Vertical Integration and Diversification

Horizontal Integration Vs Vertical Integration: with Definition \u0026 Comparison Chart
Horizontal Integration Vs Vertical Integration: with Definition \u0026 Comparison Chart

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Vertical Integration and Diversification
Be sure to see experienced and newer versions of the Instructor’s Manual at Chapter 8 Corporate Strategy: Vertical Integration and Diversification

Chapter Outline 8.1 What Is Corporate Strategy?
8.2 The Boundaries of the Firm Firms vs. Markets: Make or Buy? Alternatives on the Make-or-Buy Continuum 8.3 Vertical Integration along the Industry Value Chain Types of Vertical Integration 8.4 Corporate Diversification: Expanding Beyond a Single Market Types of Corporate Diversification Leveraging Core Competencies for Corporate Diversification Corporate Diversification and Firm Performance 8.5 Implications for the Strategist

Strategy Smart Videos Vertical integration explained with H&M
A vertically integrated retailer 1:05 Minutes Topic: Vertical Integration Instructors: This short video shows the various steps needed to get clothes designed, manufactured and retailed at H&M stores.

Strategy Smart Videos Poultry industry and vertical integration
Kristen Oaks 2:56 Minutes Topic: Vertical Integration Instructors: This local TV show in Louisiana discusses how the chicken farmers in the depression started vertical integration which is largely responsible for the poultry industry to get ahead of other meat products.

Strategy Smart Videos DeltaDental
Inefficient diversification explained with humor 0:33 Minutes Topic: Diversification Instructors: This short commercial for Delta Dental shows some funny combinations of businesses.

Strategy Smart Videos Concentration versus diversification
4:29 Minutes Topics: Diversification; Related vs. Unrelated; Benefits & Risks, Industry Life Cycle Instructors: This video clip is a lecture from an online course produced by UNSW Australia. It is part of a Master of Business and Technology program. It was posted in and brings in some examples of related or unrelated industries during the lecture.

Refocusing GE: A Future of Clean-Tech and Health Care?
ChapterCase 8 Courtesy of GE Healthcare Refocusing GE: A Future of Clean-Tech and Health Care? In 2008, more than half of GE’s profits came from GE Capital. Global financial crisis hit the company hard. Stock price fell from $42.12 to $6.66 in 17 months! GE launched two strategic initiatives: Ecomagination- clean-tech focus Healthymagination – increase access and reduce costs of health care services Also sold 51% of NBC to Comcast in 2011 and the rest in 2013. Instructors: This brief case is designed to be a clear example of how senior leadership, combined with outside circumstances, can create major changes in where large (and also small) firms decide to compete. Most students will be familiar with General Electric from their long history and the many consumer products they have produced over the years. The students, however, are less likely to know about GE’s large investments in clean-technology and health care.

8.1 What Is Corporate Strategy?
CORPORATE-LEVEL STRATEGY Corporate strategy determines the firm’s boundaries along three dimensions: Industry value chain Range of products and services Where to compete: geography Key strategic management concepts used here: Core competencies – unique strengths Economies of scale – average cost per unit decreases Economies of scope – savings producing two (or more) outputs Transaction costs – all internal and external costs associated with an economic exchange Instructors: Consideration is given here to the three dimensions of corporate strategy. The dimensions are NOT independent of each other and, as noted in the “Consider This…” extension to the chapter opener, they can either reinforce each other or conflict with one another. We find it valuable here in Chapter 8 to note that we are finally at the part of strategy that many students thought was all they knew of strategy before they started this course. The “corner office” approach to strategy in many organizations tends to focus on strategic plans and corporate strategies emanating from the CEO’s office. Students are sometimes surprised at the relative simplicity of the dimensions in Exhibit 8.1 and yet the interaction of these dimensions yields a rich variety and depth of possible corporate actions (which we will be exploring also in Chapters 9, and 10). The IM also has a good suggestion about using the Walt Disney Company is an example firm to study all 3 dimensions of corporate strategy.

8.2 The Boundaries of the Firm
TRANSACTION COST ECONOMIES Explains and predicts the scope of the firm “Market vs. firms” have differential costs External transaction costs Costs associated with economic exchanges Ex: negotiating and enforcing contracts Internal transaction costs Costs pertaining to organizing an exchange within a firm Ex: recruiting & training employees Instructors: The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on the advantages and disadvantages of firms versus markets (LO 8-2). The IM has a simple suggestion to help students understand this concept. Some students are not comfortable with the term “transaction cost economics,” but the idea it portrays is actually not too difficult to understand. In many ways, we face make-or-buy decisions all the time and choose based on our often unexpressed understanding of the trade-offs. “I will stop to buy fast food on the way home from school because I want to spend my time at home making study cards for my upcoming exam.” This simplistic example says in essence, I’m going to buy my food raw materials so that my time is spent making cognitive learning for a more successful outcome on my exam tomorrow.

Exhibit 8.1 Internal and External Transaction Costs
Instructors: Exhibit 8.1 illustrates internal and external transaction costs. Transactions cost economics is a powerful yet relatively simple framework that explains much about the underlying causes of why firm boundaries are established within markets.

Firms vs. Markets: Make or Buy?
FIRST CORPORATE STRATEGY QUESTION If Cin-house < Cmarket, then vertically integrate (make) Ex: Google hires programmers to write code in-house rather than contracting out. Disadvantage of “make” in-house Principal–agent problem owner = principal, manager = agent Disadvantage of “buy” from markets Search cost Opportunism Information asymmetries These decisions determine the firm’s boundaries.

Exhibit 8.2 Organizing Economic Activity: Firms vs. Markets
Instructors: Exhibit 8.2 may be important to spend a few minutes on depicting the advantages and disadvantages of firms vs. markets. The underlying principal–agent problem is touched on several times in the textbook (including the stakeholder discussion brought up in Chapter 1 and again in Chapter 12). While terms such as information asymmetries sound difficult, the foundational concepts are pretty simple and are certainly important for students to understand. You might want to work through a simple example for students using this exhibit to consider a make vs. buy decision. One such example would be for a fitness gym, should they do maintenance on cardio machinery in-house or outsource it to a specialized firm? What are the relative advantages and disadvantages? Similarly, should a retailer run its own e-commerce site or outsource everything to Amazon?

Principal – owner of the firm, i.e., shareholders Agent – manager performing activities on behalf of the principal Separation of ownership and control – one of the hallmarks of a publicly traded company Principal−agent problem is almost inevitable. A manager may pursue his or her own interests such as job security and managerial perks (e.g., corporate jets and golf outings that conflict with the principal’s goals – in particular, creating shareholder value) One potential way to overcome the principal−agent problem is to give stock options to managers, thus making them owners.

Alternatives on the Make-or-Buy Continuum
Short-term contacts Competitive bidding process Less than one-year term Lower prices cost advantages Strategic alliances Facilitate investment without administrative costs Ex: Long-term contacts, equity alliances, joint ventures Parent–subsidiary relationship Most integrated alternative Parent companies have command and control Ex: GM owns Opel and Vauxhall in Europe

Exhibit 8.3 Alternatives on the Make-or-Buy Continuum

Toyota Locks Up Lithium for Car Batteries
Strategy Highlight 8.1 Toyota Locks Up Lithium for Car Batteries World demand for lithium-ion batteries for cars Grew from $278 million in ‘09 to $25 billion in 2014 Toyota wants to secure long-term supply to power its hybrid fleet of over 5 million hybrids sold. Orocobre holds rights to a large lithium deposit. Upfront investment to extract of lithium is very high. To encourage investment, Toyota invested $120 million in an equity position. Instructors: This highlight touches on an area of growing concern in the 21st century. The production of many of our electronics requires access to “rare earth metals,” and there are currently relatively few active mines for these materials, most of which are in China. Lithium mining is also not widely commercialized, thus spurring firms like Toyota to vertically integrate to assure critical supplies. The New York Times produced a six minute video in 2010 on China’s vital role in the supply of global rare earth metals. Video link is here: shipments-of-rare-earths.html?scp=1&sq=rare%20earth&st=cse The IM has an exercise building from this strategy highlight. (It would also be useful after watching the above video link). This highlight offers an opportunity for an exercise in strategic decision making skills. Ask students to review the drivers for supplier power from Chapter 3. Then ask that they identify a strategy that a firm can use to reduce its exposure to the high supplier power for this commodity in the auto manufacturing industry. One such option is Toyota’s backward integration strategy; it focuses on the threat of backward integration by the focal industry. Another strategic option is to reduce the amount of rare earth metals used in the car; it addresses the criticality of the supplier’s product to the focal industry product. A third strategy is to design multiple types of batteries that can be easily interchanged; this flexibility reduces switching costs. Students will also have other ideas.

8.3 Vertical Integration along the Industry Value Chain
In what stages of the industry value chain should the firm participate? Vertical integration Ownership of its inputs, production, & outputs in the value chain Vertical value chain Industry-level integration from upstream to downstream Examples: cell phone industry value chain Many different industries and firms Instructors: In Chapter 4, we introduced the concept of the firm-level internal value chain. That internal value chain depicts the activities the firm engages in to transform inputs into outputs, with activities ranging from basic R&D to customer service. Internal, firm-level value chains are also called horizontal value chains. Thus, there are two intersecting value chains: the industry value chain running vertically from upstream to downstream, and the firm-level value chain running horizontally.2 In this chapter on corporate strategy, the one of interest is the vertical, industry value chain, portrayed in Exhibit 8.4.

Exhibit 8.4 Backward and Forward Vertical Integration along an Industry Value Chain

Types of Vertical Integration
Full vertical integration Ex: Weyerhaeuser Owns forests, mills, and distribution to retailers Backward vertical integration Ex: HTC’s backward integration into design of phones Forward vertical integration Ex: HTC’s forward integration into sales & branding Not all industry value chain stages are equally profitable. Apple – designs in-house software and hardware but partners for manufacturing Porter’s five forces (Chapter 3) useful tool here

Exhibit 8.5 HTC’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry Instructors: Exhibit 8.5 offers an engaging illustration of the value chain for an industry. We find students often are intrigued with the stages their valued smartphones and other electronics go through before arriving at the store for them to purchase. You might want to ask where students see other parts of the smartphone ecosystem, such as app developers. Another example of vertical integration is steelmaker Nucor recently buying SHV North America, providing Nucor with global sourcing of scrap materials for its innovative technology using electric-arc furnaces.

Benefits and Risks of Vertical Integration
SOME BENEFITS OF VERTICAL INTEGRATION Securing critical supplies Lowering costs & improving quality Facilitating investments in specialized assets Increasing costs & reducing quality Reducing flexibility Increasing the potential for legal repercussions SOME RISKS OF VERTICAL INTEGRATION Instructors: The Onion is an organization in the U.S. that produces humorous parody articles and videos. Here they have produced a 2 ½ minute video on outsourcing (well really off-shoring) going too far. Link is Here: You may recall from chapter 3 that the soft drink industry is structured as an oligopoly and has good potential for profits. However one area that has shifted for both Coke and Pepsi over the years is their level of vertical integration particularly related to the bottling process. This illustrates some of the benefits and risks of vertical integration. Pepsi exited the bottling industry in Why did they buy back into this segment in 2009? Pepsi exited out of the capital intensive, low margin bottling industry in 1999 to concentrate on marketing. In 2009 they bought their major bottlers for $7.8 billion to obtain more control over its quality, pricing, distribution, and in-store display, to improve decision making, and to enhance flexibility to bring innovation products to the market faster.

Alternatives to Vertical Integration
Taper integration Backward integrated but also relies on outside market firms for supplies OR Forward integrated but also relies on outside market firms for some of its distribution Strategic outsourcing Moving value chain activities outside the firm’s boundaries Ex: PeopleSoft, EDS, and Perot Systems provide HR services to many firms that choose to outsource it. Instructors: End of Chapter Ethical/Social Issues Discussion Question 1 The chapter notes that some firms choose to outsource their human resource management systems. If a firm has a core value of respecting its employees and rewarding top performance with training, raises, and promotions, does outsourcing HR management show a lack of commitment by the firm? HR management systems are soft-ware applications that typically manage payroll, benefits, hiring and training, and performance appraisal. What are the advantages and disadvantages of this decision? Think of ways that a firm can continue to show its commitment to treat employees with respect. Suggested answer from the IM. A firm can make the argument that outsourcing to full-time HR professionals who focus only on providing superb HR services is indeed the best way to show respect for the employees of your firm. The text discusses strategic outsourcing and notes that many firms indeed will outsource their HR management systems to firms such as PeopleSoft or Perot systems. This could be the best way to show a commitment to a strong HR ethic of the firm by outsourcing to an industry leader. Some students will argue that if the firm is truly committed they should build their own competencies inside the firm. Indeed, it would be difficult to argue that the firm is going to be a differentiator and build competitive advantage around an HR system that is in common usage by a wide variety of firms.

Exhibit 8.6 Taper Integration along the Industry Value Chain

8.4 Corporate Diversification: Expanding Beyond a Single Market
SECOND CORPORATE STRATEGY QUESTION Degrees of diversification Range of products and services a firm should offer Ex: PepsiCo also owns Lay’s & Quaker Oats, but sold off KFC Differences in corporate strategy between KFC & Chick-fil-A Diversification strategies Product diversification Active in several different product categories Geographic diversification Active in several different countries Product–market diversification Active in a range of both products and countries

Types of Corporate Diversification
Single-business firm derives >95% from one business Google revenues from online search Dominant-business firm 70% to 95% from one business Harley-Davidson yields 10% revenues from clothing Related diversification strategy <70% from one business Related-constrained – leverage current competencies ExxonMobil strategic move into natural gas Related-linked – share only limited links to current business Amazon move into cloud computing, Kindle tablets, & video streaming Unrelated diversification <70% and few if any links among businesses (a conglomerate) GE, LG, Tata Instructors: What makes a diversification related? While at first Ecolab’s (disinfectants and detergents for restaurants and hospitals) 2013 acquisition of Champion Technologies (oil and gas drilling chemicals) may appear unrelated, the firm viewed it as related diversification. Certainly from a customer perspective they are unrelated. However, the underlying technology in both cases is chemical and the business models are similarly designed around frequently recurring sales. They diversification may also have been driven in part by the tremendous growth in gas drilling. So you can also use this example to emphasize that diversification strategies should be predicated at least in part on a five forces analysis to assess industry profit potential. (See “Ecolab to Buy Chemicals Firm Champion Technologies” Wall Street Journal 10/12/12.

Exhibit 8.7 Different Types of Diversification

Economies of scale & scope Sharing product/ service, technology, distribution resources UNRELATED DIVERSIFICATION Financial economies •Restructuring •Internal capital markets

The Tata Group: Integration at the Corporate Level
Strategy Highlight 8.2 The Tata Group: Integration at the Corporate Level Tata Group of India founded in 1868 – uses unrelated diversification Tea, hospitality, steel, IT, power, and automobiles 500,000 employees and $100 billion in annual revenues Tata Motors The luxury division with the Jaguar and Land Rover brands Focused differentiation strategy for developed markets The Nano car division with the Tata Nano brand Focused cost-leadership strategy for emerging markets Targets non-consumers moving up from mopeds and bicycles Instructors: Discussion suggestion from the IM: If you have international students from Asia in your class, you might invite a discussion about why conglomerates and conglomerate-like structures (keiretsu and chaebol) are so much more important to the competitive landscape than unrelated diversified firms are in the U.S. and European markets. Western investors have pushed firms to break up unrelated diversifications due to the performance disadvantage illustrated in Exhibit 8.9, but this trend has not carried into Asia. Collective cultures in some Asian countries place a stronger value on relationships, which creates an important type of core competency that can be leveraged across businesses, even unrelated businesses.

Leveraging Core Competencies for Corporate Diversification
Core competence Unique skills and strengths Allows firms to increase the value of product/service Lowers the cost Examples of core competencies are: Walmart − globally distributed supply chain at low cost Infosys − high-quality/low-cost IT services The core competence – market matrix Provides guidance to executives on how to diversify in order to achieve continued growth Instructors: The IM has several examples of firms that have added tourism to their core business. These build off the 1st small group exercise at the end of chapter. The exercise gives information on a large dairy farm that is building a big business out of tourism. A video about the farm can be found here: In your group, list other industry combinations you have seen be successful. Consider why you think the combination has been a success. Students will likely have many examples from their own experience or knowledge. Here are two examples to get the conversation going… In Louisville Kentucky, a Louisville Slugger baseball bat factory opened right along a major tourist road downtown. They give tours, have games for the kids, and sell bats and other baseball-related items. In Vacaville, California, a Jelly Belly jelly bean factory routinely has an hour wait for the factory tour (and free jelly bean samples at the end). They run the guided tour with photos at the workstations when the factory processes are closed or otherwise not running.

Exhibit 8.8 The Core Competence−Market Matrix

Corporate Diversification and Firm Performance
Does corporate diversification lead to superior performance? The critical question to ask: Are the individual businesses worth more under the company’s management than if each were managed in separate firms? Research finds an inverted U-shaped relationship Type of diversification Overall firm performance Instructors: The digital companion to this book McGraw-Hill Connect has an interactive exercise on this section of the textbook. It builds student confidence on how diversification may or may not impact performance (LO 8-8).

Exhibit 8.9 The Diversification-Performance Relationship
Instructors: From the IM: In Exhibit 8.9 we present empirical findings from prior research showing that some types of diversification produce better performance than others (on the average… but what CEO thinks they will get “average” results?!). Although diversification can create shareholder value in theory, it is often difficult to realize in practice. Why then do we see so much diversification taking place? One answer is the principal–agent problem discussed earlier, in which the interests of managers and shareholders diverge. Diversification generally leads to larger entities and thus bestows more power, prestige, and pay on corporate executives. In Chapters 11 and 12, we study organizational structure and corporate governance to understand how to align interests of managers and shareholders.

Provide economies of scale, which reduces costs
FOR DIVERSIFICATION TO ENHANCE FIRM PERFORMANCE…IT MUST DO AT LEAST ONE OF THE FOLLOWING: Provide economies of scale, which reduces costs Exploit economies of scope, which increases value Reduce costs and increase value Benefit from financial economies, including: Restructuring Using internal capital markets

Exhibit 8.10 Vertical Integration and Diversification: Sources of Value Creation and Costs
Instructors: Suggested additional exercise from the IM: Here is an example that could be used to teach or assess critical reasoning skills. Rovio, the maker of the Angry Birds game, has diversified into videos. (See “Rovio Mines Video with ‘Angry Birds Toons’” Wall Street Journal 3/11/13). What type of diversification is this? What are the benefits and risks of diversification into media other than games? Can you think of other related businesses that Rovio could profitably enter? On balance what diversification strategy would you recommend for Rovio? Justify your position with logical reasoning based on theory from the textbook. Students should be encouraged to refer to Exhibit 8.8 and provide arguments for their position that describe the applicability of Rovio’s core competencies, such as their characters and story lines’ to film and other media. They also should have arguments on the impact of this diversification strategy on Rovio’s value creation and costs, using Exhibit 8.10.

Boston Consulting Group (BCG) growth-share matrix
RESTRUCTURING The process of reorganizing and divesting business units such as GE in ChapterCase 8 InBev sold Busch Gardens and SeaWorld to focus on core. Boston Consulting Group (BCG) growth-share matrix Build market share with stars and question marks. Hold market share with cash cows. Harvest (milk) as much short-term cash as possible. Divest a dog business unit.

Exhibit 8.11 Restructuring the Corporate Portfolio: The Boston Consulting Group Growth-Share Matrix

8.5 Implications for the Strategist
Effective corporate strategy helps to gain and sustain a competitive advantage. Corporate strategy needs to be dynamic over time. GE CEO Jeffrey Immelt formulated a new corporate strategy in clean-tech and health care. (ChapterCase 8) Strategic positions of Nike and adidas another example adidas founded in 1924 focused on athletic shoes Integrated manufacturing model Globalization led adidas to less integration and wider sports apparel 2013 − 40% shoes, 50% apparel, 10% equipment Nike started in 1978 as a vertically disintegrated firm. Instructors: In a recent article, McKinsey consultants argue that firms are too slow to change their corporate asset allocation . They attribute this portfolio inertia to both internal resistance to change and the stock market’s aversion to the short term pain of the changes. They suggest that new CEOs should take quick bold action to reallocate resources. Choose at new CEO who has just taken the helm of a firm at the time that your course is offered. At the time of this writing, for example, Microsoft is seeking a new CEO. Assign the students to look on the firm’s website and map out its corporate strategy in terms of diversification and vertical integration. Then show this brief video in class (about 5 minutes). Ask students to work in small groups to develop at least one suggestion for a reallocation of resources that the new CEO should consider. Video Link Here: &Height=270&Width=480

Exhibit 8.12 Dynamic Corporate Strategy: Nike versus adidas

ChapterCase 8 Consider This…
Courtesy of GE Healthcare Consider This… 2012 – GE split the energy business into three SBUs: Power and Water; Oil and Gas; and Energy Management. This move has both internal and external benefits. GE increasing its global footprint International sales were 19% in 1980; to over 52% in 2012. Tackling big problems is a strength for a conglomerate. India is seeking to replicate a “leap frog” approach in energy similar to that used in telecommunications. Challenges for firms based in developed economies Need robust solutions yet very economical Instructors: The text provides some questions here that may be good for class discussion or assignment. Below is one of our favorites for an assignment with some thoughts on the answer from the IM. Where do ecomagination and healthymagination fit on the core competence– market matrix for GE? (See Exhibit 8.8.)? The “consider this” material on energy technologies indicates that GE is looking to build upon some of their excellent engineering skills and expand into new energy markets, particularly internationally. This would correspond to the lower right box of Exhibit 8.8 (existing competence and new market). The ChapterCase opener notes that GE plans to spend $6 billion dollars on health care between 2009 and We could take this as an indication that GE needs to invest in new core competencies. GE already has a substantial health care business and it would seem, based on the data available in this chapter (and also in Chapter 7 on innovations such as the handheld ultrasound scanner), that GE is extending an existing market with new core competencies, which is the upper left quadrant of Exhibit 8.8.

Take-Away Concepts LO 8-1
Corporate strategy addresses “where to compete.” Business strategy addresses “how to compete.” Corporate strategy concerns the boundaries of the firm along three dimensions: (1) industry value chain, (2) products and services, and (3) geography (regional, national, or global markets). To gain and sustain competitive advantage, any corporate strategy must support and strengthen a firm’s strategic position, regardless of whether it is a differentiation, cost-leadership, or integration strategy. LO 8-1 Define corporate strategy and describe the three dimensions along which it is assessed.

Take-Away Concepts LO 8-2
Transaction cost economics help managers decide what activities to do in-house (“make”) versus to obtain from the external market (“buy”). When the costs to pursue an activity in-house are less than the costs of transacting in the market, then the firm should vertically integrate. Principal–agent problems and information asymmetries can lead to market failures. A principal–agent problem arises when an agent performing activities on behalf of a principal pursues his or her own interests. Information asymmetries arise when one party is more informed than another. Moving from less integrated to more fully integrated forms of transacting, alternatives include short-term contracts, strategic alliances, and parent–subsidiary relationships LO 8-2 Describe and evaluate different options firms have to organize economic activity.

Take-Away Concepts Vertical Integration Industry Value Chains
LO 8-3 Describe the two types of vertical integration along the industry value chain: backward and forward vertical integration. Vertical Integration Denotes a firm’s value added—what percentage of a firm’s sales is generated within a firm’s boundaries. Industry Value Chains (Vertical value chains) depict the transformation of raw materials into finished goods and services. Each stage typically represents a distinct industry in which a number of different firms are competing. Backward Vertical Integration Moving ownership of activities upstream nearer to the originating (inputs) point of the industry value chain. Forward Vertical Integration Moving ownership of activities closer to the end (customer) point of the value chain.

Identify and evaluate benefits and risks of vertical integration.
Take-Away Concepts Benefits of Vertical Integration Securing critical supplies Lowering costs Improving quality Facilitating scheduling and planning Facilitating investments in specialized assets Risks of Vertical Integration Increasing costs Reducing quality Reducing flexibility Increasing the potential for legal repercussions LO 8-4 Identify and evaluate benefits and risks of vertical integration.

Describe and examine alternatives to vertical integration.
Take-Away Concepts Taper Integration Strategy in which a firm is backwardly integrated but also relies on outside-market firms for some of its supplies, and/or is forwardly integrated but also relies on outside-market firms for some if its distribution. Strategic Outsourcing Moving one or more value chain activities outside the firm’s boundaries to other firms in the industry value chain. Off-shoring is the outsourcing of activities outside the home country. LO 8-5 Describe and examine alternatives to vertical integration.

Describe and evaluate different types of corporate diversification.
Take-Away Concepts A single-business firm derives 95% or more of its revenues from one business. A dominant-business firm derives between 70 and 95% of its revenues from a single business, but pursues at least one other business activity. A firm follows a related diversification strategy when it derives less than 70% of its revenues from a single business activity, but obtains revenues from other businesses linked to the primary business activity. (related-constrained or related-linked) A firm follows an unrelated diversification strategy when less than 70% of its revenues come from a single business, and there are few, if any, linkages among its businesses LO 8-6 Describe and evaluate different types of corporate diversification.

Take-Away Concepts LO 8-7
When applying an existing/new dimension to core competencies and markets, four quadrants emerge, depicted in Exhibit 8.8. The lower-left quadrant combines existing core competencies with existing markets. Consider ideas of how to leverage existing core competencies to improve their current market position. The lower-right quadrant combines existing core competencies with new market opportunities. Consider how to redeploy and recombine existing core competencies to compete in future markets. The upper-left quadrant combines new core competencies with existing market opportunities. Consider strategic initiatives of how to build new core competencies to protect and extend the firm’s current market position. The upper-right quadrant combines new core competencies with new market opportunities. This is likely the most challenging diversification strategy because it requires building new core competencies to create and compete in future markets LO 8-7 Apply the core competence–market matrix to derive different diversification strategies.

Take-Away Concepts The diversification-performance relationship is a function of the underlying type of diversification. The relationship between the type of diversification and overall firm performance takes on the shape of an inverted U (see Exhibit 8.9). Unrelated diversification often results in a diversification discount: the stock price of such highly diversified firms is valued at less than the sum of their individual business units. Related diversification often results in a diversification premium: the stock price of related-diversification firms is valued at greater than the sum of their individual business units. In the BCG matrix, the corporation is viewed as a portfolio of businesses, much like a portfolio of stocks in finance (see Exhibit 8.11). The individual SBUs are evaluated according to relative market share and the speed of market growth, and are plotted using one of four categories: dog, cash cow, star, and question mark. Each category warrants a different investment strategy. Both low levels and high levels of diversification are generally associated with lower overall performance, while moderate levels of diversification are associated with higher firm performance. LO 8-8 Explain when a diversification strategy creates a competitive advantage and when it does not.

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