Home » Strategic Management Corporate Diversification

Strategic Management Corporate Diversification

© Lucas Wenger 2018
Strategic Management
Corporate Diversification
© Lucas Wenger 2018
Where Are We in the SM Process?
Mission Objectives
Business Level
Corporate Level
How to Position a
in the Market?
Which Businesses
to Enter?
•Vertical Integration
© Lucas Wenger 2018
Strategies used as a means to avoid or be
better than competitors
• Module 3:
– Vertical Integration (8)
– Corporate Diversification (9) & organizing for
diversification (10)
• Module 4:
– Collusion (7)
– Strategic Alliances (10)
– Mergers and Acquisitions (11)
© Lucas Wenger 2018
Ethics & Strategy
• Diversification contributes to increasing firm size,
and facilitates the growth of MNEs
• Protests against the WTO, the Occupy Movement,
and more recently a populist discontent for free trade
agreements (i.e. NAFTA & TPP)
• Why? Globalization increases the total value created
in the world economy & accelerates growth (which is
largely unchallenged throughout the political
• How can we respond?
© Lucas Wenger 2018
Logic of Corporate Level Strategy
Corporate level strategy should create value:
2) such that businesses forming the corporate whole
are worth more than they would be under
independent ownership
3) that equity holders cannot create through
portfolio investing
• A corporate level strategy should create
synergies that are not available in equity
– In this pursuit, diversification potentially creates
economies of scope
1) such that the value of the corporate whole increases
© Lucas Wenger 2018
What are economies of scope?
• Increases in the net value of products or
services offered as a function of the number of
businesses in which a firm operates
© Lucas Wenger 2018
What is Corporate Diversification?
Operation in multiple industries or
markets simultaneously
à2 Categories (not mutually exclusive)
© Lucas Wenger 2018
Integration and Diversification
Backward Forward
Unrelated Related
© Lucas Wenger 2018
Categories of Corporate Diversification
Product Diversification:
Geographic Market Diversification:
Product-Market Diversification
• operating in multiple industries
• operating in multiple geographic markets
• operating in multiple industries in multiple
geographic markets
At a general level… Examples?
Darden Restaurants
Pollo Campero
© Lucas Wenger 2018
Typology of Corporate Diversification
Limited Diversification
Related Diversification
Unrelated Diversification
• single business: > 95% of sales in single business
• dominant business: 70% to 95% in single business
• related-constrained: all businesses related on most
• related-linked: some businesses related on some
• businesses are not related
© Lucas Wenger 2018
Product and Geographic Diversification
• single-business in multiple geographic areas
• single-business in one geographic area
• related-constrained in one or multiple geographic areas
• related-linked in one or multiple geographic areas
• unrelated in one or multiple geographic areas
• relatedness usually refers to products
• seemingly unrelated products may be related on
other dimensions
© Lucas Wenger 2018
Examples of Corporate Diversification
Limited Diversification
Related Diversification
Unrelated Diversification
• related-constrained:
• related-linked:
© Lucas Wenger 2018
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
© Lucas Wenger 2018
Economies of Scope
Business X Business Y Business Z
Independent: equity holder could buy shares of each firm
Business X
Business Y
Business Z
Focal Firm
+ +
Combined: equity holder buys shares in one firm
© Lucas Wenger 2018
Economies of Scope
Four Types
© Lucas Wenger 2018
Economies of Scope
Operational Economies of Scope
Sharing Activities
• exploiting efficiencies of sharing business
Example: 3M J&J
Spreading Core Competencies
• exploiting core competencies in other businesses
Example: Frito-Lay’s Trucking
• competency must be strategically relevant
© Lucas Wenger 2018
What are core competencies?
• “The collective learning in the organization,
especially how to coordinate diverse
production skills and integrate multiple
streams of technologies”
• May be generated through logical
consideration of pre-diversified firms’
resources/ capabilities or may emerge naturally
• May entail shared activates or may not/
© Lucas Wenger 2018
Economies of Scope
Financial Economies of Scope
Internal Capital Market
• premise: insiders can allocate capital across
divisions more efficiently than the external capital
• works only if managers have better information
• may protect proprietary information
• may suffer from escalating commitment
Example: Hanson Trust, PLC
© Lucas Wenger 2018
Economies of Scope
Financial Economies of Scope
Risk Reduction
• counter cyclical businesses may provide
decreased overall risk
Example: Snow Skiis & Water Skiis
• individual investors can usually do this more
efficiently than a firm
© Lucas Wenger 2018
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
Example: Ireland (Apple, among others)
• can be used to ‘smooth’ income
Why is it potentially beneficial to smooth
income (under tax code accounting rules?
© Lucas Wenger 2018
Economies of Scope
• Which of these is realizable by investors
without diversification in the focal firm (within
financial economies of scope)?
© Lucas Wenger 2018
Anticompetitive Economies of Scope
Multipoint Competition
• mutual forbearance
• a firm chooses not to compete aggressively
in one market to avoid competition in another
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
© Lucas Wenger 2018
Economies of Scope
• 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
• What is different between managerialism &
operational/financial/anticompetitive economies of scope?
The locus of value capture –firm (flowing/ principals vs. agents)
© Lucas Wenger 2018
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
© Lucas Wenger 2018
Imitability of Diversification
Less Costly-to-Duplicate Costly-to-Duplicate
Employee Compensation
Tax Advantages
Risk Reduction
Shared Activities*
Core Competencies
Internal Capital Allocation
Multipoint Competition
Exploiting Market Power
(codified/tangible) (tacit/intangible)
*may be costly depending on relationships
© Lucas Wenger 2018
But companies can succeed in Corporate
Strategy .. With proper analysis
• The Porter Test
• The 4 Poles Test
• The Combined Acid Test
© Lucas Wenger 2018
Basis of
Value Creation
Parenting Skills
The Poles of Corporate Strategy
• What businesses is this
company in?
• How is value created to these
businesses? (if at all)
• Why is this value superior to
that created by other HQs or
stand alone business? (if at all)
• What kind of
have been put in place to
achieve the target value?
• Are the 4 poles consistent?
© Lucas Wenger 2018
Porter’s Test
• The attractiveness test
• The cost of entry test
• The better off test
© Lucas Wenger 2018
The Combined Acid Test for
• Taking a Resource View:
• Do we have valuable and rare resources and capabilities that could be
transferred to (or from) or shared with the new unit?
• How valuable are these to the new/old unit?
• Do we have the Parenting Skills/Internal Organization needed for the
• Can we build/acquire the valuable (complementary) skills that we are
• Taking a Market View:
• Can we overcome the barriers to entry?
• Is this industry attractive?
Costs Versus Benefits
© Lucas Wenger 2018
Diversification Based on Activities
Sharing: The Acid Test
• Taking a Resource View:
• Do we have activities that can be shared among the units?
• Will activity sharing reduce costs or differentiation costs?
• Could we outsource this activity? Impact on Flexibility?
• Do we have the Parenting Skills/Internal Organization needed for effective
activities sharing?
• Can we build/acquire the valuable (complementary) resources that we are
• Taking a Market View:
• Can we overcome the barriers to entry?
• Is this industry attractive?
Costs Versus Benefits

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