Chapter 6

Corporate-Level Strategy
Michael A. Hitt R. Duane Ireland Robert E. Hoskisson

2000 South-Western College Publishing

Key Questions of Corporate Strategy

1. What businesses should the corporation be in? 2. How should the corporate office manage the array of business units?

Corporate Strategy is what makes the corporate whole add up to more than the sum of its business unit parts

Incentives to Diversify
Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns Firms may diversify to balance uncertain future cash flows Firm may diversify into different businesses in order to reduce risk Managers often have incentives to diversify in order to increase their compensation and reduce employment risk, although effective governance mechanisms may restrict such abuses

A Diversified Company Has Two Levels of Strategy

1. Business-Level Strategy
(Competitive Strategy)

How to create competitive advantage in each business in which the company competes
- low cost - focused low cost - differentiation - focused differentiation - integrated low cost/differentiation

2. Corporate-Level Strategy

(Companywide Strategy)

How to create value for the corporation as a whole

Levels and Types of Diversification

Low Levels of Diversification
Single business
> 95% of revenues from a single business unit A A B

Dominant business

Between 70% and 95% of revenues from a single business unit

Moderate to High Levels of Diversification

Related constrained
< 70% of revenues from dominant business; all businesses share product, technological and distribution linkages < 70% of revenues from dominant business, and only limited links exist B A B A

A C

Related linked (mixed)

Very High Levels of Diversification

Unrelated-Diversified
Business units not closely related B

Adding Value by Diversification

Diversification most effectively adds value by either of two mechanisms:
By developing economies of scope between business units in the firms which leads to synergistic benefits By developing market power which leads to greater returns

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring

Alternative Diversification Strategies

Sharing Activities
Key Characteristics: Sharing Activities often lowers costs or raises differentiation
Example: Using a common physical distribution system and sales force such as Procter & Gambles disposable diaper and paper towel divisions

Sharing Activities can lower costs if it:

Achieves economies of scale Boosts efficiency of utilization Helps move more rapidly down Learning Curve
Example: General Electrics costs to advertise, sell and service major appliances are spread over many different products

Alternative Diversification Strategies

Sharing Activities
Key Characteristics: Sharing Activities can enhance potential for or reduce the cost of differentiation
Example: Shared order processing system may allow new features customers value or make more advanced remote sensing technology available

Must involve activities that are crucial to competitive advantage

Example: Procter & Gambles sharing of sales and physical distribution for disposable diapers and paper towels is effective because these items are so bulky and costly to ship

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring

Alternative Diversification Strategies

Transferring Core Competencies
Key Characteristics:
Exploits Interrelationships among divisions Start with Value Chain analysis Identify ability to transfer skills or expertise among similar value chains Exploit ability to transfer activities

Alternative Diversification Strategies

Transferring Core Competencies
Assumptions: Transferring Core Competencies leads to competitive advantage only if the similarities among business units meet the following conditions: Activities involved in the businesses are similar enough that sharing expertise is meaningful Transfer of skills involves activities which are important to competitive advantage The skills transferred represent significant sources of competitive advantage for the receiving unit

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring

Alternative Diversification Strategies

Efficient Internal Capital Market Allocation
Assumptions: Managers have more detailed knowledge of firm relative to outside investors

Firm need not risk competitive edge by disclosing sensitive competitive information to investors
Firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities

Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring

Alternative Diversification Strategies

Restructuring
Key Characteristics: Seek out undeveloped, sick or threatened organizations or industries
Parent company (acquirer) intervenes and frequently: - Changes sub-unit management team - Shifts strategy - Infuses firm with new technology - Enhances discipline by changing control systems - Divests part of firm - Makes additional acquisitions to achieve critical mass Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations

Value-creating Strategies of Diversification Operational and Corporate Relatedness

High Sharing: Operational Relatedness Between Business Low Related Constrained Diversification Vertical Integration (Market Power) Both Operational and Corporate Relatedness (Rare Capability and Can Create Diseconomies of Scope)

Unrelated Diversification (Financial Economies)

Related Linked Diversification (Economies of Scope)

Low

High

Corporate Relatedness: Transferring Skills Into Business Through Corporate Headquarters

Diversification and Firm Performance

Performance

Dominant Business

Related Constrained

Unrelated Business

Level of Diversification