Chapter 6 CorporateLevel Strategy Michael A Hitt R

Chapter 6 Corporate-Level Strategy Michael A. Hitt R. Duane Ireland Robert E. Hoskisson © 2000 South-Western College Publishing Ch 6 -1

Strategic Inputs Chapter 2 External Environment Strategic Intent Strategic Mission Chapter 3 Internal Environment Strategy Implementation Chapter 4 Business-Level Strategy Chapter 5 Competitive Dynamics Chapter 6 Corporate-Level Strategy Chapter 10 Corporate Governance Chapter 11 Structure & Control Chapter 7 Acquisitions & Restructuring Chapter 8 International Strategy Chapter 9 Cooperative Strategies Chapter 12 Strategic Leadership Chapter 13 Outcomes Strategic Actions Strategy Formulation The Strategic Management Process Feedback Entrepreneurship & Innovation Strategic Competitiveness Above Average Returns Ch 6 -2

A Diversified Company Has Two Levels of Strategy 1. Business-Level Strategy (Competitive Strategy) How to create competitive advantage in each business in which the company competes - low cost - focused low cost - differentiation - focused differentiation - integrated low cost/differentiation 2. Corporate-Level Strategy (Companywide Strategy) How to create value for the corporation as a whole Ch 6 -3

Key Questions of Corporate Strategy 1. What businesses should the corporation be in? 2. How should the corporate office manage the array of business units? Corporate Strategy is what makes the corporate whole add up to more than the sum of its business unit parts Ch 6 -4

Levels and Types of Diversification Low Levels of Diversification Single business > 95% of revenues from a single business unit Dominant business Between 70% and 95% of revenues from a single business unit A A B Moderate to High Levels of Diversification Related constrained Related linked (mixed) < 70% of revenues from dominant business, and only limited links exist Very High Levels of Diversification Unrelated-Diversified A < 70% of revenues from dominant business; all businesses share product, technological and distribution linkages Business units not closely related B A B C C

Motives, Incentives, and Resources for Diversification Motives to Enhance Strategic Competitiveness Resources Economies of Scope Market Power Financial Economies Incentives Managerial Motives Ch 6 -6

Motives, Incentives, and Resources for Diversification Resources Incentives Managerial Motives Incentives and Resources with Neutral Effects of Strategic Competitiveness Anti-Trust Regulation Tax Laws Low Performance Uncertain Future Cash Flows Firm Risk Reduction Tangible Resources Intangible Resources Ch 6 -7

Motives, Incentives, and Resources for Diversification Resources Incentives Managerial Motives Causing Value Reduction Diversifying Managerial Employment Risk Increasing Managerial Compensation Ch 6 -8

Summary Model of the Relationship Between Firm Performance and Diversification Resources Incentives Diversification Strategy Managerial Motives Ch 6 -9

Adding Value by Diversification most effectively adds value by either of two mechanisms: By developing economies of scope between business units in the firms which leads to synergistic benefits By developing market power which leads to greater returns Ch 6 -10

Alternative Diversification Strategies Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient Internal Capital Market Allocation Restructuring Ch 6 -11

Alternative Diversification Strategies Sharing Activities Key Characteristics: Sharing Activities often lowers costs or raises differentiation Example: Using a common physical distribution system and sales force such as Procter & Gamble’s disposable diaper and paper towel divisions Sharing Activities can lower costs if it: Achieves economies of scale Boosts efficiency of utilization Helps move more rapidly down Learning Curve Example: General Electric’s costs to advertise, sell and service major appliances are spread over many different products Ch 6 -12

Alternative Diversification Strategies Sharing Activities Key Characteristics: Sharing Activities can enhance potential for or reduce the cost of differentiation Example: Shared order processing system may allow new features customers value or make more advanced remote sensing technology available Must involve activities that are crucial to competitive advantage Example: Procter & Gamble’s sharing of sales and physical distribution for disposable diapers and paper towels is effective because these items are so bulky and costly to ship Ch 6 -13

Alternative Diversification Strategies Sharing Activities Assumptions: Strong sense of corporate identity Clear corporate mission that emphasizes the importance of integrating business units Incentive system that rewards more than just business unit performance Ch 6 -14

Alternative Diversification Strategies Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient Internal Capital Market Allocation Restructuring Ch 6 -15

Alternative Diversification Strategies Transferring Core Competencies Key Characteristics: Exploits Interrelationships among divisions Start with Value Chain analysis Identify ability to transfer skills or expertise among similar value chains Exploit ability to transfer activities Ch 6 -16

Alternative Diversification Strategies Transferring Core Competencies Assumptions: Transferring Core Competencies leads to competitive advantage only if the similarities among business units meet the following conditions: Activities involved in the businesses are similar enough that sharing expertise is meaningful Transfer of skills involves activities which are important to competitive advantage The skills transferred represent significant sources of competitive advantage for the receiving unit Ch 6 -17

Alternative Diversification Strategies Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient Internal Capital Market Allocation Restructuring Ch 6 -18

Alternative Diversification Strategies Efficient Internal Capital Market Allocation Key Characteristics: Firms pursuing this strategy frequently diversify by acquisition: Acquire sound, attractive companies Acquired units are autonomous Acquiring corporation supplies needed capital Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs Add professional management & control to sub-units Sub-unit managers compensation based on unit results Ch 6 -19

Alternative Diversification Strategies Efficient Internal Capital Market Allocation Assumptions: Managers have more detailed knowledge of firm relative to outside investors Firm need not risk competitive edge by disclosing sensitive competitive information to investors Firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own Ch 6 -20

Alternative Diversification Strategies Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient Internal Capital Market Allocation Restructuring Ch 6 -21

Alternative Diversification Strategies Restructuring Key Characteristics: Seek out undeveloped, sick or threatened organizations or industries Parent company (acquirer) intervenes and frequently: - Changes sub-unit management team - Shifts strategy - Infuses firm with new technology - Enhances discipline by changing control systems - Divests part of firm - Makes additional acquisitions to achieve critical mass Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations Ch 6 -22

Alternative Diversification Strategies Restructuring Assumptions: Requires keen management insight in selecting firms with depressed values or unforeseen potential Must do more than restructure companies Need to initiate restructuring of industries to create a more attractive environment Ch 6 -23

Incentives to Diversify External Incentives: Relaxation of Anti-Trust regulation allows more related acquisitions than in the past Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns Ch 6 -24

Value-creating Strategies of Diversification Operational and Corporate Relatedness High Sharing: Operational Relatedness Between Business Low Related Constrained Diversification Vertical Integration (Market Power) Both Operational and Corporate Relatedness (Rare Capability and Can Create Diseconomies of Scope) Unrelated Diversification (Financial Economies) Related Linked Diversification (Economies of Scope) Low High Corporate Relatedness: Transferring Skills Into Business Through Corporate Headquarters Ch 6 -25

Performance Diversification and Firm Performance Dominant Business Related Constrained Level of Diversification Unrelated Business Ch 6 -26

Incentives to Diversify Internal Incentives: Poor performance may lead some firms to diversify to attempt to achieve better returns Firms may diversify to balance uncertain future cash flows Firm may diversify into different businesses in order to reduce risk Managers often have incentives to diversify in order to increase their compensation and reduce employment risk, although effective governance mechanisms may restrict such abuses Ch 6 -27

Summary Model of the Relationship Between Firm Performance and Diversification Resources Capital Market Intervention and Market for Managerial Talent Incentives Diversification Strategy Firm Performance Managerial Motives Internal Governance Strategy Implementation Ch 6 -28