Wednesday, December 25, 2013

Corporate-Level Strategy: Creating Value through Diversification

Gregory G. Dess
G. T. Lumpkin
Marilyn L. Taylor




Making Diversification Work
•         What businesses should a corporation compete in?
•         How should these businesses be managed to jointly create more value than if they were freestanding units?
Making Diversification Work
•         Diversification initiatives must create value for shareholders
•         Mergers and acquisitions
•         Strategic alliances
•         Joint ventures
•         Internal development
•         Diversification should create synergy
Synergy
•         Related businesses (horizontal relationships)
•         Sharing tangible resources
•         Sharing intangible resources
•         Unrelated businesses (hierarchical relationships)
•         Value creation derives from corporate office
•         Leveraging support activities
Creating Value
Leveraging core competencies
•         3M leverages it competencies in adhesives technologies to many industries, including automotive, construction, and telecommunications
Sharing activities
•         McKesson, a large distribution company, sells many product lines, such as pharmaceuticals and liquor, through its superwarehouses
Pooled negotiating power
•         The Times Mirror Company increases its power over customers by providing “one-stop shopping” for advertisers to reach customers through multiple media—television and newspapers—in several huge markets such as New York and Chicago
Vertical integration
•         Shaw industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input to its manufacturing process
Corporate restructuring and parenting
•         The corporate office of Cooper Industries adds value to its acquired businesses by performing such activities as auditing their manufacturing operations, improving their accounting activities, and centralizing union negotiations
Portfolio management
•         Novartis, formerly Ciba-Geigy, uses portfolio management to improve many key activities, including resource allocation and reward and evaluation systems
Related Diversification: Economies of Scope and Revenue Enhancement
•         Economies of scope
•         Cost savings from leveraging core competencies or sharing related activities among businesses in the corporation
•         Leverage or reuse key resources
n  Favorable reputation
n  Expert staff
n  Management skills
n  Efficient purchasing operations
n  Existing manufacturing facilities
Leveraging Core Competencies
•         Core competencies
•         The glue that binds existing businesses together
•         Engine that fuels new business growth
•         Collective learning in a firm
n  How to coordinate diverse production skills
n  How to integrate multiple streams of technologies
n  How to market diverse products and services
Three Criteria of Core Competencies
•         Three criteria (of core competencies) that lead to the creation of value and synergy
•         Core competencies must enhance competitive advantage(s) by creating superior customer value
•         Develop strengths relative to competitors
•         Build on skills and innovations
•         Appeal to customers
Three Criteria of Core Competencies
•         Three criteria (of core competencies) that lead to the creation of value and synergy
•         Core competencies must be difficult for competitors to imitate or find substitutes for
•         Easily imitated or replicated core competencies are not a sound basis for sustainable advantages
•         Specialized technical skills acquired only in company work experience are an example
Sharing Activities
•         Corporations can also achieve synergy by sharing tangible and value-creating activities across their business units
•         Common manufacturing facilities
•         Distribution channels
•         Sales forces
•         Sharing activities provide two payoffs
•         Cost savings
•         Revenue enhancements
Cost Savings through Sharing Activities
•         Most common type of synergy
•         Savings obtained through
•         Eliminating duplicate jobs
•         Eliminating duplicate facilities
•         Eliminating related expenses
•         Savings may be offset by
•         Greater costs of coordinating shared activities
•         Costs of compromising design or performance of a shared activity
Enhancing Revenue through Sharing Activities
•         Acquiring firm and its target may achieve a higher level of sales growth together than either could have achieved on its own
•         Combined distribution channels can escalate sales of the acquiring company’s products
•         Enhanced effectiveness of differentiation strategies
•         Can have a negative effect on a given business’s differentiation
Related Diversification: Market Power
•         Two principal means to achieve synergy through market power
•         Pooled negotiating power
•         Vertical integration
•         Government regulations may restrict this power
Pooled Negotiating Power
•         Similar businesses working together can have stronger bargaining position relative to
•         Suppliers
•         Customers
•         Competitors
•         Abuse of bargaining power may affect relationships with customers, suppliers and competitors
Vertical Integration
•         Benefits
•         Secure source of supply of raw materials
•         Secure distribution channels
•         Protection and control over assets and services
•         Access to new business opportunities and technologies
•         Simplified procurement and administrative procedures
•         Risks
•         Costs and expenses associated with increased overhead and capital expenditures
•         Loss of flexibility resulting from inability to respond quickly to changes in the external environment
•         Problems associated with unbalanced’ capacities or unfilled demand along the value chain
•         Additional administrative costs
Vertical Integration: Benefits and Risks
•         A secure source of raw materials or distribution channels.
•         Protection of and control over valuable assets.
•         Access to new business opportunities
•         Simplified procurement and administrative procedures
•         Costs and expenses associated with increased overhead and capital expenditures
•         Loss of flexibility resulting from large investments.
•         Problems associated with unbalanced capacities along the value chain.
•         Additional administrative costs associated with managing a more complex set of activities.
Vertical Integration
In making decisions associated with vertical integration, four issues should be considered
    1. Are we satisfied with the quality of the value that our present suppliers and distributors are providing?
    2. Are there activities in our industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?
    3. Is there a high level of stability in the demand for the organization’s products?
    4. How high is the proportion of additional production capacity actually absorbed by existing products or by the prospects of new and similar products?
Unrelated Diversification: Financial Synergies and Parenting
•         Most benefits from unrelated diversification are gained from vertical (hierarchical) relationships
•         Parenting and restructuring of businesses
•         Allocate resources to optimize
n  Profitability
n  cash flow
n  Growth
•         Appropriate human resources practices
•         Financial controls
Corporate Parenting
•         Parenting—creating value within business units
•         Experience of the corporate office
•         Support of the corporate office
Corporate Restructuring
•         Find poorly performing firms
•         With unrealized potential
•         On threshold of significant positive change
Corporate Restructuring
•         Corporate management must
•         Have insight to detect undervalued companies or businesses with high potential for transformation
•         Have requisite skills and resources to turn the businesses around
•         Restructuring can involve changes in
•         Assets
•         Capital structure
•         management
Portfolio Management
•         Creation of synergies and shareholder value by portfolio management and the corporate office
•         Allocate resources (cash cows to stars and some question marks)
•         Expertise of corporate office in locating attractive firms to acquire
•         Creation of synergies and shareholder value by portfolio management and the corporate office
•         Provide financial resources to business units on favorable terms reflecting the corporation’s overall ability to raise funds
•         Provide high quality review and coaching for units
•         Provide a basis for developing strategic goals and reward/evaluation systems
Means to Achieve Diversification
•         Acquisitions or mergers
•         Pooling resources of other companies with a firm’s own resource base
•         Joint venture
•         strategic alliance
•         Internal development
•         New products
•         New markets
•         New technology
Strategic Alliances and Joint Ventures
•         Introduce successful product or service into a new market
•         Lacks requisite marketing expertise
n  Doesn’t understand customer needs
n  Doesn’t know how to promote the product
n  Doesn’t have access to proper distribution channels
•         Join other firms to reduce manufacturing (or other) costs in the value chain
•         Pool capital
•         Pool value-creating activities
•         Pool facilities
•         Economies of scale
•         Develop or diffuse new technologies
•         Use expertise of two or more companies
•         Develop products technologically beyond the capability of the companies acting independently
Unmet Expectations: Strategic Alliances and Joint Ventures
•         Improper partner
•         Each partner must bring desired complementary strengths to partnership
•         Strengths contributed by each should be unique
•         Partners must be compatible
•         Partners must trust one another
Real Options Analysis
•         Stock options (financial assets)
•         Real options ( real assets or physical things)
•         Investments can be staged
•         Strategic decision-makers have “tollgates”
•         Increased knowledge about outcomes at the time of the next investment decision
Managerial Motives Can Erode Value Creation
•         Growth for growth’s sake
•         Egotism
•         Antitakeover tactics
•         Greenmail
•         Golden parachute
•         Poison pills



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