Chapter 6 Powerpoint Notes

Hitt, Ireland, Hoskisson, Strategic Management: Competitiveness & Globalization: Concepts & Cases, 13e. © 2020 Cengage.
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CHAPTER
6
Corporate-Level Strategy
LEARNING OBJECTIVES
Studying this chapter should provide you with the strategic management
knowledge needed to:
6-1 Define corporate-level strategy and discuss its purpose.
6-2 Describe different levels of diversification achieved using different
corporate-level strategies.
6-3 Explain three primary reasons firms diversify.
6-4 Describe how firms can create value by using a related diversification
strategy.
6-5 Explain the two ways value can be created with an unrelated
diversification strategy.
6-6 Discuss the incentives and resources that encourage diversification.
6-7 Describe motives that can encourage managers to over diversify a firm.
Chapter Introduction (slide 1 of 2)
• 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.
• A corporate-level strategy:
• Is used as a means to grow revenues and profits
• Focuses on diversification
• Is expected to help the firm earn above-average returns by
creating value
• Is concerned with two key issues:
1. In what product markets and businesses the firm should compete
2. How corporate headquarters should manage those businesses
Chapter Introduction (slide 2 of 2)
• Product diversification concerns:

• The scope of the markets and industries in which the firm
competes
• How managers buy, create, and sell different businesses to
match skills and strengths with opportunities presented to the
firm
• Diversification:
• Is successful when it reduces variability in the firm’s profitability
as earnings are generated from different businesses
• Provides firms with the flexibility to shift their investments to
markets where the greatest returns are possible rather than
being dependent on only one or a few markets
6-1 Levels of Diversification
• Diversified firms vary according to their level of

diversification and the connections between and
among their businesses.
• There are five categories of businesses
according to increasing levels of diversification:
1. Single business
2. Dominant business
3. Related constrained
4. Related linked
5. Unrelated
Figure 6.1
Levels and Types of Diversification
6-1a Low Levels of Diversification
• There are two types of strategies a firm with a

low level of diversification can use:
1. Single-business diversification strategy
• The firm generates 95 percent or more of its sales revenue
from its core business area.
2. Dominant-business diversification strategy
• The firm generates between 70 and 95 percent of its total
revenue within a single business area.
6-1b Moderate and High
Levels of Diversification (slide 1 of 2)
• A firm uses a related diversification strategy when:
• It generates more than 30 percent of its revenue outside a
dominant business.
• Its businesses are related to each other in some manner.
• There are two types of related diversification strategies:
1. Related constrained diversification strategy
• The links between the diversified firm’s businesses use similar
sourcing, throughput, and outbound processes.
• A related constrained firm shares resources and activities across its
businesses.
2. Related linked diversification strategy
• The firm’s portfolio of businesses have only a few links between them.
• A related linked firm concentrates on transferring knowledge and
core competencies between its businesses.
6-1b Moderate and High
Levels of Diversification (slide 2 of 2)
• A highly diversified firm that has no relationships
between its businesses follows an unrelated
diversification strategy.
• Commonly, firms using this strategy are called
conglomerates.
• Unrelated firms make no effort to share activities or
transfer core competencies between or among their
businesses.
6-2 Reasons for Diversification
• A corporate-level diversification strategy can be

used to:
• Increase a firm’s value by improving its overall
performance
• Value is created when the strategy allows a company’s
businesses to increase revenues or reduce costs while
implementing their business-level strategies.
• Have neutral effects
• Reduce a firm’s value
Table 6.1
Reasons for Diversification (slide 1 of 2)
Value-Creating Diversification
• Economies of scope (related diversification)
• Sharing activities
• Transferring core competencies
• Market power (related diversification)
• Blocking competitors through multipoint competition
• Vertical integration
• Financial economies (unrelated diversification)
• Efficient internal capital allocation
• Business restructuring
Table 6.1
Reasons for Diversification (slide 2 of 2)
Value-Neutral Diversification
• Antitrust regulation
• Tax laws
• Low performance
• Uncertain future cash flows
• Risk reduction for firm
• Tangible resources
• Intangible resources
Value-Reducing Diversification
• Diversifying managerial employment risk
• Increasing managerial compensation
6-3 Value-Creating Diversification: Related
Constrained and Related Linked Diversification
• The company using the related diversification strategy

wants to develop and exploit economies of scope
between its businesses.
• 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.
• 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)
Figure 6.2
Value-Creating Diversification Strategies:
Operational and Corporate Relatedness
6-3a Operational Relatedness:
Sharing Activities
• Firms can create operational relatedness by sharing
either:
• A primary activity
• Example: Inventory delivery systems
• A support activity
• Example: Purchasing practices
• Sharing activities is usually associated with the related
constrained diversification corporate-level strategy.
• Activity sharing:
• Is costly to implement and coordinate
• May create unequal benefits for the divisions involved
• Can lead to fewer managerial risk-taking behaviors
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.
• Firms using the related linked diversification strategy can create
value by transferring core competencies in at least two ways:
1. Because the expense of developing a core competence has already
been incurred in one of the firm’s businesses, transferring it to a second
business eliminates the need for that business to allocate resources to
develop it.
2. Because intangible resources are difficult for competitors to understand
and imitate, the unit receiving a transferred corporate-level competence
often gains an immediate competitive advantage over its rivals.
6-3c Market Power (slide 1 of 3)
• Market power may be gained by firms

successfully using a related constrained or
related linked strategy.
• Market power exists 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.
• Firms can foster 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.
• Vertical integration exists when a company
produces its own inputs (backward integration) or
owns its own source of output distribution (forward
integration).
• Vertical integration allows a firm to gain market power by developing
the ability to:
• Save on its operations
• Avoid sourcing and market costs
• Improve product quality
• Possibly protect its technology from imitation by rivals
• Potentially exploit underlying capabilities in the marketplace
• Vertical integration has limitations.
• Internal transactions may be expensive and reduce profitability.
• Bureaucratic costs may be present.
• Substantial investments in specific technologies are required, reducing
a firm’s flexibility.
• Changes in demand create capacity balance and coordination
problems.
6-3d Simultaneous Operational
Relatedness and Corporate Relatedness
• The ability to simultaneously create economies
of scale by sharing activities (operational
relatedness) and transferring core competencies
(corporate relatedness):
• Is difficult for competitors to understand and imitate
• Is very expensive to undertake
• If the cost of realizing both types of relatedness is not offset
by the benefits created, the result is diseconomies.
• Often results in discounted assets by investors
• It can be difficult for investors to identify the value that is
created by the firm that shares both activities and core
competencies.
6-4 Unrelated Diversification (slide 1 of 2)
• Firms do not seek operational relatedness or

corporate relatedness when using the unrelated
diversification corporate-level strategy.
• Financial economies are cost savings realized
through improved allocations of financial
resources based on investments inside or
outside the firm.
• An unrelated diversification strategy can create value
through two types of financial economies:
1. Efficient internal capital market allocation
2. Asset restructuring
6-4 Unrelated Diversification (slide 2 of 2)
• Firms in emerging economies often use an

unrelated diversification strategy.
• A drawback for firms using the unrelated
diversification strategy in a developed economy
is that competitors can imitate financial
economies more easily than they can replicate
the value gained from the economies of scope
developed through operational relatedness and
corporate relatedness.
6-4a Efficient Internal
Capital Market Allocation (slide 1 of 2)
• In a market economy, capital markets are
believed to efficiently allocate capital.
• Efficiency results as investors take equity positions
with high expected future cash-flow values.
• Capital is 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.
6-4a Efficient Internal
Capital Market Allocation (slide 2 of 2)
• In large diversified firms, the corporate
headquarters office distributes capital to its
businesses to create value for the overall
corporation.
• Those in a firm’s corporate headquarters generally
have access to detailed and accurate information
regarding the performance of the company’s portfolio
of businesses; thus, they have the best information to
make capital distribution decisions.
• Because it has less accurate information, the external capital
market may fail to allocate resources adequately to high-
potential investments.
6-4b Restructuring of Assets
• Financial economies can be created when firms learn

how to create value by:
1. Buying assets at a low cost
2. Restructuring the assets
3. Selling the assets at a price that exceeds their cost in the
external market
• Buying, restructuring, and then selling service-based
assets for a profit in the external market is difficult.
• This is because technology firms and service-based companies
have relatively few tangible assets that can be restructured to
create value and sell profitably.
6-5 Value-Neutral Diversification:
Incentives and Resources
• Diversification is sometimes pursued for value-
neutral reasons.
• Different incentives to diversify sometimes exist.
• The quality of the firm’s resources may permit only
diversification that is value neutral rather than value
creating.
6-5a Incentives to Diversify (slide 1 of 5)
• Incentives to diversify come from both the

external environment and a firm’s internal
environment.
• External incentives include:
• Antitrust regulations
• Tax laws
• Internal incentives include:
• Low performance
• Uncertain future cash flows
• The pursuit of synergy
• Reduction of risk for the firm
Antitrust Regulation and Tax Laws
• In the 19 60s and 19 70s:
• Antitrust laws prohibiting mergers that created increased market power
(via either vertical or horizontal integration) were stringently enforced.
• Most mergers were “conglomerate” in character.
• In the 19 80s and early 19 90s:
• Merger constraints were relaxed.
• More and larger horizontal mergers (acquisitions of target firms in the
same line of business) occurred.
• In the early 2000s:
• Antitrust concerns emerged again.
• Mergers received more scrutiny.
• In the 19 60s and 19 70s, dividends were taxed more heavily than
were capital gains.
• As a result, shareholders preferred that firms use free cash flows (liquid
financial assets for which investments in current businesses are no
longer economically viable) to buy and build companies in high-
performance industries.
• The 19 86 Tax Reform Act created an incentive for shareholders to
retain funds for purposes of diversification by:
• Reducing the individual ordinary income tax rate from 50 to 28 percent
• Changing the capital gains tax to treat capital gains as ordinary income
• At one time, acquisitions were an attractive means for securing tax
benefits, but the Financial Accounting Standards Board (F A S B)
reduced some of the incentives to make acquisitions by eliminating:
• The “pooling of interests” method to account for an acquired firm’s assets
• The write-off for research and development in process
Low Performance
• Research shows that:
• Low returns are related to greater levels of diversification.
• An overall curvilinear relationship may exist between diversification and
performance.
Uncertain Future Cash Flows

• Diversification may be an important defensive strategy:
• As a firm’s product line matures or is threatened
• During a financial downturn
• For family firms competing in mature or maturing industries
• Diversifying into other product markets or into other businesses can
reduce the uncertainty about a firm’s future cash flows.
Figure 6.3
The Curvilinear Relationship between Diversification and Performance
Synergy and Firm Risk Reduction
• Synergy exists when the value created by business units working
together exceeds the value that those same units create working
independently.
• Synergy produces joint interdependence among businesses that
constrains the firm’s flexibility to respond, which may lead the firm to:
• Become risk averse and uninterested in pursuing new product lines that
have potential but are not proven
• Constrain its level of activity sharing
• Either decision may lead to further diversification.
• Operating in environments that are more certain will likely lead to related
diversification into industries that lack potential.
• Constraining the level of activity sharing may produce additional, but
unrelated, diversification, where the firm lacks expertise.
6-5b Resources and Diversification
• A firm must have the types and levels of resources and capabilities
needed to successfully use a corporate-level diversification strategy.
• A firm’s ability to create value through diversification is influenced by
the degree to which resources are:
• Valuable
• Rare
• Difficult to imitate
• Non substitutable
• Both tangible and intangible resources facilitate diversification.
• However, intangible resources are more flexible in facilitating
diversification.
6-6 Value-Reducing Diversification:
Managerial Motives to Diversify (slide 1 of 2)
• Managerial motives to diversify beyond value-
creating and value-neutral levels include:
• The desire for increased compensation
• Reduced managerial risk
• Research evidence shows that diversification
and firm size are highly correlated.
• As firm size increases, so does:
• Executive compensation
• Social status
6-6 Value-Reducing Diversification:
Managerial Motives to Diversify (slide 2 of 2)
• Managerial motives to diversify can lead to
over diversification and a subsequent reduction in a
firm’s ability to create value.
• Managerial tendencies to over diversify may be held in
check by:
• Governance mechanisms (board of directors)
• Monitoring by owners
• Executive compensation practices
• The market for corporate control
• Evidence suggests, however, that many top-level
executives seek to be good stewards of the firm’s assets
and avoid diversifying the firm in ways that destroy value.
Summary (slide 1 of 2)
• 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.
• 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
resources or intangible resources (the most inflexible).
Summary (slide 2 of 2)
• 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
• The opportunities and threats in their country’s
institutional and competitive environments
Figure 6.4
Summary Model of the Relationship
between Diversification and Firm Performance
APPENDIX
NOTE TO INSTRUCTOR: Choose from the following questions (also found in the text at the end of the chapter)
to conduct in-class discussions around key chapter concepts.
Discussion:
• What is corporate-level strategy and why is it

important?
Discussion:
• What are the different levels of diversification

firms can pursue by using different corporate-
level strategies?
Discussion:
• What are three reasons firms choose to diversify

their operations?
Discussion:
• How do firms create value when using a related

diversification strategy?
Discussion:
• What are the two ways to obtain financial

economies when using an unrelated
diversification strategy?
Discussion:
• What incentives and resources encourage

diversification?
Discussion:
• What motives might encourage managers to

over diversify their firm?

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Hitt, Ireland, Hoskisson, Strategic Management: Competitiveness & Globalization: Concepts & Cases, 13e. © 2020 Cengage.

• Product diversification concerns:

• Diversified firms vary according to their level of

• There are two types of strategies a firm with a

• A corporate-level diversification strategy can be

• The company using the related diversification strategy

• Market power may be gained by firms

• Firms can foster market power through

• Firms do not seek operational relatedness or

• Firms in emerging economies often use an

• Financial economies can be created when firms learn

• Incentives to diversify come from both the

Uncertain Future Cash Flows

• Firms can improve their strategic

• What is corporate-level strategy and why is it

• What are the different levels of diversification

• What are three reasons firms choose to diversify

• How do firms create value when using a related

• What are the two ways to obtain financial

• What incentives and resources encourage

• What motives might encourage managers to

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