Chapter 8 - Corporate Diversification
Corporate Diversification
Overview
Corporate Diversification involves strategy formulation for firms to enter new markets or industries.
Corporate Strategy Framework
Strategic Components
Mission & Objectives: Define purpose and goals of the firm.
External Analysis: Assess market conditions and competition.
Internal Analysis: Evaluate resources and capabilities.
Strategic Choice: Decide on the direction of the firm.
Strategy Implementation: Put chosen strategies into action.
Competitive Advantage: Differentiate from competitors for profitability.
Corporate Level Strategy: Determine which businesses to enter, focusing on integration and diversification.
Logic of Corporate Level Strategy
Value Creation: Corporate strategies should lead to collective value greater than the sum of independent businesses; equity holders should not be able to achieve this through portfolio investing alone.
Synergies Required: Corporate level strategy must create synergies. Economies of scope - diversification
Integration vs. Diversification
Definitions
Integration: Aligning internal operations with external partnerships.
Diversification: Broadening portfolio by entering new markets or industries.
Links
Integration: Backward (RM) and forward links (Customer)
Diversification: No links and Many Links
Pros and Cons of Single Business Strategy
Advantages
Less ambiguity in identity and direction.
Focused resource allocation to improve competitiveness and expand into new markets.
Disadvantages
Risk of concentration: limited flexibility if markets become unattractive.
Vulnerability to shifts in technology, consumer preferences, or substitute products.
Types of General Corporate Diversification
Product Diversification
Operating across multiple industries.
Geographic Market Diversification
Expanding operations into various geographical areas.
Product-Market Diversification
Engaging in multiple industries within diverse geographic markets.
Specific Types of Corporate Diversification
Limited Diversification: Majority in one business.
Related Diversification: Businesses share resource links.
Unrelated Diversification: No connections among businesses (Conglomerates).
Competitive Advantage and Diversification
Value of Diversification
Criteria for Value Creation
Existence of economies of scope.
Cost advantage over outside equity holders in leveraging economies of scope.
Value Comparison
Independent equity holders could invest separately, versus investing in a firm capitalizing on synergies from diversification.
Types of Economies of Scope
Four Categories
Operational Economies: Efficiency through shared activities (e.g., Frito-Lay’s distribution).
Financial Economies: Manage capital allocation efficiently and risk reduction benefits.
Anticompetitive Economies: Enhance market power through extensive business networks.
Managerialism: Greater scope leads to increased managerial compensation; must evaluate incentive-driven acquisitions versus genuine value creation.
Equity Holders and Economies of Scope
Most economies are not directly beneficial to equity holders; need to assess if diversification produces captured economies of scope.
Rarity of Diversification
While diversification itself is common, the underlying economies of scope may be rare, based on unique contextual advantages.
Imitability of Diversification
Factors Affecting Duplication
Deployment of economies can fall into categories based on their cost to duplicate, influencing strategic planning.
Strategies for Substitution
Firms can use internal developments or strategic alliances to diversify without mergers, thus mitigating risks associated with acquisitions.
Summary
Understanding corporate diversification helps in determining ideal businesses for operation.
Emphasis on creating economies of scope and value that cannot be independently duplicated by external equity holders.
Conclusion
Synergistic activities that support competitive advantage can be achieved through careful analysis and implementation of diversification strategies.