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CHAPTER 6
Corporate-Level Strategy:
Creating Value through
Diversification

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No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
 Learning Objectives
After reading this chapter, you should be able to:
1. Identify the reasons for the failure of many diversification
efforts.
2. Explain how managers can create value through
diversification initiatives.
3. Explain how corporations can use related diversification to
achieve synergistic benefits through economies of scope and
market power.
4. Explain how corporations can use unrelated diversification to
attain synergistic benefits through corporate restructuring,
parenting, and portfolio analysis.
5. Describe various means of engaging in diversification –
mergers and acquisitions, joint ventures/strategic alliances,
and internal development.
6. Identify managerial behaviors that can erode the creation of
value.
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 Looking Ahead

Making Diversification Work: An Overview.

Related Diversification: Economies of Scope and
Revenue Enhancement.
Enhancing Revenue and Differentiation.
Related Diversification: Market Power.
Unrelated Diversification: Financial Synergies and
Parenting.
The Means to Achieve Diversification.
How Managerial Motives Can Erode Value Creation.

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 Corporate-Level Strategy

Consider …
What businesses should a corporation
compete in?
How can these businesses be managed so
they create “synergy” – that is, create more
value by working together than if they were
freestanding units?

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 Reasons for Diversification Failures

Acquisitions can destroy value by:

Paying a premium for the target firm.
Failing to integrate the activities of the
newly acquired businesses into the
corporate family.
Undertaking diversification initiatives that
are too easily imitated by the competition.

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 Making Diversification Work 1

Diversification initiatives must create value

for shareholders through:
• Mergers and acquisitions.
• Strategic alliances.
• Joint ventures.
• Internal development.
Diversification should create synergy.
• Business 1 plus Business 2 equals more than
two.

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 Making Diversification Work 2

A firm may diversify into related businesses.

• Benefits derive from horizontal relationships.
• Sharing intangible resources such as core
competencies in marketing.
• Sharing tangible resources such as production
facilities, distribution channels via vertical
integration.
A firm may diversify into unrelated
businesses.
• Benefits derive from hierarchical relationships.
• Value creation derived from the corporate office.
• Leveraging support activities in the value chain.
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 Related Diversification
Related diversification enables a firm to
benefit from horizontal relationships across
different businesses.
Economies of scope allow businesses to:
• Leverage core competencies.
• Sharing related activities.
• Enjoy greater revenues, enhance differentiation.

Related businesses gain market power by:

• Pooled negotiating power.
• Vertical integration.
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 Question 1

Sharing core competencies is one of the primary

potential advantages of diversification. In order for
diversification to be most successful, it is important
that
A. the similarity required for sharing core
competencies must be in the value chain, not in
the product.
B. the products use similar distribution channels.
C. the target market is the same, even if the
products are very different.
D. the methods of production are the same.

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 Related Diversification: Leveraging Core
Competencies

Core competencies reflect the collective

learning in organizations. Can lead to the
creation of value and synergy if:
• They create superior customer value.
• The value-chain elements in separate businesses
require similar skills.
• They are difficult for competitors to imitate or
find substitutes for.

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 Related Diversification: Sharing
Activities

Corporations can also achieve synergy by

sharing activities across their business
units.
Sharing tangible and value-creating activities
can provide payoffs.
• Cost savings through elimination of jobs,
facilities and related expenses, or economies of
scale.
• Revenue enhancements through increased
differentiation and sales growth.

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 Related Diversification: Market Power

Market power can lead to the creation of

value and synergy through:
• Pooled negotiating power.
• Gaining greater bargaining power with
suppliers and customers.
• Vertical integration — a firm becomes its
own supplier or distributor through:
• Backward integration.
• Forward integration.

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 Example: Question

Tesla, the automobile manufacturer, announced

that it was building a “gigafactory” to supply all
of the batteries needed for its cars. This is an
example of:
A. leveraging core competencies.
B. pooled negotiating power.
C. vertical integration.
D. sharing activities.

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 Related Diversification: Vertical
Integration, Issues
Is the company satisfied with the quality of the value that
its present suppliers and distributors are providing?

Are there activities in the industry value chain presently

being outsourced or performed independently by others
that are a viable source of future profits?

Is there a high level of stability in the demand for the

organization’s products?

Does the company have the necessary competencies to

execute the vertical integration strategies?

Will the vertical integration initiatives have potential

negative impacts on the firm’s stakeholders?
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 Related Diversification: Vertical
Integration, Transaction Costs

Transaction cost perspective.

Every market transaction involves some transaction
costs.
• Search costs.
• Negotiating costs.
• Contract costs.
• Monitoring costs.
• Enforcement costs.
• Need for transaction specific investments.
• Administrative costs.
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 Unrelated Diversification
Unrelated diversification enables a firm to
benefit from vertical or hierarchical relationships
between the corporate office and individual
business units through:
•The corporate parenting advantage.
• Providing competent central functions.
•Restructuring to redistribute assets.
• Asset, capital, and management restructuring.
•Portfolio management.
• BCG growth/share matrix.

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 Unrelated Diversification: Parenting and
Restructuring
Parenting allows the corporate office to create
value through management expertise and
competent central functions.
In restructuring the parent intervenes.
• Asset restructuring involves the sale of
unproductive assets.
• Capital restructuring involves changing the debt–
equity mix, adding debt or equity.
• Management restructuring involves changes in the
top management team, organizational structure,
and reporting relationships.

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 Unrelated Diversification: Portfolio
Management

Portfolio management involves a better

understanding of the competitive position of an
overall portfolio or family of businesses by:
• Suggesting strategic alternatives for each
business.
• Identifying priorities for the allocation of resources.
• Using Boston Consulting Group’s (BCG)
growth/share matrix.

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 Unrelated Diversification: Portfolio
Management, BCG
Each circle
represents one of
the firm’s business
units. The size of
the circle
represents the
relative size of the
business unit in
terms of revenue.

Exhibit 6.4 The Boston Consulting

Group (BCG) Portfolio Matrix
Access the text alternative for slide images.

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 Unrelated Diversification: Portfolio
Management, Limitations
Limitations of portfolio models:
• SBUs are compared on only two dimensions and
each SBU is considered a standalone entity.
• Are these the only factors that really matter?
• Can every unit be accurately compared on that basis?
What about possible synergies?
• An oversimplified graphical model is no substitute
for managers’ experience.
• Following strict and simplistic rules for resource
allocation can be detrimental to a firm’s long-term
viability.

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 Goal of Diversification = Risk Reduction?

Diversification can reduce variability in

revenues and profits over time. However,
• Stockholders can diversify portfolios at a much
lower cost.
• Stockholders don’t have to worry about integrating
the acquisition into their portfolio.
• Economic cycles are difficult to predict, so why
diversify?
Choice to diversify must be part of an overall
diversification strategy.

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 Means of Diversification

Diversification can be accomplished via:

• Mergers and acquisitions.
• Divestments.
• Pooling resources of other companies with a firm’s
own resource base through strategic alliances
and joint ventures.
• Internal development through corporate
entrepreneurship or new venture development.

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 Mergers and Acquisitions

Mergers involve a combination or consolidation

of two firms to form a new legal entity.
• On a relatively equal basis.
• Are relatively rare.

Acquisitions involve one firm buying another

either through stock purchase, cash, or the
issuance of debt.

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 Mergers and Acquisitions: Motives
Acquiring is faster than building.
Acquiring valuable resources can expand product
offerings and services and/or enter new market
segments.
Mergers and acquisitions help a firm develop
synergy.
• Leveraging core competencies.
• Sharing activities.
• Building market power.
Can consolidate an industry, forcing other players to
merge.
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 Mergers and Acquisitions: Limitations

Takeover premiums for acquisitions are typically

very high.

Competing firms can imitate advantages.

Competing firms can copy synergies.

Managers’ egos get in the way of sound business

decisions

Cultural issues may doom the intended benefits.

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 Question 2

Divestment can be the common result of an

acquisition. Divesting businesses can accomplish
many different objectives. These include:
A. enabling managers to focus their efforts more
directly on the firm’s core businesses.
B. providing the firm with more resources to
spend on more attractive alternatives.
C. raising cash to help fund existing businesses.
D. All of these are correct.

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 Mergers and Acquisitions: Divestment
Objectives

Divestment objectives include:

• Cutting the financial losses of a failed acquisition.
• Redirecting focus on the firm’s core businesses.
• Freeing up resources to spend on more attractive
alternatives.
• Raising cash to help fund existing businesses.

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 Mergers and Acquisitions: Divestment
Success
Successful divestiture involves:
• Removing emotion from the decision.
• Knowing the value of the business you’re selling.
• Timing the deal right.
• Maintaining a sizable pool of potential buyers.
• Telling a story about the deal.
• Running divestitures systematically through a
project office.
• Communicating clearly and frequently.

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 Strategic Alliances and Joint Ventures:
Motives
Strategic alliances and joint ventures are
cooperative relationships between two (or
more) firms with potential advantages.
• Ability to enter new markets through:
• Greater financial resources.
• Greater marketing expertise.

• Ability to reduce manufacturing or other costs in

the value chain.
• Ability to develop and diffuse new technologies.

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 Strategic Alliances and Joint Ventures:
Limitations
Need for the proper partner:
• Partners should have complementary strengths.
• Partner’s strengths should be unique.
• Uniqueness should create synergies.
• Synergies should be easily sustained and defended.

• Partners must be compatible and willing to trust

each other.

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 Internal Development

Corporate entrepreneurship and new venture

internal development motives:
• No need to share the wealth with alliance partners.
• No need to face difficulties associated with combining
activities across the value chains.
• No need to merge diverse corporate cultures.
• No need for external funding for new development.

Limitations:
• Time-consuming.
• Need to continually develop new capabilities.

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 Managerial Motives

Managerial motives: Managers may act in

their own self interest, eroding rather than
enhancing value creation.
• Growth for growth’s sake.
• Top managers gain more prestige, higher rankings,
greater incomes, more job security.
• It’s exciting and dramatic!

• Excessive egotism.
• Use of antitakeover tactics.

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 Managerial Motives: Antitakeover Tactics

Antitakeover tactics include:

• Greenmail.
• Golden parachutes.
• Poison pills.

Can benefit multiple stakeholders – not just

management.
Can raise ethical considerations because the
managers of the firm are not acting in the best
interests of the shareholders.

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 End of Main Content

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