COMP 421 Lecture Notes - Lecture 6: Resource Allocation, Vertical Integration, Market Power

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Corporate level strategy
Diversification
play a major role in the behavior of large firms.
Product diversification concerns
the scope of the industries and markets in which the firm
competes.
how managers buy, create and sell different businesses to match
skills and strengths with opportunities presented to the firm.
The 2 strategy levels
Business-level strategy Each business unit in a diversified firm chooses its own as its
means of competing in its individual product markets.
Corporate-level strategy (company-wide)
Specifies actions taken by the firm to gain a competitive
advantage by selecting and managing a group of different
businesses competing in different product markets.
Corporate-level strategy’s value
degree to which the businesses in the portfolio are worth
more under the corporate HQ management than otherwise
(parenting advantage)
What businesses should the firm be in?
How should the corporate office manage the group of
businesses?
Center of gravity
The upstream stages add value by reducing the variety of
raw materials found on the earth's surface to a few standard
commodities. The purpose is to produce flexible, predictable
raw materials and intermediate product from which an
increasing variety of downstream products are made.
The down stream stages add value through producing a
variety of products to meet varying customer needs. The
downstream value is added through advertising, product
positioning, marketing channels, and R&D.
The upstream and downstream
companies face diff problems.
he mid-set of upstream managers is geared toward
standardization and efficiency.
downstream managers try to customize and tailor output to
diverse customer needs. They want to target particular sets of
end users.
Center of gravity is position on a scale of upstream to
downstream of a company
Mintzberg typology of diversification
Strategic Choices (for Core Business)
Differentiation can be in
price, commodity, image, service, quality, design
Scope can be
unsegmented, segmented, niche, customization
Growth can be
market elaboration, product development, geographical
expansion, market consolidation, market skimming, expansion by
take-over or internal growth
Extending the
Core Business
(Diversification)
Vertical integration - across supply chain eg. from
woodlands to paper
By-product diversification - using by-products eg. pulp &
paper machinery
Crystalline diversification - rapidly increasing end-products
from core competencies
Related diversification - related and same center of gravity
Linked diversification - related but different centre of gravity
Unrelated diversification - self explanatory
Reconceiving the Core
(Restructuring and Consolidation)
Business redefinition
Timex redefines watches as inexpensive, utilitarian; IKEA knock-
down kits redefine furniture retailing; Amazon.com redefines book
selling
core relocation
upstream, downstream, shift in function, theme or core
competence (Nokia shift from forest products to telecom)
Business recombination:
bundling and unbundling (Coke restructures bottlers)
Downsize
harvest, shrink, divest, liquidate, retrench
Resources and diversification: Firm must have both
Incentives to diversify
Resources required to create
value through diversification
tangible resources
financial resources highly flexible and associated with greater
extent of diversification
physical resources (plant & equipment) less flexible & usually
associated with related diversification
intangible resources
may offer the basis for more lasting value creation through
diversification
Strategic competitiveness is improved when the level of
diversification is appropriate for the level of available
resources.
Value creation is determined more by appropriate use of
resources than by incentives to diversify.
Reasons for firm diversification
See Exhibit 1 in Appendix for more details
1. Value creating diversification
2. Value Neutral Diversification
3. Value reducing diversification
Levels of diversification
Exhibit 2 in Appendix for lvls of diversification
Exhibit 5 in Appendix - Curve linear relationship between
diversification and performance
Relationship between diversification and firm
performance - Exhibit 3 Appendix
ways to create value through
economies of scope
Sharing activities:
Operational relatedness
by sharing either a primary activity such as inventory delivery
systems, or a support activity such as purchasing.
requires sharing strategic control over business units.
may create risk because business-unit ties create links between
outcomes.
Transferring corporate
competencies: Corporate
relatedness
Using complex sets of resources and capabilities to link different
businesses through managerial and technological knowledge,
experience, and expertise.
Exhibit 4, Appendix for Value creating diversification
strategies
Related diversification
Firms create value by building upon or extending:
resources
capabilities
core competencies
Economies of scope
Cost savings or value creation that occurs when a firm transfers
capabilities and competencies developed in one of its businesses
to another of its businesses.
Generally cost savings arise from
operational relatedness in sharing activities, but operational
relatedness can also create value
Generally value is created from
corporate relatedness in transferring skills or corporate core
competencies among units and between units and HQ,but
corporate relatedness can also slash costs
The difference between sharing activities and transferring
competencies is based on how resources are jointly used to
create economies of scope.
Corporate relatedness
Creates value by
eliminates resource duplication
provides intangible resources
Related diversification strategy
can lead to market power
Market power exists when a firm can
sell its products above the existing competitive level
reduce the costs of its primary and support activities below the
competitive level.
Multipoint competition
Two or more diversified firms simultaneously compete in the
same product areas or geographic markets.
Vertical integration
Backward integration — a firm produces its own inputs.
Forward integration — a firm operates its own distribution system
for delivering its outputs.
Simultaneous operational relatedness
and corporate relatedness
Involves managing two sources of knowledge simultaneously
(operation and corporate economies of scope)
Many such efforts often fail because of implementation difficulties.
Unrelated diversification may create value through
Financial economies
Cost savings realized through improved allocations of financial
resources.
through
Efficient internal
capital allocations Corporate office distributes capital to business divisions to create
value for overall company. (It knows their actual and potential
performance)
In developed countries, financial economies are more easily
duplicated by competitors than are gains from operational and
corporate relatedness.
Purchase of other corporations and restructuring the assets
Resource allocation decisions may
become complex, so success
often requires:
focus on mature, low-technology businesses.
focus on businesses less reliant on a client orientation.
Why diversify Internal Incentives eg synergy benefits , uncertain future
cash flows, risk reduction
External (institution-based) Incentives eg. anti-trust laws, tax
laws.
Exhibit 6 for specifics
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Document Summary

Forward integration a firm operates its own distribution system for delivering its outputs. Backward integration a firm produces its own inputs. Two or more diversified firms simultaneously compete in the same product areas or geographic markets. sell its products above the existing competitive level reduce the costs of its primary and support activities below the competitive level. Many such efforts often fail because of implementation difficulties. Involves managing two sources of knowledge simultaneously (operation and corporate economies of scope) Related diversification strategy can lead to market power. Simultaneous operational relatedness and corporate relatedness eliminates resource duplication provides intangible resources. Cost savings realized through improved allocations of financial resources. Corporate office distributes capital to business divisions to create value for overall company. (it knows their actual and potential performance) In developed countries, financial economies are more easily duplicated by competitors than are gains from operational and corporate relatedness. Resource allocation decisions may become complex, so success often requires:

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