Hill 8e Basic Ch10

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Theory of Strategic Management with Cases, 8e

Hills, Jones

Chapter Ten Corporate Diversification Strategy


Corporate-Level Strategy should allow a company to perform the value creation functions at lower cost or in a way that allows for differentiation and premium price.

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


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


Expanding Beyond a Single Industry

BUT staying within a single industry: Can be dangerous if the industry matures and goes into

decline May cause firms to miss the opportunity to leverage their

distinctive competencies in new industries Can cause firms to develop a 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 the 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.


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:


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


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.


Transferring Competencies

• The competencies transferred must involve activities that are important for establishing competitive advantage

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.


Transfer of Competencies at Philip Morris

Figure 10.2


• 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


• Economies of scope arise when business units are able to effectively able to pool, share, and utilize expensive resources or capabilities:

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


Sharing Resources at Procter & Gamble

Figure 10.3


• Allows customers to reduce their number of suppliers for convenience and cost savings.

• Examples: telecommunications and medical equipment industries.

Use product bundling to differentiate products and expand product lines in order to satisfy customers’ needs for a package of related products.

Using Product Bundling


• 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 in check a competitor that has either entered the industry or has the potential to do so.

Managing Rivalry


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. Superior strategic capabilities – effectively manage the

managers of the business units and helping them think through strategic problems

General organizational competencies are skills that transcend individual functions or business units.

Utilizing General Organizational Competencies


Two Types of Diversification Related diversification

Entry 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


Commonalities Between Value Chains of Three Business Units

Figure 10.4


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:


Coordination Among Related Business Units

Figure 10.5


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

The choice of strategy depends on a comparison of the benefits of each strategy versus the cost of pursuing it:

Firms may pursue both strategies simultaneously


Sony’s Web of Corporate-Level Strategy

Figure 10.6


Entry Strategies to Implement the 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


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


Scale of Entry Versus ProfitabilityFigure 10.7


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:


The Attractions of Acquisitions

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:


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


Guidelines for Successful Acquisition

Target identification and preacquisition screening for: • Financial position• Distinctive competencies and competitive advantage• Changing industry boundaries• Management capabilities• 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


Joint VenturesAttractions: 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


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.

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Hill 8e Basic Ch10