Corporate Strategy - Diversification

Question 1

Definition and General Notes

Answer 1

Determines the scope of the firm and hence, in which markets the firm should operate. The Corporate Strategy is a way for a company to create value through the configuration and coordination of its multimarket activities.

Question 2

Scope in markets determined by three factors

Answer 2

1. Vertical Integration
2. Product market diversification (Horizontal)
3. Geographic diversification/ expansion

Question 3

Ownership of businesses/ activities in different markets

Answer 3

1. Full ownership (M&A, greenfield)
2. Partial ownership (JV)
3. No ownership (Contracts)

Question 4

How to achieve value creation through Corporate Strategy

Answer 4

1. Scope: right businesses to be in, where synergies can be
2. Organizational design and coordination: how should the portfolio of businesses be coordinated and which processes are needed to create value
3. Ownership: internal vs. external, full vs. partial ownership

Question 5

Product Market Diversification Strategies

Answer 5

1. Single Business Strategy
   - low level diversification
   - leveraging competencies
   - 95% of revenues from dominant business
2. Dominant Business Strategy
   - dominant and minor business share compentencies
   - 70 to 95% of revenues from dominant business
3. Related Diversification Strategy
   - moderate level diversification
   - less than 70% of revenues from dominant business
   - related constraint: all businesses share activites
   - related linked: some share
4. Unrelated Diversification Strategy
   - very high-level diversification
   - no businesses share compentencies

Question 6

Reasons for diversification

Answer 6

1. Value-Creating Diversification
   - Economies of scope
   - Market power
   - Financial economies
2. Value-Neutral Diversification
   - Antitrust regulation
   - Tax laws
   - Low performance
   - Uncertain future cash flows
   - Risk reduction for firm
   - Tangible resources
   - Intangible resources
3. Value-Reducing Diversification
   - Diversifying managerial employment risk
   - Increasing managerial compensation

Question 7

Corporate Strategy: Scope

Answer 7

Related diversification leads to economies of scope and synergies.

1. Horizonzal - sharing activites and resources, cost saving, increased WTP
2. Vertical - bigger share of pie, increase size of pie, increased market power

Question 8

Reasons for diversification: Synergies

Answer 8

Cost Synergies: Centralizing procurement, joint distribution, combing salesforce
Revenue Synergies: Volume and/ or customer’s WTP increases due to cross-selling

Through sharing activities and resources

Question 9

Reasons for diversification: Market Power

Answer 9

Market Power exist when a company can sell its product above existing competitive level and reduce costs of primary and support activities below the competitive level

Vertical integration can increase market power.
MMC and lowering competitive rivalry can increase this

Question 10

Reasons for diversification: Financial Economies

Answer 10

Cost savings realized through improved allocations of financial resources

Two types:

• efficient capital allocations
• purchase other corporations and restructure their assets

Potential source for value creating in unrelated diversification

Question 11

Unrelated Diversification

Answer 11

The general belief in diversification discount in the valuation of companies.

Conglomerates:

• Mostly present in emerging markets
• BU is granted autonomy
• Little coordination between BU

Why does it make sense?

• market failure
• portfolio of quality businesses

Question 12

Diversification: Costs + Drawbacks

Answer 12

Managers are driven by a desire for increased compensation, which destroys value and does not deliver synergies

Drawbacks:

• Coordination cost
• Lack of managerial experience
• Distraction for core-business

Framework - Performance <> Level of diversification (Performance first increases with diversification and then decreases)

Question 13

Vertical Integration Framework

Answer 13

See slides