Transcript [Company Name] - Thammasat University

Bourgeois, Duhaime,
& Stimpert
Chapter 9
Corporate Strategy and
Diversification
Copyright © 1999 by Harcourt Brace & Company
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Chapter Objectives


Define corporate strategy, describe some of the
reasons why firms diversify, identify and describe
different types of corporate diversification, and
assess the advantages and disadvantages associated
with each.
Identify sources of synergy in diversified firms while
also describing why synergies are so difficult to
achieve.
Copyright © 1999 by Harcourt Brace & Company
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Chapter Objectives


(cont.)
Explore the complex relationship between
diversification and firm performance.
In particular, explore the influence of managers and
managerial thinking on the relationship between
diversification and performance.
 See
Exhibit 9.1 on following slide.
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Exhibit 9.1: Model of Strategic
Management
Decisions about
Business Definition
Managers' Mental Models
+ Industry environments
+ How to compete
+ Appropriate size/diversity,
how businesses are related,
how diversification should
be managed
+ How to organize
Decisions about
Business Strategy
Decisions about
Corporate Strategy
and Diversification
Market Position,
Resources, and
Capabilities
Performance
and
Competitive
Ad vantage
Decisions about
Organizational
Structure
Feedback
reinforces or
suggests changes
in managers'
mental models
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Introduction

Definition of Corporate Strategy
 Address
the question: “What is the appropriate scale
and scope of the enterprise?”
• Influences how large and how diversified firms will be.
• Successful corporate strategies are not only the
product of successful definition
– Also the result of organizational capabilities or
competencies that allow firms to exploit potential
economies/synergies that large size or diversity can offer.
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Introduction

(cont.)
Why Firms Diversify
 To
grow
 To more fully utilize existing resources and
capabilities
 To escape from undesirable or unattractive
industry environments
 To make use of surplus cash flows
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Introduction

(cont.)
Types of Diversification
 Vertical
Integration
• Strategy of acquiring control over additional links in
value chain of producing and delivering
products/services.
• Backward Integration
– Moving closer to sources of raw materials by acquiring
resource suppliers or manufacturing the components
needed for production of final product.
• Forward Integration
– Just the opposite: moving closer to end-user (acquire retail
outlets for distribution, etc.).
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Engineering
and Design
Exhibit 9.2:
Vertical
Integration
Purchasing
Backward Integration
Assembly and
Production
Forward Integration
After-Sale
Service
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Introduction

(cont.)
Advantages of vertical integration (shown in
Exhibit 9.3)
 Greater control
over costs and supply of
components.
 Avoids the transaction costs associated with
dealing with vendors or retailers.
 Ability to protect proprietary technology.
 Ability to maintain or cultivate a company’s
reputation for outstanding quality or service.
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Introduction

(cont.)
Disadvantages of vertical integration
 Higher fixed
overhead costs.
 Integrated firms must deal with transfer price dilemma
which can create serious morale and other internal
problems.
 Demand uncertainty creates problems.
• Low demand can lead to underutilization of plant
capacity.
• High demand can result in dependence on outside
suppliers.
 Technological
change can leave these firms stuck with
old technology.
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Introduction

(cont.)
Horizontal or related diversification
 Strategy
of adding related or similar product/service
lines to existing core business, either through
acquisition of competitors or through internal
development of new products/services.
 Advantages (from Exhibit 9.4)
• Opportunities to achieve economies of scale and
scope.
• Opportunities to expand product offerings or expand
into new geographical areas.
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Introduction
 Disadvantages
(cont.)
of related diversification
• Complexity and difficulty of coordinating different
but related businesses.

Conglomerate or unrelated diversification
 Forms
pursue this strategy for several reasons:
• Continue to grow after a core business has matured
or started to decline.
• To reduce cyclical fluctuations in sales revenues and
cash flows.
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Introduction
(cont.)
 Problems
with conglomerate or unrelated
diversification:
• Managers often lack expertise or knowledge about
their firms’ businesses.

Global diversification
 Usually
motivated by desire to grow (Boeing,
Kellogg’s, Caterpillar).
 Simplest route is exporting.
 Others include licensing or franchising.
 Most complex route is to establish wholly-owned
subsidiaries.
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Introduction
 Challenges
(cont.)
in global diversification:
• Most difficult challenge is to appreciate the unique
cultures and customs of foreign markets.
– Need for products to be adapted to accommodate these
markets.
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Aim of Corporate
Strategy: Synergy


Aim of diversification should be to create value or
wealth in excess of what firms would enjoy without
diversification.
Synergy: the value of the combined firm after
acquisition should be greater than the value of the
two firms prior to acquisition.
 Obtained
in three ways:
• Exploiting economies of scale.
– Exist when unit costs decline with increases in
production.
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Aim of Corporate
Strategy: Synergy
(cont.)
• Exploiting economies of scope.
– Using the same resource to do different things.
• Efficient allocation of capital.
– Many assets in acquired firms are undervalued -managers seek to exploit these opportunities and
improve their operations and add value to their
businesses.
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Problems in Exploring
Potential Synergies


Poor understanding of how diversification activities
will “fit” or be coordinated with existing businesses.
Acquisition process is fraught with risks.
 Managers
might fail to conduct an adequate
strategic analysis of acquisition candidate.
• Will often try to complete the deal too quickly
before other potential buyers begin a bidding war.
• Managers will often focus on the attractive features
See
of a candidate, while giving less attention to the
Exhibit 9.5 negative features.
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Problems in Exploring
Potential Synergies (cont.)
 Even
after making an acquisition, managers must
still integrate the new business into their
company’s existing portfolio of businesses.
• Differences in organizational cultures.
• Should new business be standalone operation or
should it be merged into one of the existing
businesses?
See Exhibits
9.6 and 9.7
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Problems in Exploring
Potential Synergies (cont.)

Problems associated with internal development of
new businesses.
 Most
problems due to considerable time and
investment required to launch new business.
• On average, most new product lines require 10 years
before generating positive cash flows and net
income.
 Difficult
to assess the risks associated with new
investment opportunity.
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Diversification and
Performance: The Score

What is relationship between diversification and firm
performance?
 Academics,
consultants,and financial community
have dim view of diversification.
 Some studies suggest that diversification beyond a
core business leads to lower performance.
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Diversification and
Performance: The Score (cont.)
 Exhibit
9.8 summarizes findings of study that
sought to determine how much various factors,
including industry attractiveness, business strategy,
and corporate strategy contribute to performance.
• Findings suggest that industry attractiveness and
business strategy together explain more than 99% of
variation of business unit performance.
See
Exhibit 9.8
– Corporate strategy has no apparent effect on
performance!
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Diversification and
Performance: The Score (cont.)
 Additional
studies conclude that corporate strategy
rarely makes significant contribution to
shareholder value.
 Recent study is shown in Exhibit 9.9 below:
Less
Diversified
LowPerforming
Firms
HighPerforming
Firms
47
46
46
47
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Diversification and
Performance: The Score (cont.)
 Findings
of Exhibit 9.9:
• categorization of firms into the 4 diversificationperformance groups is remarkably balanced.
– High-performing firms are just as likely to be more
diversified as they are to be less diversified.
– Low-performing firms are just as likely to be less
diversified as they are to be more diversified.
• No significant performance differences between
high-performing more or less diversified firms.
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Diversification and
Performance: The Score (cont.)

Summary
 Though
diversification has been disastrous for
many firms, diversified firms can also be
successful.
 Studies have found no obvious differences between
high- and low-performing diversified firms along
several important strategic dimensions.
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Crucial Role of
Managers


Successful diversification strategies result from the
ability of managers to develop skill and competency
at managing diversification.
Managers must develop two important types of
mental models:
 Must
have well-developed understandings of their
firm’s diversity and relatedness that define their
companies.
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Crucial Role of
Managers (cont.)
• Understandings of how their firm’s businesses are
related are important for 2 reasons:
– They will influence how managers describe their
organizations to important stakeholders.
– Managers’ understandings also describe or suggest how
their businesses are related to each other.
 Must
also have well-developed beliefs about how
diversification should be managed in order to
achieve synergies.
• How to coordinate the activities of businesses in
order to achieve synergies.
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Crucial Role of
Managers (cont.)
• How to allocate resources to the various businesses
in a diversified firm.
• Whether various functional activities such as
engineering, finance and accounting, marketing and
sales, production, and research and development
should be centralized at the corporate HQ or be
decentralized and operated by SBU managers.
• How to compensate and reward business unit
managers so that their goals and objectives are best
aligned with those of the organization.
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Crucial Role of
Managers (cont.)

The “Learning Hypothesis”
 Managers
learn from trial and error.
• They evaluate success of past strategic decisions.
• These acquired beliefs become embedded in an
organization’s routine operating procedures.
– Usually difficult for rivals to imitate.
 By
engaging in a number of acquisitions over time,
managers can come to develop an expertise about
how the acquisition process should be managed.
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Crucial Role of
Managers (cont.)
• Those firms with management teams that have more
experience at managing diversification will enjoy
higher performance than those firms that do not
have that experience.
– Evidence suggests that firm’s stock market performance
is directly related to diversification experience (see
Exhibit 9.10 on following slide).
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Exhibit 9.10: Five-Year Stock Market
Performance of Four Bank Holding
Companies that Are Active Acquirers
44%
Banc One
118%
NationsBank
Norwest
142%
195%
First Bank
234%
Wells Fargo
0%
50%
100%
150%
200%
250%
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Future of Corporate
Diversification

Divestment activity
 More
firms attempting to shed unrelated
acquisitions in order to focus on core businesses.
• However, diversification as a whole increased during
1988-1992 period.
• Firms will continue to diversify to reduce their
reliance on declining business lines or industries.
 Logical
to conclude that those firms most likely to
de-diversify may be those that are having the most
trouble managing diversification.
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Future of Corporate
Diversification (cont.)

Corporate restructuring efforts
 Undertaken
to emphasize those value-chain
activities that contribute to their competitive
advantage.

Outsourcing
 Firms
are outsourcing the less critical activities
that perhaps do not contribute significantly to their
competitive advantage.
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Conclusions

Size alone does not guarantee firms an advantage.
 Coordination
required to exploit economies of scale
and scope is not without cost.
 Size creates additional challenges and difficulties,
including problems of communication and
coordination.

Higher levels of diversification are not incompatible
with high performance -- nor do they necessarily
imply that firms will suffer lower performance levels.
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Conclusions

(cont.)
Critical factor in determining success is the level of
management expertise in formulating and
implementing corporate strategy.
 More
difficult for diversified firms.
 Managers of large diversified firms possess a
variety of well-developed mental models that
provide them with powerful understandings of how
to manage their firms.
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Key Points Introduced
in Chapter 9

Corporate strategy is concerned with determining the
appropriate scale (size) and scope (extent of
diversification) of firms.
 Firms
can be small or large and they can focus on
single line of business or they can participate in many
diverse industries.

Firms diversify for variety of reasons.
 Desire
to grow.
 More fully utilize existing resources and capabilities.
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Key Points Introduced
in Chapter 9 (cont.)
 Escape
from undesirable or unattractive industry
environments.
 Make use of surplus cash.

Each major type of diversification has advantages and
disadvantages associated with it and each entails unique
management challenges.
 Vertical
integration.
 Horizontal or related diversification.
 Conglomerate or unrelated diversification.
 Global diversification.
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Key Points Introduced
in Chapter 9 (cont.)

Aim of all corporate strategies should be to achieve
synergies.
 Divisions,
segments, and SBUs of firm should
create more value together that they would as
independent businesses.

Ways to achieve synergies:
 Exploit
economies of scale.
 Exploit economies of scope.
 Allocate capital more efficiently than competitors.
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Key Points Introduced
in Chapter 9 (cont.)

Factors which complicate firms’ efforts to achieve
synergies:
 Poor understanding
of how diversification
activities will “fit” or be coordinated with existing
businesses.
 Dangers or risks associated with acquisition of new
businesses.
 Problems associated with internal development of
new businesses.
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Key Points Introduced
in Chapter 9 (cont.)

As a result, relationship between diversification and
performance is complex.
 Conventional
wisdom suggests that higher levels of
diversification lead to lower level of performance.
• This wisdom has received very little empirical
support.
• However, many successful, highly diversified firms
exist.
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Key Points Introduced
in Chapter 9 (cont.)

Managers’ beliefs play key role in influencing the
relationship between diversification and firm
performance.
 Two
specific beliefs are key to successful
management of diversification:
• Managers’ understanding of how their firms’
businesses are related.
• Managers’ beliefs about how diversification and
corporate strategy should be managed.
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Key Points Introduced
in Chapter 9 (cont.)
 Learning
from experience is key to developing
skills at managing diversification.
• This chapter hypothesizes that those firms with
management teams that have more experience at
managing diversification will enjoy higher
performance.
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