Corporate Strategy: Diversification

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Corporate StrategyDiversification

• Learning Objectives
• To identify types of diversification and when
  this strategy can create value to the firm and
  generate sustained competitive advantage
• Have any of you experienced corporate
  diversification with your employers ?

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Means to Achieve Diversification
Type of Diversification Pros Cons
Mergers Acquisitions quickly enter new markets, industries mgt. control - premium price - integrating mgt. culture
Strategic Alliances Joint Venture quickly enter new markets, technology lower investment - choosing a partner - dividing the pie - trust
Internal Development captures all the value mgt. control - time consuming- limited knowledge
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Corporate DiversificationAccording to J. Barney

• using a corporate diversification strategy, a
  firm operates in multiple industries or markets
  simultaneously
• Types of corporate diversification
• Limited
• Related
• Unrelated
• How are these types different ?
• Why are these differences important ?

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Types of Corporate Diversification
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Corporate Diversification andCompetitive
Advantage

• Analyze corporate diversification from VRIO
  perspective
• Two conditions must hold for this strategy to
  produce value
• Valuable economies of scope
• Stockholders cannot achieve these economies at a
  lesser-cost by themselves
• What do we mean by economies of scope ?

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Common Types of Economies of Scope(motivations
for corporate diversification)

• Operational economies of scope
• Shared activities
• Core competencies
• Financial economies of scope
• Internal capital allocation
• Risk reduction
• Tax advantages
• Anticompetitive economies of scope
• Multipoint competition
• Exploiting market power

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Operational Economies of Scope

• operational economies come from shared
  activities or core competencies
• Shared activities Examples of shared activities
  ?
• Core competencies
• Definition of core competencies ?
• Are these the same as synergies, the most
  abused word in corporate diversification lingo ?

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Financial Economies of Scope

• financial economies come from internal capital
  allocation, risk reduction and possible tax
  advantages
• Internal capital allocation
• Do firms get better information ?
• Are decision makers subject to
• escalation of commitment ?
• Risk reduction
• How well can shareholders do this themselves ?
• Tax advantages use losses to offset other gains
• Are these powerful arguments for corporate
  diversification ?

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Anticompetitive Economies of Scope

• anticompetitive tactics are most often noticed
  when a firm experiences multipoint competition
  with another firm, or seeks to exploit market
  power
• Multipoint competition
• Examples of multipoint competition ?
• Exploiting market power
• Examples of exploiting market power ?
• Legality and ethics of tacit collusion and
  predatory pricing ?

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Managerial Incentives to Diversify

• Management compensation is more likely related to
  firm size (sales revenue) than to economic
  performance
• Implications build sales quickly, M A activity
• Is this a fair criticism of CEOs in corporate
  America ?

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Corporate Diversification and VRIO Framework

• if these economies of scope provide value, they
  must still pass other hurdles in the VRIO
  framework
• Rarity of diversification is based on the
  resulting economies of scope, not diversification
  per se
• Imitability of diversification is also based on
  the resulting economies of scope

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Imitability of Diversification

• Economies that are
• less-costly-to-duplicate
• Shared activities
• Risk reduction
• Tax advantages

• Economies that are
• more-costly-to-duplicate
• Core competencies
• Internal capital allocation
• Multipoint competition
• Exploiting market power

What criteria makes these more or less costly to
duplicate ? Substitutes for diversification ?
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Examples of Corporate Diversification

• Apple Computer introduces an I-Pod MD3 Player
  with a larger memory.
• General Electric borrows money from BankAmerica
  at 3 interest and then makes capital available
  to its jet engine subsidiary at 8 interest.
• A venture capital firm invests in a firm in the
  bio-technology industry and a firm in the
  entertainment industry.
• Another venture capital firm invests in two firms
  in the bio-technology industry.
• For each example, Identify the type of economy of
  scope.