Creating Value through Diversification

chapter 6
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education

CorporateLevel Strategy:

Learning Objectives
6-2

After reading this chapter, you should have a good understanding of: LO6.1 The reasons for the failure of many
diversification efforts.

LO6.2 How managers can create value through

diversification initiatives.

LO6.3 How corporations can use related

diversification to achieve synergistic benefits through economies of scope and market power.

Learning Objectives
6-3

LO6.4 How corporations can use unrelated

diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis.

LO6.5 The various means of engaging in

diversification mergers and acquisitions, joint ventures/strategic alliances, and internal development.

LO6.6 Managerial behaviors that can erode the

creation of value.

Corporate-Level Strategy
6-4

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?

Making Diversification Work

6-5

Diversification
Mergers

initiatives must create value for shareholders through

and acquisitions Strategic alliances Joint ventures Internal development

Diversification
Business 1

should create synergy

Business 2 More than two

Making Diversification Work

6-6

firm may diversify into related businesses

derive from horizontal relationships
Sharing

Benefits

intangible resources such as core competencies in marketing Sharing tangible resources such as production facilities
A

firm may diversify into unrelated businesses

Benefits
Value

derive from hierarchical relationships

creation derived from the corporate office Leveraging support activities in the value chain

Related Diversification
6-7

Related

diversification enables a firm to benefit from horizontal relationships across different businesses Economies of scope allow businesses to:
Leverage

core competencies Share related activities Enjoy greater revenues

Related
Pooled

businesses gain market power by:

negotiating power Vertical integration

Question?
6-8

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.

B. C. D.

the similarity required for sharing core competencies must be in the value chain, not in the product. the products use similar distribution channels. the target market is the same, even if the products are very different. the methods of production are the same.

Leveraging Core Competencies

6-9

Related Diversification:

Core

competencies reflect the collective learning in organizations. Can lead to the creation of value and synergy if
create superior customer value value chain elements in separate businesses require similar skills

They The

They

are difficult for competitors to imitate or find substitutes for

Related Diversification:
Sharing Activities
6-10

Corporations

can also achieve synergy by sharing activities across their business units.
tangible & value-creating activities can provide payoffs:
Cost

Sharing

savings through elimination of jobs, facilities & related expenses, or economies of scale enhancements through increased differentiation & sales growth

Revenue

Related Diversification:
Market Power
6-11

Market
Pooled

power can lead to the creation of value and synergy through

negotiating power
Gaining

greater bargaining power with suppliers & customers

Vertical

integration - becoming its own supplier or distributor through

Backward Forward

integration

integration

Example: Question?
6-12

Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input into its manufacturing process. This is an example of
A. B. C. D.

leveraging core competencies. pooled negotiating power. vertical integration. sharing activities.

Related Diversification:
Vertical Integration
6-13

Exhibit 6.3 Simplified Stages of Vertical Integration: Shaw Industries

Related Diversification:
Vertical Integration
6-14

1.

It is the company satisfied with the quality of the value that its present suppliers & 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 organizations products?

2.

3.

4.
5.

Does the company have the necessary competencies to execute the vertical integration strategies?
Will the vertical integration initiatives have potential negative impacts on the firms stakeholders?

Related Diversification:
Vertical Integration
6-15

The

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

Unrelated Diversification
6-16

Unrelated

diversification enables a firm to benefit from vertical or hierarchical relationships between the corporate office & individual business units through The corporate parenting advantage
Providing

competent central functions

Restructuring
Asset,
BCG

to redistribute assets

capital, & management restructuring

Portfolio

management

growth/share matrix

Unrelated Diversification:
Parenting & Restructuring
6-17

Parenting

allows the corporate office to create value through management expertise & competent central functions In restructuring the parent intervenes:
Asset

restructuring involves the sale of unproductive assets Capital restructuring involves changing the debtequity mix, adding debt or equity Management restructuring involves changes in the top management team, organizational structure, & reporting relationships

Unrelated Diversification:
Portfolio Management
6-18

Portfolio

management involves a better understanding of the competitive position of an overall portfolio or family of businesses by
Suggesting

business Identifying priorities for the allocation of resources Using Boston Consulting Groups (BCG) growth/share matrix

strategic alternatives for each

Unrelated Diversification:
Portfolio Management
6-19

Each circle represents one of the firms business units. The size of the circle represents the relative size of the business unit in terms of revenue.
Exhibit 6.5 The Boston Consulting Group (BCG) Portfolio Matrix

Unrelated Diversification:
Portfolio Management
of portfolio models:
6-20

Limitations
SBUs
Are

are compared on only two dimensions & each SBU is considered a standalone entity
these the only factors that really matter? Can every unit be accurately compared on that basis? What about possible synergies?

An

oversimplified graphical model substitutes for managers experience Following strict & simplistic rules for resource allocation can be detrimental to a firms long-term viability

Example: Goal of Diversification =

Risk Reduction?
6-21

Diversification
Stockholders

can reduce variability in revenues & profits over time. However

can diversify portfolios at a much lower cost & economic cycles are difficult to predict, so why diversify?

Example
Aircraft

= General Electrics businesses:

engines, power generation equipment, locomotive trains, large appliances, healthcare products, financial products, lighting, mining, oil & gas Why is GE in so many businesses?

Means of Diversification
6-22

Diversification
Mergers
And

can be accomplished via

& acquisitions

divestment

Pooling

resources of other companies with a firms own resource base through

Strategic

alliances & joint ventures

Internal

Development through
entrepreneurship

Corporate

Mergers and Acquisitions

6-23

Mergers

involve a combination or consolidation of two firms to form a new legal entity:

Are

relatively rare The two firms are on a relatively equal basis

Acquisitions

involve one firm buying another either through stock purchase, cash, or the issuance of debt

Mergers and Acquisitions

6-24

Exhibit 6.6 Global Value of Mergers and Acquisitions ($ trillion)

Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis

Mergers and Acquisitions: Motives

6-25

In

high-technology & knowledgeintensive industries, speed is critical: acquiring is faster than building. M&A allows a firm to obtain valuable resources that help it expand its product offerings & services. M&A helps a firm develop synergy:
Leveraging

core competencies Sharing activities Building market power

Mergers and Acquisitions: Motives

6-26

M&A

can lead to consolidation within an industry, forcing other players to merge. Corporations can also enter new market segments by way of acquisitions.

Mergers and Acquisitions: Limitations

6-27

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

Question?
6-28

Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These include
A. B. C. D.

enabling managers to focus their efforts more directly on the firms core businesses. providing the firm with more resources to spend on more attractive alternatives. raising cash to help fund existing businesses. all of the above.

Mergers and Acquisitions: Divestment

6-29

Divestment
Cutting

objectives include:

the financial losses of a failed acquisition Redirecting focus on the firms core businesses Freeing up resources to spend on more attractive alternatives Raising cash to help fund existing businesses

Mergers and Acquisitions: Divestment

6-30

Successful
Removing

divestiture involves:

emotion from the decision Knowing the value of the business youre 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

Strategic Alliances & Joint Ventures: Motives

6-31

Strategic

alliances & joint ventures are cooperative relationships 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 & diffuse new technologies

Strategic Alliances & Joint Ventures: Limitations

6-32

Need

for the proper partner:

Partners

should have complementary strengths Partners strengths should be unique

Uniqueness

should create synergies Synergies should be easily sustained & defended

Partners

must be compatible & willing to trust each other

Internal Development
6-33

Corporate
No

entrepreneurship & new venture development motives:

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

Limitations:
Time-consuming Need

to continually develop new capabilities

Managerial Motives
6-34

Managerial

motives: Managers may act in their own self interest eroding rather than enhancing value creation through
Growth
Top

for growths sake

managers gain more prestige, higher rankings, greater incomes, more job security Its exciting and dramatic!
Excessive

egotism Use of antitakeover tactics

Managerial Motives: Antitakeover Tactics

6-35

Antitakeover
Green

tactics include:

mail 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