Chapter 5: Corporate-Level Strategy

Part II: Strategic Actions: Strategy Formulation

Chapter 6: Corporate-Level Strategy
• Overview: Seven content areas
– Define and discuss corporate-level strategy
– Different levels of diversification
– Three primary reasons firms diversify
– Value creation: related diversification strategy
– Value creation: unrelated diversification strategy
– Incentives and resources encouraging value-neutral
diversification
– Management motives encouraging firm
overdiversification
 Introduction
• 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
– Expected to help firm earn above-average returns
– Value ultimately determined by 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
• Corporate-level strategy is concerned with two key issues:
in what product markets and businesses the firm should
compete and how corporate headquarters should manage
those businesses.
• For the diversified company, a business-level must be
selected for each of the businesses in which the firm has
decided to compete.
 Product diversification (PD)
• A primary form of corporate-level strategies, concerns the scope of the
markets and industries in which the firm competes as well as “how
managers buy, create, and sell different businesses to match skills and
strengths with opportunities presented to the firm.”
• Successful diversification is expected to reduce variability in the
firm’s profitability as earnings are generated from different
businesses.
• Diversification can also provide firms with the flexibility to shift their
investments to markets where the greatest returns are possible rather
than being dependent on only one or a few markets.
• CEOs and their top-management teams are responsible for
determining the best portfolio for their company
 Introduction
GE Rolls-Royce PLC
• 1st in aircraft-engine industry • 2nd in aircraft-engine industry
• Involved in hundreds of businesses: • No longer makes luxury cars; operation
manufacturing light bulb, medical devices; was parceled off to BMW and
operating self-storage facilities; broadcasting (it Volkswagen in 1998.
owns NBC) • 72% of its revenue coming from aircraft
• Less than 10% of its revenue coming from engine
aircraft engine

Business-level: Within industry

Both face the same competitive pressures: how to compete against Pratt & Whitney (3rd largest)

Corporate-level
GE faces strategic issues that are less relevant to Roll-Royce, in terms of managing the portfolio of
business
 Levels of Diversification
1. Low Levels
A firm pursuing a low level of diversification uses either a
single- or a dominant-business, corporate-level
diversification strategy
–Single Business Strategy: firm generates 95% or
more of its sales revenue from its core business area
–Dominant Business Diversification Strategy: firm
generates 70-95% of total sales revenue within a single
business area
–Firms that focus on one or very few businesses and
markets can earn positive returns, because they
develop capabilities useful for these markets and can
provide superior service to their customers
2. Moderate to High Levels
A firm generating more than 30 percent of its revenue outside a
dominant business and whose businesses are related to each other in
some manner uses a related diversification corporate-level strategy

– Related Constrained Diversification Strategy

• Less than 70% of revenue comes from the dominant business
• Direct links between the firm's businesses
• A firm shares resources and activities across its businesses with a related
constrained strategy.
• E.g. Procter & Gamble

– Related Linked Diversification Strategy (Mixed related and unrelated)

• Less than 70% of revenue comes from the dominant business
• Mixed: Linked firms sharing fewer resources and assets among their businesses
(compared with related constrained, above),
3. Very High Levels: Unrelated
• A highly diversified firm that has no relationships between its
businesses follows an unrelated diversification strategy
• Less than 70% of revenue comes from dominant business
• No relationships between businesses
• Commonly, firms using this strategy are called conglomerates.
• HWL is a leading international corporation with five core businesses:
ports and related services; property and hotels; retail; energy,
infrastructure, investments and telecommunications.
• These businesses are not related to each other, and the firm makes no
efforts to share activities or to transfer core competencies between or
among them
Levels and Types of Diversification
 Reasons for Diversification
• A number of reasons exist for diversification:
–Value-creating: Typically, a diversification strategy is used to
increase the firm’s value by improving its overall performance.
–Value is created either through related or unrelated diversification
when the strategy allows a company’s businesses to increase
revenues or reduce costs while implementing their business-level
strategies
–Value-neutral: Value-neutral reasons for diversification include
a desire to match and thereby neutralize a competitor’s market
power (e.g., to neutralize another firm’s advantage by acquiring a
similar distribution outlet).
–Value-reducing: Diversifying managerial employment risk
–Increasing managerial compensation
Value-Creating Diversification Strategies:
Operational and Corporate Relatedness
 (VCD):Related Strategies
• Purpose: Gain market power relative to competitors
• Related diversification wants to develop and exploit economies of scope
between its businesses
– Economies of scope: Cost savings firm creates by successfully sharing some of its resources and
capabilities or transferring one or more corporate-level core competencies that were developed in
one of its businesses to another of its businesses
• Rapid responses to changes in market demand, product design and mix, output
rates, and equipment scheduling
• Greater control, accuracy, and repeatability of processes
• Reduced costs from less waste and lower training and changeover costs
• Firms seek to create value from economies of scope through two basic kinds of
operational economies: sharing activities (operational relatedness) and transferring
corporate-level core competencies (corporate relatedness).

• VCD: Composed of ‘related’ diversification strategies including Operational

and Corporate relatedness
 (VCD): Related Strategies
• 1. Operational Relatedness: Sharing activities
– Can gain economies of scope
– Share primary or support activities (in value chain)
– Related constrained share activities in order to create value
– 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
 Corporate Relatedness
• Core competency transfer
– Complex sets of resources and capabilities linking different businesses
through managerial and technological knowledge, experience and
expertise
– Two sources of value creation
• Expense incurred in first business and knowledge transfer reduces resource
allocation for second business
• Intangible resources 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.
– Use related-linked diversification strategy
– One way managers facilitate the transfer of corporate-level core competencies is by
moving key people into new management positions.
 Value-Creating Diversification
(VCD):Related Strategies
• Firms 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
level, to reduce costs of primary and support activities below the competitive
level, or both.
– Ericsson has the largest share of the global market in telecommunications
equipment, and for many years its leadership position has afforded the company
considerable market power.
– Multimarket (or Multipoint) Competition
• Exists when 2 or more diversified firms simultaneously compete in the same product or
geographic markets.
• Through multi-point 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.
 – Related diversification strategy may include
• Some firms using a related diversification strategy engage in vertical
integration to gain market power.
• Vertical integration exists when a company produces its own inputs
(backward integration) or owns its own source of output distribution
(forward integration).
• Vertical integration is commonly used in the firm’s core business to gain
market power over rivals
• In some instances, firms partially integrate their operations, producing and
selling their products by using company-owned businesses as well as
outside sources.
 (VCD): Unrelated Strategies
• Creates value through two types of financial economies
– Cost savings realized through improved allocations of financial resources based
on investments inside or outside firm
• Efficient internal capital market allocation
• Efficient internal capital allocations reduce risk among the firm’s businesses—
for example, by leading to the development of a portfolio of businesses with
different risk profiles.
• Because those in a firm’s corporate headquarters generally have access to
detailed and accurate information regarding the actual and potential future
performance of the company’s portfolio of businesses, they have the best
information to make capital distribution decisions
• Compared with corporate office personnel, external investors have relatively
limited access to internal information and can only estimate the performances
of individual businesses as well as their future prospects.
• Moreover, although businesses seeking capital must provide information to
potential suppliers (e.g., banks or insurance companies), firms with internal
capital markets can have at least two informational advantages.
• First, information provided to capital markets through annual reports and other
sources emphasize positive prospects and outcomes. External sources of capital
have a limited ability to understand the operational dynamics within large
organizations.
• Even external shareholders who have access to information are unlikely to
receive full and complete disclosure.
• Second, although a firm must disseminate information, that information also
becomes simultaneously available to the firm’s current and potential
competitors.
• Competitors might attempt to duplicate a firm’s value-creating strategy with
insights gained by studying such information.
• Thus, the ability to efficiently allocate capital through an internal market helps
the firm protect the competitive advantages it develops while using its
corporate-level strategy as well as its various business-unit–level st rategies.
 –Restructuring of acquired assets
• Financial economies can also be created when firms learn how to create value by
buying, restructuring, and then selling the restructured companies’ assets in the
external market.
• 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.
• For both high-technology firms and service-based companies, relatively few
tangible assets can be restructured to create value and sell profitably. It is
difficult to restructure intangible assets such as human capital and effective
relationships that have evolved over time between buyers (customers) and
sellers (firm personnel).
• Ideally, executives will follow a strategy of buying businesses when prices are
lower, such as in the midst of a recession, and selling them at late stages in an
expansion.
• Firm A buys firm B and restructures assets so it can operate more profitably, then A sells
B for a profit in the external market
 Value-Neutral Diversification:
Incentives and Resources
Incentives to diversify come from both the external environment and a
firm’s internal environment.
• Incentives to Diversify
– Antitrust Regulation and Tax Laws (External incentives )
– Low Performance
– Uncertain Future Cash Flows
– Synergy and Firm Risk Reduction
– Resources and Diversification
 Value-Reducing Diversification:
Managerial Motives to Diversify
• Top-level executives may diversify in order to diversity their own
employment risk, as long as profitability does not suffer
excessively
– Diversification adds benefits to top-level managers but not
shareholders
– This strategy may be held in check by governance mechanisms
or concerns for one’s reputation
Summary Model of the Relationship
Between Diversification and Firm
Performance