McGraw-Hill/Irwin
Copyright
© 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
STRATEGIC MANAGEMENT
Corporate-Level
Strategy: Creating Value through Diversification
Strategic Management
(BA 491)
Corporate-Level Strategy
2
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Making Diversification
Work
- Diversification
initiatives must create value for shareholders
- Mergers and
acquisitions
- Strategic
alliances
- Joint ventures
- Internal development
- Diversification
should create synergy
= 1
> 2
+
Business
2
Business
1
3
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Business
2
Business
1
Synergy
- Related businesses
(horizontal relationships)
- Sharing tangible
resources
- Sharing intangible
resources
Production
facilities
Distribution
channels
Favorable
reputation
Patents,
copyrights, etc.
Specialized
skills
Manufacturing
facilities
4
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Technology
development
Synergy
- Unrelated
businesses (hierarchical relationships)
- Value creation
derives from corporate office
- Leveraging
support activities
Business
2
Business
1
Procurement
Information
systems
Human
resource mgmt
Firm
infrastructure
5
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Reasons to Diversify
(good to poor)
- Leveraging
core competencies
- Increasing
market power
- Sharing infrastructure
- Balancing
financial resources
- Maintaining
growth
- Reducing risk
6
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Creating Value
Leveraging core competencies
- 3M leverages
it competencies in adhesives technologies to 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 superwarehouses
Related Diversification:
Economies of Scope
Related Diversification:
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—television and newspapers—in
several huge markets such as New York and Chicago
Vertical integration
- Shaw industries,
a giant carpet manufacturer, increases its control over raw materials
by producing much of its own polypropylene fiber, a key input to its
manufacturing process
7
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Creating Value
Corporate restructuring
and parenting
- The corporate
office of Cooper Industries adds value to its acquired businesses by
performing such activities as auditing their manufacturing operations,
improving their accounting activities, and centralizing union negotiations
Portfolio management
- Novartis,
formerly Ciba-Geigy, uses portfolio management to improve many key activities,
including resource allocation and reward and evaluation systems
Unrelated Diversification:
Parenting, Restructuring, and Financial Synergies
8
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Related Diversification:
Economies of Scope and Revenue Enhancement
- 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
9
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Leveraging Core Competencies
- Core competencies
- The glue that
binds existing businesses together
- Engine that
fuels new business growth
- Collective
learning in a firm
- How to coordinate
diverse production skills
- How to integrate
multiple streams of technologies
- How to market
diverse products and services
10
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Superior
Customer
value
Three Criteria of Core
Competencies
- 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
- Develop strengths
relative to competitors
- Build on skills
and innovations
- Appeal to
customers
11
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Three Criteria of Core
Competencies
- Three criteria
(of core competencies) that lead to the creation of value and synergy
- Different
businesses in the firm must be similar in at least one important way
related to the core competence
- Not essential
that products or services themselves be similar
- Is essential
that one or more elements in the value chain require similar essential
skills
- Brand image
is an example
Superior
Customer
value
Businesses
similar in way related to core competency
12
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Three Criteria of Core
Competencies
- Three criteria
(of core competencies) that lead to the creation of value and synergy
- Core competencies
must be difficult for competitors to imitate or find substitutes for
- Easily imitated
or replicated core competencies are not a sound basis for sustainable
advantages
- Specialized
technical skills acquired only in company work experience are an example
Superior
Customer
value
Businesses
similar in way related to core competency
Difficult
to imitate or find substitutes for
13
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Sharing 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
14
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Savings through
Sharing Activities
- Most common
type of synergy
- Savings obtained
through
- Eliminating
duplicate jobs
- Eliminating
duplicate facilities
- Eliminating
related expenses
- Savings may
be offset by
- Greater costs
of coordinating shared activities
- Costs of compromising
design or performance of a shared activity
15
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Enhancing Revenue through
Sharing Activities
- Acquiring
firm and its target may achieve a higher level of sales growth together
than either could have achieved on its own
- Combined distribution
channels can escalate sales of the acquiring company’s products
- Enhanced effectiveness
of differentiation strategies
- Can have a
negative effect on a given business’s differentiation
16
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Related Diversification:
Market Power
- Two principal
means to achieve synergy through market power
- Pooled negotiating
power
- Vertical integration
- Government
regulations may restrict this power
17
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Pooled Negotiating Power
- 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
Business
1
Bargaining
power
Business
2
Bargaining
power
Bargaining
power
18
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Dependency
Dependency
Vertical Integration
- Benefits
- Secure source
of supply of raw materials
- Secure distribution
channels
- Protection
and control over assets and services
- Access to
new business opportunities and technologies
- Simplified
procurement and administrative procedures
Dependency
Business
1
Business
2
19
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Vertical Integration
- Risks
- Costs and
expenses associated with increased overhead and capital expenditures
- Loss of flexibility
resulting from inability to respond quickly to changes in the external
environment
- Problems associated
with unbalanced’ capacities or unfilled demand
along the value chain
- Additional
administrative costs
Business
1
Business
2
Dependency
20
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Vertical Integration:
Benefits and Risks
- 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.
Benefits
Risks
- Costs and
expenses associated with increased overhead and capital expenditures
- Loss of flexibility
resulting from large investments.
- Problems
associated with unbalanced capacities along the value chain.
- Additional
administrative costs associated with managing a more complex set of
activities.
21
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Vertical Integration
In making decisions associated
with vertical integration, four issues should be considered
- Are we satisfied
with the quality of the value that our present suppliers and distributors
are providing?
- Are there
activities in our 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?
- How high is
the proportion of additional production capacity actually absorbed by
existing products or by the prospects of new and similar products?
22
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Analyzing Vertical Integration:
The Transaction Cost Perspective
Market
transaction
Monitoring
costs
Monitoring
costs
Enforcement
costs
Enforcement
costs
Costs
of written contract
Costs
of written contract
Negotiating
costs
Negotiating
costs
Search
costs
Search
costs
Search
costs
Search
costs
Negotiating
costs
Negotiating
costs
23
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Unrelated Diversification:
Financial Synergies and Parenting
- Most benefits
from unrelated diversification are gained from vertical (hierarchical)
relationships
- Parenting
and restructuring of businesses
- Allocate resources
to optimize
- Profitability
- cash flow
- Growth
- Appropriate
human resources practices
- Financial
controls
24
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2005 by The McGraw-Hill Companies, Inc. All rights reserved.
- Plans
- Budgets
- Procurement
- Legal
functions
- Financial
functions
- Human
resource management
Corporate Parenting
- Parenting—creating
value within business units
- Experience
of the corporate office
- Support of
the corporate office
Corporate
office
Business
unit
Business
unit
Business
unit
25
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Corporate Restructuring
- Find poorly
performing firms
- With unrealized
potential
- On threshold
of significant positive change
Corporate
office
Business
unit
Business
unit
Business
unit
- Sell off
parts
- Reduce
payroll
- Change
strategies
- Change
management
- Infuse
new technologies
- Reduce
unnecessary expenses
Business
unit
Business
unit
Business
unit
26
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Corporate Restructuring
- 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
27
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Portfolio Management
Key
Each circle represents
one of the firm’s business units
Size of circle
represents the relative size of the business unit in terms of revenue
$
$
28
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Portfolio Management
- Creation
of synergies and shareholder value by portfolio management and the corporate
office
- Allocate resources
(cash cows to stars and some question marks)
- Expertise
of corporate office in locating attractive firms to acquire
29
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Portfolio Management
- Creation
of synergies and shareholder value by portfolio management and the corporate
office
- Provide financial
resources to business units on favorable terms reflecting the corporation’s
overall ability to raise funds
- Provide high
quality review and coaching for units
- Provide a
basis for developing strategic goals and reward/evaluation systems
30
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Means to Achieve 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
31
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Mergers and Acquisitions
AOL/Time Warner 2001 _____ $148
billion
Vodafone/Mannesmann 2000
_____ $299 billion
Pfizer/Warner-Lambert 2000
_____ $78 billion
Glaxo/SmithKline 2000
_____ $40 billion
Chase/J. P. Morgan 2000
_____ $26 billion
Exxon/Mobil 1999 $
8 billion _____
SBC/Ameritech 1999 _____ $68
billion
WorldCom/MCI 1998 _____ $94
billion
Travelers/Citicorp 1998
$109 billion _____
Daimler/Chrysler 1991
_____ $36 billion
Value Created Value Destroyed
Deal Year Since Combination Since
Combination
Exhibit 6.5
Ten Biggest Mergers and Acquisitions of All Time and Their Effect on
Shareholder Wealth
As of July
1, 2002.
Source: K.
H. Hammonds, “The Numbers Don’t Lie,” Fast Company,
September 2002, p. 80.
32
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Strategic Alliances and
Joint Ventures
- Introduce
successful product or service into a new market
- 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
Entering
new markets
33
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Strategic Alliances and
Joint Ventures
- Join other
firms to reduce manufacturing (or other) costs in the value chain
- Pool capital
- Pool value-creating
activities
- Pool facilities
- Economies
of scale
Entering
new markets
Reducing
costs in value chain
34
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Strategic Alliances and
Joint Ventures
- Develop or
diffuse new technologies
- Use expertise
of two or more companies
- Develop products
technologically beyond the capability of the companies acting independently
Entering
new markets
Reducing
costs in value chain
Developing
diffusing new technology
35
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Unmet Expectations: Strategic
Alliances and Joint Ventures
- 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
36
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Real Options Analysis
- Stock options
(financial assets)
- Real options
( real assets or physical things)
- Investments
can be staged
- Strategic
decision-makers have “tollgates”
- Increased
knowledge about outcomes at the time of the next investment decision
37
Copyright ©
2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Managerial Motives Can
Erode Value Creation
- Growth for
growth’s sake
- Egotism
- Antitakeover
tactics
- Greenmail
- Golden parachute
- Poison pills
