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DIVERSIFICATION: Horizontal Expansion

Three Dimensions of Corporate Strategy

Business Diversification
Vertical Integration Geographic/global Expansion
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Extent of Corporate Diversification:


Firms vary by Degree of 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 3

Motives for 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

Corporate Advantages from Diversification


(1) Sharing Linkages Between Businesses

Bus. A

Bus. B

Bus. C

Bus. D

(2) Sharing Core Competence


Bus. A Bus. B

Core Competence
Bus. C Bus. D

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Corporate Advantages from Diversification

Market Power Economies of Scope Economies of Internalizing Transactions Internal Market System Information Advantages

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Scope Advantages from 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
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Scale Advantages from 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
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Information Advantages of the Diversified Corporation

* About capabilities and characteristics of employees * Established firms are the most successful in commercial development of new businesses * Agency problems need to create disciplines of the capital market within the diversified corporation

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Diversification and Performance


Diversification into related industries may be more profitable than into unrelated industries

Source: Rumelt (1974)

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Approaches to Corporate Strategy


Related Diversification Strategies Sharing Activities Transferring Core Competencies

Unrelated Diversification Strategies Efficient internal capital market allocation

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Sharing Activities
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 & 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
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BCG Growth-Share Matrix


Annual real rate of market growth %
Earnings: Cash flow: high stable, growing neutral invest for growth Earnings: low, unstable, growing Cash flow: negative Strategy: analyze to determine whether business can be grown into a star, or will degenerate into a dog

High

Strategy:

Earnings: Cash flow:

high stable high stable milk

Earnings: Cash flow: Strategy:

low, unstable neutral or negative divest

Low

Strategy:

High

Relative Market Share

Low

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