6-6-Corporate-Level Strategy Creati.docx

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Corporate-Level Strategy:
Creating Value through Diversification
McGraw-Hill/Irwin
Strategic Management, 3/e
Copyright © 2007 The McGraw-Hill Companies, Inc. All rights
reserved.
Chapter six
Part 2:
strategic formulation

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Learning ObjectivesAfter reading this chapter, you should have
a good understanding of:How managers can create value
through diversification initiatives.The reasons for the failure of
many diversification efforts.How corporations can use related
diversification to achieve synergistic benefits through
economies of scope and market power.
McGraw-Hill/Irwin
reserved.
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a good understanding of:How corporations can use unrelated
diversification to attain synergistic benefits trough corporate
restructuring, parenting, and portfolio analysis.The various
means of engaging in diversification-mergers and acquisitions,
joint ventures/strategic alliances, and internal development.

McGraw-Hill/Irwin
reserved.
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a good understanding of:The benefits and potential drawbacks
of real options analysis (ROA) in making resource allocation
decisions under conditions of high uncertainty.Managerial
behaviors that can erode the creation of value.
McGraw-Hill/Irwin
reserved.

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Making Diversification Work
McGraw-Hill/Irwin
reserved.What businesses should a corporation compete in?How
should these businesses be managed to jointly create more value
than if they were freestanding units?
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Making Diversification Work
McGraw-Hill/Irwin
reserved.Diversification initiatives must create value for
shareholdersMergers and acquisitionsStrategic alliancesJoint
venturesInternal developmentDiversification should create

synergy
Business 2
Business 1
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Synergy
McGraw-Hill/Irwin
reserved.Related businesses (horizontal relationships)Sharing
tangible resourcesSharing intangible resources

Business 2
Business 1
Production facilities
Distribution channels
Favorable reputation
Patents, copyrights, etc.
Specialized skills
Manufacturing facilities
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Synergy

McGraw-Hill/Irwin
reserved.Unrelated businesses (hierarchical relationships)Value
creation derives from corporate officeLeveraging support
activities
Technology development
Business 2
Business 1
Procurement
Information systems

Human resource mgmt
Firm infrastructure
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Creating Value
McGraw-Hill/Irwin
reserved.
Leveraging core competencies3M leverages it competencies in
adhesives technologies to many industries, including
automotive, construction, and telecommunications
Sharing activitiesMcKesson, a large distribution company, sells
many product lines, such as pharmaceuticals and liquor, through
its superwarehouses
Related Diversification: Economies of Scope
Related Diversification: Market Power
Pooled negotiating powerThe Times Mirror Company increases
its power over customers by providing “one-stop shopping” for
advertisers to reach customers through multiple media—
television and newspapers—in several huge markets such as
New York and Chicago
Vertical integrationShaw industries, a giant carpet
manufacturer, increases its control over raw materials by
producing much of its own polypropylene fiber, a key input to
its manufacturing process
Exhibit 6.2 Creating Value through Related and Unrelated
Diversification

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Creating Value
McGraw-Hill/Irwin
reserved.
Corporate restructuring and parentingThe corporate office of
Cooper Industries adds value to its acquired businesses by
performing such activities as auditing their manufacturing
operations, improving their accounting activities, and
centralizing union negotiations
Portfolio managementNovartis, formerly Ciba-Geigy, uses
portfolio management to improve many key activities, including
resource allocation and reward and evaluation systems
Unrelated Diversification: Parenting, Restructuring, and
Financial Synergies
Exhibit 6.2 Creating Value through Related and Unrelated
Diversification

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Related Diversification: Economies of
Scope and Revenue Enhancement
McGraw-Hill/Irwin
reserved.Economies of scopeCost savings from leveraging core
competencies or sharing related activities among businesses in
the corporationLeverage or reuse key resourcesFavorable
reputationExpert staffManagement skillsEfficient purchasing
operationsExisting manufacturing facilities
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Leveraging Core Competencies
McGraw-Hill/Irwin
reserved.Core competenciesThe glue that binds existing
businesses togetherEngine that fuels new business
growthCollective learning in a firmHow to coordinate diverse
production skillsHow to integrate multiple streams of
technologiesHow to market diverse products and services
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Three Criteria of Core Competencies
McGraw-Hill/Irwin
reserved.Three criteria (of core competencies) that lead to the
creation of value and synergyCore competencies must enhance
competitive advantage(s) by creating superior customer
valueDevelop strengths relative to competitorsBuild on skills
and innovationsAppeal to customers

Superior
Customer
value
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McGraw-Hill/Irwin
reserved.Three criteria (of core competencies) that lead to the
creation of value and synergyDifferent businesses in the firm
must be similar in at least one important way related to the core
competenceNot essential that products or services themselves be
similarIs essential that one or more elements in the value chain
require similar essential skillsIs essential that one or more
elements in the value chain require similar essential skillsBrand
image is an example

Superior
Customer
value
Businesses similar in way related to core competency
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McGraw-Hill/Irwin
reserved.
Three criteria (of core competencies) that lead to the creation of
value and synergyCore competencies must be difficult for
competitors to imitate or find substitutes forEasily imitated or
replicated core competencies are not a sound basis for
sustainable advantagesSpecialized technical skills acquired only
in company work experience are an example

Superior
Customer
value
Businesses similar in way related to core competency
Difficult to imitate or find substitutes for
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Sharing Activities
McGraw-Hill/Irwin
reserved.Corporations can also achieve synergy by sharing
tangible and value-creating activities across their business
unitsCommon manufacturing facilitiesDistribution
channelsSales forcesSharing activities provide two payoffsCost
savingsRevenue enhancements

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Related Diversification: Market Power
McGraw-Hill/Irwin
reserved.Two principal means to achieve synergy through
market powerPooled negotiating powerVertical
integrationGovernment regulations may restrict this power
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McGraw-Hill/Irwin
reserved.Similar businesses working together can have stronger
bargaining position relative
toSuppliersCustomersCompetitorsAbuse of bargaining power
may affect relationships with customers, suppliers and

competitors
Pooled Negotiating Power
Bargaining power
Bargaining power
Bargaining power
Business 1
Business 2
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Vertical Integration
McGraw-Hill/Irwin
reserved.BenefitsSecure source of supply of raw
materialsSecure distribution channelsProtection and control
over assets and servicesAccess to new business opportunities
and technologiesSimplified procurement and administrative

procedures
DependencySuppliersCustomers
DependencySuppliersCustomers
Dependency
Business 1
Business 2
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McGraw-Hill/Irwin
reserved.RisksCosts and expenses associated with increased
overhead and capital expendituresLoss of flexibility resulting
from inability to respond quickly to changes in the external
environmentProblems associated with unbalanced capacities or

unfilled demand along the value chainAdditional administrative
costs
Dependency
Business 1
Business 2
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Vertical Integration: Benefits and Risks
McGraw-Hill/Irwin
reserved.
A secure source of raw materials or distribution channels.
Protection of and control over valuable assets.
Access to new business opportunities
Simplified procurement and administrative procedures.
Benefits

Risks
Costs and expenses associated with increased overhead and
capital expenditures
Loss of flexibility resulting from large investments.
Problems associated with unbalanced capacities along the value
chain.
Additional administrative costs associated with managing a
more complex set of activities.
Exhibit 6.4 Benefits and Risks of Vertical Integration
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McGraw-Hill/Irwin
reserved.
In making decisions associated with vertical integration, four
issues should be considered:
Are we satisfied with the quality of the value that our present
suppliers and distributors are providing?Are there activities in
our industry value chain presently being outsourced or
performed independently by others that are a viable source of

future profits?Is there a high level of stability in the demand for
the organization’s products?How high is the proportion of
additional production capacity actually absorbed by existing
products or by the prospects of new and similar products?
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Analyzing Vertical Integration:
The Transaction Cost Perspective
McGraw-Hill/Irwin
reserved.

Market transaction
Monitoring costs
Monitoring costs
Enforcement costs
Enforcement costs
Costs of written contract
Costs of written contract
Search costs
Search costs
Negotiating costs
Negotiating costs
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Unrelated Diversification: Financial Synergies and Parenting
McGraw-Hill/Irwin
reserved.Most benefits from unrelated diversification are gained
from vertical (hierarchical) relationshipsParenting and
restructuring of businessesAllocate resources to
optimizeProfitabilityCash flowGrowthAppropriate human
resources practicesFinancial controls

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Corporate Parenting
McGraw-Hill/Irwin
reserved.
Parenting—creating value within business unitsExperience of
the corporate officeSupport of the corporate
officePlansBudgetsProcurementLegal functionsFinancial
functionsHuman resource management
Corporate office
Business unit

Business unit
Business unit
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Corporate Restructuring
McGraw-Hill/Irwin
reserved.
Find poorly performing firmsWith unrealized potentialOn
threshold of significant positive changeSell off partsReduce
payrollChange strategiesChange managementInfuse new
technologiesReduce unnecessary expenses
Corporate office
Business unit

Business unit
Business unit
Business unit
Business unit
Business unit
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Corporate Restructuring
McGraw-Hill/Irwin
reserved.Corporate management mustHave insight to detect
undervalued companies or businesses with high potential for
transformationHave requisite skills and resources to turn the
businesses aroundRestructuring can involve changes
inAssetsCapital structureManagement

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Portfolio Management
McGraw-Hill/Irwin
reserved.
Adapted from Exhibit 6.5 The Boston Consulting Group (BCG)
Portfolio Matrix
Key
Each circle represents one of the firm’s business units
Size of circle represents the relative size of the business unit in
terms of revenue
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McGraw-Hill/Irwin
reserved.Creation of synergies and shareholder value by
portfolio management and the corporate officeAllocate
resources (cash cows to stars and some question
marks)Expertise of corporate office in locating attractive firms
to acquire
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McGraw-Hill/Irwin
reserved.Creation of synergies and shareholder value by
portfolio management and the corporate officeProvide financial
resources to business units on favorable terms reflecting the
corporation’s overall ability to raise fundsProvide high quality
review and coaching for unitsProvide a basis for developing
strategic goals and reward/evaluation systems

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Means to Achieve Diversification
McGraw-Hill/Irwin
reserved.Acquisitions or mergersPooling resources of other
companies with a firm’s own resource baseJoint
ventureStrategic allianceInternal developmentNew productsNew
marketsNew technology
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Strategic Alliances and Joint Ventures
McGraw-Hill/Irwin
reserved.Introduce successful product or service into a new
marketLacks requisite marketing expertiseDoesn’t understand
customer needsDoesn’t know how to promote the
productDoesn’t have access to proper distribution channels
Entering new markets
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McGraw-Hill/Irwin
reserved.Join other firms to reduce manufacturing (or other)
costs in the value chainPool capitalPool value-creating
activitiesPool facilitiesEconomies of scale

Reducing costs in value chain
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McGraw-Hill/Irwin
reserved.Develop or diffuse new technologiesUse expertise of
two or more companiesDevelop products technologically
beyond the capability of the companies acting independently

Reducing costs in value chain
Developing diffusing new technology
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Unmet Expectations: Strategic Alliances
and Joint Ventures
McGraw-Hill/Irwin
reserved.Improper partnerEach partner must bring desired
complementary strengths to partnershipStrengths contributed by
each should be uniquePartners must be compatiblePartners must
trust one another

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Real Options Analysis
McGraw-Hill/Irwin
reserved.Stock options (financial assets)Real options ( real
assets or physical things)Investments can be stagedStrategic
decision-makers have “tollgates”Increased knowledge about
outcomes at the time of the next investment decision
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Managerial Motives Can Erode Value Creation
McGraw-Hill/Irwin
reserved.Growth for growth’s sakeEgotismAntitakeover
tacticsGreenmailGolden parachutePoison pills

Part 1: Post a Response
"Strategic Alliance Performance" Please respond to the
following:
· From the case study, predict three (3) potential challenges that
can arise in the strategic relationships among Yum!,
McDonald’s, and Sinopec. Recommend three (3) actions that
these companies can take in order to either prevent or mitigate
these potential problems. Provide a rationale for your response.
· According to the textbook, four (4) factors may influence the
performance of alliances and networks: (1) equity, (2) learning
and experience, (3) nationality, and (4) relational capabilities.
Use the Internet to research one (1) strategic alliance.
Determine which one (1) of the aforementioned influential
factors has been the most influential in the selected strategic
alliance’s success. Provide a rationale for your response.
**Please review the power point and let us know what you think
(As attach file).**
Part 2: Respond to a Peer
From the case study, predict three (3) potential challenges that
can arise in the strategic relationships among Yum!,
McDonald’s, and Sinopec. Recommend three (3) actions that
these companies can take in order to either prevent or mitigate

these potential problems. Provide a rationale for your response.
Potential Challenges:
1. Cross-cultural clashes: McDonald’s and Sinopec are
companies formed in two completely separate countries. One of
the possible reasons that McDonald’s was being outperformed
by KFC and Pizza Hut may have been attributed, at least in part,
to an incomplete understanding or appreciation of the Chinese
culture and/or business environment. The relationship from
Sinopec could strengthen McDonald’s acceptance into and
understanding of Chinese culture and business. It could also
suffer if McDonald’s American leadership is too rigid and
inflexible in these areas in the area of cultural assimilation.
- Cross-cultural activities that help Chinese employees &
leadership understand American culture better and that help
American employees understand Chinese culture better
- Open communication and encouraged communications across
all lines of business at all levels of the business
- Understanding and embracing differences
2. Inability to unify behind a single macro message: A fast food
restaurant and a gas station do have some fundamental
characteristics in common. However, they are also completely
different types of businesses that customers ultimately expect
different experiences from interactions from fast food joints
than they do from gas stations. Forming one vision from two
separate entities (both with long successful histories of doing
business) may prove to be a challenge and without a unified
message there is no common goal to work towards.
- Figure out if customers are expected to view this relationship
- Explain to customer the benefit of the having a gas station and
a restaurant in one place

- Create separateness inside the business so that even though
customers are eating their meal at a gas stations there is a real
separation of dining space and gas station
3. Unrealistic expectations: There needs to be a clearly defined
expectation before this strategic relationship occurs or each
company may be working towards objectives and goals that
don’t fit into the other company’s business model.
- How much do both companies expect to grow from this
relationship?
- How much does each company expect to grow from this
relationship?
- Make sure that the flow from one space (restaurant) the other
(gas station) is seamless.
https://www.linkedin.com/pulse/strategic-alliances-success-
failures-ron-byron-phd
According to the textbook, four (4) factors may influence the
performance of alliances and networks: (1) equity, (2) learning
and experience, (3) nationality, and (4) relational capabilities.
Use the Internet to research one (1) strategic alliance.
Determine which one (1) of the aforementioned influential
factors has been the most influential in the selected strategic
alliance’s success. Provide a rationale for your response.
Apple & IBM: To quote IBM, its new partnership with Apple
“brings together the analytics and enterprise-scale computing of
IBM with the elegant user experience of iPhone and iPad to
deliver a new level of value for businesses”. The alliance will
draw on Apple’s consumer experience, hardware and software
integration and help invigorate IBM’s image, which has sagged
a bit in recent years. The partnership will leverage IBM’s big
data analytics and more than 100,000 industry sales consultants
and software developers, to help Apple penetrate the global

corporate enterprise market. To quote Apple “the partnership
will add a new class of apps to connect users to big data &
analytics, on their iOS devices”.
https://www.forbes.com/sites/michellegreenwald/2014/12/11/11
-of-the-bestsmartestmost-interesting-strategic-brand-
partnerships-of-2014/#69ef31eb38f8
I believe that learning and experience is the most influential
factor in the relationship between IBM & Apple. Both
companies are built upon colorful histories of innovation and
ingenuity that has led each to be pioneers and leaders in the
technological industry.

6-6-Corporate-Level Strategy Creati.docx

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