Strategic Management:
creating competitive advantages
Chapter 6
Corporate-Level Strategy: Creating Value through Diversification
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
After reading this chapter, you should have a good understanding of:
How managers can create value through diversification initiatives.
The reasons for the failure of many diversification efforts. How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
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Learning Objectives
After reading this chapter, you should have a good understanding of:
How corporations can use unrelated diversification to attain synergistic benefits trough corporate restructuring, parenting, and portfolio analysis. The various means of engaging in diversification-mergers and acquisitions, joint ventures/strategic alliances, and internal development.
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
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Learning Objectives
After reading this chapter, you should have a good understanding of:
The value of real options analysis (ROA) in making resource allocation decisions under conditions of high uncertainty. Managerial behaviors that can erode the creation of value.
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Joint ventures
Internal development
Business 1
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Business 2
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Synergy
Related businesses (horizontal relationships)
Sharing tangible resources
Synergy
Unrelated businesses (hierarchical relationships)
Value creation derives from corporate office
Firm infrastructure
Business 2
Procurement
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Creating Value
Related Diversification: Economies of Scope
Leveraging core competencies 3M leverages it competencies in adhesives technologies to many industries, including automotive, construction, and telecommunications Sharing activities McKesson, a large distribution company, sells many product lines, such as pharmaceuticals and liquor, through its superwarehouses
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Creating Value
Unrelated Diversification: Parenting, Restructuring, and Financial Synergies
Corporate restructuring and parenting The corporate office of Cooper Industries adds value to its acquired businesses by performing such activities as auditing their manufacturing operations, improving their accounting activities, and centralizing union negotiations Portfolio management Novartis, formerly Ciba-Geigy, uses portfolio management to improve many key activities, including resource allocation and reward and evaluation systems
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Three criteria (of core competencies) that lead to the creation of value and synergy Core competencies must enhance competitive advantage(s) by creating superior customer value Develop strengths relative to competitors
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Three criteria (of core competencies) that lead to the creation of value and synergy Different businesses in the firm must be similar in at least one important way related to the core competence Not essential that products or services themselves be similar
Is essential that one or more elements in the value chain require similar essential skills
Brand image is an example
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
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Three criteria (of core competencies) that lead to the creation of value and synergy Core competencies must be difficult for competitors to imitate or find substitutes for Easily imitated or replicated core competencies are not a sound basis for sustainable advantages Specialized technical skills acquired only in company work experience are an example
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Sharing Activities
Corporations can also achieve synergy by sharing tangible and value-creating activities across their business units
Common manufacturing facilities Distribution channels Sales forces
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Related Diversification: Market Power Two principal means to achieve synergy through market power
Pooled negotiating power Vertical integration
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Abuse of bargaining power may affect relationships with customers, suppliers and competitors
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Vertical Integration
Benefits
Dependency Suppliers Customers Business 2
Dependency
Secure source of supply of raw materials Secure distribution channels Protection and control over assets and services Access to new business opportunities and technologies Simplified procurement and administrative procedures
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Vertical Integration
Risks
Costs and expenses associated with increased overhead and capital expenditures
Dependency
Business 2
Loss of flexibility resulting from inability to respond quickly to changes in the external environment Problems associated with unbalanced capacities or unfilled demand along the value chain Additional administrative costs
Business 1
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Vertical Integration
In making decisions associated with vertical integration, four issues should be considered
1. Are we satisfied with the quality of the value that our present suppliers and distributors are providing? 2. Are there activities in our industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? 3. Is there a high level of stability in the demand for the organizations products? 4. How high is the proportion of additional production capacity actually absorbed by existing products or by the prospects of new and similar products?
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Search costs
Market transaction
Negotiating costs
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Corporate Parenting
Corporate office
Plans Budgets Support of the corporate Procurement Legal functions office Financial functions Human resource management Business unit Business unit Business unit
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Corporate Restructuring
Corporate office
Sell off parts Reduce payroll On threshold of Change strategies Change management significant positive Infuse new technologies Reduce unnecessary expenses change Business Business unit unit Business Business unit unit Business Business unit unit
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Corporate Restructuring
Capital structure
management
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Portfolio Management
Key
Each circle represents one of the firms business units Size of circle represents the relative size of the business unit in terms of revenue
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Portfolio Management
Creation of synergies and shareholder value by portfolio management and the corporate office
Allocate resources (cash cows to stars and some question marks) Expertise of corporate office in locating attractive firms to acquire
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Portfolio Management
Creation of synergies and shareholder value by portfolio management and the corporate office
Provide financial resources to business units on favorable terms reflecting the corporations overall ability to raise funds
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strategic alliance
Internal development
New products
New markets
New technology
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Deal
AOL/Time Warner 2001 Vodafone/Mannesmann 2000 Pfizer/Warner-Lambert 2000 Glaxo/SmithKline 2000 Chase/J. P. Morgan 2000 Exxon/Mobil 1999 SBC/Ameritech 1999 WorldCom/MCI 1998 Travelers/Citicorp 1998 Daimler/Chrysler 1991
As of July 1, 2002.
Source: K. H. Hammonds, The Numbers Dont Lie, Fast Company, September 2002, p. 80.
Exhibit 6.5 Ten Biggest Mergers and Acquisitions of All Time and Their Effect on Shareholder Wealth
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
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Doesnt understand customer needs Doesnt know how to promote the product Doesnt have access to proper distribution channels
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Join other firms to reduce manufacturing (or other) costs in the value chain
Pool capital
Economies of scale
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Egotism
Antitakeover tactics
Greenmail
Golden parachute Poison pills
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