Lecture 7 Flashcards
Corporate surplus
The value of the company is higher than the sum of its parts
CAGR
Compound annual growth rate
Good sides of CAGR
Compound annual growth rate
- considers compounding effect
- Provides a standardised comparison for different investments
Downsides of CAGR
Compound annual growth rate
- ignores volatility (ups & downs) during the investment period
- doesn’t account for deposits or withdraws
What does CAGR measure
It measures the average annual return of investment considering compounding
Conglomerate discount
When a big firm is worth less than the sum of its parts
Diversification
A corporate strategy to create a corporate advantage
Key question of corporate strategy
How to create a competitive advantage for the whole company
Normative perspective
• Focuses on what ought to be (values-driven decisions).
• Ensures alignment with company vision and mission, beyond profitability.
Does the Corporate Strategy Make Sense?
Mnemonic: RACE-VALUE
1. Resources: Do businesses share tangible/intangible resources?
2. Alignment: Are capabilities and strategies complementary?
3. Customers: Are supplier/customer relationships shared?
4. Execution: Do they have similar competitive strategies?
5. Vision: Does it align with values, mission, vision?
6. Areas: Do they serve similar geographic areas?
7. LUcrative: Are they in growing/profitable industries?
8. Evaluation: Does it resonate across all tests?
What is corporate strategy according to Michael Porter?
Company strategy is what makes the corporate whole add up to more than the sum of its parts
- Michael Porter
Parenting advantage
refers to the value a corporate parent (the overarching company) adds to its subsidiaries by effectively managing, supporting, and guiding them.
This advantage comes from the parent company’s ability to provide resources, expertise, and strategic oversight that individual business units wouldn’t achieve on their own.
Key idea: The parent company enhances the performance of its subsidiaries, creating synergy rather than unnecessary interference.
Reasons for corporate diversification
“Great Managers Excel At Spreading Rewards”
• Growth
• Market Power
• Efficiency Gains
• Addressing Declining Markets
• Spreading Risks
• Responding to Stakeholder Expectations
Diversification types
Into related business
Into unrelated business
Into both related and unrelated
Why do we diversify into related businesses
We diversify into industries because of strategic resources
Unrelated diversification advantages
- spread business risk
- stability of profits
- financial resources can be directed to those industries that offer the best profit prospects
- if bargain - priced firms with big profit potential are bought, shareholder wealth can be enhanced
Disadvantages of unrelated diversification
- demanding managerial requirements
- lack of cross-business strategic-fits offers no potential for synergistic advantages
SIC code
Standard industry classification code
4 digit code that tells us the industries in which a company operates
T/F Total Entropy of 1 means the company presets in only one business and decreases with diversification
Herfindahl Index (HI) of one means the company operates in only one business and decreases with diversification
Factors to consider in judging business-unit performance
“Some People Contribute Real Effort Creating Impact.”
• S: Sales Growth
• P: Profit Growth
• C: Contribution to Earnings
• R: Return on Capital
• E: Economic Value Added
• C: Cash Flow Generation
• I: Industry Strength Ratings
