Chapter

Six

Corporate-Level Strategy:
Creating Value through
Diversification

TRANSPARENCY-51

Learning
Objective
s

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 diversificationmergers and
acquisitions, joint ventures/strategic alliances, and internal
development
Managerial behaviors that can erode the creation of value

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

CHAPTER
6

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-52

Exhibit 6.1

Diversification and Corporate

Performance:
A Disappointing History
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 valueby 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

Sources: Lipin, S. & Deogun,

N. 2000. Big merges of the
90s 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.

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.

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

CHAPTER
6

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-53

Exhibit 6.2

Creating Value through Related and

Unrelated
Diversification
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 mediatelevision and newspapersin several
huge markets such as New York and Chicago
Vertical Integration
Shaw Industriesa giant carpet manufacturerincreases 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 asCHAPTER
well as reward and evaluation systems.

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-54

Exhibit 6.3

Simplified Stages of Vertical Integration:

Shaw Industries

Polypropylene
Fiber Production

Raw
RawMaterials
Materials

Carpet Manufacturing

Manufacturing
Manufacturingofoffinal
finalproduct
product

Backward Integration

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

Retail Stores

CHAPTER
6

Distribution
Distribution

Forward Integration

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-55

Exhibit 6.4

Benefits and Risks of Vertical Integration

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 associated with managing a more complex set

of activities

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

CHAPTER
6

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-56

Exhibit 6.5

The BCG Portfolio Matrix

22%

Stars

Question Marks

20%

Business Growth Rate

18%
16%
14%
12%
10%

Cash Cows

8%

Dogs

6%
4%

0.1X

0.2X

0.3X

0.4X

0.5X

1X

1.5X

2X

4X

10X

2%

Relative Market Share

Notes:
1. Each circle represents one of the corporations 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
units size to that of its largest competitor.
CHAPTER

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-57

Exhibit 6.6

The top ten mergers

Below are the worlds biggest mergers. Listed are the partners, each deals status
or date of completion, and values in billions.

Sources: Thomson
Financial
Securities Data; AP
Wire Reports

Partners

Date

1. Vodafone AirTouch PLC-Mannesmann AG

April 12, 2000

$161

2. Pfizer Inc.-Warner-Lambert Co.

June 19, 2000

$116

3. America Online-Time Warner

January 11, 2001

$111

4. Exxon Corp.-Mobil Corp.

Nov. 30, 1999

$81

5. (tie) Glaxo Wellcome PLC-SmithKline Beecham

PLC

December 27, 2000

$72

5. (tie) SBC Communications Inc.-Ameritech

Oct. 8, 1999

$72

7. Vodafone Group PLC-Airtouch Communications Inc.

June 30, 1999

$69

8. Bell Atlantic Corp.-GTE Corp. (now Verizon)

May 30, 2000

$60

9. Total Fina-Elf Aquitaine (now Total Fina Elf S.A.)

Feb. 9, 2000

$54

10. Viacom Inc.-CBS Corp.

May 4, 2000

$50

STRATEGIC MANAGEMENT
McGraw-Hill/Irwin

CHAPTER
6

Value ($ billions)

Gregory G. Dess and G. T. Lum

Copyright 2003 by The McGraw-Hill Companies, Inc. All rights

TRANSPARENCY-58

Exhibit 6.7

The Seven Habits of a Less-ThanEffective Merger

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 its being sold off.

HABIT #3

Put first things first: Organize and execute around priorities.

REALITY

After the 1997 merger between Coveys company and Franklin Resources, management didnt trim overlapping jobs
thus increasing overhead and hurting margins.

HABIT #4

Think win/win: Theres plenty for everybody . . . . One persons 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 alternativessomething that wasnt there before.

REALITY

The combined company maintained two headquarters, limiting opportunities to build on each others strengths.

HABIT #7

Sharpen the saw: Preserv[e] and enhanc[e] the greatest asset that you haveyou . . . . Renew the four dimensions
of your naturephysical, 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
Source: Grover, R. 1999. Gurus who failed their own course. Business Week, November 8, 125-126.
shopping day.
CHAPTER

STRATEGIC MANAGEMENT
Gregory G. Dess and G. T. Lum
6
McGraw-Hill/Irwin
Copyright 2003 by The McGraw-Hill Companies, Inc. All rights