CH 6 – Corporate-Level Strategy. Creating Value through Diversification

Corporate-Level Strategy: How does it create profit?

Corporate-Level Strategy: a strategy that focuses on gaining long-term revenue, profits, and market value through managing operations in multiple businesses 

— synergies among the business of a firm ; the stronger the synergies, the more profit

• (multi. Business strategies and ONE corporate strategies)

• Within a conglomerate firm/company

Diversification

the process of firms expanding their operations by entering new businesses

Related Diversification

A firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power

— products of the firms’ different businesses are somehow/partially related 

• Similar raw materials, suppliers, production/plant/manufacturing, etc.

Related Diversification

Economies of Scope

cost saving from leveraging core competencies or sharing activities among businesses in a corporation — leads to either leveraging core competencies or activities

• Leveraging Core Competencies: a firm’s strategic resources that reflect the collective learning in the organization  

  • developed knowledge in one business and transferring that knowledge into another business

• Sharing Activities: having activities in two or more businesses’ value chains done by one of the businesses 

  • having a central hub of a service/activity (i.e., HR, financing, etc.) for the firm to be used across all of their business

Pooled Negotiating Power

the improvement in bargaining position relative to suppliers and customers 

• have synergy between business of the firm increases the negotiating/barging  power of the firm

Market Power

firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investments — ability to act like a olig/monopoly

Vertical Integration

an expansion of the firm by integrating preceding or successive production processes

• LOW: not a large presence of the firm within the manuf. & distri. of their products

• HIGH: LARGE presence of the firm within the manuf. & distri. of their products

• HIGH V.I allows the firm to hold their cards close to their chest and leverage their power against their competitors that may be subject to their power and have to buy their components of their supply chain and/or won’t be able to to compete due to the firm w/ HIGH V.I having total competitive advantage 

• Lack of information access DECREASES the bargaining power of consumers, INCREASES the bargaining power of firm

Transaction Cost Perspective

vertical integration is better than market transactions when transaction costs are high

• Transaction Costs: search, negotiating, contracting, monitoring, and enforcement costs

  • ALL the effort related in making a purchase/transaction 

    • when transaction costs are low, stray away from vertical integration

FULL vertical integration Benefits and Risks

Benefits:

• Secure source of raw material or distribution channels

• Control of valuable assets

  • Able to have high turnaround of the production/manufacturing due to high vertical integration

Risks:

• Higher overhead costs and capital expenditures

• Loss of flexibility — MORE assets own, harder to channel all aspects of the firm 

Unrelated Diversification

 a firm entering a different business that has little horizontal interactions with other businesses in a firm  — unrelated products/business of a firm

• Horizontal Interactions: relationships among business units 

  • create: core competencies, sharing activities, market power

• Vertical Interactions: relationships between business units and corporate office

  • create: corporate parenting, restructuring, portfolio management 

    •  value lies in CORPORATE office

Corporate Parenting and Restructuring

Parenting Advantage: the positive contributions of the corporate office to a new business as a result of expertise and support provided and not as a result of substantial changes in assets, capital structure, or management

Restructuring: the intervention of a corporate office in a new business that substantially changes assets, capital structure and or management 

• Selling parts of business, changing management, downsizing, reducing costs, etc.

Portfolio Management

a method for (1) assessing the competitive position of a portfolio of businesses within a corporation, (2) suggesting strategic alternatives for each business, and (3) identifying priorities for the allocation of resources across the businesses 

Portfolio Management – BCG Matrix

BCG Matrix

HIGH-HIGH / Stars: long term growth potential and should continue to receive 

• Doesn't make a profit, but a good investment due to the forecasted growth of the industry

  • If a company ONLY have stars, can go out of business

LOW-HIGH / Question Marks: resources should be invested in them to enhance their competitive positions 

• Either invest a lot to transform ? into a STAR, or divest and make it a DOG

HIGH-LOW / Cash Cow: limited long-run potential but a sources of cash flow to invest in stars and question marks 

• Makes MOST profit , but NO growth

  • Can go out of business if there's no industry growth or innovation

• When CC starts to dip, DISCONTINUE — they don't become dogs

LOW-LOW / Dog: should be divested

• BAD – divested, get rid of

Triangle of LOVE

1. Take money from CASH COW

2. Put that $$ into a ?

3. Hopes of that ? will become a STAR

4. And hopes of that STAR will be made into a CASH COW

The 3 Means to Achieve Diversification

1. Mergers and Acquisitions

2. Strategic Alliance and Joint Ventures

3. Internal Development

1. Mergers and Acquisitions

Merger: combining two or more firms into one new legal entity

Acquisition: the INcorporation of one firm into another through purchase

• “ONLY” a larger company can acquire a smaller company through their purchase 

PROS: 

• Obtain valuable resources 

• Attain economies of scope, market power, or leveraging core competencies

• Consolidate the industry 

  • Reducing the amount of competitors by buying them out 

CONS:

• Takeover premium for the acquisitions can be high 

• Cultural differences among companies can doom the benefits 

2. Strategic Alliance and Joint Ventures

Strategic Alliance: a cooperative relationship between two or more firms

Joint Venture: new entities formed within a strategic alliance in which two or more firms (the parents) contribute equity to form the new legal entity

PROS:

• Entering new markets

• Reducing costs in the value chain

• Developing and diffusing new technologies

CONS:

• Lacking synergies

• Lacking trust

3. Internal Development

Internal Development: entering a new business through investment in new facilities, often called corporate entrepreneurship and new venture development — in-house development and innovations 

PROS:

• Do not share wealth generated

• No difficulties for combining activities

CONS:

• It can be time-consuming

*price of the stock ISN’T the price of the of the ENTIRE company

• Increased demand and purchases of stock = increase of stock price 

• Stand-alone/CURRENT standard value vs. Synergy Net Present Value (“future” value)

  • Synergy defines the ACTUAL value

How Managerial Motives can Erode Value Creation – DUE TO SELFISHNESS

• Even if diversification can lead to increased performance, in a vast amount of cases it leads to performances losses — FAILS

• Acquisitions in 60% of cases lead to value destruction instead of value creation — FAIL

50% of strategic alliances fail

Growth for Growth’s Sake

managers’ action to growth the size of the firms and not to increase long-term profitability to serve managerial self-interest 

• M&A done not for the company’s benefit/interest, but for their own benefit/interest

Egotism

managers’ actions to shape their firms’ strategies to serve their selfish interest rather than to maximize long-term shareholder value