Chapter 6

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

2000 South-Western College Publishing

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Str In ate p gic ut

Chapter 2 Externa l Environme nt Chapter 3 Interna l Environme nt

Strategic Intent Strategic Mission

Strategy Formulation
Chapter 4 BusinessLevel Strateg y Chapter 7 Acquisitions & Restructurin g Chapter 5 Competitiv eDynamic s Chapter 8 Internation al Strateg y Chapter 6 CorporateLevel Strateg y Chapter 9 Cooperativ eStrategi es Strateg Action ic s

The Strategic Manageme nt Strategy Process

Implementation
Chapter 10 Corporat e Governan ce Chapter 12 Strategi c Leadershi p Chapter 11 Structur e & Control Chapter Entrepreneurshi 13
p

& Innovation

Feedba ck

Strategi c Competitivene ss Above Average Return s

Str ate Out gic com es

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A Diversified Company Has Two Levels of Strategy

1. Business-Level Strategy (Competitive Strategy)create competitive advantage in each How to
business in which the company competes
- low cost - focused low cost - differentiation - focused differentiation - integrated low cost/differentiation

2. Corporate-Level Strategy (Companywide Strategy)create value for the corporation as a whole How to
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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
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Levels and Types of Diversification

Low Levels of Diversification
Single business Dominant business
> 95% of revenues from a single business unit Between 70% and 95% of revenues from a single business unit A A B A B A B A B C
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Moderate to High Levels of Diversification

Related constrained Related linked (mixed)
< 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 C

Very High Levels of Diversification

Unrelated-Diversified
Business units not closely related

Motives, Incentives, and Resources for Diversification

Resources
Motives to Enhance Strategic Competitiveness Economies of Scope Market Power Financial Economies

Incentives Managerial Motives

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Motives, Incentives, and Resources for Diversification

Resourc es Incentive s Manageri al Motives
Incentives and Resources with Neutral Effects of Strategic Anti-Trust Competitiveness Regulation Tax Laws Low Performance Uncertain Future Cash Flows Firm Risk Reduction Tangible Resources Intangible Resources
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Motives, Incentives, and Resources for Diversification

Resourc es Incentive s Manageri al Motives

Managerial Motives Causing Value Reduction Diversifying Managerial Employment Risk Increasing Managerial Compensation
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Summary Model of the Relationship Between Firm Performance and Diversification

Resourc es Incentive s Manageri al Motives
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Diversificatio n Strategy

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

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Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
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Alternative Diversification Strategies

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

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
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Alternative Diversification Strategies

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

Sharing Activities

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

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Sharing Assumptions: Activities

Alternative Diversification Strategies

Strong sense of corporate identity Clear corporate mission that emphasizes the importance of integrating business units Incentive system that rewards more than just business unit performance

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Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
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Alternative Diversification Strategies

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

Transferring Core Competencies

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Alternative Diversification Strategies

Assumptions:

Transferring Core Competencies

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
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Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
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Efficient Internal Capital Market Allocation

Key Characteristics: Firms pursuing this strategy frequently diversify by acquisition: Acquire sound, attractive companies Acquired units are autonomous Acquiring corporation supplies needed capital Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs Add professional management & control to sub-units Sub-unit managers compensation based on unit resultsCh6-

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
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Alternative Diversification Strategies

Alternative Diversification Strategies

Related Diversification Strategies
Sharing Activities Transferring Core Competencies

Unrelated Diversification Strategies

Efficient Internal Capital Market Allocation Restructuring
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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 firm with new - Infuses technology discipline by changing control - Enhances systems part of - Divests 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

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Alternative Diversification Strategies

Restructuring
Assumptions: Requires keen management insight in selecting firms with depressed values or unforeseen potential Must do more than restructure companies Need to initiate restructuring of industries to create a more attractive environment

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Incentives to Diversify
External Incentives: Relaxation of Anti-Trust regulation allows more related acquisitions than in the past Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns
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Value-creating Strategies of Diversification Operational and Corporate Relatedness

High Sharing: Operation al Relatedne ss Between Business Low Related Constrained Diversification Vertical Integration (Market Power) Unrelated Diversification (Financial Economies) Both Operational and Corporate Relatedness (Rare Capability and Can Create Diseconomies of Scope)

Related Linked Diversification (Economies of Scope) High

Low

Corporate Relatedness: Transferring Skills Into Business Through Corporate Headquarters

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Diversification and Firm Performance

Performance

Dominan t Business

Level of Diversification

Related Constraine d

Unrelated Business
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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
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Summary Model of the Relationship Between Firm Performance and Diversification

Capital Market Intervention and Market for Managerial Talent

Resourc es Incentive s Manageri al Motives

Diversificatio n Strategy

Firm Performan ce

Internal Governance

Strategy Implementation
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