Topic 4:

Corporate-Level Strategy

Chapter 6: Corporate-Level Strategy and Diversification

Introduction

As businesses grow, they often look beyond their initial markets, seeking opportunities in new arenas. This chapter delves into the strategies that guide these high-level decisions. For you, the college student, understanding corporate-level strategy is like gaining a bird's-eye view of the business world. It is about seeing the bigger picture, connecting the dots, and recognizing vast opportunities.

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6-1. Corporate-Level Strategy Defined

Corporate-level strategy determines the scope and direction of a firm's activities and the industries in which the firm competes. Its primary purpose is to identify how the firm can add value to its different business units while achieving overarching organizational objectives.

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6-2. Levels of Diversification

Diversification can be categorized into:

Single Business: More than 95% of revenue comes from a single business.
Dominant Business: Between 70% to 95% of revenue comes from a dominant business, with other businesses playing a supporting role.
Related Diversification: Less than 70% of revenue comes from the main business, and there are linkages among the firm's businesses.
Unrelated Diversification: Less than 70% of revenue comes from the main business, with no linkages among the firm's businesses.

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6-3. Reasons for Diversification

Value Creation: Diversification can lead to economies of scope, where the firm can use its core competencies to increase value across its businesses.
Risk Reduction: Diversifying can spread risks across a broader revenue base.
Profit Maximization: Entering profitable industries can increase overall returns.

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6-4. Value Creation in Related Diversification

Using a related diversification strategy, firms can create value through:

Sharing Activities: Sharing resources and activities across businesses can lead to economies of scale, reducing costs.
Transferring Core Competencies: Corporate-level core competencies can be applied across multiple business units, leading to competitive advantage.
Market Power: Leveraging its position in one business to establish a competitive advantage in another, often through multipoint competition or vertical integration.

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6-5. Value Creation in Unrelated Diversification

Unrelated diversification can create value through:

Corporate Parenting: The corporate office can add value through its management expertise, improving the efficiency and profitability of its business units.
Financial Economies: The firm can create value by leveraging its internal capital market, optimizing resource allocation, and improving financial returns.

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6-6. Incentives and Resources Encouraging Diversification

Antitrust Regulation: Regulations can prevent firms from dominating a single industry, pushing them to diversify.
Tax Incentives: Tax benefits can make diversification financially attractive.
Low Performance: Firms with declining performance in their primary industry might diversify to improve returns.
Synergy: The belief that the combined performance of the diversified firm will exceed the sum of its parts.

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6-7. Motives for Over-Diversification

Managerial Self-Interest: Managers might diversify to increase their compensation or job security.
Compensation: Managerial compensation might be tied to the size or complexity of the firm rather than its profitability.
Power and Prestige: Managing a larger, more diversified firm can enhance a manager's power and prestige.

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Conclusion

Corporate-level strategy is pivotal in determining a firm's diversification path. While diversification can offer numerous benefits, from risk reduction to value creation, it is essential for firms to ensure that their diversification strategies align with their core competencies and market opportunities. Over-diversification, driven by misaligned incentives, can dilute a firm's focus and erode value.

MEGA Moment

Depending on your instructor and class modality, you may soon have access to very detailed financial information regarding each of your competitors. This information can be overwhelming and is typically less significant to participants early in the simulation. When and if these data are available, you will have as much financial information about your competitors as you have about your own company.

A clever team will dissect their competitors' financial statements in an attempt to determine their strategies. To be clear, you will never "know" your competition's strategy, but one must attempt to gain directional insight in order to deploy your resources for maximum impact.

Access to and analysis of complete financial statements for your competitors will provide you with many clues regarding their business-level and corporate-level strategies. Are your competitors focusing more on some of their business units than others? Are some of your competitors investing heavily in business units where costs are low and economies of scale are high? How about high margin cost? Is it apparent that some of your competition intends to specialize? What does this mean for your team? If there is a competitor you would like to surpass in the next decision, does your corporate strategy leverage the elements that give you the advantage you need to make that move?

You now have information relating to the fundamentals of business strategy, including:
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What is strategy?
External and industry scan
Internal analysis
Business-level strategy
Competitive dynamics
Corporate-level strategy

Apply your understanding of these concepts iteratively for each of the remaining MEGA decisions, leveraging the complete financial and market data given to all participants.

Depending on your instructor and class modality, you may have the opportunity to participate in an international merger. This happens in the decision in Round 4. This merger will offer new upside and risks to participants. It also further complicates the decision process and your competitive and financial analysis. Now is the time to review your understanding of the fundamentals of business strategy. If these are well understood, you are ready for the next challenge. You will soon be moving into M&A, International, Organizational, and Governance themes. Again, your understanding of each of these topics will be challenged through application in the simulation exercise.

Key Terms

Corporate-Level Strategy
Economies of Scope
Economies of Scale
Corporate-Level Core Competencies
Market Power

Multipoint Competition
Vertical Integration
Financial Economies
Synergy

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Topic 4 Mini Cases

6.1 Mini Case Study: "SteelMakers Inc. - A Leap Into Value-Creating Diversification"

Introduction: Diversification is a strategy that involves expanding a company's operations into new products or market areas. When diversification creates value and leverages economies of scope, it means the company can generate cost savings by sharing or transferring resources and capabilities across its businesses. In the context of related diversification, there are two types: related constrained and related linked. The former involves sharing more than just a few resources between businesses, while the latter involves only limited sharing or transferring of capabilities. This case study explores how SteelMakers Inc., a fictional steel company, embarked on a value-creating, related constrained diversification journey.

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Background: SteelMakers Inc. has been a dominant player in the steel industry for decades, known for its high-quality steel used primarily in construction. With a vast infrastructure of steel plants and a skilled workforce, the company has been looking for avenues to diversify its operations.

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The Diversification Move: Identifying a growing demand for specialized steel in the automobile industry, SteelMakers Inc. decided to diversify into producing high-strength, lightweight steel for car manufacturing. This type of steel would enhance fuel efficiency by reducing the vehicle's weight while ensuring safety through its strength.

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Economies of Scope:

Shared Resources: SteelMakers utilized its existing steel plants to produce this new type of steel, ensuring cost savings in infrastructure.
Transferred Capabilities: The company's R&D department, which had vast experience in steel innovation for construction, collaborated closely with automobile experts to develop the new product.
Joint Distribution Channels: SteelMakers leveraged its existing relationships with distributors, offering them both construction and automobile steel, leading to reduced distribution costs and increased bargaining power.

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Related Constrained Move: The diversification was a clear example of a related constrained move, for the following reasons:

High Degree of Sharing: SteelMakers did not just share a few resources or capabilities between its construction steel and automobile steel businesses. Instead, it deeply integrated its production facilities, R&D, and distribution channels to serve both markets.
Common Core Competencies: The core competency of producing high-quality steel was central to both the original and diversified business, making the diversification constrained to this competency.

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Conclusion: SteelMakers Inc.'s foray into the automobile steel segment demonstrates the power of value-creating, related constrained diversification. By leveraging economies of scope and building upon their core competencies, the company not only tapped into a new revenue stream but also enhanced its overall competitive advantage. This case underscores the importance of understanding the nuances of diversification and how deep integration between businesses can lead to significant value creation.

6.2 Mini Case Study: "SteelMakers Elite - Harnessing Market Power Through Related Linked Diversification"

Introduction: Diversification strategies can be driven by various motivations. While economies of scope focus on cost savings from shared operations, market power is about improving competitive positioning by leveraging relationships between different businesses. In the realm of related diversification, a related linked strategy involves diversifying into businesses that are related at some level but do not necessarily share a high degree of operational commonality. This case study explores SteelMakers Elite's journey of tapping into market power through a related linked diversification strategy.

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Background: SteelMakers Elite, a subsidiary of the larger SteelMakers Inc., has been a leader in producing specialized steel for high-end architectural projects. With a reputation for premium products, they have built strong relationships with elite architectural firms and luxury real estate developers.

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The Diversification Move: Identifying an opportunity in the luxury interior design market, SteelMakers Elite decided to diversify into producing high-end steel-based furniture and decor. This new venture, named "EliteDecor," would cater to the upscale clientele of luxury homes and offices.

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Market Power:

Leveraged Relationships: SteelMakers Elite utilized its strong connections with architectural firms and real estate developers to introduce EliteDecor. These firms, already trusting the SteelMakers brand, were more inclined to recommend or use EliteDecor in their projects.
Bundled Offerings: SteelMakers Elite offered bundled deals, providing discounts to clients who opted for both their architectural steel and EliteDecor products.
Exclusive Access: Given their reputation, SteelMakers Elite had access to exclusive design events, expos, and trade shows, providing EliteDecor with a platform to reach its target audience effectively.

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Related Linked Strategy: The move to high-end steel decor was a classic example of a related linked diversification, for the following reasons:

Limited Operational Overlap: While both businesses revolved around steel, their production processes, design considerations, and target market nuances were distinct. The architectural steel was about structural integrity and grandeur, while EliteDecor focused on aesthetics and craftsmanship.
Strategic Link: The link between the two businesses was not in shared operations but in the brand reputation and client relationships. The trust and prestige associated with SteelMakers Elite were the bridges that connected its core business with its diversified venture.

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Conclusion: SteelMakers Elite's venture into the luxury decor segment showcases the potential of market power-driven, related linked diversification. By leveraging brand reputation and established relationships, the company could enter a new market segment with a competitive edge. For students comparing the two cases, the distinction is clear: while the first case emphasized operational synergies (economies of scope) and deep integration (related constrained), this case pivots on leveraging market relationships (market power) with strategic, yet limited operational overlap (related linked).