Competing for Advantage 3rd Edition

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 Chapter 8—Corporate-Level Strategy

CHAPTER SUMMARY

This chapter focuses on the use of corporate-level strategies to define the business arenas
in which organizations will participate. Diversification strategy is the primary vehicle used at the
corporate level to create value for a portfolio of businesses that exceeds the value potential of the
individual businesses under different ownership. Diversification is examined at various levels
and different degrees of connectedness amongst the individual businesses within a corporation.
Value-creating reasons for firms to use corporate-level strategies are explored, with a
look at multimarket competition and vertical integration as means to gain power over
competitors.
Value-neutral and value-reducing reasons for diversifying are also presented, along with
the design of organizational structure that facilitates implementation for each type of corporate-
level strategy discussed.

CHAPTER OUTLINE

Levels of Diversification
Low Levels of Diversification
Moderate and High Levels of Diversification
Reasons for Diversification
Diversification and the Multidivisional Structure
Related Diversification
Operational Relatedness: Sharing Activities
Using the Cooperative Form of the Multidivisional Structure to Implement the Related
Constrained Strategy
Corporate Relatedness: Transferring of Core Competencies
Using the Strategic Business-Unit Form of the Multidivisional Structure to Implement the
Related Linked Strategy
Market Power through Multimarket Competition and Vertical Integration
Simultaneous Operational Relatedness and Corporate Relatedness
Unrelated Diversification
Efficient Internal Capital Market Allocation
Restructuring
Using the Competitive Form of the Multidivisional Structure to Implement the
Unrelated Diversification Strategy
Value-Neutral Diversification: Incentives and Resources
Incentives to Diversify
Resources and Diversification
Value-Reducing Diversification: Managerial Motives to Diversify
Summary
Ethics Questions

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KNOWLEDGE OBJECTIVES

1. Define corporate-level strategy and discuss its importance to the diversified firm.
2. Describe the advantages and disadvantages of single and dominant business
strategies.
3. Explain three primary reasons why firms move from single and dominant business
strategies to more diversified strategies to enhance value creation.
4. Describe the multidivisional structure (M-form) and controls and discuss the
difference between strategic controls and financial controls.
5. Describe how related diversified firms create value by sharing or transferring core
competencies.
6. Explain the two ways value can be created with an unrelated diversification strategy.
7. Explain the use of the three versions of the multidivisional structure (M-form) to
implement different diversification strategies.
8. Discuss the incentives and resources that encourage diversification.
9. Describe motives that can be incentives for managers to diversify a firm too much.

LECTURE NOTES

Corporate-Level Strategy – This section introduces how a diversification strategy allows a firm
to use its knowledge, skills, and resources to pursue opportunities for value creation in new
business areas, seeking to develop new capabilities and acquire new resources while doing so. It
defines the concept of corporate-level strategy in terms of the five major elements of strategy and
product diversification before outlining the chapter’s examination of different levels and types of
diversification.

See slide 1. Competing for Advantage

Introduction PART III: CREATING COMPETITIVE ADVANTAGE
Chapter 8: Corporate-Level Strategy

See slide 2. The Strategic Management Process – Overview

Figure 1.6
Creating Competitive Advantage
• Business-level strategy – competitive advantages the firm will
use to effectively compete in specific product markets
• Competitive rivalry and dynamics – analysis of competitor
actions and responses is relevant input for selecting and using
specific strategies
• Cooperative strategy – an important trend of forming
partnerships to share and develop competitive resources
• Corporate-level strategy – concerns the businesses in which the
company intends to compete and the allocation of resources in
diversified organizations

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 Chapter 8—Corporate-Level Strategy

• Acquisition and restructuring strategies – primary means used

by diversified firms to create corporate-level competitive
advantages
• International strategy – significant sources of value creation and
above-average returns

See slide 3. Key Terms

Key Terms ▪ Corporate-level strategy - specifies actions a firm takes to gain a
competitive advantage by selecting and managing a portfolio of
businesses that compete in different product markets or
industries

Corporate-Level Strategy – A diversification strategy (introduced in

Chapter 7) allows a firm to use its knowledge, skills, and resources to
pursue opportunities for value creation in new business areas, seeking to
develop new capabilities and acquire new resources while doing so.

Discussion points:
- Like a firm’s business-level and cooperative strategies,
corporate-level strategies are intended to help a firm create
value which leads to high performance.
- Some suggest that few corporate-level strategies actually create
value.
- A corporate-level strategy’s value is ultimately determined by
the degree to which the businesses in the portfolio are worth
more under the management of the company than they would be
under any other ownership.
- One way to measure the success of a corporate-level strategy is
to determine whether the aggregate returns across all of a firm’s
business units exceed what those returns would be without the
overall corporate strategy.

See slide 4. Five Elements that Identify a Firm’s Strategy – revisited from
Figure 2.4 Chapter 2

Corporate-level strategy answers the question regarding arenas: In what

product markets and businesses should the firm compete and how
should corporate headquarters manage those businesses?

Discussion points:
- Defining the business arenas – critical starting point for
strategic planning and management
- Commonly used growth vehicles – internal development, joint
ventures, licensing, franchising, and acquisitions

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- Differentiators – help a firm determine how it is expected to win

customers in the marketplace
- Staging – the timing of strategy and the sequence of moves the
firm will take to carry it out (increasingly important because of
the speed of change in the competitive environment)
- Economic logic – pulls together all of the above elements and
focuses on achieving above-average financial returns

See slide 5. Product Diversification – the primary form of corporate-level strategy

Discussion
Discussion points:
- It is concerned with the scope of the industries and markets in
which the firm competes.
- It defines how managers should buy, create, and sell different
businesses to match the firm’s skills and strengths with
opportunities in the external environment.
- By generating earnings from several different business units, it
is expected to reduce variability in the firm's profitability.
- There is a cost to developing and monitoring a diversification
strategy, which must be balanced with the benefits of
establishing an ideal portfolio of businesses.
- CEOs and their top management team are ultimately responsible
for determining the ideal portfolio of businesses for the firm.

Levels of Diversification – This section introduces the different levels of diversification that vary
according to the connections between and among businesses within a corporation.

See slide 6. Levels and Types of Diversification – Diversified firms vary according
Figure 8.1 to their level of diversification and the degree of connections between
and among their businesses. Figure 8.1 defines five categories of
diversification.

Discussion points:
- A firm is related through its diversification when there are
several links between its business units.
- The more links among businesses, the more constrained is the
relatedness of diversification.
- Unrelatedness refers to the absence of direct links between
businesses.
- Firms using each type of diversification strategy constantly
adjust the mix in their portfolio of businesses as well as
decisions about how to manage their businesses.

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1. In what ways might the firm share related links between

business units?
a. Shared products or services
b. Shared technologies
c. Shared distribution channels

Low Levels of Diversification – This section discusses two types of strategy used by firms
pursuing low levels of diversification.

See slide 7. Key Terms

Key Terms ▪ Single business strategy - corporate-level strategy in which the
firm generates 95% or more of its sales revenue from its core
business area
▪ Dominant business diversification strategy - corporate-level
strategy in which the firm generates between 70% and 95% of
its total sales revenue within a single business area

Low Levels of Diversification – Two types of strategy are used by

firms pursuing low levels of diversification.

Example of single business strategy: Medifast

Example of dominant business diversification strategy: UPS

Moderate and High Levels of Diversification – This section discusses two types of strategy
used by firms pursuing moderate to high levels of diversification.

See slide 8. Key Terms

Key Terms ▪ Related diversification strategy - corporate-level strategy in
which the firm generates more than 30% of its sales revenue
outside a dominant business and whose businesses are related to
each other in some manner
▪ Related constrained diversification strategy - related
diversification strategy characterized by direct links between the
firm's business units
▪ Related linked diversification strategy - related diversification
strategy characterized by only a few links between the firm’s
business units

Moderate Levels of Diversification – Two types of strategy are used

by firms pursuing moderate levels of diversification.

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Discussion points:
- A related constrained firm shares a number of resources and
activities among its businesses.
Examples: The Campbell Soup Company, P&G, and Merck &
Co.
- A diversified company that has a portfolio of businesses with
only a few links between them is combining related and
unrelated approaches and is using the related linked
diversification strategy.
Examples: J&J and GE
o Compared with related constrained firms, related linked
firms share fewer resources and assets among their
businesses, instead concentrating on transferring knowledge
and competencies among the businesses.

See slide 9. Key Terms

Key Terms ▪ Unrelated diversification strategy - corporate-level strategy for
highly diversified firms in which there are no well-defined
relationships between business units

High Levels of Diversification – Highly diversified firms have no well-

defined relationships between their businesses. These types of firms are
also known as conglomerates.

Examples: United Technologies, Textron, and Samsung

See slide 10. Curvilinear Relationship between Diversification and Performance

Figure 8.2 – Research evidence suggests a curvilinear relationship exists between
diversification levels and firm performance.

Discussion points:
- Lower performance is expected for dominant business and
unrelated business strategies.
- This chapter covers why a diversification strategy that involves
a portfolio of closely related firms is likely to be higher
performing than other types of diversification strategies.
- It is important to note two caveats to this pattern of
diversification and performance.
o Some firms are successful with each type of diversification
strategy.
o Some research suggests that all diversification leads to
trade-offs and a certain level of suboptimization.

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Reasons for Diversification – This section discusses a variety of reasons that firms use a
corporate-level diversification strategy.

See slide 11. Reasons for Diversification – Table 8.1 lists many of the reasons firms
Table 8.1 use a corporate-level diversification strategy and serves as an outline for
much of the rest of this chapter.

Discussion points:
- Value-creating diversification
o Most often corporate-level managers use a diversification
strategy in an attempt to improve the firm’s overall
performance.
o Value is created when the strategy allows a company’s
business units to increase revenues or reduce costs.
o Related strategies seek to gain economies or market power.
o Unrelated strategies seek financial benefits.
- Value-neutral diversification
o In this case, the strategy does not necessarily guide the firm
toward any particular type of value-creation.
o The prevailing logic of diversification suggests that the firm
should diversify into additional markets when it has excess
resources, capabilities, and core competencies with multiple
uses.
o Although these factors might push a firm toward
diversification, hopefully its managers will actually pursue a
type of diversification that will add value to the firm.
- Value-reducing diversification
o Diversification may actually increase costs or reduce a
firm’s revenue and total value.
o These situations tend to be driven by the personal
motivations of managers who are guiding the firm’s
diversification strategy.
Examples: Reduced employment risk, increased
compensation, and empire building (see Slide 50)

2. What are some value-neutral reasons for diversifying?

a. Government-induced stimuli such as antitrust regulation
and tax laws
b. Concerns about low performance, uncertainty of future
cash flows, or other types of business risk
c. To take advantage of tangible or intangible resources
the firm possesses that would facilitate diversification

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See slide 12. Value-Creating Strategies of Diversification – two ways

Figure 8.3 diversification strategies can create value:
Operational relatedness: sharing activities
Corporate relatedness: transferring knowledge, skills, or core
competencies

Discussion points:
- The study of these independent relatedness dimensions
highlights the importance of resources and key competencies in
strategic decisions.
- The vertical dimension of Figure 8.3 indicates sharing activities
(operational relatedness).
- The horizontal dimension depicts corporate capabilities for
transferring knowledge (corporate relatedness).
- Firms with a strong capability in managing operational synergy,
especially in sharing assets between its businesses, fall in the
upper left quadrant. This quadrant also represents vertical
sharing of assets through vertical integration.
- The lower right quadrant represents a highly developed
corporate capability for transferring a skill or skills across
businesses. This capability is located primarily in the corporate
office.
- The use of either operational relatedness or corporate
relatedness is based on a knowledge asset that the firm can
either share or transfer.
- Unrelated diversification is also shown in Figure 8.3 in the
lower left quadrant. The unrelated diversification strategy
creates value through financial economies rather than through
either operational relatedness or corporate relatedness among
business units.
- The upper right quadrant represents a rare capability of
achieving both operational and corporate relatedness
simultaneously, which can inadvertently create diseconomies of
scope. (Refer to Slide 33 for further discussion.)

Diversification and the Multidivisional Structure – This section discusses the type of
organizational structure needed to support implementation of multi-business strategies.

See slide 13. Key Terms

Key Terms ▪ Multidivisional structure (M-form) - organizational structure
which ties together several operating divisions, each
representing a separate business or profit center to which
responsibility for daily operations and business-unit strategy is
delegated

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Diversification and the Multidivisional Structure – The

multidivisional organizational structure is used to support
implementation of multi-business strategies. (Recall from Chapter 5.)

Discussion points:
- Each division in the corporation represents a distinct, self-
contained business with its own business-level structure.
- The M-form ties all of those divisions together.
- Diversification is a dominant corporate-level strategy in the
global economy, so the M-form organizational structure is used
extensively throughout the world.
- Proper use of the M-form in a diversified firm can lead to value
creation.

See slide 14. Original Benefits of the M-form – The M-form was an innovative
Discussion response to coordination and control problems that surfaced during the
1920s in the functional structures then used by large firms such as
DuPont and General Motors. As initially designed, the M-form was
thought to have these three major benefits.

Discussion points:
- Active monitoring of performance through the M-form
increases the likelihood that decisions made by managers
heading individual units will be in the shareholders’ best
interests.
- The M-form may be used to support implementation of both
related and unrelated diversification strategies.
- This structure helps firms successfully manage the many
demands of diversification, including those related to processing
vast amounts of information.

See slide 15. Key Terms

Key Terms ▪ Organizational controls - management tool which indicates how
to compare actual results with expected results and suggests
corrective actions to take when the difference between actual
and expected results in unacceptable
▪ Strategic controls - subjective criteria intended to verify that the
firm is using appropriate strategies for the conditions in the
external environment and given the company's competitive
advantages
▪ Financial controls - objective criteria used to measure firm
performance against previously established quantitative
standards

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Organizational Controls – an important aspect of the M-form

Discussion points:
- Organizational controls
o Guide the use of strategy
o Firms rely on two types: strategic and financial
- Strategic controls
o Deal with the content of strategic actions rather than their
outcomes
o Examine the fit between what the firm might do (as
suggested by opportunities in its external environment) and
what it can do (as indicated by its competitive advantages)
(see Chapters 2 and 4)
o Effective strategic controls help the firm understand what it
takes to be successful, to set appropriate strategic goals, and
to monitor goal achievement
o Demand rich and frequent communications between top
managers responsible for evaluating overall firm
performance and those with primary responsibility for
implementing the firm’s strategies in its divisions
o Used when there is a corporate-wide emphasis on sharing
among business units
o Require corporate-level managers to understand each of
their businesses very well, which is most likely when the
businesses are related
o Difficult to use with extensive diversification
- Financial controls
o Emphasized to evaluate the performance of business units in
unrelated diversified firms
o Include accounting-based measures
Examples: RoI, RoA, and economic value-added
o Used when activities and capabilities are not being shared
among business units

See slide 16. Variations of the M-form

Variations
Discussion points:
- The cooperative form of the multidivisional structure is used for
related diversification strategies.
- The strategic business-unit (SBU) form of the multidivisional
structure is used for related diversification strategies.
- The competitive form of the multidivisional structure is used for
unrelated diversification strategies.

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Related Diversification – This section describes the strategy intended to develop and exploit
economies of scope between business units to build upon or extend the firm’s resources,
capabilities, or core competencies and to create value. Operational and corporate relatedness
determine how resources are used to create economies of scope.

See slide 17. Key Terms

Key Terms ▪ Economies of scope - cost savings that the firm creates by
successfully transferring some of its capabilities and
competencies that were developed in one of its businesses to
another of its businesses
▪ Synergy - conditions that exist when the value created by
business units working together exceeds the value those same
units create working independently

Related Diversification – This type of strategy builds upon or extends

the company’s resources, capabilities, or core competencies to create
value. An option for firms operating in multiple industries or product
markets, the objective is to develop and exploit economies of scope
between business units.

Operational and corporate relatedness determine how resources are

jointly used to create economies of scope. (Refer to Slide 12 or Figure
8.3.)

Operational Relatedness: Sharing Activities – This section presents how and why firms create
operational relatedness and discusses issues which affect the degree to which activity sharing
creates positive outcomes.

See slide 18. Operational Relatedness: Sharing Activities – Firms create

Discussion operational relatedness by sharing either value chain activities or
support functions (see discussion in Chapter 4). Sharing activities is
quite common, especially among related constrained firms. Several
issues affect the degree to which activity sharing creates positive
outcomes.

Discussion points:
- Firms expect activity sharing among units to result in increased
value creation and improved financial returns.
- Research has revealed that firms with more related units have
lower levels of risk.
- Building appropriate coordination mechanisms can contribute to
successful creation of economies of scope.
Example: Information systems

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- More attractive results are obtained through activity sharing

when facilitated by a strong corporate office.
- Coordination challenges must be effectively managed.
o Activity sharing can be risky because business-unit ties
create links between outcomes.
Example: Falling demand for one product can reduce
revenues that cover the fixed costs of operating a shared
facility
o Organizational conflict between divisions can interfere with
success.
Example: Managers may perceive and resent
disproportionate sharing of gains
- Managing interdependencies between related businesses
increases coordination costs.
o Synergy only improves performance if the benefits are
greater than the costs.
o Despite additional costs, research shows that related
diversification can create value.
Example: Horizontal acquisitions in the banking industry

Using the Cooperative Form of the Multidivisional Structure to Implement the Related
Constrained Strategy – This section discusses the formation of divisions around products or
markets to develop an organizational structure for implementing a related constrained
diversification strategy.

See slide 19. Key Terms

Key Terms ▪ Cooperative form - organizational structure using horizontal
integration to bring about interdivisional cooperation

Using the Cooperative Form of the Multidivisional Structure to

Implement the Related Constrained Strategy – involves the
formation of divisions around products or markets

See slide 20. Cooperative Form of the Multidivisional Structure for

Figure 8.4 Implementation of a Related Constrained Strategy – This figure uses
product divisions to represent the cooperative form of the M-form,
although market divisions could also be used.

Discussion points:
- All of the divisions share one or more corporate strengths.
Examples: Production competencies, marketing competencies,
and channel dominance

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- Interdivisional sharing of competencies helps the firm create

economies of scope.
- Interdivisional sharing depends on cooperation.
- Increasingly, it is important that the links include both
intangible resources (such as knowledge) and tangible resources
(such as facilities and equipment). (Resources are discussed in
more detail in the notes for Slide 49.)

See slide 21. Integrating Mechanisms of the Cooperative Form of the

Integrating Multidivisional Structure – Different characteristics of structure (refer to
Mechanisms Chapter 5) are used as integrating mechanisms to facilitate interdivisional
cooperation in the cooperative form.

Discussion points:
- Centralization – of some organizational functions at the corporate
level allows the linking of activities among divisions
o Work completed in these centralized functions is managed by
the firm’s central office with the purpose of exploiting
common strengths among divisions by sharing competencies.
Examples: HR management, R&D, marketing, and finance
- Standardization – involves adoption of uniform processes and
procedures
- Formalization – of the firm’s rules and procedures

See slide 22. Success Factors of the Cooperative Form of the Multidivisional
Success Factors Structure

Discussion points:
- Success is influenced by how well information is processed
among divisions.
o Cooperation among divisions implies a loss of managerial
autonomy, and division managers may not readily commit
themselves to the type of integrative information-processing
activities that this structure demands.
- Success relies on the use of strategic controls.
o Divisional managers’ performance can be evaluated at least
partly on the basis of how well they have facilitated
interdivisional cooperative efforts.
- Success can be impacted by the use of proper reward systems.
o Using reward systems that emphasize overall company
performance, besides financial outcomes achieved by
individual divisions, helps overcome problems associated
with the cooperative form.

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- Success can be influenced by managerial commitment levels

(which can soften the response to some lost managerial
autonomy).
o Coordination among divisions sometimes results in an
unequal flow of positive outcomes to divisional managers.
o A high level of managerial commitment can overcome
perceived imbalances in benefits from the sharing of
corporate competencies.

Corporate Relatedness: Transferring of Core Competencies – This section presents the

sharing of intangible assets that are the foundation of core competencies across divisions to create
value in multidivisional firms.

See slide 23. Key Terms

Key Terms ▪ Corporate-level core competencies - complex sets of resources
and capabilities that link different businesses, primarily through
managerial and technological knowledge, experience, and
expertise

Corporate Relatedness: Transferring of Core Competencies – Over

time, the firm’s intangible resources become the foundation of its core
competencies.

See slide 24. Corporate Relatedness: Transferring of Core Competencies

Discussion
Discussion points:
- Related linked firms (see Figure 8.3) often transfer
competencies across businesses, thereby creating value in at
least two ways.
o Because the expense of developing a competence has been
incurred in one unit, transferring it to a second business unit
eliminates the need for the second unit to allocate resources
to develop the competence.
o Intangible resources are difficult for competitors to
understand and imitate; therefore, the unit receiving a
transferred competence often gains an immediate
competitive advantage over its rivals.
Examples: Cargill and Catholic Health Initiatives

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Using the Strategic Business-Unit Form of the Multidivisional Structure to Implement the
Related Linked Strategy – This section discusses the formation of strategic business units
(SBU's) to develop an organizational structure for implementing a related linked diversification
strategy and the complexities of this structural form.

See slide 25. Key Terms

Key Terms ▪ Strategic business-unit form - form of multidivisional
organization structure with three levels used to support the
implementation of a diversification strategy

Using the Strategic Business-Unit Form of the Multidivisional

Structure to Implement the Related Linked Strategy – involves the
formation of strategic business units (SBU's)

See slide 26. Three Levels of the SBU Form

Levels
Example: GE

See slide 27. SBU Form of the Multidivisional Structure for Implementation of a
Figure 8.5 Related Linked Strategy

Discussion points:
- Divisions within each SBU share product or market
competencies to develop economies of scope and possibly
economies of scale.
- The divisions of one SBU have little in common with the
divisions of the other SBUs.
- Each SBU is a profit center that is controlled and evaluated by
the headquarters office.
- Both financial and strategic controls are necessary, but for
different reasons.
o Financial controls are more vital to the headquarters’
evaluation of each SBU.
o Strategic controls are critical when the heads of SBUs
evaluate their divisions’ performance.
o Strategic controls are also critical to the headquarters’
efforts to determine whether the company has chosen an
effective portfolio of businesses and whether those
businesses are being effectively managed.
- There is need for strategic systems that promote exploration to
identify new products and markets and mechanisms to spur
actions that exploit current product lines and markets.

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- One way to facilitate the transfer of competencies is to move

key people into new management positions, but this can be
complicated by human resource tendencies.
o Business-unit managers of older divisions may be reluctant
to transfer key people who have accumulated knowledge
and experience critical to that unit’s success.
o Key people may not want to transfer, especially if the
transfer involves relocation to a distant location or a
different country.
o Top-level managers from the transferring division may
interfere with transferring competencies meant to fulfill the
firm’s diversification objectives.

Market Power through Multimarket Competition and Vertical Integration – This section
describes the use of related diversification strategies to gain market power.

See slide 28. Market Power through Related Diversification – In addition to

Introduction previously-discussed objectives, related diversification strategies can
also be used to gain market power.

See slide 29. Key Terms

Key Terms ▪ Market power - exists when a firm is able to price and sell its
products above the existing competitive level or to reduce costs
of value chain activities and support functions below the
competitive level, or both
▪ Multimarket (or multipoint) competition - exists when two or
more diversified firms simultaneously compete in the same
product or geographic markets

Market Power through Multipoint Competition

Discussion points:
- Multipoint competition was introduced in Chapter 6 as a
condition that influences competitive rivalry.
- Recall that competition in the same markets can reduce the
likelihood of aggressive competitive action, a situation known
as mutual forbearance.
Example: Marriott and Hilton

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See slide 30. Key Terms

Key Terms ▪ Vertical integration - exists when a company produces its own
inputs or owns its own source(s) of output distribution
▪ Taper integration - exists when a firm sources inputs externally
from independent suppliers as well as internally within the
boundaries of the firm, or disposes of its outputs through
independent outlets in addition to company-owned distribution
channels

Market Power through Vertical Integration

Discussion points:
- Vertical integration
o When a company produces its own inputs – backward
integration
o When a company owns its own sources of output
distribution – forward integration
Example: Hanwha-SolarOne
- Taper integration
o Partial integration of operations
Example: To match or neutralize another firm’s advantage by
acquiring a distribution outlet similar to the rival’s

See slide 31. Use of Vertical Integration to Gain Market Power – Vertical
Discussion integration is often used in the firm’s core business to gain market
power over or relative to rivals.

Discussion points:
- Market power is gained as the firm develops the ability to save
money on its operations, to avoid market costs, to improve
product quality, and possibly to protect its technology from
imitation by rivals.
- Market power is also created when firms have strong ties
between their assets for which no market prices exist – where
establishing a market price would result in high search and
transaction costs, so firms vertically integrate rather than remain
separate businesses.
- A cooperative M-form similar to that described in association
with the related constrained firm supports a vertical integration
strategy (see Figure 8.4 or Slide 20).

See slide 32. Limitations of Vertical Integration – Although vertical integration can
Discussion create value, especially through market power, it is not without risks and
costs.

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Discussion points:
- Internal transactions from vertical integration may be expensive
and reduce profitability relative to competitors.
- Bureaucratic costs may be present with vertical integration.
- Because vertical integration can require substantial investments
in specific technologies, it may reduce the firm’s flexibility,
especially when technology changes quickly.
- It may be necessary to sell a product outside of the firm as well
as to the internal division to cover fixed costs or achieve
economies to provide a good price to internal customers.
- Many manufacturing firms are reducing vertical integration as a
means of gaining market power.
Examples: Intel, Dell, Ford, and General Motors are developing
independent supplier networks instead
Example: Flextronics represents a new breed of large contract
manufacturers leading the revolution in supply-chain
management

Simultaneous Operational Relatedness and Corporate Relatedness – This section discusses

the difficulties firms may face when simultaneously seeking operational and corporate forms of
economies of scope through shared activities and competencies.

See slide 33. Simultaneous Operational Relatedness and Corporate Relatedness –

Introduction Simultaneously creating economies of scope by sharing activities
(operational relatedness) and transferring core competencies (corporate
relatedness) may be difficult to achieve. (Refer to upper right quadrant
in Figure 8.3 or on Slide 12.)

Discussion points:
- If the costs associated with managing both types of relatedness
exceed the benefits, then firms may experience what is called
diseconomies of scope.
- The implications of this dual strategy:
o Managing two sources of information is very difficult.
o More process mechanisms to facilitate integration and
coordination may be required.
o Success is likely to produce a sustainable competitive
advantage as imitation becomes difficult.
Example: Walt Disney Company

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See slide 34. Process and Integrating Mechanisms – More process mechanisms are
Integrating required to facilitate the integration and coordination necessary to
Mechanisms achieve simultaneous operational relatedness and corporate relatedness.

Discussion points:
- Liaison roles could be established in each division to reduce the
amount of time division managers spend integrating and
coordinating their unit’s work with the work taking place in
other divisions.
- Temporary teams or task forces may be formed around projects
for which success depends on sharing competencies that are
embedded within several divisions.
- Formal integration departments might be established in firms
that frequently use temporary teams or task forces.
- Cooperative or SBU M-forms are most likely to be used to
implement a dual strategy, depending on the degree of
diversification (i.e., more diversification would likely require
the SBU form).
- Ultimately, a matrix organization may evolve in firms
implementing this dual strategy.

See slide 35. Key Terms

Key Terms ▪ Matrix organization - organizational structure in which a dual
structure combines both functional specialization and business
product or project specialization

Simultaneous Operational Relatedness and Corporate Relatedness

Unrelated Diversification – This section introduces a comprehensive discussion of the use of a

corporate-level unrelated diversification strategy to create value.

See slide 36. Key Terms

Key Terms ▪ Financial economies - cost savings realized through improved
allocations of financial resources based on investments inside or
outside the firm

Unrelated Diversification

See slide 37. Financial Economies that Create Value – Two types of financial
Discussion economies can create value in an unrelated diversification strategy.

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Discussion points:
- Efficient internal capital allocations theoretically reduce total
corporate risk by creating a portfolio of businesses with
different risk profiles.
o In a market economy, capital markets are thought to
efficiently allocate capital:
- Through investor ownership of shares of firm equity
with high future cash-flow values.
- Through debt, as bondholders and financiers try to
improve the value of their investments by taking stakes
in businesses with high growth prospects.
o In large diversified firms, the corporate office distributes
capital to business divisions to create value for the overall
company.
- Restructuring the assets of purchased corporations can increase
the profitability of their operations.
o As in the real estate business, buying assets at low prices,
restructuring them, and selling them at a price exceeding
their cost generates a positive return on the firm’s invested
capital.
o Some conglomerates have pursued value creation through
restructuring firms in this way.
o Today this strategy is most often pursued by private equity
firms, which are like an unrelated diversified firm in that
they have large portfolios of acquired businesses that they
buy, restructure, and sell to another company or through a
public offering.

Efficient Internal Capital Market Allocation – This section highlights the advantages (and
some disadvantages) of firms with internal capital markets which fund investments and
operations.

See slide 38. Efficient Internal Capital Market Allocation – Several advantages
Discussion exist for firms with internal capital markets which fund investments and
operations.

Discussion points:
- Because corporate managers have access to more detailed and
accurate information about the firm’s businesses, they should be
expected to make distributions that result in gains exceeding
those that would be made with capital allocated by the capital
market.

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o Compared with corporate office personnel, external

investors have relatively limited access to internal
information and can only estimate divisional performance
and future business prospects.
o Information provided to capital markets through annual
reports and other sources may not include negative
information, but emphasize only positive prospects and
outcomes.
o Even external shareholders who have access to information
have no guarantee of full and complete disclosure.
o Because it has less accurate information, the external capital
market may fail to allocate resources adequately to high-
potential investments compared with corporate office
investments.
- External sources of capital have limited ability to understand the
dynamics within large organizations.
- In an internal capital market, the corporate office can fine-tune
or correct its capital allocations, whereas intervention from
outside the firm would involve significant changes or
adjustments, such as bankruptcy or a change in the top
management team.

See slide 39. The “Conglomerate Discount” – Research suggests that in efficient
Discussion capital markets, the unrelated diversification strategy may be
discounted.

Discussion points:
- For years, stock markets have applied a conglomerate discount,
valuing diversified manufacturing conglomerates an average of
20% less than the sum of their parts.
- The discount still applies, in good economic times and bad.
- Extraordinary manufacturers (like GE) can defy it for a while,
but more ordinary ones (like Philips and Siemens) cannot.

3. What is a potential reason for the conglomerate discount?

The discount is likely caused by the fact that firms using an
unrelated diversification strategy tend to substitute
acquisitions for innovation over time. When too many
resources are allocated to analyzing and completing
acquisitions to further diversify, the firm neglects to allocate
appropriate resources to nurture internal innovation.

See slide 40. The Downside of Unrelated Diversification

Discussion

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Discussion points:
- Despite these challenges, some firms still use it.
- Large diversified business groups are found in many European
countries, where the number of firms using the conglomerate or
unrelated diversification strategy has actually increased.
- Some research suggests that an unrelated diversification strategy
may work better in developing economies.
Example: Conglomerates continue to dominate private sectors
in Latin America, China, Korea, and Taiwan
Example: Typically family-controlled, these corporations also
account for the greatest percentage of private firms in India

4. Explain why unrelated diversification appears to be a more

effective strategy in emerging economies than in developed
nations.
In developed economies, financial economies are more
easily duplicated than are the gains derived from
operational relatedness and corporate relatedness, which
reduces the long-term competitive advantages of an
unrelated diversification strategy.
In emerging economies, managers may be more efficient at
allocating capital where it can be put to good use than the
financial markets in those countries, where the absence of a
“soft infrastructure” (including effective financial
intermediaries, sound regulations, and contract laws)
supports and encourages use of the unrelated diversification
strategy.
In emerging economies, such as those in India and Chile,
diversification increases the performance of firms affiliated
with large diversified business groups.

Restructuring – This section discusses how firms create financial economies by buying,
restructuring, and selling other companies' assets in the external market.

See slide 41. Restructuring – Firms can create financial economies by buying,
Discussion restructuring, and selling other companies' assets in the external market,
but it requires an understanding of significant trade-offs.

Discussion points:
- Because of the uncertainty of demand for high-technology
products, decisions about resource allocation become too
complex and create information-processing overload on small
corporate staffs found in unrelated diversified firms.

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- High-technology businesses also depend heavily on human

resources, who may leave or demand higher pay and deplete the
value of an acquired firm.
- Professional service businesses are particularly vulnerable to a
loss in valued human resources triggered by an acquisition or a
change in ownership.

5. What types of professional service businesses are particularly

vulnerable to the loss of valued human resources triggered by an
acquisition or a change in ownership?
a. Accounting
b. Law
c. Advertising
d. Consulting
e. Investment banking

Using the Competitive Form of the Multidivisional Structure to Implement the Unrelated
Diversification Strategy – This section discusses the formation of independent divisions to
develop an organizational structure for implementing an unrelated diversification strategy.

See slide 42. Key Terms

Key Terms ▪ Competitive form - organizational structure in which the firm's
divisions are completely independent

Using the Competitive Form of the Multidivisional Structure to

Implement the Unrelated Diversification Strategy – involves the
formation of independent divisions

See slide 43. Competitive Form of the Multidivisional Structure for

Figure 8.6 Implementation of an Unrelated Strategy

Discussion points:
- Unlike the divisions in the cooperative structure (see Figure 8.4
or Slide 20), the divisions that are part of the competitive
structure do not share common corporate strengths.
- Because strengths aren’t shared in the competitive structure,
integrating devices aren’t developed for the divisions to use.
- The efficient internal capital market that is the foundation for
use of the unrelated diversification strategy requires
organizational arrangements that emphasize divisional
competition rather than cooperation.

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See slide 44. Benefits of Internal Competition – Specific performance expectations

Discussion and accountability for independent divisions stimulate internal
competition for future resources in the competitive form of the
multidivisional structure.

Discussion points:
- Flexibility – Corporate headquarters can have divisions working
on different technologies to identify those with the greatest
future potential. Resources can then be allocated to the division
that is working with the most promising technology to fuel the
entire firm’s success.
- Change – Division heads know that future resource allocations
are a product of excellent current performance as well as
superior positioning of their division in terms of future
performance.
- Motivation – The challenge of competing against internal peers
can be as great as the challenge of competing against external
marketplace competitors.
- The benefits of internal capital allocations or restructuring
cannot be fully realized unless divisions are held accountable
for their own independent performance.

See slide 45. Headquarters’ Role in the Competitive Form of the Multidivisional
Discussion Structure for Implementation of an Unrelated Strategy

Discussion points:
- Maintains a distant relationship to avoid intervention in
divisional affairs
o Audits operations
o Disciplines managers whose divisions perform poorly
- Uses organizational controls (primarily financial controls) to
emphasize and support internal competition among separate
divisions and to form the basis for allocating corporate capital
based on division performance
o Uses strategic controls to set rate-of-return targets
o Uses financial controls to monitor divisional performance
relative to those return targets
- Allocates cash flow on a competitive basis, rather than
automatically returning cash to the division that produced it
- Focuses on performance appraisal, resource allocation, and legal
aspects associated with acquisitions to verify that the firm’s
portfolio of businesses will lead to financial success

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See slides 46-47. Characteristics of Various Structural Forms

Summary

Value-Neutral Diversification: Incentives and Resources – This section introduces a

discussion of diversification strategy that is not designed with value-creating objectives in mind.

Incentives to Diversify – This section outlines value-neutral incentives, both internal and
external, that encourage organizations and managers to diversify.

See slide 48. Value-Neutral Diversification: Incentives and Resources – Firms

Discussion sometimes select a diversification corporate strategy that is not designed
to create value.

Value-Neutral Incentives to Diversify – Both external and internal

factors influence managerial decisions to diversify.

Discussion points:
- Antitrust regulation
o Designed to reduce mergers that establish excessive market
power
o Increasing scrutiny over current volume of merger and
acquisition activity
o Commission created by the Antitrust Modernization Act of
2002 – examines existing antitrust laws and will impact
diversification strategies of U.S. firms in years to come
- Tax laws
o Individual tax rates for capital gains and dividends –
shareholder incentive to increase diversification before
1986, a deterrent after 1986
o 1986 Tax Reform Act – diminished some of the tax
advantages of diversification through acquisitions
- Low performance
o Low returns related to increased levels of value-neutral
diversification
o Manager willingness to take higher risks or unusual steps to
improve performance
Example: Seven Network Ltd.
- Uncertain future cash flows
o Defensive strategy sometimes employed as a product line
matures or when long-term survival is threatened
Example: PepsiCo

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o Defensive strategy sometimes employed by small firms

whose long-term survival is threatened
Example: BGC Partners Inc.
- Synergy
o Realized by achieving economies of scope
o More likely when business units are highly related and
managers integrate activities across the firm
- Risk management
o Increased risk of large-scale performance problems from
greater relatedness and integration – synergy produces
interdependence among business units, which reduces firm
flexibility to respond to changing external conditions
o Difficulties in one area of the firm reverberate in another or
across the entire firm in tightly-linked businesses
o Increased risk averse tendencies and behavior in managers –
result in decisions which constrain sharing or diversifying
activity

Resources and Diversification – This section notes the importance of resources and capabilities
required by the firm to successfully use a corporate-level diversification strategy.

See slide 49. Resources and Diversification – Sufficient resources are necessary for
Discussion a firm to implement a diversification strategy.

Although financial, intangible, and tangible resources can all facilitate

successful diversification, they vary in their ability to create value. The
degree to which resources are valuable, rare, costly to imitate, and
nonsubstitutable (see Chapter 4) influence their ability to create value
through diversification.

Discussion points:
- Financial resources
o Free cash flows are a financial resource that may be used to
diversify the firm.
o These types of financial resources tend to be highly visible
to competitors and thus more imitable and less likely to
create value over the long term.
- Intangible resources
o They tend to be more valuable because they are hard for
competitors to recognize or imitate.
Examples: Knowledge, skills, and relationships with
stakeholders
o They tend to be more flexible.

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oExcess capacity of intangible resources can often be used to

diversify.
Example: Excess capacity in a sales force may be used to
sell similar products
o They can encourage even more diversification.
Example: Tacit knowledge
- Tangible resources
o They tend to be less flexible assets.
o Excess capacity can often only be used for closely related
products, especially those requiring highly similar
manufacturing technologies.
Example: Plant and equipment necessary to produce a good
or service
o They may create resource interrelationships in production,
marketing, procurement, and technology (activity sharing),
which also reduces flexibility.

Value-Reducing Diversification: Managerial Motives to Diversify – This section discusses

the motivations behind some managers' decisions to engage in diversification strategies that do
not benefit the organization.

See slide 50. Value-Reducing Diversification: Managerial Motives to Diversify –

Discussion Motivations behind some managers' decisions to diversify are unrelated
to value-neutral reasons (i.e., incentives and resources) and value-
creating reasons (e.g., economies of scope).

Discussion points:
- Desire for increased compensation for handling the complexities
and difficulties of managing larger firms
- Belief that diversified firms will not be impacted by
performance peaks and valleys that lead to job loss
- Pursuit of greater responsibility and self-importance
- Internal governance mechanisms – prevent behavior that is not
in the best interests of the firm (discussed further on Slide 51
and extensively in Chapter 11)

See slide 51. Governance Mechanisms – available to protect shareholder interests

Discussion from self-interested managerial tendencies to diversify too much

Discussion points:
- Internal governance mechanisms available to monitor manager
decisions and ensure the best interests of the firm are being
sought.

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o Board of director vigilance

o Monitoring by owners
o Long-term oriented executive compensation
- When internal governance mechanisms are weak, the external
market for corporate control may act as a disciplining force for
top managers.
o Loss of adequate internal governance may result in poor
performance, thereby triggering a threat of takeover.
o A takeover may improve efficiency by replacing ineffective
managerial teams.
o If current managers feel vulnerable to this sort of discipline,
they may pursue defensive tactics, known as poison pills, to
fend off an acquisition and preserve their jobs. (Other
defensive tactics are discussed in Chapter 11.)
Example: The “golden parachute”
o A threat of external governance, although restraining
managers, does not flawlessly control managerial motives
for diversification.
- Managers’ desire to retain a strong reputation can reduce (self-
check) their propensity to engage in self-serving behavior at the
expense of the organization.

See slide 52. Summary Model of the Relationship between Diversification and
Figure 8.7 Firm Performance – The level of diversification that can be expected
to have the greatest positive effect on performance is based partly on
how the interaction of value-creating influences, value-neutral
influences, and value-reducing influences affects the adoption of
particular diversification strategies.

Discussion points:
- The greater the incentives and the more flexible the resources,
the higher the level of expected diversification.
- Financial resources (the most flexible) should have a stronger
relationship to the extent of diversification than either tangible
or intangible resources.
- Tangible resources (the most inflexible) are useful primarily for
related diversification.
- In summary:
o Diversification allows a firm to create value by productively
using excess resources.
o Consistent with all strategies presented in Part III of the
text, a diversification strategy can be expected to enhance
performance only when the firm has the competitive
advantages required to successfully use the strategy.

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o For diversification strategies, the firm should possess the

competitive advantages needed to form and manage an
effective portfolio of businesses and to restructure that
portfolio as necessary.

Ethical Questions – Recognizing the need for firms to effectively interact with stakeholders
during the strategic management process, all strategic management topics have an ethical
dimension. A list of ethical questions appears after the Summary section of each chapter in the
textbook. The topic of ethics is best covered throughout the course to emphasize its prevalence
and importance. We recommend posing at least one of these questions during your class time to
stimulate discussion of ethical issues relevant to the chapter material that you are covering. (See
slides 53-58.)

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