Corporate Strategy - Diversification Flashcards
Definition and General Notes
Determines the scope of the firm and hence, in which markets the firm should operate. The Corporate Strategy is a way for a company to create value through the configuration and coordination of its multimarket activities.
Scope in markets determined by three factors
- Vertical Integration
- Product market diversification (Horizontal)
- Geographic diversification/ expansion
Ownership of businesses/ activities in different markets
- Full ownership (M&A, greenfield)
- Partial ownership (JV)
- No ownership (Contracts)
How to achieve value creation through Corporate Strategy
- Scope: right businesses to be in, where synergies can be
- Organizational design and coordination: how should the portfolio of businesses be coordinated and which processes are needed to create value
- Ownership: internal vs. external, full vs. partial ownership
Product Market Diversification Strategies
- Single Business Strategy
- low level diversification
- leveraging competencies
- 95% of revenues from dominant business - Dominant Business Strategy
- dominant and minor business share compentencies
- 70 to 95% of revenues from dominant business - Related Diversification Strategy
- moderate level diversification
- less than 70% of revenues from dominant business
- related constraint: all businesses share activites
- related linked: some share - Unrelated Diversification Strategy
- very high-level diversification
- no businesses share compentencies
Reasons for diversification
- Value-Creating Diversification
- Economies of scope
- Market power
- Financial economies - Value-Neutral Diversification
- Antitrust regulation
- Tax laws
- Low performance
- Uncertain future cash flows
- Risk reduction for firm
- Tangible resources
- Intangible resources - Value-Reducing Diversification
- Diversifying managerial employment risk
- Increasing managerial compensation
Corporate Strategy: Scope
Related diversification leads to economies of scope and synergies.
- Horizonzal - sharing activites and resources, cost saving, increased WTP
- Vertical - bigger share of pie, increase size of pie, increased market power
Reasons for diversification: Synergies
Cost Synergies: Centralizing procurement, joint distribution, combing salesforce
Revenue Synergies: Volume and/ or customer’s WTP increases due to cross-selling
Through sharing activities and resources
Reasons for diversification: Market Power
Market Power exist when a company can sell its product above existing competitive level and reduce costs of primary and support activities below the competitive level
Vertical integration can increase market power.
MMC and lowering competitive rivalry can increase this
Reasons for diversification: Financial Economies
Cost savings realized through improved allocations of financial resources
Two types:
- efficient capital allocations
- purchase other corporations and restructure their assets
Potential source for value creating in unrelated diversification
Unrelated Diversification
The general belief in diversification discount in the valuation of companies.
Conglomerates:
- Mostly present in emerging markets
- BU is granted autonomy
- Little coordination between BU
Why does it make sense?
- market failure
- portfolio of quality businesses
Diversification: Costs + Drawbacks
Managers are driven by a desire for increased compensation, which destroys value and does not deliver synergies
Drawbacks:
- Coordination cost
- Lack of managerial experience
- Distraction for core-business
Framework - Performance <> Level of diversification (Performance first increases with diversification and then decreases)
Vertical Integration Framework
See slides
