Transcript Strategic Management: Competitiveness and Globalization

Questions
• Why do firms diversify?
– What drives the need to grow?
– How is value created?
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Transaction Cost Economics
• Make vs. Buy Decision
– Question of relative efficiency (firm vs.
market) based on specifics of the firm
– The firm is a bundle of transactions
– The goal is to choose the right
governance form for the transaction(s)
given asset specificity and partners’
incentives
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Related/Unrelated
Related diversification
• The new business area has “meaningful”
commonalities with the core business.
Unrelated diversification
• Unrelated diversification lacks commonalities.
• The objectives are mainly financial, to generate
profit streams that are either larger, less uncertain, or
more stable that they would be otherwise.
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Performance???
• 1950-1980, 2021 acquisitions made in new
industries by 33 large, diversified U.S.
companies, More than half were divested by
1986 (Porter, HBR, 1987)
• 931 unrelated diversifications, 74% were
divested (Porter, HBR, 1987).
• Sample of Fortune 500 firms – related highest
in performance, followed by less related and
finally unrelated (Rumelt, Strategic Management Journal,
1982)
• 450 related diversifications had a significantly
higher ROA than 20 unrelated diversification
firms (Simmonds, Strategic Management Journal 1990)
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Diversification implies two levels of
strategy
1. Business-Level
Capabilities/resources to create
competitive advantage within each
business
- low cost
- differentiation
- focused low cost - focused differentiation
- integrated low cost/differentiation
2. Corporate-Level
Capabilities/resources needed to create
value across businesses
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Corporate Strategy Decisions
1. What businesses to be in?
2. How to manage interrelationships?
3. Who decides what?
Corporate Strategy is
focused on generating
returns in excess of those
that shareholders can
obtain for themselves by
diversifying investments
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Value Creation & Diversification
• Economies of scope adapting/transferring
resources and activities across businesses
• Market power - e.g., Vertical & horizontal
integration, scale economies (Porter)
• Financial economics (e.g., advantages w.r.t.
time, uncertainty, options, information)
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Rationales (many questionable)
Incentives
Resources
Managerial
Motives
Incentives do not generate
value through resources /
capabilities and so have
neutral effects
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Anti-trust regulation
Tax laws
Low performance
Uncertain future cash flows
Firm risk reduction
No critical capability supported
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Rationales (cont’d)
Incentives
Resources
Managerial
Motives
Resources / capabilities
affect value creation (but
have varying effects)
• Tangible resources
 financial resources
 physical assets
• Intangible resources
 tacit knowledge
 customer relations
 image and reputation
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Rationales (cont’d)
Incentives
TMT motives to diversify and
shareholder goals are often
misaligned
Resources
• Diversifying managerial
compensation/employment
risk
Managerial
Motives
• Increasing managerial
compensation (grows along
with firm size)
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Ability to Share activities
How to think about
Value-creation
Both Operational and
Related Constrained
Corporate Relatedness
Diversification
(Rare Capability High
Risk
V/H integration
Diseconomies of
(Market Power)
Scope)
Low
Unrelated
Diversification
(Financial
Economies)
Related Linked
Diversification
(Economies of
Scope)
Low
High
Ability to transfer skills/capabilities
among businesses
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Adding Value by Diversifying
Diversification creates value through
two mechanisms:
– Economies of scope: cost savings
attributed to transferring the capabilities
and competencies developed in one
business to a new business
– Market power: when a firm is able to
achieve an improved configuration of
resources / activities resulting in:
• price premium advantages for its products /
services
• reduced costs of its primary and support
activities
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Scale economies?
Cost advantages from
• Pooling activities to reach minimum
efficient scale (e.g., centralized acctg,
MIS,)
• Centralizing administration & control
e.g. strategic planning, creating internal
capital market, legal, etc.
Risks???
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So, back to the two basic approaches
Related Diversification
– share activities
– transfer core competencies
Unrelated Diversification
– More efficiently allocate internal capital
– restructure
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Sharing Activities:
• Sharing activities often lowers costs or raises
differentiation (↑ mkt power)
• Costs lowered if:
– achieves economies of scale
– boosts capacity utilization
– Speeds movement down the Learning Curve
• Sharing activities can enhance potential for or
reduce the cost of differentiation
– Must involve value chain activities impt to
competitive advantage
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Sharing Activities:
• Strong sense of corporate identity
• Clear corporate mission that emphasizes the
importance of integrating business units
• Incentive system that balances business unit
& aggregate performance
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Transferring
Skills/Capabilities
• Exploits interrelationships among
divisions
• Start with value chain analysis
– identify ability to transfer skills or
expertise among similar value chains
How can an ability to transfer
activities be developed?
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Assumptions
Transferring Core
Competencies:
• 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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Efficient Internal Capital
Market Allocation:
• Firms pursuing this 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 sub-unit
managers compensation based on unit results19
Efficient Internal Capital
Market Allocation:
• Assumes managers have more knowledge of the
firm and its potential than outside investors
• Private information – no disclosure of
sensitive competitive information to investors
• Firm may be able to reduce risk by allocating
resources among diversified businesses
(shareholders can diversify more economically on
their own)
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Restructuring:
• Seek out undeveloped, poorly managed or
threatened organizations
• Parent company (acquirer) intervenes to:
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change sub-unit management team
shift strategy
embed new technology
tighten control systems
divest parts of firm
Acquire more businesses to achieve critical
configuration
• Sell the firm
Examples?
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Performance
Relationship Between
Diversification and Performance
Dominant
Business
Related
Constrained
Unrelated
Business
Level of Diversification
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