Discussion Read and reflect on the assigned readings for the week. Then post what you thought was the most important concept(s), method(s), term(s), and/or
Discussion Read and reflect on the assigned readings for the week. Then post what you thought was the most important concept(s), method(s), term(s), and/or any other thing that you felt was worthy of your understanding in each assigned textbook chapter.
Your initial post should be based upon the assigned reading for the week, so the textbook should be a source listed in your reference section and cited within the body of the text. Other sources are not required but feel free to use them if they aid in your discussion.
Also, provide a graduate-level response to each of the following questions:
What were some of the largest mergers and acquisitions over the past two years? What was the rationale for these actions? Do you think they will be successful? Explain.
[Your post must be substantive and demonstrate insight gained from the course material. Postings must be in the student’s own words – do not provide quotes!] [Your initial post should be at least 450+ words and in APA format (including Times New Roman with font size 12 and double spaced).
Dess, G., McNamara, G., Eisner, A., & Lee, S. H. (2021). Strategic Management: Creating Competitive Advantages (10th edition). McGraw-Hill Higher Education CHAPTER 6
Corporate-Level Strategy: Creating Value through Diversification
Copyright Anatoli Styf/Shutterstock
After reading this chapter, you should have a good understanding of:
6-1 The reasons for the failure of many diversification efforts.
6-2 How managers can create value through diversification initiatives.
6-3 How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.
6-4 How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis.
6-5 The various means of engaging in diversification – mergers and acquisitions, joint ventures/strategic alliances, and internal development.
6-6 Managerial behaviors that can erode the creation of value.
Consider . . .
What businesses should a corporation compete in?
How can these businesses be managed so they create “synergy” – that is, create more value by working together than if they were freestanding units?
Corporate-level strategy = a strategy that focuses on gaining long-term revenue, profits, and market value through managing operations in multiple businesses. Determining how to create value through entering new markets, introducing new products, or developing new technologies is a vital issue in strategic management, but maintaining a focus on “creating value” is essential to long-term success. Research shows that a majority of acquisitions of public corporations result in value destruction rather than value creation. Therefore, these questions must be continually asked and answered.
Making Diversification Work (1 of 2)
Diversification initiatives must create value for shareholders through
Mergers and acquisitions
Diversification should create synergy.
Business 1 plus Business 2 equals More than two.
Diversification = the process of firms expanding their operations by entering new businesses. Diversification initiatives – whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development – must be justified by the creation of value for shareholders. But this is not always the case. Firms typically pay high premiums when they acquire a target firm. So why should companies even bother with diversification initiatives? The answer is synergy, which means “working together,” and synergistic effects should be multiplicative – one plus one should equal more than two.
Making Diversification Work (2 of 2)
A firm may diversify into related businesses.
Benefits derive from horizontal relationships.
Sharing intangible resources such as core competencies in marketing
Sharing tangible resources such as production facilities, distribution channels via vertical integration
A firm may diversify into unrelated businesses.
Benefits derive from hierarchical relationships.
Value creation derived from the corporate office
Leveraging support activities in the value chain
Related businesses are those that share resources. Unrelated businesses have few similarities in products or industries, However the corporate office can add value through such activities as robust information systems or superb human resource practices. Benefits derived from horizontal (related diversification) and hierarchical (unrelated diversification) relationships are not mutually exclusive. Many firms that diversify into related areas benefit from information technology expertise in the corporate office. Similarly, unrelated diversifiers often benefit from the “best practices” of sister businesses even though their products, markets, and technologies may differ dramatically. An example would be a corporate parent with strong support activities in the value chain such as information systems or human resource practices.
Related diversification enables a firm to benefit from horizontal relationships across different businesses.
Economies of scope allow businesses to:
Leverage core competencies
Share related activities
Enjoy greater revenues, enhance differentiation
Related businesses gain market power by:
Pooled negotiating power
Related diversification = a firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power. Economies of scope = cost savings from leveraging core competencies or sharing related activities among businesses in a corporation. Core competencies = a firm’s strategic resources that reflect the collective learning in the organization. Sharing activities = having activities of two or more businesses’ value chains done by one of the businesses. A firm can also enjoy greater revenues if two businesses attain higher levels of sales growth combined than either company could attain independently (this is the synergistic effect). Firms also can enhance the effectiveness of their differentiation strategies by means of sharing activities among business units. A shared order-processing system, for example, may permit new features and services that a buyer will value. Market power = firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment. Pooled negotiation power = the improvement in bargaining position relative to suppliers and customers. Be careful, though: acquiring related businesses can enhance a corporation’s bargaining power, but it must be aware of the potential for retaliation. Vertical integration = an expansion or extension of the firm by integrating preceding or successive production processes. Vertical integration occurs when a firm becomes its own supplier or distributor.
Question (1 of 2)
Sharing core competencies is one of the primary potential advantages of diversification. In order for diversification to be most successful, it is important that
the similarity required for sharing core competencies must be in the value chain, not in the product.
the products use similar distribution channels.
the target market is the same, even if the products are very different.
the methods of production are the same.
Answer: A. See the discussion of core competencies and the criteria for success.
Related Diversification: Leveraging Core Competencies
Core competencies reflect the collective learning in organizations. Can lead to the creation of value and synergy if…
They create superior customer value.
The value-chain elements in separate businesses require similar skills.
They are difficult for competitors to imitate or find substitutes for.
Core competencies = a firm’s strategic resources that reflect the collective learning in the organization. This collective learning includes how to coordinate diverse production skills, integrate multiple streams of technologies, and market diverse products and services. Core competencies = the glue that binds existing businesses together, achieved by transferring accumulated skills and expertise across business units in a corporation. Core competencies can lead to the creation of value and synergy, but these core competencies must enhance competitive advantage(s) by creating superior customer value – by building on existing skills and innovations in a way that appeals to customers, as at Apple. Different businesses in the firm must also be similar in at least one important way related to the core competence. It’s not essential that products or services themselves be similar; it is essential that one or more elements in the value chain require similar essential skills – IBM’s computing power is an example. Finally, core competencies must be difficult for competitors to imitate or find substitutes for. Specialized technical skills acquired during a company’s work experience, such as at Amazon, are an example.
Related Diversification: Sharing Activities
Corporations can also achieve synergy by sharing activities across their business units.
Sharing tangible & value-creating activities can provide payoffs.
Cost savings through elimination of jobs, facilities & related expenses, or economies of scale
Revenue enhancements through increased differentiation & sales growth
Sharing activities = having activities of two or more businesses’ value chains done by one of the businesses. Tangible value-creating activities can include common manufacturing facilities, distribution channels, and sales forces. Cost savings are generally highest when one company acquires another from the same industry in the same country. Sharing activities inevitably involve costs that the benefits must outweigh such as the greater coordination required to manage a shared activity. Sharing activities can also increase the effectiveness of differentiation strategies. For instance, a shared order-processing system may permit new features and services that a buyer will value. However, sharing activities among businesses in a corporation can have a negative effect on a given business’s differentiation. An example is when Ford owned Jaguar and customers found out it shared its basic design and manufacturing with the Mondeo; customers had a lower perceived value of Jaguar.
Related Diversification: Market Power
Market power can lead to the creation of value and synergy through…
Pooled negotiating power
Gaining greater bargaining power with suppliers & customers
Vertical integration – becoming its own supplier or distributor through
Market power = firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment. Pooled negotiating power = the improvement in bargaining position relative to suppliers and customers. Similar businesses working together or the affiliation of the business with a strong parent can strengthen an organization’s purchasing clout. However, managers must carefully evaluate how the combined businesses may affect relationships with actual and potential customers, suppliers, and competitors – they may retaliate! Vertical integration = an expansion or extension of the firm by integrating preceding or successive production processes. Vertical integration occurs when a firm becomes its own supplier or distributor. The firm can incorporate more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integration).
Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input into its manufacturing process. This is an example of
leveraging core competencies.
pooled negotiating power.
Answer: C. See Exhibit 6.3. See the Shaw Industries website at http://shawfloors.com/
Example: Related Diversification: Vertical Integration
Example: Simplified Stages of Vertical Integration: Shaw Industries
Jump to Appendix 1 for long description.
Vertical integration can be a viable strategy for many firms. Shaw Industries is a carpet maker that has attained a dominant position in the industry via a strategy of vertical integration. Shaw has successfully implemented strategies of both forward AND backward integration.
Related Diversification: Vertical Integration, Issues
Is the company satisfied with the quality of the value that its present suppliers & distributors are providing?
Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?
Is there a high level of stability in the demand for the organization’s products?
Does the company have the necessary competencies to execute the vertical integration strategies?
Will the vertical integration initiatives have potential negative impacts on the firm’s stakeholders?
In making vertical integration decisions, five issues should be considered. If the performance of organizations in the vertical chain is satisfactory, it may not, in general, be appropriate for a company to perform these activities itself. However, even if a firm IS outsourcing value-chain activities to companies that are doing a credible job, it may be missing out on substantial profit opportunities. Note: high demand or sales volatility are not that conducive to vertical integration. With a high level of fixed costs in plant and equipment as well as operating costs that accompany endeavors toward vertical integration, widely fluctuating sales demand can either strain resources (in times of high demand) or result in unused capacity (in times of low demand). Finally, successfully executing strategies of vertical integration can be very difficult and can require significant competencies. In addition, managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitors.
Related Diversification: Vertical Integration, Transaction Costs
Transaction cost perspective
Every market transaction involves some transaction costs.
Need for transaction specific investments
Transaction cost perspective = a perspective that the choice of a transaction’s governance structure, such as vertical integration or market transaction, is influenced by transaction costs, including search, negotiating, contracting, monitoring, and enforcement costs, associated with each choice. Transaction costs are the sum of the above costs. These transaction costs can be avoided by internalizing the activity, in other words, by producing the input in-house. However, vertical integration gives rise to administrative costs as well. Coordinating different stages of the value chain now internalized within the firm causes administrative costs to go up. Decisions about vertical integration are, therefore, based on a comparison of transaction costs and administrative costs. If transaction costs are lower than administrative costs, it is best to resort to market transactions and avoid vertical integration. On the other hand, if transaction costs are higher than administrative costs, vertical integration becomes an attractive strategy.
Unrelated diversification enables a firm to benefit from vertical or hierarchical relationships between the corporate office & individual business units through…
The corporate parenting advantage
Providing competent central functions
Restructuring to redistribute assets
Asset, capital, & management restructuring
BCG growth/share matrix
Unrelated diversification = a firm entering a different business that has little horizontal interaction with other businesses of a firm. Benefits of unrelated diversification come from the vertical or hierarchical relationships, or creation of synergies from the interaction of the corporate office with the individual business units. The corporate office can contribute to parenting and restructuring of often acquired businesses or can add value by viewing the entire corporation as a family or portfolio of businesses and allocating resources to optimize corporate goals of profitability, cash flow, and growth. Parenting advantage = the positive contributions of the corporate office to a new business as a result of expertise and support provided, and not as a result of substantial changes in assets, capital structure, or management. Restructuring = the intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management, including selling off parts of the business, changing the management, reducing payroll and unnecessary sources of expenses, changing strategies, and infusing the new business with new technologies, processes, and reward systems. Portfolio management = a method of (a) assessing the competitive position of a portfolio of businesses within a corporation, (b) suggesting strategic alternatives for each business, and (c) identifying priorities for the allocation of resources across the businesses.
Unrelated Diversification: Parenting & Restructuring
Parenting allows the corporate office to create value through management expertise & competent central functions.
In restructuring the parent intervenes.
Asset restructuring involves the sale of unproductive assets.
Capital restructuring involves changing the debt–equity mix, adding debt or equity.
Management restructuring involves changes in the top management team, organizational structure, & reporting relationships.
Parenting relates to the positive contributions of the corporate office to a new business as a result of expertise and support provided in areas such as legal, financial, human resource management, procurement, and the like. Corporate parents also help subsidiaries make wise choices in their own acquisitions, divestitures, and new internal development decisions. With a restructuring strategy the corporate office tries to find either poorly performing firms with unrealized potential or firms in industries on the threshold of some significant, positive change. The parent intervenes, often selling off parts of the business; changing the management; reducing payroll and unnecessary sources of expenses; changing strategies; and infusing the company with new technologies, processes, reward systems, and so forth. When the restructuring is complete, the firm can either “sell high” and capture the added value or keep the business and enjoy financial and competitive benefits. In order for this to work, the corporate parent must have the requisite skills and resources to turn the businesses around, even if they may be in new and unfamiliar industries.
Unrelated Diversification: Portfolio Management
Portfolio management involves a better understanding of the competitive position of an overall portfolio or family of businesses by…
Suggesting strategic alternatives for each business
Identifying priorities for the allocation of resources
Using Boston Consulting Group’s (BCG) growth/share matrix
The key purpose of portfolio models is to assist a firm in achieving a balanced portfolio of businesses. A balanced portfolio consists of businesses whose profitability, growth, and cash flow characteristics complement each other and add up to a satisfactory overall corporate performance. Portfolio analysis allows the corporation (1) to allocate resources among the business units according to prescribed criteria (i.e., use cash flows from the “cash cows” to fund promising “stars”); (2) identify attractive acquisitions; (3) provide financial resources on favorable terms; (4) provide high-quality review and coaching for the individual businesses; (5) provide a basis for developing strategic goals and rewards/evaluation systems for business managers.
Unrelated Diversification: Portfolio Management, BCG
Each circle represents one of the firm’s business units. The size of the circle represents the relative size of the business unit in terms of revenue.
Exhibit 6.4 The Boston Consulting Group (BCG) Portfolio Matrix
Jump to Appendix 2 for long description.
In the BCG approach, each of the firm’s strategic business units (SBUs) is plotted on a two-dimensional grid in which the axes are relative market share and industry growth rate. Relative market share is measured by the ratio of the business units size to that of its largest competitor. Growth rate is estimated from market data. The four quadrants of the grid include stars: firms with long-term growth potential that should continue to receive substantial investment funding; question marks: SBUs operating in high-growth industries with relatively weak market shares where resources should be invested in them to enhance their competitive positions; cash cows: SBUs with high market shares in low-growth industries that have limited long-run potential but represent a source of current cash flows to fund investments in “stars” and “question marks”; dogs: SBUs with weak positions and limited potential – most analysts recommend that they be divested.
Unrelated Diversification: Portfolio Management, Limitations
Limitations of portfolio models:
SBUs are compared on only two dimensions & each SBU is considered a standalone entity.
Are these the only factors that really matter?
Can every unit be accurately compared on that basis? What about possible synergies?
An oversimplified graphical model is no substitute for managers’ experience.
Following strict & simplistic rules for resource allocation can be detrimental to a firm’s long-term viability.
Limitations of portfolio models: comparing SBUs on only two dimensions, viewing each SBU as a stand-alone entity and ignoring synergies, treating the process as largely mechanical, relying on strict rules for resource allocation, making overly simplistic prescriptions and ignoring a firm’s potential long-term viability.
Example: Goal of Diversification = Risk Reduction?
Diversification can reduce variability in revenues & profits over time. However…
Stockholders can diversify portfolios at a much lower cost & economic cycles are difficult to predict, so why diversify?
Example = General Electric’s businesses:
Aircraft engines, power generation equipment, locomotive trains, large appliances, healthcare products, financial products, lighting, mining, oil & gas
Why is GE in so many businesses?
See http://www.ge.com/products. GE is widely diversified, although not as greatly as they once were – they used to own NBC – the National Broadcasting TV group, which GE merged with Vivendi to form NBC Universal – but divested this entity in 2011. With this divestiture, it could be argued that GE is in the business of “imagination,” since all its remaining products, except for the financial services business, can be considered offshoots of founder Thomas A. Edison’s inventions that made life easier through technology. As the chapter says, GE’s range of diversification has resulted in stable earnings over time, and a very low-risk profile. This allows them to borrow money at very favorable rates, money that they, in turn, use to provide financing to buyers of their products – hence the financial services division! So GE’s level of diversification DOES help the company reduce risk.
Means of Diversification
Diversification can be accomplished via
Mergers & acquisitions
Pooling resources of other companies with a firm’s own resource base through
Strategic alliances & joint ventures
Internal Development through
New venture development
Diversification, either related or unrelated, allows a firm to achieve synergies and create value for its shareholders. There are three basic means by which a firm can diversify. Mergers = the combining of two or more firms into one new legal entity. Acquisitions = the incorporation of one firm into another through purchase. Through mergers and acquisitions, corporations can directly acquire another firm’s assets and competencies. A firm can also divest previous acquisitions. Divestment = the exit of a business from the firm’s portfolio. By using a joint venture or strategic alliance, corporations can pool the resources of other companies with their own resource base. Strategic alliance = a cooperative relationship between two or more firms. Joint ventures = new entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity. Finally, corporations may diversify into new products, markets, and technologies through internal development. Internal development = entering a new business through investment in new facilities, often called corporate entrepreneurship and new venture development. Corporate entrepreneurship involves the leveraging and combining of the firm’s own resources and competencies to create synergies and enhance shareholder value.
Mergers and Acquisitions
Mergers involve a combination or consolidation of two firms to form a new legal entity.
On a relatively equal basis
Acquisitions involve one firm buying another either through stock purchase, cash, or the issuance of debt.
The most visible and often costly means to diversify is through acquisitions. Exhibit 6.5 illustrates the dramatic volatility in worldwide M&A activity over the last several years. Increase in merger and acquisition activity can indicate market optimism. It’s an indication that markets are willing to finance these transactions. Government policies such as regulatory actions and tax policies can also make the M&A environment more or less favorable. Finally, currency fluctuations can influence the rate of cross-border acquisitions with firms in countries with stronger currencies being in a stronger position to acquire.
Mergers and Acquisitions: Motives
In high-technology & knowledge-intensive industries, speed is critical: acquiring is faster than building.
M&A allows a firm to obtain valuable resources that help it expand its product offerings & services.
M&A helps a firm develop synergy.
Leveraging core competencies
Building market power
M&A can lead to consolidation within an industry, forcing other players to merge.
Corporations can also enter new market segments by way of acquisitions.
In certain industries speed is critical, so acquiring is faster than building. Example = Apple acquiring Siri Inc. Acquisitions can quickly add new technology to product offerings and meet changing customer needs. Example = Cisco Systems. Acquisitions can help a firm leverage core competencies, share activities, and build market power. Example = eBay’s acquisition of GSI Commerce, StubHub and Gmarket allows it to become a full-service provider of online retailing systems. M&A can lead to consolidation within an industry, forcing other players to merge. Example = consolidation in the airline industry: Delta – Northwest, United – Continental. Corporations can also enter a new market segments by way of acquisitions. Example = Fiat acquired Chrysler to gain access to the U.S. auto market. See Exhibit 6.6.
Mergers and Acquisitions: Limitations
Takeover premiums for acquisitions are typically very high.
Competing firms can imitate advantages.
Competing firms can copy synergies.
Managers’ egos get in the way of sound business decisions
Cultural issues may doom the intended benefits.
By estimates, 70 to 90% of acquisitions destroy shareholder value. See Strategy Spotlight 6.4. Two times out of three, the stock price of the acquiring company falls once the deal is made public. Since the acquiring firm often pays a 30% or higher premium for the target company, the acquirer must create synergies and scale economies that result in sales and market gains exceeding the premium price. This is sometimes hard to do. Because competing firms can often imitate advantages or copy synergies, investors may not be willing to pay a high premium for the stock. M&A costs are paid for upfront. Conversely, firms pay for R&D, ongoing marketing, and capacity expansion over time. This stretches out the payments needed to gain new competencies, but investors want to see immediate results. If the M&A does not perform as planned, managers who pushed for the deal may find their reputation tarnished. Finally, creating a singular organizational culture from multiple national or business cultures can be very difficult. Example = SmithKline and the Beecham Group.
Question (2 of 2)
Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These include
enabling managers to focus their efforts more directly on the firm’s core businesses.
providing the firm with more resources to spend on more attractive alternatives.
raising cash to help fund existing businesses.
all of the above.
Answer: D. Divestment = the exit of a business from the firm’s portfolio. See limitations of mergers and acquisitions, and how divesting a business can accomplish many different objectives, as on the next slide.
Mergers and Acquisitions: Divestment Objectives
Divestment objectives include:
Cutting the financial losses of a failed acquisition
Redirecting focus on the firm’s core businesses
Freeing up resources to spend on more attractive …