Corporate Level Strategy

Chapter Chapter 6 6

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

©2000 South-Western College Publishing

Ch6

A Diversified Company Has Two Levels of Strategy 1. Business-Level Strategy

(Competitive Strategy)

How to create competitive advantage in each business in which the company competes - low cost - focused low cost - differentiation - focused differentiation - integrated low cost/differentiation

2. Corporate-Level Strategy

(Companywide Strategy)

How to create value for the corporation as a whole

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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

Ch6

Levels and Types of Diversification Low Levels of Diversification Single business

> 95% of revenues from a single business unit

Dominant business

Between 70% and 95% of revenues from a single business unit

A A B

Moderate to High Levels of Diversification Related constrained

A

< 70% of revenues from dominant business; all businesses share product, technological and distribution linkages

B A

Related linked (mixed) < 70% of revenues from dominant

business, and only limited links exist

Very High Levels of Diversification Unrelated-Diversified

Business units not closely related

C

B

C

A B

C

Motives, Incentives, and Resources for Diversification Motives to Enhance Strategic Competitiveness

Resources

Economies of Scope Market Power Financial Economies

Incentives Managerial Motives

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Motives, Incentives, and Resources for Diversification Resources

Incentives Managerial Motives

Incentives and Resources with Neutral Effects of Strategic Competitiveness Anti-Trust 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 Resources

Incentives Managerial Motives

Managerial Motives Causing Value Reduction Diversifying Managerial Employment Risk Increasing Managerial Compensation

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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 Sharing Activities

Key Characteristics: Sharing Activities often lowers costs or raises differentiation Example: Using a common physical distribution system and sales force such as Procter & Gamble’s disposable diaper and paper towel divisions

Sharing Activities can lower costs if it: Achieves economies of scale Boosts efficiency of utilization Helps move more rapidly down Learning Curve Example: General Electric’s costs to advertise, sell and service major appliances are spread over many different products

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Alternative Diversification Strategies Sharing Activities

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

Must involve activities that are crucial to competitive advantage Example: Procter & Gamble’s 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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Alternative Diversification Strategies Sharing Activities

Assumptions: 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 Transferring Core Competencies

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

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Alternative Diversification Strategies Transferring Core Competencies

Assumptions: 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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Alternative Diversification Strategies

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 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 - Infuses firm with new technology - Enhances discipline by changing control systems - Divests part of 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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Value-creating Strategies of Diversification Operational and Corporate Relatedness High Sharing: Operational Relatedness Between Business Low

Related Constrained Diversification Vertical Integration (Market Power)

Both Operational and Corporate Relatedness (Rare Capability and Can Create Diseconomies of Scope)

Unrelated Diversification (Financial Economies)

Related Linked Diversification (Economies of Scope)

Low

High

Corporate Relatedness: Transferring Skills Into Business Through Corporate Headquarters

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Performance

Diversification and Firm Performance

Dominant Business

Related Constrained

Level of Diversification

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

Ch6-

Summary Model of the Relationship Between Firm Performance and Diversification Resources

Capital Market Intervention and Market for Managerial Talent

Incentives

Diversification Strategy

Firm Performance

Managerial Motives Internal Governance

Strategy Implementation

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