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Chapter Ten
Corporate-Level Strategy:
Formulating and
Implementing Related and Unrelated
Diversification
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Corporate-Level Strategy should allow a company, or one of its business units, to perform the value-creation functions at lower cost or in a way that allows for differentiation and premium price.
Companies must adopt a long-term perspectiveConsider how changes in the industry and its products, technology, customers, and competitors will affect its
current business model and future strategies.
Corporate-Level Strategy
Corporate strategy is used to identify: 1. Businesses or industries that the company should
compete in2. Value creation activities which the company should
perform in those businesses 3. Method to enter or leave businesses or industries
in order to maximize its long-run profitability
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Diversification Strategy is the company’s decision to enter one or more new industries (that are distinct from its established operations) to take advantage of its existing distinctive competencies and business model.
Corporate-Level Strategy of Diversification
Types of diversification: Related diversification Unrelated diversification Methods to implement a
diversification strategy:
Internal new ventures Acquisitions Joint ventures
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Expanding Beyond a Single Industry
BUT a company’s fortunes are tied closely to the profitability of its original industry:
Can be dangerous if the industry matures and goes into decline
May be missing the opportunity to leverage their distinctive competencies in new industries
Tendency to rest on their laurels and not engage in constant learning
Staying inside a single industry allows a company to:• Focus its resources ‘Stick to its knitting’
To stay agile, companies must leverage –find new ways to take advantage of their distinctive
competencies and core business model in new markets and industries.
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A Company as a Portfolio of Distinctive Competencies
Consider how those competencies might be leveraged to create opportunities in new industries
Existing competencies versus new competencies that would need to be developed
Existing industries in which a company competes versus new industries
Reconceptualize the company as a portfolio of distinctive competencies . . . rather than a portfolio of products:
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Establishing a Competency Agenda
Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright ©
1994 by Gary Hamel and C. K. Prahalad. All rights reserved.
Figure 10.1
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Increasing ProfitabilityThrough Diversification
Transferring competencies among existing businesses
Leveraging competencies to create new businesses
Sharing resources to realize economies of scope
Using product bundling Managing rivalry by
using diversification as a means in one or more industries Exploiting general organizational competencies that
enhance performance within all business units
A diversified company can create value by:
Managers often consider diversification when their company is generating free cash flow – with resources in excess of those needed to maintain competitive advantage.
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Transferring Competencies
• The competencies transferred must involve activities that are important for establishing competitive advantage
• Tend to acquire businesses related to their existing activities because of the commonality between one or more value-chain functions
Transferring competencies across industries: taking a distinctive competency developed in one industry and implanting it in an EXISTING business unit in another industry
For such a strategy to work, the distinctive competency being
transferred must have real strategic value.
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Transfer of Competencies at Philip Morris
Figure 10.2
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• The difference between leveraging and transferring competencies is that an entirely NEW business is created
• Different managerial processes are involved
• Tend to use R&D competencies to create new business opportunities in diverse areas
Leveraging competencies: taking a distinctive competency developed by a business in one industry and using it to create a NEW business unit in a different industry
Leveraging Competencies
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Economies of scope arise when business units are able to effectively able to pool, share, and utilize expensive resources or capabilities:1. Companies that can share resources
have to invest proportionately less than companies that cannot share.
2. Resource sharing can result in economies of scale.
Sharing resources and capabilities across two or more business units in different industries to realize economies of scope.
Economies of scope are possible only when there are significant commonalities between
one or more value-chain functions.
Sharing Resources
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Sharing Resources at Procter & Gamble
Figure 10.3
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• Allows customers to reduce their number of suppliers for convenience and cost savings.
• Increased value of orders gives customers increased commitment and bargaining power with suppliers.
Use product bundling to differentiate products and expand products lines in order to satisfy customers’ needs for a package of related products.
Using Product Bundling
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• Multipoint competition is when companies compete with each other in different industries.
• Companies can manage rivalry by signaling that competitive attacks in one industry will be met by retaliatory attacks in the aggressor’s home industry.
• Mutual forbearance from signaling may result in less intense rivalry and higher industry profits.
Manage rivalry by holding a competitor in check that has either entered its industry or has the potential to do so.
Managing Rivalry
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These capabilities help each business unit perform at a higher level than if it operated as an individual company:1. Entrepreneurial capabilities – encourage risk taking while
managing & limiting the amount of risk undertaken 2. Organizational design – create structure, culture, and
control systems that motivate and coordinate employees3. Superstrategic capabilities – effectively manage the
managers of the business units and helping them think through strategic problems
General organizational competencies are skills of a company’s top managers and functional experts that transcend individual functions or business units.
These managerial skills are often not present, as they are rare and difficult to develop and put into action.
Exploiting General Organizational Competencies
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Types of Diversification
Related diversificationEntry into a new business activity in a different industry that: • Is related to a company’s existing business activity or
activities and• Has commonalities between one or more components of
each activity’s value chainBased on transferring and leveraging competencies, sharing resources, and bundling products
Unrelated diversificationEntry into industries that have no obvious connection to any of a company’s value-chain activities in its present industry or industries
Based on using only general organizational competencies to increase profitability of each business unit
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Commonalities Between Value Chains of Three Business Units
Figure 10.4
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Disadvantages and Limits of Diversification
1. Changing Industry and Firm-Specific Conditions• Future success of this strategy is hard to predict.• Over time, changing situations may require businesses
to be divested.
2. Diversification for the Wrong Reasons• Must have clear vision as to how value will be created.• Extensive diversification tends to reduce rather than improve
profitability.
3. Bureaucratic Costs of Diversification• Costs are a function of the number of business units in a
company’s portfolio, and the• Extent to which coordination is required to gain the benefits.
Conditions that can make diversification disadvantageous:
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Coordination Among Related Business Units
Figure 10.5
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Choosing a Strategy
Related diversification• When company’s competencies can be applied across a
greater number of industries and• Company has superior capabilities to keep bureaucratic
costs under control
Unrelated diversification• When functional competencies have few useful applications
across industries and• Company has good organizational design skills to build
distinctive competencies Web of corporate level strategy
• May pursue both related and unrelated diversification• As well as other strategies that improve long-term profitability
The choice of strategy depends on a comparison of the benefits of each strategy versus the cost of pursuing it:
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Sony’s Web of Corporate-Level Strategy
Figure 10.6
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Diversification That Dissipates Value
Diversifying to pool risks• Stockholders can diversify their own portfolios at lower costs
than the company can.• This represents an unproductive use of resources as profits
can be returned to shareholders as dividends.• Research suggests that corporate diversification is not an
effective way to pool risks.
Diversifying to achieve greater growth• Growth on its own does not create value.• Business cycles of different industries are inherently difficult
to predict.
Based on a large number of academic studies:Extensive diversification tends to reduce,
rather than improve, company profitability.
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Entry Strategies to Implement Multibusiness Model
Internal New Ventures• Company has a set of valuable competencies in its existing
businesses.• Competences leveraged or recombined to enter new business
areas.
Acquisitions• Company lacks important competencies to compete in an area.• Company can purchase an incumbent company that has those
competencies at a reasonable price.
Joint Ventures• Company can increase the probability of success by teaming
up with another company with complementary skills.• Joint ventures are preferred when risks and costs of setting up
a new business unit are more than company can assume.
Various entry strategies may be employed based on the company’s competencies and capabilities:
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Pitfalls of New Ventures
Scale of entry• Large-scale entry is initially
more expensive than small- scale entry, but it brings higher returns in the long run.
Commercialization• Technological possibilities
should not overshadow market needs and opportunities.
Poor implementation• Demands on cash flow• Need clear strategic objectives• Anticipate time and costs
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Scale of Entry and Profitability
Figure 10.7
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Guidelines for Successful Internal New Venturing
Research aimed at advancing basic science and technology
Development research aimed at finding and refining commercial applications for the technology
Foster close links between R&D and marketing; between R&D and manufacturing
Selection process for choosing ventures Monitor progress
Structured approach to managing internal new venturing:
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The Attractions of Acquisition
Used to achieve diversification when the company lacks important competencies
Enable a company to move quickly Perceived as less risky than internal new
ventures An attractive way to enter a new industry
that is protected by high barriers to entry
Acquisitions are the principle strategy used to implement horizontal integration:
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Acquisition Pitfalls
Integrating the acquired company• Difficulty in integrating value-chain and management activities• High management and employee turnover in acquired
company Overestimating the economic benefits
• Overestimate the competitive advantages and value-added that can be derived from the acquisition
• Pay too much for the target company The expense of acquisitions
• Premium paid for publicly traded companies • Premium cancels out the prospective value-creating gains
Inadequate preacquisition screening• Weaknesses of acquisitions’ business model are not clear
There is ample evidence that many acquisitions fail to create value or to realize their anticipated benefits:
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Guidelines for Successful Acquisition
Target identification and preacquisition screening for: 1. Financial position2. Distinctive competencies and competitive advantage3. Changing industry boundaries4. Management capabilities5. Corporate culture
Bidding strategy• Avoid hostile takeovers and speculative bidding.• Encourage friendly takeover with amicable merger.
Integration• Eliminate duplication of facilities and functions.• Divest unwanted business units included in acquisition.
Learning from experience• Conduct post-acquisition audits.
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Joint Ventures
Attractions: Helps avoid the risks and costs of building a new
operation from the ground floor Teaming with another company that has
complementary skills and assets may increase the probability of success
Pitfalls: Requires the sharing of profits if the new business
succeeds Venture partners must share control – conflicts on
how to run the joint venture can cause failure Run the risk of giving critical know-how away to
joint venture partner
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Restructuring
Why restructure?• Diversification discount: investors see highly
diversified companies as less attractive » Complexity and lack of transparency in financial
statements» Too much diversification » Diversification for the wrong reasons
• Response to failed acquisitions• Innovations in strategic management have
diminished the advantages of vertical integration or diversification
Restructuring is the process of divesting businesses and exiting industries to focus on core distinctive competencies in order to increase company profitability.