Lecture Outline

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Lecture Outline
Strategic Management and Competitive
Advantage Jay B. BarneyWilliam S. Hesterly
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Chapter 7
Corporate Diversification
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Chapter Objectives (1 of 3)

• Define corporate diversification and describe
  five types of corporate diversification.
• Specify the two conditions that a corporate
  diversification strategy must meet in order to
  create economic value.
• Define the concept of economies of scope and
  identify eight potential economies of scope a
  diversified firm might try to exploit.

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Chapter Objectives (2 of 3)

• Identify which of these economies of scope a
  firms outside equity investors are able to
  realize on their own at low cost.
• Specify the circumstances under which a firms
  diversification strategy will be rare.
• Indicate which of the economies of scope
  identified in this chapter are more likely to be
  subject to low-cost imitation and which are less
  likely to be subject to low-cost imitation.

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Chapter Objectives (3 of 3)

• Identify two potential substitutes for corporate
  diversification.
• Identify economies of scope that can be realized
  through international operations.

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The Strategic Management Process
External Analysis
Strategic Choice
Strategy Implementation
Competitive Advantage
Mission
Objectives
Which Businesses to Enter?
Internal Analysis
Vertical Integration
Corporate Level Strategy
Diversification
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Logic of Corporate Level Strategies(1 of 3)

• Corporate Level Strategy Should Create Value
• Such that businesses forming the corporate whole
  are worth more than they would be under
  independent ownership.
• That equity holders cannot create through
  portfolio investing.
• Therefore
• A corporate level strategy must crate synergies
• Economies of scopediversification
• Economies of scope exist in a firm when the value
  of the products or services it sells increases as
  a function of the number of businesses that firm
  operates in.

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Logic of Corporate Level Strategies(2 of 3)
Examples of Economics of Scope
McDonalds
P G
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Logic of Corporate Level Strategies(3 of 3)
Additional Example of Economics of Scope
General Motors
General Motors Vehicles
General Motors Credit
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Integration and Diversification
Integration
Raw Materials
Distribution
Focal Firm
Customer
Supplier
Forward
Backward
Diversification
Other Businesses
Other Businesses
Current Businesses
No Links
Many Links
Unrelated
Related
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Example of Unrelated Diversification
General Electric
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Levels of Diversification(1 of 3)
Limited Diversification
Single business 95 or more of firm revenues
comes from a business Example WD-40 Dominant-bus
iness between 70 and 95 of firm revenues comes
from a single business Example Donatos Pizza
A
E
F
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Levels of Diversification(2 of 3)
Related Diversification
Related-constrained less than 70 of firm
revenues comes from a single business, and
different businesses share numerous links and
common attributes Example Pepsi Related-linked
less than 70 of firm revenues comes from a
single business, and different businesses share
only a few links and common attributes or
different links and common attributes Example
Disney
K
M
L
N
Q
S
R
T
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Levels of Diversification(3 of 3)
Unrelated Diversification
Unrelated Diversification Less than 70 of firm
revenues comes from a single business, and there
are few, if any, links or common attributes among
businesses Example General Electric
W
Y
X
Z
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Types of Corporate Diversification(1 of 3)

• At a general level
• Product Differentiation
• Operating in multiple industries
• Geographic Market Diversification
• Operating in multiple geographic markets
• Product-Market Diversification
• Operating in multiple industries in multiple
  geographic markets

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Types of Corporate Diversification(2 of 3)
Product Differentiation
Geographic Market Differentiation
Product Market Differentiation

• Pepsi
• Soft drinks
• Frito-Lay Snacks
• Tropicana
• Gatorade

The Home Depot 1,950 stores in all 50 states

• Boeing
• Commercial aircraft
• Military aircraft
• Satellites
• Defense applications

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Types of Corporate Diversification(3 of 3)

• At a more specific level
• Limited Diversification
• Single business gt 95 of sales in single
  business
• Dominant business 70 to 95 in single business
• Related Diversification
• Related constrained all businesses related on
  most dimensions
• Unrelated Diversification
• Businesses are not related

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Product and Geographic Diversification

• Possibilities
• Single-business in one geographic area
• Single-business in multiple geographic areas
• 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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Competitive Advantage

• If a diversification strategy meets the VRIO
  criteria
• Is it valuable?
• Is it rare?
• Is it costly to imitate?
• Is the firm organized to exploit it?

.it may create a competitive advantage
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Value of Diversification(1 of 2)

• Two Criteria
• There must be some economy of scope
• The focal firm must have a cost advantage over
  outside equity holders in exploiting any
  economies of scope

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Value of Diversification(2 of 2)
Value


Independent equity holder could buy shares of
each firm
Focal Firm
Value
Economies Of Scope
Combined equity holder buys shares in one firm
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Economies of Scope(1 of 7)

• Four Types
• Operational
• Financial
• Anticompetitive
• Managerialism

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Economies of Scope(2 of 7)

• Operational Economies of Scope
• Sharing Activities
• Exploiting efficiencies of sharing business
  activities
• Example Frito-Lays Trucking
• Spreading Core Competencies
• Exploiting core competencies in other businesses
• Competencies must be strategically relevant
• Example Orbitz

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Economies of Scope(3 of 7)

• 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(4 of 7)

• Financial Economies of Scope
• Risk reduction
• Counter cyclical businesses may provide decreased
  overall risk
• However,
• Individual investors can usually do this more
  efficiently than a firm
• Example Snow Skis and Water Skis

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Economies of Scope(5 of 7)

• Financial Economies of Scope
• Tax Advantage
• Transfer pricing policy allows profits in one
  division to be offset by losses in another
  division
• This is especially true internationally
• Can be used to smooth income

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Economies of Scope(6 of 7)

• 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(7 of 7)

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

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Equity Holders and Economies of Scope

• Equity Holders and Economies of Scope
• Most economies of scope cannot be captured by
  equity holders
• Risk reduction can be captured by equity holders
• Managers should consider whether corporate
  diversification will generate economies of scope
  that equity holders can capture
• If a corporate diversification move is unlikely
  to generate valuable economies of scope, managers
  should avoid it

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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(1 of 2)
Duplication of Economies of Scope
Less Costly-to-Duplicate
Costly-to-Duplicate
Core Competencies
Employee Compensation
Tax Advantages
Internal Capital Allocation
Multipoint Competition
Risk Reduction
Shared Activities
Exploiting Market Power
(tacit/intangible)
(codified/tangible)
may be costly depending on relationships
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Imitability of Diversification(2 of 2)
Substitution of Economies of Scope
Internal Development
Strategic Alliances
find a partner with the desired
complementary assets
start a new business under the corporate whole
avoids potential cross- firm integration issues
less costly than acquiring a firm
Competitors may use these strategies to arrive at
a position of diversification without buying
another firm
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International Diversification(1 of 2)
Three Types of International Risk
Financial
Cultural/Popular
Political
nationalization
currency exchange
product may not be accepted simply because of
your country of origin
quotas
general economic conditions
tariffs
regulations
Example Resistance to McDonalds by Frances
older generation
Example Bolivia nationalized its petroleum indus
try in the 70s
Example Asian economic crisis of the 1990s
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International Diversification(2 of 2)

• Managing International Risks
• Political
• Find a local partner
• Political neutrality
• Negotiate with government
• Foreign governments often have an interest in
  direct investment
• Example Case International in Brazil

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Summary(1 of 2)

• Corporate Strategy In what businesses should the
  firm operate?
• An understanding of diversification helps
  managers answer that question
• Two Criteria
• Economies of scope must exist
• Must create value that outside equity holders
  cannon create on their own

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Summary(2 of 2)

• Economies of Scope
• A case of synergycombined activities generate
  greater value than independent activities
• May generate competitive advantage if they meet
  the VRIO criteria
• Firms should pursue diversification only if
  careful analysis shows that competitive advantage
  is likely