Corporate-Level Strategy

Introduction
• Corporate-level strategy : Specifies actions a firm takes
to gain a competitive advantage by selecting and
managing a group of different businesses
competing in different product markets
– Expected to help firm earn above-average returns
– Value ultimately determined by degree to which “the
businesses in the portfolio are worth more under the
management of the company then they would be
under any other ownership
• Product diversification (PD): primary form of corporate-level
strategy example Foster group in wine and beer or
Interpublic group in marketing and advertising acquiring
businesses during downturn. Yet never a risk free option.
• What business the firm is in?
• How to manage the businesses?
• Whether whole is better than parts under strategy
• Two basic Questions
• Could the corporate parent add value to the new business? Or could the new
entity support parent businesses?

PepsiCo Corporate strategy

Business strategies
Pizza Hut KFC
Beverages differentiation Integ cost/diff
Integ diff/cost Taco Bell
Cost leadership

Functional strategies marketing, production, HR, Finance

Issues for consideration in Diverification

– The level of diversification

– Connection or linkages among the business units
Levels of Diversification
• Companies vary according to 5 levels of relatedness
in diversification, which has its benefits and risks
• 1. Low Levels
– Single Business Strategy
• Corporate-level strategy in which the firm generates 95% or
more of its sales revenue from its core business area
• Wrigley Co in chewing gum business is highly competitive who
acquired Kraft foods with Life Savers and Altoids brands-moving
towards dominant business strategy but got acquired by Mars in
2008 with dominant strategy in confection business
– Dominant Business Diversification Strategy
• Corporate-level strategy whereby firm generates 70-95% of
total sales revenue within a single business
• UPS generates 61% form US packages delivery, 21% from
international and 17% from non-packaging business- UPS may
become more diversified due to later 2 businesses
• Hershey Foods with dominant business in confectionery
Levels of Diversification (Cont’d)

• 2. Moderate to High Levels

– Related Constrained Diversification Strategy
• Less than 70% of revenue comes from the dominant business
• Direct links (i.e., share products, technology and distribution
linkages) between the firm's businesses
• P&G, Merck and Company, Kodak, Campbell Soup, use related
constrained strategy
– Related Linked Diversification Strategy (Mixed related
and unrelated)
• Less than 70% of revenue comes from the dominant business
• Mixed: Linked firms sharing fewer resources and assets
among their businesses (compared with related constrained,
above), concentrating on the transfer of knowledge and
competencies among the businesses
• General Electric, J&J are examples of related linked strategy
Levels of Diversification

• 3. Very High Levels: Unrelated

• Less than 70% of revenue comes from dominant business
• No relationships between businesses
• United Technologies, Textron and Samsung follow unrelated
strategy as revenue comes from many unrelated businesses
• They are also known as conglomerates
• Conglomerates in private economy dominate in emerging
markets of India, China, Korea and Latin American companies
• Many companies that once followed unrelated startegies in
60’s and 70’s are restructuring to follow related diversification
strategies because of their
– Inability to manage high levels of diversification
– Recognition that lower level of diversification would match their
competencies better with environmental threats and opportunities
Levels and Types of Diversification
Reasons for Diversification

• A number of reasons exist for diversification

including
– Value-creating
• Operational relatedness: sharing activities between
businesses
• Corporate relatedness: transferring core competencies into
business
– Value-neutral
– Value-reducing
Reasons for Diversification- 3 categories of
reasons

• Value-Creating Diversification-
– Economies of scope- related diversification
(Sharing of activities,
Transferring core competencies)
– Market power- neutralize competitor market power-
related diversification
(Blocking competitors through multipoint competition,
Vertical Integration)
– Financial economies-unrelated diversification
(Efficient internal capital allocation,
Business restructuring)
Value Neutral Diversification

• Anti trust regulation

• Tax laws
• Low performance
• Uncertain future cash flows
• Risk reduction for the firm
• Slack Tangible resources
• Slack Intangible resources
Value reducing Diversification

• Diversifying managerial employment risk

• Increasing managerial compensation
Value-Creating Diversification Strategies : Operational
and Corporate Relatedness

High Related Constrained Both operational

Diversification Corporate Relatedness

Operational Relatedness:
Sharing
Activities
Between
Businesses

Unrelated Related Linked

Low
Diversification Diversification

Low High

Corporate relatedness:
Transferring Core Competencies Into Businesses
Value-Creating Diversification (VCD): Related
constrained and related linked Strategies

• Purpose: Gain market power relative to

competitors
• Related diversification wants to develop and
exploit economies of scope between its businesses
– Economies of scope: Cost savings firm creates by
successfully sharing some of its resources and
capabilities or transferring one or more corporate-level
core competencies that were developed in one of its
businesses to another of its businesses
• VCD: Composed of ‘related’ diversification
strategies including Operational and Corporate
relatedness
Value-Creating Diversification (VCD): Related
constrained Strategies (Cont’d)

• 1. Operational Relatedness: Sharing activities

– Can gain economies of scope
– Share primary or support activities (in value chain such
as inbound /outbound logistics and operations or sales
force)-Oracle acquisition strategy-related constrained
which provided CA and market power over rivals
• Risky as ties create links between outcomes-
interdependencies across units e.g sharing of production of
two products can fail if one business fails
– Related constrained share activities in order to create
value-P&G paper towel business and baby diaper share
lot of activities
– Not easy, often synergies not realized as planned-
Foster’ s group shared sales force unsuccessfully
– Some findings from research are summarized in next
slide
Value-Creating Diversification (VCD): Related
linked Strategies (Cont’d)

• 2. Corporate Relatedness: Core competency

transfer
– Complex sets of resources and capabilities linking
different businesses through managerial and
technological knowledge, experience and expertise
– Two sources of value creation
• Expense incurred in first business and knowledge transfer
reduces resource allocation for second business- HP
transferred ink printer technology to photo copier
• Intangible resources difficult for competitors to understand
and imitate, so immediate competitive advantage over
competition- Virgin group has transferred its marketing
competence to airlines, cosmetics, music, drinks, mobile
phones, health club. Honda transferred engine technology to
motor cycles, lawn movers, cars and trucks
– Use related-linked diversification strategy
Problems in implementation

• One way to transfer competence is through

moving key people in second business. But
managers or employees themselves may be
unwilling to transfer or ask for higher
compensation
• The business managers may be unwilling to
transfer key people to meet corporate objective at
the expense of business unit
• Besides too much outsourcing can lower the
usefulness of core competence, thereby reduce
their usefulness to other business
Value-Creating Diversification (VCD): Related
Strategies (Cont’d)

• Market Power
– Exists when a firm is able to sell its products above the
existing competitive level, to reduce costs of primary
and support activities below the competitive level, or
both.
– This is implemented through related constrained and
related linked diversification
– Mars acquired Wrigley through related constrained
diversification and created 14.4% market share going
above Cadbury and Nestle with shares of 10.1 and
7.7% and Hershey was left with 5.5%
– Market power can be created through multipoint
competition and vertical integration
Market Power

– Multimarket (or Multipoint) Competition

• Exists when 2 or more diversified firms simultaneously
compete in the same product or geographic markets.
• The action taken by UPS and FedEx in two markets, overnight
delivery and ground shipping
• UPS has moved into overnight delivery and FedEx has moved
into ground shipping.
• DHL is leading in Europe. All three are trying to capture
international markets like in Hong Kong to get share in
Chinese business.
• DHL had to exit US market because of two major rivals
– Related diversification strategy may also include
• Vertical Integration
• Virtual integration
Market Power-vertical integration

• Can gain market power

• When a company produces its own inputs(backward
integration) or owns its own distribution channel(forward
integration)
• Desire to increase market power over rivals by
– Developing the ability to save on its operations
– Avoiding market costs
– Improving product quality
– Protecting its technology from imitation by rivals
– Having strong ties between their assets for which no market
price exists
– CVS a Walgreen competitor, recently merged with Caremark, a
pharma benefit manager-moved from retail only to broad-based
health care. But Walgreen can tie up with another benefit
manager
Risks of vertical integration

• There are risks and costs that accompany it

• Outside suppliers may be able to provide inputs at lower
costs and possibly of higher quality
• The cost of coordinating the vertically integrated activities
may exceed the value of the control realized through VI
• VI may result in loss of competitiveness if internal unit
does not keep up with changes in technology
• Internal unit may not absorb all the capacity, forcing it to
sell to outsiders
• Many corporations do not pursue VI but may develop
strong supplier network or engage in virtual integration
or ecommerce.
• De-integration is witnessed in Dell, ford, General Motors.
Selectron is thriving on this supplier based inputs trend
Simultaneous operational and corporate relatedness

• Both can be implemented simultaneously

• Diffciult for competitors to understand and thus
sustainable
• However, difficult to implement
• Also diseconomies of scale can follow
• Also investors may not understand and thus can under
value such corporations
• Johnson and Johnson use this strategy
• Likewise Walt Disney uses this strategy
• Within studio entertainment business, Disney can get
economies of scope by sharing activities across different
distribution companies. Core competence is developed by
deep understanding of customers
Value-Creating Diversification (VCD):
Unrelated Strategies

• Creates value through two types of financial

economies
– Cost savings realized through improved allocations of
financial resources based on investments inside or
outside firm
• Efficient internal capital market allocation
• These are more efficient than the external capital allocation
• This is possible because the corporate office has more
information about its businesses’ future prospects
• External markets have less or inaccurate understanding
• Negative information may not have been disclosed
• The inside knowledge of complex firm is difficult to assess
• Also firm can safeguard internal information from competitors
• Corrective action can be carried out by the corporate office
• External markets can take drastic actions to force bankruptcy
or remove management
• Internal market can adjust managerial incentives and remedy
the problem
• In efficient capital markets the unrelated strategy may be
discounted, called ‘conglomerate discount’ which is about
20%
• However financial economies arising out of unrelated
diversification may be imitated and thus no sustainable
advantage
• In emerging markets conglomerates are the right strategy
because of institutional weaknesses and weak soft
infrastructure .
– Restructuring of acquired assets
• Firm A buys firm B and restructures assets so it can operate
more profitably, then A sells B for a profit in the external
market
• Success in unrelated diversification requires that firms focus
on firms in mature markets, low technology industries
• Avoid service businesses because of their client and sales
orientation
 The Curvilinear Relationship between
Diversification and Performance

Performance

Dominant Related Unrelated

Business Constrained/ linked Business

Level of Diversification
Value-Reducing Diversification:
Managerial Motives to Diversify

• Top-level executives may diversify in order to

diversity their own employment risk and
compensation increases as long as profitability
does not suffer excessively
– Diversification adds benefits to top-level managers but
not shareholders
– This strategy may be held in check by governance
mechanisms or concerns for one’s reputation
– In general managers diversify their firms so that
returns are not compromised and are in the best
interest of shareholders
– Corporate scandals can be controlled through
government controls and markets and corp. governance
 Summary Model of the Relationship Between
Diversification and Firm Performance

Capital Market
Intervention and the
Value-creating Market for
Influences Managerial Talent
• Economies of Scope
• Market Power
• Financial Economics

Value-Neutral
Influences Diversification Firm
• Incentives Strategy Performance
• Resources

Value-Reducing
• Managerial Motives
To Diversify

Internal Strategy
Governance Implementation