DIVERSIFICATION: DIVERSIFICATION: Horizontal Horizontal Expansion Expansion Three Three Dimensions Dimensions of of Corporate Corporate Strategy Strategy Business Diversification Vertical Integration Geographic/global Expansion Diversification 2 Examples Examples Then Now

Coca Cola Eli Lily Honda Nintendo Nokia GE Sharp AT&T Samsung Daewoo Diversification 3 Extent Extent of of Corporate Corporate Diversification: Diversification: Firms Firms vary vary by by Degree Degree of of Diversification

Diversification Low Levels of Diversification Single-Business - > 95% of revenues from a singles business unit Dominant-Business - 70-95% from a single business unit Vertically-integrated Businesses - 70% of sales in value chain Moderate to High Levels of Diversification Related-Diversified - 70% or more from businesses that are related. Businesses must share product, technological or distribution linkages. Businesses may be related-linked or related constrained High Levels of Diversification Unrelated-Diversified - <70% in related business units Diversification 4 Motives Motives for for Diversification Diversification Operational economies of scope and scale (Strategic Competitiveness) shared and transferred activities leveraging core competencies Financial economies of scope (Internal Capital Market)

internal capital allocation risk reduction tax advantages Anticompetitive economies of scope (Market Power) multipoint competition exploiting market power Employee Incentives (Growth Motive) diversifying employees risk and improving promotion chances maximizing management compensation Avoid declining industries Diversification 5 Corporate Corporate Advantages Advantages from from Diversification Diversification (1) Sharing Linkages Between Businesses Bus. B

Bus. A Bus. C Bus. D (2) Sharing Core Competence Bus. B Bus. A Core Competence Bus. C Bus. D

Diversification 6 Corporate Corporate Advantages Advantages from from Diversification Diversification Market Power Economies of Scope Economies of Internalizing Transactions Internal Market System Information Advantages Diversification 7 Scope

Scope Advantages Advantages from from Diversification Diversification Economies of scope -- cost reduction from achieving minimum scale in an input factor, derived from producing multiple products * tangible assets, e.g., distribution and service networks, R&D * intangible assets, e.g., brand names, corporate reputations, technology * organizational capabilities, e.g., management capabilities, marketing skills Diversification 8 Scale Scale Advantages Advantages from from Diversification Diversification Economies of Scale in Administration, Financing and Control

= cost advantages from reaching minimum efficient scale in administrative and control activities by centralizing similar activities at the corporate HQ, and by operating an internal capital market * Administration, e.g. centralized strategic planning, centralized legal functions, etc. * Control, e.g. centralized accounting and financial functions * Financing, e.g. centralized internal capital allocation function Diversification 9 Diversification Diversification and and Performance Performance Diversification into related industries may be more profitable than into unrelated industries

Source: Rumelt (1974) Diversification 10 Approaches Approaches to to Corporate Corporate Strategy Strategy Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient internal capital market allocation Diversification 11 Sharing Activities Sharing Sharing Activities Activities

Key Characteristics Sharing Activities often lowers costs or raises differentiation Example: Using a common physical distribution system and sales force such as Procter & Gambles 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 Electrics costs to advertise, sell and service major appliances are spread over many different products Diversification 12 High Low Annual real rate of market growth %

BCG BCG Growth-Share Growth-Share Matrix Matrix Earnings: high stable, growing Earnings: Cash flow: neutral Cash flow: negative Strategy: invest for growth Strategy: Earnings:

high stable Earnings: low, unstable Cash flow: high stable Cash flow: neutral or negative Strategy: milk Strategy: divest High

low, unstable, growing analyze to determine whether business can be grown into a star, or will degenerate into a dog Relative Market Share Low Diversification 13

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