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cap_6_hitt.pptx
PART 2: STRATEGIC ACTIONS: STRATEGY FORMULATION
CHAPTER 6 CORPORATE-LEVEL STRATEGY
Authored by:
Marta Szabo White, PhD.
Georgia State University
THE STRATEGIC MANAGEMENT PROCESS
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KNOWLEDGE OBJECTIVES
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● Define corporate-level strategy and discuss its purpose.
● Describe different levels of diversification with different corporate-level strategies.
● Explain three primary reasons firms diversify.
● Describe how firms can create value by using a related diversification strategy.
KNOWLEDGE OBJECTIVES
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● Explain the two ways value can be created with an unrelated diversification strategy.
● Discuss the incentives and resources that encourage diversification.
● Describe motives that can encourage managers to over diversify a firm.
CORPORATE–LEVEL STRATEGY: WHAT BUSINESSES SHOULD A FIRM COMPETE IN?
TWO KEY ISSUES
1. In what product markets and businesses should the firm compete?
2. How should corporate headquarters manage those businesses?
IMPORTANT DEFINITION
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CORPORATE–LEVEL STRATEGIES
■ MARKET DEVELOPMENT - moving into different geographic markets
■ PRODUCT DEVELOPMENT - developing new products and/or significantly improving on existing products
■ HORIZONTAL INTEGRATION - acquisition of competitors; horizontal movement at the same point in the value chain
■ VERTICAL INTEGRATION - becoming your own supplier or distributor through acquisition; vertical movement up or down the value chain
IMPORTANT DEFINITIONS
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CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
■ DIVERSIFICATION - growing into new business areas either related (similar to existing business) or unrelated (different from existing business); allows a firm to create value by productively using excess resources
■ The diversified firm operates in several different and unique product markets and likely in several businesses; it forms two types of strategies: corporate-level (or company-wide) and business-level (or competitive)
■ For the diversified corporation, a business-level strategy must be selected for each one of its businesses
IMPORTANT DEFINITION
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CORPORATE-LEVEL STRATEGY
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ONE
BUSINESS-
LEVEL
STRATEGY
A single-product market/single geographic location firm employs one business-level strategy and one corporate-level strategy identifying what or which industry the firm will compete in
SEVERAL BUSINESS-LEVEL STRATEGIES
A diversified firm employs a separate business-level strategy for each product market area in which it competes and one or more corporate-level strategies dealing with product and/or geographic diversity
CORPORATE–LEVEL STRATEGY: DIVERSIFICATION
■ This chapter focuses on DIVERSIFICATION
■ VALUE CREATION: low – high levels of diversification
● The sharing of resources (the related constrained strategy)
● The transferring of core competencies across the firm’s different businesses (the related linked strategy)
● Managerial motives to diversify can actually destroy some of the firm’s value
IMPORTANT DEFINITION
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LEVELS OF DIVERSIFICATION
FIGURE 6.1
Levels and Types of Diversification
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LEVELS OF DIVERSIFICATION
A firm is related through its diversification when its businesses share links across:
■ PRODUCTS (goods or services)
■ TECHNOLOGIES
■ DISTRIBUTION CHANNELS
The more links among businesses, the more “constrained” is the relatedness of diversification
“Unrelated” refers to the absence of direct links between businesses
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LEVELS OF DIVERSIFICATION
1. Low Levels
Dominant Business Diversification Strategy
Corporate-level strategy whereby firm generates 70-95% of total sales revenue within a single business area
EXAMPLE: UPS
United Parcel Service (UPS) uses this strategy. UPS generates 60 percent of its revenue from its U.S. package delivery business and 22 percent from its international package business, with the remaining 18 percent coming from the firm’s non-package business
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LEVELS OF DIVERSIFICATION
2. Moderate to High Levels
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), concentrating on the transfer of knowledge and competencies among the businesses
EXAMPLE: GE
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LEVELS OF DIVERSIFICATION
3. Very High Levels: Unrelated
Less than 70% of revenue comes from dominant business
No relationships between businesses
EXAMPLES:
3M
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REASONS FOR DIVERSIFICATION
TABLE 6.1
Reasons for Diversification
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VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION
FIRM CREATES VALUE BY BUILDING UPON OR EXTENDING:
Resources
Capabilities
Core competencies
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VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION
PURPOSE: gain market power relative to competitors
ADVANTAGE: ECONOMIES OF SCOPE
Cost savings that occur when a firm transfers capabilities and competencies developed in one of its businesses to another of its businesses
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VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION
OPERATIONAL RELATEDNESS: SHARING ACTIVITIES
■ Can gain economies of scope
■ Share primary or support activities (in value chain), e.g., a primary activity such as inventory delivery systems, or a support activity such as purchasing
■ Risky as ties create links between outcomes
■ Related constrained share activities in order to create value
■ Not easy, often synergies not realized as planned
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VALUE-CREATING DIVERSIFICATION: RELATED CONSTRAINED AND RELATED LINKED DIVERSIFICATION
MARKET POWER
■ Relevant for:
●RELATED CONSTRAINED
●RELATED LINKED
■ 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
■ Related diversification strategy may include:
● Vertical integration
Backward integration: a firm produces its own inputs
Forward integration: a firm operates its own distribution system for delivering its outputs
● Virtual integration
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UNRELATED DIVERSIFICATION
EXCEED
EFFICIENT INTERNAL CAPITAL MARKET ALLOCATION
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INTERNAL CAPITAL MARKET
EXTERNAL CAPITAL MARKET
the gains that would accrue to shareholders from capital being allocated by the external capital market
In large diversified firms, capital distributions may generate gains from internal capital market allocations that
UNRELATED DIVERSIFICATION
RESTRUCTURING OF ASSETS
Restructuring creates financial economies
A firm creates value by buying, restructuring, then selling the restructured firms’ assets in the external market
An economic downturn can present opportunities but also some risks
Resource allocation decisions may become complex, so success often requires:
Focus on mature, low-technology businesses
Focus on businesses not reliant on a client orientation
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DIVERSIFICATION ADVANTAGES
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RELATED DIVERSIFICATION
UNRELATED DIVERSIFICATION
FINANCIAL ECONOMIES
ECONOMIES OF SCOPE
INCENTIVES TO DIVERSIFY
External incentives
■ Antitrust regulations
■ Tax laws
Internal incentives
■ Low performance
■ Uncertain future cash flows
■ Synergy and Firm Risk Reduction
VALUE-NEUTRAL DIVERSIFICATION: INCENTIVES AND RESOURCES
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EXTERNAL INCENTIVES TO DIVERSIFY
Antitrust Regulation
Antitrust laws in 1960s and 1970s discouraged mergers that created increased market power (vertical or horizontal integration)
Mergers in the 1960s and 1970s thus tended to be unrelated (conglomerate)
1980s: Relaxation of antitrust enforcement results in more and larger horizontal mergers
Late 1990s: Industry-specific deregulation spurred increased merger activity in banking, telecommunications, oil and gas, and electric utilities
Early 2000s: Antitrust concerns seem to be emerging and mergers are more closely scrutinized
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EXTERNAL INCENTIVES TO DIVERSIFY (cont’d)
Antitrust Regulation
Tax Laws
High tax rates on dividends cause a corporate shift from dividends to buying and building companies in high-performance industries
1986 Tax Reform Act
Reduced individual ordinary income tax rate from 50 to 28 percent
Treated capital gains as ordinary income
Thus created incentive for shareholders to prefer dividends to acquisition investments, as the 1986 Tax Reform Act diminished some of the corporate tax advantages of diversification
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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
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VALUE-REDUCING DIVERSIFICATION: MANAGERIAL MOTIVES TO DIVERSIFY
MANAGERIAL MOTIVES TO DIVERSIFY
■ Managerial risk reduction
■ Desire for increased compensation
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DIVERSIFICATION AND FIRM PERFORMANCE
FIGURE 6.4
Summary Model of the Relationship between Diversification and Firm Performance
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