Corporate Strategy and Diversification Notes

Learning Objectives

  • Define corporate strategy and describe its three dimensions.
  • Explain why firms grow.
  • Describe and evaluate different options that firms have to organize economic activity.
  • Describe the two types of vertical integration along the industry value chain: backward and forward.
  • Identify and evaluate benefits and risks of vertical integration.
  • Describe and examine alternatives to vertical integration.
  • Describe and evaluate different types of corporate diversification.
  • Apply the core competence-market matrix to derive different diversification strategies.
  • Explain when a diversification strategy creates a competitive advantage and when it does not.
  • Understand internal organization possibilities in response to diversification.

Corporate Strategy

  • Definition: Decisions made by leaders affecting multiple business units towards competitive advantage across industries and markets.
  • Boundaries of the firm:
    • Vertical integration.
    • Diversification.
    • Geographic scope.

Reasons for Firm Growth

  • Increase profits and shareholder returns.
  • Lower costs and achieve economies of scale/scope.
  • Increase market power (pricing power).
  • Reduce risk through diversification.
  • Respond to changing regulations/technologies.
  • Motivate management with growth opportunities.

Vertical Integration

Types of Vertical Integration

  • Backward Integration: Involves acquiring a business that supplies goods or services to the firm.
  • Forward Integration: Involves acquiring a business that distributes or sells products or services.

Benefits of Vertical Integration

  • Lowering costs.
  • Improving product quality.
  • Facilitating scheduling and planning.
  • Securing critical supplies and distribution channels.
  • Capitalizing on specialized assets.

Risks of Vertical Integration

  • Increasing costs.
  • Reducing flexibility.
  • Reducing product/service quality.
  • Increasing the potential for legal risks.

Alternatives to Vertical Integration

  • Taper Integration: Combination of in-house production with outside suppliers.
  • Strategic Outsourcing: Transferring internal value chain activities to other firms (e.g., HR, IT).

Corporate Diversification

Types of Diversification

  • Product Diversification: Offering a wider variety of products or services.
  • Geographic Diversification: Expanding into new markets or regions.
  • Product-Market Diversification: Combining product and geographic diversification.

Variations of Corporate Diversification

  1. Single Business: >95% revenue from one unit (e.g., Birkenstock).
  2. Dominant Business: 70%-95% revenue from one unit (e.g., Harley-Davidson).
  3. Related Diversification: Businesses share competencies (e.g., Johnson & Johnson).
  4. Unrelated Diversification (Conglomerate): Few or no shared competencies (e.g., Samsung).

Corporate Strategy: Value and Costs

  • Value Creation:
    • Securing critical supplies and distribution channels.
    • Economies of scale and scope.
  • Cost Sources:
    • Coordination and influence costs.

The Core Competence-Market Matrix

  • Utilizes company core competencies to create a competitive advantage in new markets.

Organizational Structure Changes

  • Simple Structure: For small firms; founders make all decisions.
  • Functional Structure: Groups by functional expertise; often used by firms with narrow focus.
  • Multidivisional Structure: Used by diversifying firms; each unit operates independently with profit/loss responsibility.
  • Matrix Structure: Combines functional and multidivisional structures; increases complexity but allows for domain expertise.

Principal-Agent Problem

  • Owners (principals) aim to maximize shareholder value, while managers (agents) may pursue personal interests.

Information Asymmetry

  • Occurs when one party holds more information than another, potentially leading to suboptimal market outcomes.