DIVERSIFICATION: Horizontal Expansion

Three Dimensions of Corporate Strategy Business Diversification Vertical Integration Geographic/global Expansion

Examples Then Now Coca Cola Eli Lily Honda Nintendo Nokia GE Sharp AT&T Samsung Daewoo

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

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

Corporate Advantages from Diversification (1) Sharing Linkages Between Businesses Bus. Bus. Bus. Bus. A B C D (2) Sharing Core Competence Bus. Bus. A B Core Competence Bus. Bus. C D

Corporate Advantages from Diversification Market Power Economies of Scope Economies of Internalizing Transactions Internal Market System Information Advantages

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

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

Diversification and Performance Diversification into related industries may be more profitable than into unrelated industries Source: Rumelt (1974)

Approaches to Corporate Strategy Related Diversification Strategies Sharing Activities Transferring Core Competencies Unrelated Diversification Strategies Efficient internal capital market allocation

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 & Gamble’s 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 Electric’s costs to advertise, sell and service major appliances are spread over many different products

BCG Growth-Share Matrix Earnings: high stable, growing Cash flow: neutral Strategy: 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 Annual real rate of market growth % Earnings: high stable Cash flow: high stable Strategy: milk Earnings: low, unstable Cash flow: neutral or negative Strategy: divest Low High Low Relative Market Share