IE ELEC 102: Strategic Management

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A Report on Corporate-Level Strategy

presented to the
Department of Industrial Engineering
of the School of Engineering of the
University of San Carlos
Cebu City, Philippines
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By:

Pacaldo, Ma. Celaine

Panghulan, Sifa Marie

Ruiz, Ezra

Quiao, Thea

Submitted to:

Engr. James Anthony T. Toledo, MBA, MM

Instructor
Corporate-Level Strategy and its Purpose
Corporate-level strategies, which are strategies firms use to diversify their operations from a
single business competing in a single market into several product markets—most commonly, into
several businesses. Thus, a corporate-level strategy specifies actions a firm takes to gain a
competitive advantage by selecting and managing a group of different businesses competing in
different product markets. Corporate-level strategies help companies to select new strategic
positions—positions that are expected to increase the firm’s value.

Because the diversified firm operates in several different and unique product markets and likely in
several businesses, it forms two types of strategies: corporate-level (company wide) and business-
level (competitive). Corporate-level strategy is concerned with two key issues: in what product
markets and businesses the firm should compete and how corporate headquarters should manage
those businesses. As is the case with a business-level strategy, a corporate-level strategy is expected
to help the firm earn above-average returns by creating value. Some suggest that few corporate-
level strategies actually create value.

Other Product/ Market Growth Strategies

· MARKET DEVELOPMENT - moving into different geographic markets

· PRODUCT DEVELOPMENT - developing new products and/or significantly improving on

existing products

· HORIZONTAL INTEGRATION - acquisition of competitors; horizontal movement at the same

point in the value chain

· VERTICAL INTEGRATION - becoming your own supplier or distributor through acquisition;

vertical movement up or down the value chain

Corporate-Level Strategy: Diversification

PRODUCT DIVERSIFICATION - a primary form of corporate-level strategies; concerns the scope of

the markets and industries in which the firm competes as well as “how managers buy, create, and
sell different businesses to match skills and strengths with opportunities presented to the firm.”

Successful diversification is expected to:

 o Reduction in profitability variability as earnings are generated from different
businesses

o Independence/flexibility to shift investments to those markets with the greatest

returns

And this is really why incorporating level strategy diversification is a really important topic to
cover. It concerns the scope of the markets and industries in which our firm is going to compete in.
So the ideal portfolio of businesses balances diversifications, costs and benefits.

Levels of Diversification (diagram)

So, you can see here in the diagram there’s different levels of diversification. You have low
levels, right up to very high levels of diversification. You can go through each of those and look at
ways in which, sometimes we talk about where you have low levels of diversification, maybe 95% of
revenue comes from one business. Whereas if we look at highly diversified companies that may be
less than 70% of revenue comes from the dominant business. Sometimes, as you can see, there will
be links between each of the businesses and we say that is high levels of related, and then you have
completely unrelated diversification where there’s no links between, as you can see here in the
diagram, businesses A, B and C.

Levels of diversification: Low levels

1. Low Levels

• Single Business Strategy

• Corporate-level strategy in which the firm generates 95% or more of its

sales revenue from its core business area

EXAMPLE: WRIGLEY

• Wm. Wrigley Jr. Company, the world’s largest producer of chewing and
bubble gums, historically used a single-business strategy while operating
in few product markets

• 2005: Wrigley employed the dominant-business strategy, when it

acquired the confectionary assets of Kraft Foods Inc., including Life
Savers and Altoids.

• 2008- Wrigley was acquired by Mars, a privately held global confection

company.

1. Low Levels

• Dominant Business Diversification Strategy

• Corporate-level strategy whereby firm generates 70-95% of total sales

revenue within a single business area

EXAMPLE: UPS

• United Parcel Service (UPS) uses this strategy. UPS generates 60 percent of its revenue
from its U.S. package delivery business and 22 percent from its international package
business, with the remaining 18 percent coming from the firm’s non-package business

Levels of diversification: Moderate to high levels

2. Moderate to High Levels

• Related Constrained Diversification Strategy

• Less than 70% of revenue comes from the dominant business

• Direct links (i.e., share products, technology, and distribution linkages)

between the firm's businesses

EXAMPLES:

• The Publicis Groupe uses a related constrained strategy, deriving value from the potential
synergy across its various groups (mobile and interactive online communication,
television, magazines and newspapers, cinema and radio, and outdoor signage),
especially the digital capabilities in its advertising business. Given its recent performance,
the related constrained strategy has created value for Publicis customers and its
shareholders by helping target particular audiences through appropriate media and digital
strategies.

2. Moderate to High Levels

• Related Linked Diversification Strategy (mixed related and unrelated)

• Less than 70% of revenue comes from the dominant business

• Mixed: Linked firms sharing fewer resources and assets among their
businesses (compared with related constrained), concentrating on the
transfer of knowledge and competencies among the businesses

EXAMPLE:

GE uses a related-linked corporate-level diversification strategy. Compared with related constrained firms,
related linked firms share fewer resources and assets between their businesses, concentrating instead on
transferring knowledge and core competencies between the businesses.

Levels of diversification: Very High Levels: Unrelated

3. Very High Levels: Unrelated

• Less than 70% of revenue comes from dominant business

• No relationships between businesses

EXAMPLES:

• Hutchison Whampoa Limited (HWL) HWL is a leading international corporation with five
core businesses: ports and related services; property and hotels; retail; energy,
infrastructure, investments and others; and telecommunications. These businesses are
not related to each other, and the firm makes no efforts to share activities or to transfer
core competencies between or among them. Each of these five businesses is quite large
as exemplified by the retailing arm of the retail and manufacturing business which has
more than 9,300 stores in 33 countries. Groceries, cosmetics, electronics, wine, and
airline tickets are some of the product categories featured in these stores. This firm’s size
and diversity suggest the challenge of successfully managing the unrelated diversification
strategy.
Reasons for Diversification
Value-Creating Diversification: Related Constrained and Related Linked Diversification

This figure, figure 6.2, shows that there are two ways that diversification strategies can
create value, which are the: (1) Operational relatedness and (2)Corporate relatedness. Studies of
these independent relatedness dimensions show the importance of resources and key
competencies.
 The vertical dimension of the figure depicts opportunities to share operational activities
between businesses (operational relatedness) while the horizontal dimension suggests
opportunities for transferring corporate-level core competencies (corporate relatedness).

In the upper left quadrant (Related Constrained Diversification), means that firms with a
strong capability in managing operational synergy, especially in sharing assets between its
businesses will likely fall in this quadrant.

The lower quadrant of the figure (Related Linked Diversification) represents a highly
developed corporate capability for transferring one of more core competencies across businesses.
Unrelated diversification (which will be discussed later) is also illustrated in Figure 6.2 in the lower
left quadrant. Financial economies, rather than either operational or corporate relatedness, are the
source of value creation for firms using the unrelated diversification strategy.

With the related diversification corporate-level strategy, the firm builds upon or extends its:
● Resources,
● Capabilities, and
● Key Competencies
to build a competitive advantage by creating value for customers.

Economies of scope are cost savings a firm creates by successfully sharing resources and
capabilities or transferring one or more corporate-level core competencies that were developed in
one of its businesses to another of its businesses.

As illustrated in Figure 6.2, firms seek to create value from economies of scope through two
basic kinds of operational economies:
(1) sharing activities (operational relatedness)
(2) transferring corporate-level core competencies (corporate relatedness)

The difference between sharing activities and transferring competencies is based on how
separate resources are jointly used to create economies of scope.

● 6-3a Operational Relatedness: Sharing Activities

 Firms can create operational relatedness by sharing either a primary activity (e.g., inventory
delivery systems) or a support activity (e.g., purchasing practices). Firms using the related
constrained diversification strategy share activities in order to create value. Procter & Gamble uses
this corporate-level strategy.

This can be risky also because ties among firm’s business creates links between outcomes.
For instance, if demand for one business’s product is reduced, it may not generate sufficient
revenues to cover the fixed costs required to operate the shared facilities. These types of
organizational difficulties can reduce activity-sharing success. Additionally, activity sharing requires
careful coordination between the businesses involved.

Although activity sharing across businesses is not risk-free, research shows that it can create
value and can gain economies of scope. Gaining economies of scope by sharing activities across a
firm’s businesses may be important in reducing risk and in creating value.
More attractive results are obtained through activity sharing when a strong corporate
headquarters office facilitates it.

● 6-3b Corporate Relatedness: Transferring of Core Competencies

Corporate-level core competencies are complex sets of resources and capabilities that link
different businesses, primarily through managerial and technological knowledge, experience, and
expertise.

Two sources of value creation:

● Expense incurred in first business and knowledge transfer reduces resource
allocation for second business.
● Intangible resources are difficult for competitors to understand and imitate, so
immediate competitive advantage over competition.

One way managers facilitate the transfer of corporate-level core competencies is by moving
key people into new management positions. However, the manager of an older business may be
reluctant to transfer key people who have accumulated knowledge and experience critical to the
business’s success. Research also suggests too much dependence on outsourcing can lower the
usefulness of core competencies thereby, reducing their useful transferability to other business units
in the diversified firm.

● 6-3c Market Power

May be relevant for:
● Related constrained, or
● related linked strategy

Market Power is when a firm is able to sell its products above the existing competitive level
or to reduce the costs of its primary and support activities below the competitive level, or both. In
addition to efforts to gain scale as a means of increasing market power, firms can foster increased
market power through: multipoint competition and vertical integration.

Multipoint competition exists when two or more diversified firms simultaneously compete
in the same product areas or geographical markets. Through multi-point competition, rival firms
often experience pressure to diversify because other firms in their dominant industry segment have
made acquisitions to compete in a different market segment.

Some firms using a related diversification strategy engage in vertical integration to gain
market power. Vertical integration exists when a company produces its own inputs (backward
integration) or owns its own source of output distribution (forward integration). It is commonly used
in the firm’s core business to gain market power over rivals.

Market power is gained as the firm develops the ability to save on its operations, avoid
sourcing and market costs, improve product quality, possibly protect its technology from imitation
by rivals, and potentially exploit underlying capabilities in the marketplace.

● 6-3d Simultaneous Operational Relatedness and Corporate Relatedness

Some firms simultaneously seek operational and corporate relatedness to create economies
of scope. The ability to simultaneously create economies of scope by sharing activities (operational
relatedness) and transferring core competencies (corporate relatedness) is difficult for competitors
to understand and learn how to imitate. Many such efforts often fail because of implementation
difficulties. If the cost of realizing both types of relatedness is not offset by the benefits created, the
result is diseconomies because the cost of organization and incentive structure is very expensive.
6.4 Unrelated Diversification
Firms do not seek either operational relatedness or corporate relatedness when using the
unrelated diversification corporate-level strategy. An unrelated diversification strategy
(see Figure 6.2) can create value through two types of financial economies. Financial
economies are cost savings realized through improved allocations of financial resources
based on investments inside or outside the firm.
Efficient internal capital allocations can lead to financial economies. Efficient internal
capital allocations reduce risk among the firm’s businesses—for example, by leading to
the development of a portfolio of businesses with different risk profiles. The second type
of financial economy concerns the restructuring of acquired assets. Here, the diversified
firm buys another company, restructures that company’s assets in ways that allow it to
operate more profitably, and then sells the company for a profit in the external market.

Efficient Internal Capital Market Allocation

In a market economy, capital markets are believed to efficiently allocate capital. Efficiency
results as investors take equity positions (ownership) with high expected future cash-flow
values. Capital is also allocated through debt as shareholders and debt holders try to
improve the value of their investments by taking stakes in businesses with high growth
and profitability prospects.

In large diversified firms, the corporate headquarters office distributes capital to its
businesses to create value for the overall corporation. As exampled in the Strategic Focus,
GE has used this approach to internal capital allocation among its unrelated business
units. The nature of these distributions can generate gains from internal capital market
allocations that exceed the gains that would accrue to shareholders as a result of capital

being allocated by the external capital market. Because those in a firm’s corporate head-
quarters generally have access to detailed and accurate information regarding the actual
and potential future performance of the company’s portfolio of businesses, they have the
best information to make capital distribution decisions.

Restructuring of Assets
Financial economies can also be created when firms learn how to create value by buying,
restructuring, and then selling the restructured companies’ assets in the external market. As in the
real estate business, buying assets at low prices, restructuring them, and selling them at a price that
exceeds their cost generates a positive return on the firm’s invested capital. This is a strategy that
has been taken up by private equity firms, who buy, restructure and then sell, often within a four or
five year period. Unrelated diversified companies that pursue this strategy try to create financial
economies by acquiring and restructuring other companies’ assets, but it involves significant trade-
offs. For example, United Technologies as illustrated in the Strategic Focus has used this strategy.
Likewise, Danaher Corp.’s success requires a focus on mature manufacturing businesses because of
the uncertainty of demand for high-technology products. It has acquired 400 businesses since 1984
and applied the Danaher Business System to reduce costs and create a lean organization.

Value-Neutral Diversification: Incentives and Resources

The objectives firms seek when using related diversification and unrelated diversification
strategies all have the potential to help the firm create value through the corporate-level strategy.
However, these strategies, as well as single- and dominant-business diversification strategies, are
sometimes used with objectives that are value-neutral. Different incentives to diversify sometimes
exist, and the quality of the firm’s resources may permit only diversification that is value neutral
rather than value creating.

Incentives to Diversify
Incentives to diversify come from both the external environment and a firm’s internal
environment.
● Antitrust Regulation and Tax Laws
Government antitrust policies and tax laws provided incentives for U.S. firms to diversify in
the 1960s and 1970s. Antitrust laws prohibiting mergers that created increased market
power (via either vertical or horizontal integration) were stringently enforced during that
period. Merger activity that produced conglomerate diversification was encouraged
primarily by the Celler-Kefauver Antimerger Act (1950), which discouraged horizontal and
vertical mergers. As a result, many of the mergers during the 1960s and 1970s were
“conglomerate” in character, involving companies pursuing different lines of business.
Between 1973 and 1977, 79.1 percent of all mergers were conglomerate in nature.

● Low Performance
 Some research shows that low returns are related to greater levels of diversification.
If high performance eliminates the need for greater diversification, then low performance
may provide an incentive for diversification.

● Uncertain Future Cash Flows

As a firm’s product line matures or is threatened, diversification may be an important
defensive strategy.96 Small firms and companies in mature or maturing industries sometimes find it
necessary to diversify for long-term survival.
Diversifying into other product markets or into other businesses can reduce the uncertainty
about a firm’s future cash flows.

● Synergy and Firm Risk Reduction

Diversified firms pursuing economies of scope often have investments that are too inflexible
to realize synergy among business units. As a result, a number of problems may arise. Synergy exists
when the value created by business units working together exceeds the value that those same units
create working independently. However, as a firm increases its relatedness among business units, it
also increases its risk of corporate failure because synergy produces joint interdependence among
businesses that constrains the firm’s flexibility to respond.

6-5b Resources and Diversification

Resource-based theory can be confusing because the term resources is used in many different
ways within everyday common language. It is important to distinguish strategic resources from other
resources. To most individuals, cash is an important resource. Tangible goods such as one’s car and
home are also vital resources. When analyzing organizations, however, common resources such as
cash and vehicles are not considered to be strategic resources. Resources such as cash and vehicles
are valuable, of course, but an organization’s competitors can readily acquire them. Thus an
organization cannot hope to create an enduring competitive advantage around common resources.

A strategic resource is an asset that is valuable, rare, difficult to imitate, and nonsubstitutable.
Apple has many strategic resources, including their proprietary software and hardware platforms,
which have evolved from numerous innovations and improvements over literally decades; the Apple
store; many aspects of the overall buying experience including price; and a culture of innovation. It
didn’t hurt to have Steve Jobs, a charismatic, innovative thinker, as their CEO for many years. Many
computer companies have struggled to make money with razor-thin profit margins. Apple, using a
different business model focused on their strategic resources, has succeeded with years of record
profits. At one time, based on stocks, Apple was the most valuable company in the world.

The tangibility of a firm’s resources is an important consideration within resource-based theory.

Tangible resources are resources that can be readily seen, touched, and quantified, such as physical
assets, property, plant, equipment, and cash. In contrast, intangible resources are resources that are
difficult to see, touch, or quantify, such as the knowledge and skills of employees, a firm’s
reputation, and a firm’s culture. In comparing the two types of resources, intangible resources are
more likely to meet the criteria for strategic resources (i.e., valuable, rare, difficult to imitate, and
nonsubstitutable) than are tangible resources. Executives who wish to achieve long-term
competitive advantages should therefore place a premium on trying to nurture and develop their
firms’ intangible resources.

Diversification strategies are used to extend the company’s product lines and operate in
several different markets. The general strategies include concentric, horizontal and conglomerate
diversification.

Each strategy focuses on a specific method of diversification. The concentric strategy is used
when a firm wants to increase its products portfolio to include like products produced within the
same company, the horizontal strategy is used when the company wants to produce new products
in a similar market, and the conglomerate diversification strategy is used when a company starts
operating in two or more unrelated industries.

Diversification strategies help to increase flexibility and maintain profit during sluggish
economic periods.

6-6 Value-Reducing Diversification: Managerial Motives to Diversify

Managerial motives to diversify can exist independent of value-neutral reasons (i.e.,

incentives and resources) and value-creating reasons (e.g., economies of scope).
 The desire for increased compensation and reduced managerial risk are two motives for top-
level executives to diversify their firm beyond value-creating and value-neutral levels. In slightly
different words, top-level executives may diversify a firm in order to spread their own employment
risk, as long as profitability does not suffer excessively.

Diversification provides additional benefits to top-level managers that shareholders do not

enjoy. Research evidence shows that diversification and firm size are highly correlated, and as firm
size increases, so does executive compensation. Because large firms are complex, difficult-to-
manage organizations, top-level managers commonly receive substantial levels of compensation to
lead them, but the amounts vary across countries. Greater levels of diversification can increase a
firm’s complexity, resulting in still more compensation for executives to lead an increasingly
diversified organization. Governance mechanisms, such as the board of directors, monitoring by
owners, executive compensation practices, and the market for corporate control, may limit
managerial tendencies to over diversify. These mechanisms are discussed in more detail in Chapter
10.

In some instances, though, a firm’s governance mechanisms may not be strong, allowing
executives to diversify the firm to the point that it fails to earn even average returns. The loss of
adequate internal governance may result in relatively poor performance, thereby triggering a threat
of takeover. Although takeovers may improve efficiency by replacing ineffective managerial teams,
managers may avoid takeovers through defensive tactics, such as “poison pills,” or may reduce their
own exposure with “golden parachute” agreements. Therefore, an external governance threat,
although restraining managers, does not flawlessly control managerial motives for diversification.

Most large publicly held firms are profitable because the managers leading them are positive
stewards of firm resources, and many of their strategic actions, including those related to selecting
a corporate-level diversification strategy, contribute to the firm’s success. As mentioned,
governance mechanisms should be designed to deal with exceptions to the managerial norms of
making decisions and taking actions that increase the firm’s ability to earn above-average returns.
Thus, it is overly pessimistic to assume that managers usually act in their own self-interest as
opposed to their firm’s interest.

Top-level executives’ diversification decisions may also be held in check by concerns for their
reputation. If a positive reputation facilitates development and use of managerial power, a poor
reputation can reduce it. Likewise, a strong external market for managerial talent may deter
managers from pursuing inappropriate diversification. In addition, a diversified firm may acquire
other firms that are poorly managed in order to restructure its own asset base. Knowing that their
firms could be acquired if they are not managed successfully encourages executives to use value-
creating diversification strategies.

As shown in the figure, the level of diversification with the greatest potential positive effect
on performance is based partly on the effects of the interaction of resources, managerial motives,
and incentives on the adoption of particular diversification strategies. As indicated earlier, the
greater the incentives and the more flexible the resources, the higher the level of expected
diversification. Financial resources (the most flexible) should have a stronger relationship to the
extent of diversification than either tangible or intangible resources. Tangible resources (the most
inflexible) are useful primarily for related diversification.

As discussed in this chapter, firms can create more value by effectively using diversification
strategies. However, diversification must be kept in check by corporate governance. Appropriate
strategy implementation tools, such as organizational structures, are also important for the
strategies to be successful (see Chapter 11).
 We have described corporate-level strategies in this chapter. In the next chapter, we discuss
mergers and acquisitions as prominent means for firms to diversify and to grow profitably. These
trends toward more diversification through acquisitions, which have been partially reversed due to
restructuring (see Chapter 7), indicate that learning has taken place regarding corporate-level
diversification strategies. Accordingly, firms that diversify should do so cautiously, choosing to focus
on relatively few, rather than many, businesses. In fact, research suggests that although unrelated
diversification has decreased, related diversification has increased, possibly due to the restructuring
that continued into the 1990s through the early twenty-first century. This sequence of
diversification followed by restructuring has occurred in Europe and in countries such as Korea,
following actions of firms in the United States and the United Kingdom. Firms can improve their
strategic competitiveness when they pursue a level of diversification that is appropriate for their
resources (especially financial resources) and core competencies and the opportunities and threats
in their country’s institutional and competitive environments.