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Chapter Six Corporate-Level Strategy:Creating Value through Diversification
Learning Objectives TRANSPARENCY-51 After studying 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 • How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis • The various means of engaging in diversification—mergers and acquisitions, joint ventures/strategic alliances, and internal development • Managerial behaviors that can erode the creation of value
TRANSPARENCY-52 Diversification and Corporate Performance: A Disappointing History Exhibit 6.1 The summaries of the studies below consistently support the notion that attaining the intended payoffs from diversification efforts are very elusive: • Michael Porter of Harvard University studied the diversification records of 33 large, prestigious U.S. companies over the 1950-1986 period and found that most of them have divested many more acquisitions than they had kept. The corporate strategies of most companies had dissipated rather than enhanced shareholder value—by taking over companies and breaking them up, corporate raiders had thrived on failed corporate strategies. • Another study evaluated the stock market reaction to 600 acquisitions over a period between 1975 and 1991. The results indicate that acquiring firms suffered an average 4 percent drop in market value (after adjusting for market movements) in the three months following the acquisition announcement. • A study conducted jointly by Business Week and Mercer Management Consulting, Inc., analyzed 150 acquisitions worth more than $500 million that took place between July 1990 and July 1995. Based on total stock returns from three months before the announcement and up to three years after the announcement: 30 percent substantially eroded shareholder returns. 20 percent eroded some returns. 33 percent created only marginal returns. 17 percent created substantial returns. • A study by Salomon Smith Barney of U.S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquiring firms have, on average, under-performed the S&P stock index by 14 percentage points and under-performed their peer group by four percentage points after the deals were announced. Sources: Lipin, S. & Deogun, N. 2000. Big merges of the 90’s prove disappointing to shareholders. Wall Street Journal, October 30: C1; A study by Dr. G. William Schwert, University of Rochester, cited in Pare, T. P. 1994. The new merger boom. Fortune, November 28:96; and Porter, M.E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3):43.
TRANSPARENCY-53 Creating Value through Related and Unrelated Diversification Exhibit 6.2 Related Diversification: Economies of Scope Leveraging Core Competences • 3M leverages its competences in adhesives technologies to many industries, including automotive, construction, and telecommunications Sharing Activities • McKesson, a large distribution company, sells many product lines such as pharmaceuticals and liquor through its super warehouses Related Diversification: Market Power Pooled Negotiating Power • The 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 Integration • Shaw 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 Unrelated Diversification: Parenting, Restructuring, and Financial Synergies Corporate Restructuring and Parenting • The 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 Analysis • Novartis, formerly Ciba-Geigy, uses portfolio analysis to improve many key activities, including resource allocation as well as reward and evaluation systems.
TRANSPARENCY-54 Simplified Stages of Vertical Integration: Shaw Industries Exhibit 6.3 PolypropyleneFiber Production Carpet Manufacturing Retail Stores Raw Materials Manufacturing of final product Distribution Backward Integration Forward Integration
TRANSPARENCY-55 Benefits and Risks of Vertical Integration Exhibit 6.4 Benefits • Secure a source of raw materials or distribution channels • Protection and control over valuable assets • Access to new business opportunities • Simplified procurement and administrative procedures 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 associatedwith managing a more complex set of activities
22% Stars Question Marks 20% 18% 16% 14% Business Growth Rate 12% 10% Cash Cows Dogs 8% 6% 4% 2% 0.5X 0.4X 0.3X 0.2X 0 4X 10X 1X 0.1X 1.5X 2X Relative Market Share TRANSPARENCY-56 The BCG Portfolio Matrix Exhibit 6.5 Notes: 1. Each circle represents one of the corporation’s business units. The size of the circle represents the relative size of the business unit in terms of revenues. 2. Relative market share is plotted as a logarithmic scale to be consistent with experience curve effects. This is very similar to learning curves and central to the BCG growth share matrix. 3. Relative market share is measured by the ratio of the business unit’s size to that of its largest competitor.
TRANSPARENCY-57 The top ten mergers Exhibit 6.6 Below are the world’s biggest mergers. Listed are the partners, each deal’s status or date of completion, and values in billions. Sources: Thomson Financial Securities Data; AP Wire Reports
TRANSPARENCY-58 The Seven Habits of a Less-Than-Effective Merger Exhibit 6.7 HABIT #1 Be proactive: “Act or be acted upon.” REALITY Company was slow to see the potential of electronic planning devices which initially cut into product sales. HABIT #2 Begin with the end in mind: “You carefully think through the product or the service that you want to provide in terms of your market target, then you organize all the elements . . . to meet that objective.” REALITY The company delayed selling off noncore assets, such as a commercial printing business, which occupied management time and cut into profit margins. Now it’s being sold off. HABIT #3 Put first things first: “Organize and execute around priorities.” REALITY After the 1997 merger between Covey’s company and Franklin Resources, management didn’t trim overlapping jobs—thus increasing overhead and hurting margins. HABIT #4 Think win/win: “There’s plenty for everybody . . . . One person’s success is not achieved at the expense or the exclusion of the success of others.” REALITY The two sales staffs were combined, but initially the compensation systems were not. That caused resentment among those who made less. HABIT #5 Seek first to understand, then to be understood: “An effective salesperson first seeks to understand the needs, the concerns, the situation of the customer.” REALITY Most sales staff was kept at Utah headquarters, so the company was unable to assess changing client needs out in the field. HABIT #6 Synergize: “We create new alternatives—something that wasn’t there before.” REALITY The combined company maintained two headquarters, limiting opportunities to build on each other’s strengths. HABIT #7 Sharpen the saw: “Preserv[e] and enhanc[e] the greatest asset that you have—you . . . . Renew the four dimensions of your nature—physical, spiritual, mental, and social/emotional.” REALITY Company was true to this principle by giving workers Sundays off. But that meant closing its 127 stores on a busy shopping day. Source: Grover, R. 1999. Gurus who failed their own course. Business Week, November 8, 125-126.