Strategic Audit Report

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Chapter9.pdf

© Lucas Wenger 2018

Strategic Management Week 9 – Chapter 9

Corporate Diversification

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Where Are We in the SM Process?

Mission Objectives

External Analysis

Internal Analysis

Strategic Choice

Strategy Implementation

Competitive Advantage

Business Level Strategy

Corporate Level Strategy

How to Position a Business

in the Market? Which Businesses

to Enter?

•Vertical Integration •Diversification

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Strategies used as a means to avoid or be better than competitors

• Module 3: – Vertical Integration (8) – Corporate Diversification (9) & organizing for

diversification (10) • Module 4:

– Collusion (7) – Strategic Alliances (10) – Mergers and Acquisitions (11)

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Ethics & Strategy

• Diversification contributes to increasing firm size, and facilitates the growth of MNEs

• Protests against the WTO, the Occupy Movement, and more recently a populist discontent for free trade agreements (i.e. NAFTA & TPP)

• Why? Globalization increases the total value created in the world economy & accelerates growth (which is largely unchallenged throughout the political spectrum)

• How can we respond?

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Logic of Corporate Level Strategy Corporate level strategy should create value:

2) such that businesses forming the corporate whole are worth more than they would be under independent ownership

3) that equity holders cannot create through portfolio investing

• A corporate level strategy should create synergies that are not available in equity markets

- In this pursuit, diversification potentially creates economies of scope

1) such that the value of the corporate whole increases

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What are economies of scope?

• Increases in the net value of products or services offered as a function of the number of businesses in which a firm operates

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What is Corporate Diversification?

Operation in multiple industries or markets simultaneously

à2 Categories (not mutually exclusive)

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Integration and Diversification

Integration

Diversification

ForwardBackward

Current Businesses

No Links

Many Links

Unrelated Related

Other Businesses

Other Businesses

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Categories of Corporate Diversification

Product Diversification:

Geographic Market Diversification:

Product-Market Diversification

• operating in multiple industries

• operating in multiple geographic markets

• operating in multiple industries in multiple geographic markets

At a general level… Examples? Darden Restaurants

Starbucks

Pollo Campero

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Typology of Corporate Diversification

Limited Diversification

Related Diversification

Unrelated Diversification

• single business: > 95% of sales in single business • dominant business: 70% to 95% in single business

• related-constrained: all businesses related on most dimensions

• related-linked: some businesses related on some dimensions

• businesses are not related

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Product and Geographic Diversification Possibilities:

• single-business in multiple geographic areas

• single-business in one geographic area

• related-constrained in one or multiple geographic areas

• related-linked in one or multiple geographic areas

• unrelated in one or multiple geographic areas Note:

• relatedness usually refers to products

• seemingly unrelated products may be related on other dimensions

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Examples of Corporate Diversification

Limited Diversification

Related Diversification

Unrelated Diversification

Example

• related-constrained: PepsiCo

• related-linked: Disney

•GE

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Value of Diversification

Two Criteria

1) There must be some economy of scope

2) The focal firm must have a cost advantage over outside equity holders in exploiting any economies of scope

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Economies of Scope

Business X Business Y Business Z

Independent: equity holder could buy shares of each firm

Value

Business X

Business Y

Business Z

Focal Firm

Value

+ +

Economies Of

Scope

Combined: equity holder buys shares in one firm

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Economies of Scope

Four Types

Operational

Financial

Anticompetitive

Managerialism

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Economies of Scope

Operational Economies of Scope Sharing Activities

• exploiting efficiencies of sharing business activities

Example: 3M J&J

Spreading Core Competencies

• exploiting core competencies in other businesses

Example: Frito-Lay’s Trucking

• competency must be strategically relevant

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What are core competencies?

• “The collective learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technologies”

• May be generated through logical consideration of pre-diversified firms’ resources/ capabilities or may emerge naturally

• May entail shared activates or may not/

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Economies of Scope

Financial Economies of Scope Internal Capital Market

• premise: insiders can allocate capital across divisions more efficiently than the external capital

market • works only if managers have better information

• may protect proprietary information

• may suffer from escalating commitment

Example: Hanson Trust, PLC

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Economies of Scope

Financial Economies of Scope Risk Reduction

• counter cyclical businesses may provide decreased overall risk

Example: Snow Skiis & Water Skiis

• individual investors can usually do this more efficiently than a firm

however,

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Economies of Scope

Financial Economies of Scope

Tax Advantages

• transfer pricing policy allows profits in one division to be offset by losses in another division

• this is especially true internationally Example: Ireland (Apple, among others)

• can be used to ‘smooth’ income Why is it potentially beneficial to smooth income (under tax code accounting rules?

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Economies of Scope

• Which of these is realizable by investors without diversification in the focal firm (within financial economies of scope)?

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Anticompetitive Economies of Scope Multipoint Competition

• mutual forbearance • a firm chooses not to compete aggressively in one market to avoid competition in another

market Example: American Airlines & Delta: Dallas & Atlanta

Market Power • using profits from one business to compete in

another business • using buying power in one business to obtain advantage in another business

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Economies of Scope Managerialism

• an economy of scope that accrues to managers at the expense of equity holders

• managers of larger firms receive more compensation (larger scope = more compensation)

• therefore, managers have an incentive to acquire other firms and become ever larger

• even though the incentive is there, it is difficult to know if managerialism is the reason for an

acquisition • What is different between managerialism &

operational/financial/anticompetitive economies of scope? The locus of value capture –firm (flowing/ principals vs. agents)

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Rareness of Diversification

Diversification per se is not rare Underlying economies of scope may be rare

• relationships that allow an economy of scope to be exploited may be rare

• an economy of scope may be rare because it is naturally or economically limited

• a soft drink bottler buys the only source of spring water available

• a hotel in a resort town creates a large water park, there are only enough customers to support one park

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Imitability of Diversification

Less Costly-to-Duplicate Costly-to-Duplicate

Employee Compensation

Tax Advantages

Risk Reduction

Shared Activities*

Core Competencies

Internal Capital Allocation

Multipoint Competition

Exploiting Market Power (codified/tangible) (tacit/intangible)

*may be costly depending on relationships

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But companies can succeed in Corporate Strategy .. With proper analysis

• The Porter Test • The 4 Poles Test • The Combined Acid Test

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Basis of Value Creation

Parenting Skills

Scope Modification

Internal Organization

The Poles of Corporate Strategy

• What businesses is this company in?

• How is value created to these businesses? (if at all)

• Why is this value superior to that created by other HQs or stand alone business? (if at all)

• What kind of systems/structures/processes have been put in place to achieve the target value?

• Are the 4 poles consistent?

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Porter’s Test

• The attractiveness test • The cost of entry test • The better off test

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The Combined Acid Test for Diversification

• Taking a Resource View: • Do we have valuable and rare resources and capabilities that could be

transferred to (or from) or shared with the new unit? • How valuable are these to the new/old unit? • Do we have the Parenting Skills/Internal Organization needed for the

transfer? • Can we build/acquire the valuable (complementary) skills that we are

lacking? • Taking a Market View: • Can we overcome the barriers to entry? • Is this industry attractive?

Costs Versus Benefits

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Diversification Based on Activities Sharing: The Acid Test

• Taking a Resource View: • Do we have activities that can be shared among the units? • Will activity sharing reduce costs or differentiation costs? • Could we outsource this activity? Impact on Flexibility? • Do we have the Parenting Skills/Internal Organization needed for effective

activities sharing? • Can we build/acquire the valuable (complementary) resources that we are

lacking? • Taking a Market View: • Can we overcome the barriers to entry? • Is this industry attractive?

Costs Versus Benefits