Chapter 7
Corporate
Diversification
Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall.
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Corporate Diversification
Corporate
Diversification
The Strategic Management Process
External
Analysis
Mission
Strategic
Choice
Objectives
Strategy
Implementation
Competitive
Advantage
Which Businesses
to Enter?
Internal
Analysis
Corporate Level
Strategy
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• Vertical Integration
• Diversification
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Corporate Diversification
Corporate
Diversification
Logic of Corporate Level Strategy
Corporate level strategy should create value:
1) such that businesses forming the corporate whole
are worth more than they would be under
independent ownership
2) that equity holders cannot create through
portfolio investing
Therefore,
• a corporate level strategy must create
synergies
• economies of scope - diversification
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Corporate Diversification
Corporate
Diversification
Integration and Diversification
Integration
Forward
Backward
Diversification
Other
Businesses
No
Links
Other
Businesses
Current
Businesses
Unrelated
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Related
Many
Links
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Corporate Diversification
Corporate
Diversification
Types of Corporate Diversification
At a general level…
Product Diversification:
• operating in multiple industries
Geographic Market Diversification:
• operating in multiple geographic markets
Product-Market Diversification
• operating in multiple industries in multiple
geographic markets
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Corporate Diversification
Corporate
Diversification
Types of Corporate Diversification
At a more specific level…
Limited Diversification
• single business: > 95% of sales in single business
• dominant business: 70% to 95% in single business
Related Diversification
• related-constrained: all businesses related on most
dimensions
• related-linked: some businesses related on some
dimensions
Unrelated Diversification
• businesses are not related
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Corporate Diversification
Corporate
Diversification
Product and Geographic Diversification
Possibilities:
• single-business in one geographic area
• single-business in multiple geographic areas
• related-constrained in one or multiple geographic areas
• related-linked in one or multiple geographic areas
• unrelated in one or multiple geographic areas
Note:
• relatedness usually refers to products
• seemingly unrelated products may be related on
other dimensions
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Corporate Diversification
Corporate
Diversification
Competitive Advantage
If a diversification strategy meets the
VRIO criteria…
Is it Valuable?
Is it Rare?
Is it costly to Imitate?
Is the firm Organized to exploit it?
…it may create competitive advantage.
Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall.
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Corporate Diversification
Corporate
Diversification
Value of Diversification
Two Criteria
1) There must be some economy of scope
2) The focal firm must have a cost advantage over
outside equity holders in exploiting any
economies of scope
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Corporate Diversification
Corporate
Diversification
Value of Diversification
Business X + Business Y + Business Z
Value
Independent: equity holder could buy shares of each firm
Focal Firm
Business X
Economies
Of
Scope
Business Y
Value
Business Z
Combined: equity holder buys shares in one firm
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Four Types
Operational
Financial
Anticompetitive
Managerialism
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Operational Economies of Scope
Sharing Activities
• exploiting efficiencies of sharing business
activities
Example: Frito-Lay’s Trucking
Spreading Core Competencies
• exploiting core competencies in other businesses
• competency must be strategically relevant
Example: Orbitz
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Financial Economies of Scope
Internal Capital Market
• premise: insiders can allocate capital across
divisions more efficiently than the external capital
market
• works only if managers have better information
• may protect proprietary information
• may suffer from escalating commitment
Example: Hanson Trust, PLC
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Financial Economies of Scope
Risk Reduction
• counter cyclical businesses may provide
decreased overall risk
however,
• individual investors can usually do this more
efficiently than a firm
Example: Snow Skiis & Water Skiis
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Financial Economies of Scope
Tax Advantages
• transfer pricing policy allows profits in one
division to be offset by losses in another division
• this is especially true internationally
• can be used to ‘smooth’ income
Example: Ireland
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Anticompetitive Economies of Scope
Multipoint Competition
• mutual forbearance
• a firm chooses not to compete aggressively
in one market to avoid competition in another
market
Example: American Airlines & Delta: Dallas & Atlanta
Market Power
• using profits from one business to compete in
another business
• using buying power in one business
to obtain advantage in another business
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Corporate Diversification
Corporate
Diversification
Economies of Scope
Managerialism
• an economy of scope that accrues to managers
at the expense of equity holders
• managers of larger firms receive more compensation
(larger scope = more compensation)
• therefore, managers have an incentive to
acquire other firms and become ever larger
• even though the incentive is there, it is difficult
to know if managerialism is the reason for an
acquisition
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Corporate Diversification
Corporate
Diversification
Equity Holders and Economies of Scope
Most economies of scope cannot be captured
by equity holders
• risk reduction can be captured by equity holders
Managers should consider whether corporate
diversification will generate economies of scope
that equity holders can capture
• if a corporate diversification move is unlikely
to generate valuable economies of scope,
managers should avoid it
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Corporate Diversification
Corporate
Diversification
Rareness of Diversification
Diversification per se is not rare
Underlying economies of scope may be rare
• relationships that allow an economy of scope
to be exploited may be rare
• an economy of scope may be rare because
it is naturally or economically limited
• a soft drink bottler buys the only source of
spring water available
• a hotel in a resort town creates a large water park,
there are only enough customers to support one park
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Corporate Diversification
Corporate
Diversification
Imitability of Diversification
Duplication of Economies of Scope
Less Costly-to-Duplicate
Costly-to-Duplicate
Employee Compensation
Core Competencies
Tax Advantages
Internal Capital Allocation
Risk Reduction
Multipoint Competition
Shared Activities*
Exploiting Market Power
(codified/tangible)
(tacit/intangible)
*may be costly depending on relationships
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Corporate Diversification
Corporate
Diversification
Imitability of Diversification
Substitution of Economies of Scope
Internal Development
• start a new business under
the corporate whole
• avoids potential crossfirm integration issues
Strategic Alliances
• find a partner with the
desired complementary
assets
• less costly than
acquiring a firm
Competitors may use these strategies to arrive at a
position of diversification without buying another firm
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Corporate Diversification
Corporate
Diversification
Summary
Corporate Strategy: In what businesses should
the firm operate?
• an understanding of diversification helps managers
answer that question
Two Criteria:
1) economies of scope must exist
2) must create value that outside equity holders
cannot create on their own
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Corporate Diversification
Corporate
Diversification
Summary
Economies of Scope
• a case of synergy—combined activities generate
greater value than independent activities
• may generate competitive advantage if they
meet the VRIO criteria
Firms should pursue diversification only if careful
analysis shows that competitive advantage is likely!
Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall.
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Corporate Diversification
Corporate
Diversification
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without the prior written permission of the publisher. Printed in the
United States of America.
Copyright ©2010 Pearson Education, Inc.
publishing as Prentice Hall
Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall.
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