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Session 5.docx

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York University
Administrative Studies
ADMS 4900
You- Ta Chuang

Session 5 Corporate Level Strategy: diversification 3 main motives for diversification 1. To grow (revenue/customers) 2. To reduce risks a. End markets (buyers) e.g. if Ontario sales decreases, Alberta buyers still exists b. Factor markers e.g. if one supplier fails, another supplier can pick up the slack 3. To reduce transaction costs outside a firm (beyond money) Relatedness: similar markets, related core competence (e.g. McDonalds coffee) Synergy creation is a form of value creation  economies of scope Economies of scope: number of products and services provided by a company in different markets, and reducing the costs of the products and services by sharing the companies existing resources; synergy (e.g. bell store offer various services) How can synergies be created through related diversification? 1. Leveraging core competence (using core competence to diversify) 2. Sharing activities to increase economies of scope (share activities/resources to reduce cost and increase efficiency) 3. To increase market power (more products  more market share) 2 types of vertical integration Supply Market Backward Integration Focal Firm Forward Integration Distribution Channel Backward Integration: e.g GM using GM parts, Metro selling “Select” products Forward Integration: e.g. Apple using Apple Stores Critical Question: “What activity is the company doing?” Benefits of Vertical Integration  Lower transaction costs outside the firm (quality, cost, delivery); beyond money  New market opportunities  Secure supply/distribution channel Risks of Vertical Integration  May divert away from core competence  Transaction cost within a firm may increase (rather than monitoring and outside suppliers quality, you now need to monitor the quality within your firm); must compare if transaction cost is lower within the firm, or outside the firm; Make or Buy decision Means to achieve diversification  M&A  just requires capital  Pooling resources of other companies with a firm’s own resource base (Alliances) o Joint venture o Strategic alliance  Internal Development  better control over process o New products o New markets o New technology Internal Development Risks  Bear all the risk since you are alone  Require more resources Within the porters 5 forces model, if 2 competitors merge (horizontal M&A; related markets)  Market power increases (market share increases)  Supplier power decreases in relation to the competitors  Threat of new entrants decreases  Buyer power decreases in relation to the competitors Within the porters 5 forces model, if a supplier merges with a competitor (vertical M&A)  Secure your supply; decreases supplier power in relation to the competitor (middle)  Threat of new entrant decreases  Acquiring competitor will be in a better position to compete with their competitors (in related markets) According to the VRIO model, a firm pursue’s M&A, because the company they want to acquire have unique resources and capabilities. Acquisitions are popular practices, but most acquisitions lead to poor performance. 3 factors  Perception of synergies between firms (if perception is wrong, performance will suck e.g. Ebay buying Skype)  Acquisition experience (lack of learning curve  poor performance) o General Experience (all acquisition activities) o Target-specific Experience (horizontal acquisition vs. vertical acquisition)  Change in industry position  vertical integration puts your position in question. If your position improves, performance will improve and vice versa. Strategic Alliance:  Voluntary agreements between firms in which each firm contributes to resources to achieve agreed objectives  Shared risk and resources Scale alliances: alliances can increase economies of scale in a firm’s activity; cost of an activity split between firms Linked alliances: alliances can increase economies of scope by combining different resources/capabilities e.g. supplying technology while another company provides the marketing Alliance with competition: lower competition, supplier power, buyer power, threat of new entrants (Porters) Alliance with distributor: lower competition, supplier power, threat of new entrants (Porters) VRIO Model: you want to form alliance to gain access to unique resources and capabilities. Alliances are easy to imitate. Alliance provides 2 benefits  Common benefits: the benefits for all participants/partners (scale/scope of economies)  Private benefits: the benefits that a firm can potentially use for the purposes beyond the alliance; learning race (e.g. technology company using an Indian marketing company, then can market on their own after learning about the market)  More private benefits  more aggressive learning race (competitive)  Less private benefits  cooperative, because the common benefits from the alliance is huge Risks of alliances  Behavioral risks o Adverse selection: the potential partners misrepresent their capabilities/resources that they can bring to alliances (intentional/unintentional) o Moral hazard: partners refuse to honor what has been agreed upon o Hold up: the specific investment in the alliance cannot be used for other purposes Partner selection  Good name within partnership > Big Name companies  Using referrals from people you have worked with rather than a strangers referral  Overtime different partners form cliques; Cliques are very powerful in the industry Potential benefit to go with a stranger need to be greater than cost/risk (punishment from clique & risk associated with stranger) Effects of alliances on firm performance  Firms performances vary after alliances because they need to know how to capture the created value  Absorptive capacity: the capability to transform external resources/capabilities to desired outcomes  Alliance experience: learning curve o General experience o Alliance-type specific experience Chapter 6: Corporate-Level Strategy: Creating Value through Diversification Diversification initiatives, whether through m&a, strategic alliances and joint ventures, or internal development, must be justified by the creation of value for shareholders. Firms diversify to attain synergy. Firms may diversify into a related business. The primary potential benefit to be derived comes from sharing intangible resources and tangible resources across multiple businesses that can utilize the same resources and spread their costs over a larger revenue base. This leads to shared costs and increased market power. Firms may diversify into unrelated businesses. In these instances, the primary potential benefits derive largely from value created by the sharing of support activities. This leads to benefits from “best practices” of sister businesses. Related Diversification: Economies of Scope and Revenue Enhancement Related diversification leads to Economies of Scope. Economies of scope are cost savings from leveraging core competencies, sharing resources, or sharing related activities among businesses within the corporation.  Leveraging Core Competencies: Managers often misread the strength of competitors by disregarding their core competencies. Core competencies reflect the collective learning in organizations. For a core competency to create value and provide a viable basis for synergy, it must meet three criteria: a. The core competence must enhance competitive advantages by creating superior customer value b. Different businesses in the corporation must be similar in at least one important way related to the core competence  one element in the value chain must require similar skills in creating competitive advantage if the corporation is to capitalize on its core competencies c. The core competence must be difficult for competitors to imitate or find substitutes  No SCA if easily replicated  Sharing Activities: sharing tangible activities across business units can provide two primary pay offs: a. Cost Savings: most common type of synergy and the easiest to estimate. Can be derived from elimination of jobs, facilities, and related expenses that are no longer required when functions are consolidated, or from economies of scale from purchasing. Generally highest cost savings when acquisition is within same industry. Must make sure cost savings benefits is greater than costs incurred through shared activity  compromise of activities by “stretching it to thin” b. Enhancing Revenue: usually two businesses may achieve a higher level of sales growth together than either one could on its own (shared distribution channels). Can also lead to effectiveness of differentiation through sharing of activities, and decrease in cost of differentiation leading to greater revenue. Differentiation through shared activities may have negative effects if consumers perspective on new business is poor, therefore extending that perception to your product/service. Market Power Businesses working together can place them in a better position in the industry according to Porters 5 forces. Doing business with a strong rival can decrease supplier’s bargaining power, threaten competition, and provide stronger barriers to substitutes and threat of new entrants. Consolidation in an industry also increases a firm’s market share. Although combining businesses can increase bargaining power, it can also cause retaliation from existing customers e.g. McDonalds vs. Pepsi. Regulations may also limit businesses ability to gain very large market share. Vertical Integration Represents an expansion or extension of the firm by integrating preceding or successive productive processes. Engines  Automobile Manufacturer  Dealer.  Benefits o A secure source of raw materials or distribution channels that cannot be “held hostage” to external markets where costs can fluctuate over time o Protection and contr
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