economies of scope (related diversification) Sharing activities Transferring core competencies Market power (related diversification) Blocking competitors through multipoint competition Vertical integration Financial economies (unrelated diversification) Efficient internal capital allocation Business restructuring Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Table 6.1 Reasons for Diversification (2 of 2) Value-Neutral Diversification Value-Reducing Diversification Antitrust regulation Diversifying managerial Tax laws employment risk Low performance Increasing managerial Uncertain future cash flows compensation Risk reduction for firm Tangible resources Intangible resources Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Reasons for Diversification (1 of 4) The broad objective of a diversification strategy is to increase the firm’s value by improving its overall performance. Value is created when the firm’s corporate-level strategy helps the firm do better in implementing its business-level strategies, either by increasing revenues or reducing costs within those business units. One way to do this is to pursue synergies through sharing tangible or intangible resources across those business units. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Reasons for Diversification (2 of 4) Synergy exists when the value created by business units working together exceeds the value that those same units create working independently. This type of synergy comes from economies of scope, which are economic factors that lead to cost savings through successfully sharing resources and capabilities or transferring one or more corporate-level core competencies that were developed in one of a firm’s businesses to another of its businesses. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Reasons for Diversification (3 of 4) A firm may increase market power through diversification by: − reducing costs below the levels of close competitors or increasing the firm’s ability to charge a price that is higher than competitors. − producing inputs for its value creation system that were previously bought from other companies (backward vertical integration). − vertically integrating forward by becoming its own customer for some of its products or services. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Reasons for Diversification (4 of 4) A firm can increase value through diversification by allocating capital and other resources to business units that need them the most to stay competitive or to the highest-performing business units, thus providing a high return on those additional investments. A firm may use a diversification strategy to: − adapt to changes in the external environment. − respond to low performance. − try to address uncertain cash flows. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Knowledge Check 6-3 All the following are value-creating reasons for diversification EXCEPT: a. market power. b. financial economies. c. economies of scope. d. risk reduction for the firm. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-4 Value-Creating Diversification: Related Constrained and Related Linked Diversification Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Value-Creating Diversification: Related Constrained and Related Linked Diversification Operational relatedness and corporate relatedness among the businesses of a diversified firm can both lead to the creation of value. Firms seek to create value from economies of scope through two basic kinds of operational economies: − Operational relatedness provides opportunities to share resources among the operational activities of the firm. − Corporate relatedness provides opportunities for transferring corporate- level competencies across businesses of the firm. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Figure 6.2 Value-Creating Diversification Strategies: Operational and Corporate Relatedness Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Operational Relatedness: Sharing Activities Firms can create operational Activity sharing: relatedness by sharing either: − is costly to implement and − a primary activity, or coordinate. − a support activity. − may create unequal benefits for the divisions involved. Sharing activities is usually − can lead to fewer managerial risk- associated with the related taking behaviors. constrained diversification corporate-level strategy. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Corporate Relatedness: Transferring of Core Competencies 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 using the related linked diversification strategy can create value by transferring core competencies in at least two ways: − Because the expense of developing a core competence has already been incurred in one of the firm’s businesses, transferring it to a second business eliminates the need for that business to allocate resources to develop it. − Because intangible resources are difficult for competitors to understand and imitate, the unit receiving a transferred corporate-level competence often gains an immediate competitive advantage over its rivals. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Market Power Firms using a related diversification strategy may gain market power when successfully using a related constrained or related linked strategy. Market power exists when a firm is able to sell its products above the existing competitive price level, reduce the costs of its primary and support activities below the cost levels of competitors, or both. Firms can foster increased market power through multipoint competition. − Through multipoint competition, rival firms often experience pressure to diversify because other firms in their dominant industry segment have made acquisitions to compete in a different market segment. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Vertical Integration (1 of 2) Vertical integration exists when a − avoid sourcing and market costs. company produces its own inputs − improve product quality. (backward integration) or owns its − possibly protect its technology own source of output distribution from imitation by rivals. (forward integration). − potentially exploit underlying Vertical integration allows a firm to capabilities in the marketplace. gain market power by developing the ability to: − save on its operations. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Vertical Integration (2 of 2) Vertical integration has limitations. − Internal transactions may be expensive and reduce profitability. − Bureaucratic costs may be present. − Substantial investments in specific technologies are required, reducing a firm’s flexibility. − Changes in demand create capacity balance and coordination problems. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Simultaneous Operational Relatedness and Corporate Relatedness The ability to simultaneously create economies of scale by sharing activities (operational relatedness) and transferring core competencies (corporate relatedness): − is difficult for competitors to understand and imitate. − is very expensive to undertake. − often results in discounted assets by investors.  It can be difficult for investors to identify the value that is created by the firm that shares both activities and core competencies. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Knowledge Check 6-4 Firms seek to create value from economies of scope through two basic kinds of operational economies: a. operational relatedness and market power. b. multipoint competition and corporate relatedness. c. operational relatedness and corporate relatedness. d. vertical integration and horizontal integration. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-5 Value Creation through Unrelated Diversification Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Value Creation through Unrelated Diversification Firms do not seek operational relatedness or corporate relatedness when using the unrelated diversification corporate-level strategy. Financial economies are cost savings realized through improved allocations of financial resources based on investments inside or outside the firm. An unrelated diversification strategy can create value through two types of financial economies: − Efficient internal capital market allocation − Asset restructuring Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Efficient Internal Capital Market Allocation (1 of 3) In a market economy, capital markets are believed to efficiently allocate capital. − Efficiency results as investors take equity positions with high expected future cash-flow values. − Capital is allocated through debt as shareholders and debt holders try to improve the value of their investments by taking stakes in businesses with high growth and profitability prospects. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Efficient Internal Capital Market Allocation (2 of 3) In large diversified firms, the corporate headquarters office distributes capital to its businesses to create value for the overall corporation. Managers in a firm’s corporate headquarters generally have access to more detailed and more accurate information regarding the actual and potential future performance of each of the businesses in the company’s portfolio than investors in the capital markets. External investors have relatively limited access to internal information and can only estimate the performances of individual businesses as well as their future prospects. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Efficient Internal Capital Market Allocation (3 of 3) Challenges associated with an unrelated diversification strategy: − One of the biggest problems occurs when the corporate office tries to micromanage the business units in its portfolio. − Another problem is that competitors can imitate financial economies more easily than they can replicate the value gained from the economies of scope developed through operational relatedness and corporate relatedness. These challenges are particularly relevant in developed economies. The advantages of unrelated diversification outweigh these problems in emerging economies. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Restructuring of Assets Financial economies can be Buying, restructuring, and then created when firms learn how to selling service-based assets for create value by: a profit in the external market is − buying assets at a low cost. difficult. − restructuring the assets. − This is because technology firms and service-based − selling the assets at a price that companies have relatively few exceeds their cost in the tangible assets that can be external market. restructured to create value and sell profitably. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Knowledge Check 6-5 What type of financial economy would be used to reduce risk among the firm's businesses when using an unrelated diversification strategy? a. Activity sharing b. Internal capital allocations c. Restructuring of acquired assets d. Transfer of core competencies Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-6 Incentives Driving Value-Neutral Diversification Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Incentives Driving Value-Neutral Diversification The quality and quantity of the − External incentives include: firm’s resources may permit only  Antitrust regulations diversification that is value neutral  Tax laws rather than value creating. − Internal incentives include: Incentives to diversify come from  Low performance both the external environment and a firm’s internal environment.  Uncertain future cash flows  The pursuit of synergy  Reduction of risk for the firm Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Antitrust Regulation In the 1960s and 1970s: In the 1980s and early 1990s: − antitrust laws prohibiting mergers − merger constraints were relaxed. that created increased market − more and larger horizontal power (via either vertical or mergers (acquisitions of target horizontal integration) were firms in the same line of business) stringently enforced. occurred. − most mergers were In the early 2000s: “conglomerate” in character. − antitrust concerns emerged again. − mergers received more scrutiny. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Tax Laws (1 of 2) In the 1960s and 1970s, dividends were taxed more heavily than were capital gains. − As a result, shareholders preferred that firms use free cash flows (liquid financial assets for which investments in current businesses are no longer economically viable) to buy and build companies in high-performance industries. The 1986 Tax Reform Act created an incentive for shareholders to retain funds for purposes of diversification by: − reducing the individual ordinary income tax rate from 50 to 28 percent. − changing the capital gains tax to treat capital gains as ordinary income. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Tax Laws (2 of 2) At one time, acquisitions were an attractive means for securing tax benefits, but the Financial Accounting Standards Board (FASB) reduced some of the incentives to make acquisitions by eliminating: − the “pooling of interests” method to account for an acquired firm’s assets. − the write-off for research and development in process. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Low Performance Research shows that: − low returns are related to greater levels of diversification. − an overall curvilinear relationship may exist between diversification and performance. There can be negative synergy (where potential synergy between acquiring and target firms is illusory), problems between leaders, and cultural fit difficulties that make value creation difficult. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Uncertain Future Cash Flows and Reduced Risk of Failure As a firm’s product line matures or A firm that is overexposed to risk of is threatened, diversification may failure because of be an important defensive strategy. interdependencies among its related businesses or uncertain Diversifying into other product cash flows may decide to begin markets or into other businesses operating in different environments. can reduce the uncertainty about a firm’s future cash flows. Neither diversifying to address uncertain cash flows or expanding into different environments is likely to create more value. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Knowledge Check 6-6 _____ and _____ provided incentives for U.S. firms to diversify in the 1960s and 1970s. a. Government antitrust policies; tax laws b. Mergers; acquisitions c. Free cash flows; dividends d. Capital gains taxes; divestitures Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  6-7 Managerial Motives to Diversify Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 6.3 The Curvilinear Relationship Between Diversification and Performance Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Managerial Motives to Diversify (1 of 4) Managerial motives to diversify can exist independent of value- neutral or value-creating reasons, including the desire for: − reduced managerial risk. − higher compensation. Diversification provides additional benefits to top-level managers that shareholders do not enjoy. Top-level executives may diversify a firm in order to spread their own employment risk, as long as profitability does not suffer excessively. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Managerial Motives to Diversify (2 of 4) If profits take a big drop as a result of the additional diversification, executives will still be at risk of being replaced by the board of directors. This sort of unprofitable diversification is often called empire building. Because diversification can increase a firm’s size and thus managerial compensation, managers may have motives to diversify a firm to a level that reduces its value. Research evidence shows that diversification and firm size are highly correlated, and, as firm size increases, so does executive compensation and social status. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Managerial Motives to Diversify (3 of 4) Managerial tendencies to over diversify may be held in check by governance mechanisms, such as: − the board of directors. − monitoring by owners. − executive compensation practices. − the threat of being taken over through an acquisition. The loss of adequate internal governance may result in relatively poor performance, thereby triggering a threat of takeover. This result is referred to as a capital market intervention. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Managerial Motives to Diversify (4 of 4) Although takeovers may improve firm performance by replacing ineffective managerial teams, managers may avoid takeovers through defensive tactics, such as “poison pills” that make the firm less attractive. Most large publicly held firms are profitable because the managers leading them are positive stewards of firm resources, and many of their strategic actions, including those related to selecting a corporate-level diversification strategy, contribute to the firm’s success. Top-level executives’ diversification decisions may also be held in check by concerns for their reputation. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Figure 6.4 Summary Model of the Relationship Between Diversification and Firm Performance Source: Adapted from R. E. Hoskisson & M. A. Hitt, 1990, Antecedents and performance outcomes of diversification: A review and critique of theoretical perspectives, Journal of Management, 16: 498. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Knowledge Check 6-7 Which of the following statements is true of managerial motives to diversify? a. Top-level executives’ diversification decisions may be held in check by concerns for their reputation. b. A strong external market for managerial talent may influence managers to pursue inappropriate diversification. c. Knowing that their firms could be acquired if they are not managed successfully discourages executives from using value-creating diversification strategies. d. An external governance threat is the most effective control of managerial motives for diversification. Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Summary Click the link to review the objectives for this presentation. Link to Objectives Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.