Corporate Strategy Diversification - Prof. Dr. Bernd Venohr

© 2006 Dr. Bernd Venohr 

Corporate Strategy 

7 

Diversification 

Prof. Dr. Bernd Venohr 

Berlin, June 2007

Agenda (NEU) 

Introduction to Strategy 

1 

2 

3 

4 

Business Strategy 

5 

6 

7 


Course Overview and Strategy Concept 

Communication and Problem Solving 

Economics of Strategy 

Shareholder Value 

External Environment 

Internal Environment 

Competitive Positioning 

Corporate Strategy 

8 

9 

10 

Strategy Process 

11 

12 


Mergers & Acquisitions 

Global Strategy 

Organizational Structure and Control 

Strategic Leadership 

2

Where are we today? 

External 

Environment 


Introduction to Strategy 

Business Strategy Corporate Strategy 

5 6 

7 

Competitive 

Positioning 

1 Strategy Concept 2 

Economics of 

Strategy 

3 3 4 

Internal 

Environment 

Strategy Process 

11 

12 

Organizational 

Structure and 

Control 

Strategic 

Leadership 

Communication and 

Problem Solving 

Shareholder Value 

8 

Mergers & 

Acquisitions 


9 10 

Global 

Strategy 

3

Corporate vs. business level strategy: a diversified company, 

which is active in more than one business, has two levels of 

strategy (BITTE LOGOS DP HINEINKOPIEREN( 

Example: Deutsche Post World Net 

CORPORATE 

LEVEL 

BUSINESS 

LEVEL 

Mail 

Source: Corey Phelps; Mgmt 430 


Express 

Example: Deutsche Post World Net 

DPWN 

Logistics 

Financial 

Services 

4

Key issues corporate versus business strategy 

CORPORATE STRATEGY: How to create a competitive advantage 

for the whole company 

� What businesses should we be in? 

� How should these be managed? 

� How to create value for the corporation as a whole? 

BUSINESS STRATEGY: How to create a competitive advantage in 

specific, individual product markets 

� Which customers to serve (who?) – segmentation 

� Which customers needs to satisfy (what?) – differentiation 

� Resources and value chain activities necessary to satisfying customer 

needs (how?) – “core competencies” 


5

Key Challenges for a value-creating corporate strategy 

� Direct competition occurs at the business unit level 

� Corporate Strategy adds costs and constraints to business 

units 

� Shareholders can easily diversify themselves 

Source: Porter, From competitive advantage to corporate strategy 


6

Goal of Corporate Strategy: create corporate advantage 

� Goal of corporate strategy 

- to build corporate advantage 

- earn above normal returns 

� Three tests on the existence of corporate advantage 

- Does ownership of the business create benefit 

somewhere in the corporation? (Does parentage matter?) 

- Are those benefits greater than the cost of corporate 

overhead? 

- Does the corporation create more value with the business 

than any other possible corporate parent or alternative 

governance structure? 

Source: Collis and Montgomery, 1998 


7

Focus of corporate strategy: where a firm competes, 

i.e. the scope of its activities 

[A] Single 

Integrated 

Firm 

[B] Several 

Specialized 

Firms linked 

by Markets 


Vertical Market - Geographical 

Scope Scope Scope 

V 1 

V 2 

V 3 

V 1 

V 2 

V 3 

P 1 

P 2 

P 3 

C 1 

C 2 

C 3 

P 1 P 2 P 3 C 1 C 2 C 3 

In situation [A] the business units are integrated within a single firm. 

In situation [B] the business units are independent firms linked by markets. 

Are the administrative costs of the integrated firm less than the transaction 

costs of markets? 

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)

Corporate strategy: diversification into new areas by 

employing one of the three levers 

1 

2 

3 

Markets: Products and Services and Customer segments 

Vertical: Value Chain 

Geography 


9

Levels and types of diversification: the“related ratio” 

Low Levels of Diversification 

Single business 

Moderate to High Levels of Diversification 

Related linked (mixed) < 70% of revenues from dominant 

business, only limited links exist 

Very High Levels of Diversification 

> 95% of revenues from single 

business unit 

Dominant business Between 70% and 95% of 

revenues from single business unit 

Related constrained 

Unrelated- 

< 70% of revenues from dominant 

business; all businesses share 

activities in value chain 

Business units not closely related 

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 

2004) 

Diversified 


A 

B 

A 

A 

B C 

A 

B C 

A 

B C 

10

Two alternative diversification strategies: 

related versus unrelated 

� Related diversification strategies: firm moves from a core of activities 

in a specific product market to other related activities and markets 

– Demand and/or cost linkages between lines of business 

– Sharing value chain activities and transferring core competencies 

� Unrelated diversification strategies 

– Replace external capital market with internal capital market allocation 

– No linkages between businesses 



11

Two directions of related diversification: 

vertical and horizontal 

� Horizontal diversification (HD) : different businesses in similar stage of 

value chain 

– concentric diversification: businesses are highly related 

– conglomerate: businesses are unrelated 

� Vertical diversification (VD) : Number of stages a firm engages in the 

value chain 

– Forward (into distribution channels) vs. backward integration (sources of 

supply) 

– Make vs. buy 



12

Vertical Diversification: 

Number of stages a firm engages in the value chain 



Vertical Dimension 

IT Hardware 

Software 

IT Consulting and 

Outsourcing 

13

Horizontal Diversification: number of different product 

markets a company is active in 



Power 

Generation 

Horizontal Diversification 

I&C 

Net-works 

Medical 

Solutions 

14

Degree of vertical diversification (integration) 

explained by transaction cost theory 

� Developed by Ronald Coase ( Nobel Memorial Prize in 

Economics in 1991 ; The Nature of the Firm) 

� Why economy is populated by a number of business firms, 

instead of consisting exclusively of a many independent, selfemployed 

people who contract with one another ? 

� Key driver: transaction costs of the market (= cost of 

locating, negotiating, and enforcing a contract) . Firms will arise 

when they can arrange to produce what they need internally 

and avoid these costs. 

� There is a natural limit to what can be produced internally : 

"decreasing returns to the entrepreneurial function“ ( overhead 

costs and mistakes in resource allocation) 

Source: Coase, Ronald. "The Nature of the Firm".; Wikepedia 


15

Vertical diversification: Owning and directing additional 

activities makes sense if external markets don‘t function well 

� Activity is more efficient within the firm (cost / benefit) 

– Lower transaction costs and improved coordination vs. 

– Sacrifice scale/scope economies 

� Protect leakage of technology 

� Create market power via creation of entry barriers 

– Integrate backwards: buy up key supplier 

– Integrate forward: lock up distribution 

� Undo effects of market power: eliminate market power of supplier or buyer 

� Acquire information about value chain steps 

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004) 


16

Vertical diversification: Some Vertical Integration Fallacies 

� Firms should make (integrate) to keep for themselves profits earned 

by market firms: profits represent returns necessary to attract investment 

and would be required of any firm 

� Vertically integrated firms can produce an input at cost and will have 

cost advantage over nonintegrated firms who have to buy inputs at 

market prices 

– hidden opportunity costs for vertically integrated firm: no sales in open 

market (less scale economies); less competitive pressures 

– increasing cost of coordinating vertical activities 



17

Vertical diversification: 

recent trends in vertical relationships 

� From competitive contracting to supplier partnerships, e.g. in autos 

� From vertical integration to outsourcing (not just components, also IT, 

distribution, and administrative services) 

� Diffusion of franchising 

� Technology partnerships (e.g. IBM-Apple; Canon-HP) 

� Inter-firm networks 

General conclusion: 

Boundaries between firms and markets becoming increasingly blurred. 



18

Vertical diversification: Different Types of Vertical Relationships 

Low Formalization High 

Spot sales/ 

purchases 


Long-term 

contracts 

Agency 

agreements 

Informal 

supplier/ 

customer 

relationships 

Franchises 

Supplier/ 

customer 

partnerships 

Joint 

ventures 

Vertical 

integration 

Low Degree of Commitment High 

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)

Horizontal diversification benefits (synergies) arise 

because of shared resources that exist across product 

market boundaries 

� Cost-driven synergies: Sharing of activities lowers costs 

– Supply-based joint resources (Economies of scope): if a firm produces two 

related products, the total costs of producing them jointly is lower than the sum of 

the cost of producing them separately (share fixed costs between different 

products) due to resource sharing. 

– Examples : common distribution facilities, brands, joint R&D 

� Demand-based synergies: raise differentiation 

– customers perceive linkages in products 

– risky, since quite often based on customers cognitive links betweeen products 

(„perceptions“) which can change quickly 



20

Horizontal diversification: Identify cross-business shared 

resources by comparing value chains across businesses 

Business A 

Business B 

Business C 

Business D 

Business E 


Inbound 

Logistics 

Technology Operations 

Value Chain Activities 

Sales and 

Marketing 

Distribution Service 

Opportunity to combine purchasing activities (gain more leverage with suppliers) 

Opportunity to share technology, transfer technical skills, combine R&D 

Opportunity to combine sales & marketing activities, use common distribution channels, 

leverage use of a common brand name, and/or combine after-sale service 

No sharing 


21

Example horizontal diversification: Procter & Gamble 

using a common physical distribution system and 

sales force 

Procter & Gamble Strategic Field 

Source: Walker W. Lewis, „The CEO and Corporate Strategy in the 80‘s: Back to Basics“, 1984 

Reprinted by permission of The institute of Management Sciences, Providence, RI 


22

Horizontal diversification: 

Transferring Core Competencies 

� Exploit intangible interrelationships among divisions 

� Identify ability to transfer skills and expertise among similar value chains 

(across divisions) 

– Activities must be sufficiently similar that sharing is possible 

– Transfer of skills involve activities which are important to competitive advantage 

– The skills transferred represent significant sources of advantage for the receiving 

business unit 

� Examples: 

– Deutsche Post logistics expertise 

– Toyota’s core competence in engines 

– Apple`s core competence in design 



23

Horizontal diversification: Significant management 

challenges in actually achieving the potential benefits 

� Diversification alone will not produce superior performance: “benefits 

don’t just happen” 

� Management skills in capturing potential benefits of interrelationships 

are a key success factor 

� Key levers are: 

– strong sense of corporate identity and mission that emphasizes the 

importance of integrating business units 

– allocation of management attention 

– allocation of capital and shared resources to different business units 

– management hiring/training 

– incentive systems that reward more than just business unit performance 


24

Unrelated Diversification: diversifying into businesses 

with no meaningful value chain relationships or demand 

side synergies 

� Conglomerates/Holding Companies: to venture into “any business in which we think we 

can make a profit” 

� Assumptions 

– Managers have superior information vs. outside investors 

– Top management can more precisely allocate resources to businesses than external 

market 

� Key characteristics of unrelated diversification 

– Often pursued through acquisitions: sound companies in attractive markets 

– Acquired businesses will stay autonomous 

– Corporate headquarter acts as portfolio manager 


• Supplies needed capital to each business 

• Transfers resources from “cash cows” to businesses with high growth potential 

– Add professional management and strict financial controls 

– Unit managers compensated on unit results 


25

Example of unrelated diversification: Virgin Group 

*Source: virgin.com Homepage 


26

Example of unrelated diversification: Virgin Group - 

Richard Branson as founder and CEO 


27

Unrelated diversification: benefits and risks 

� Potential benefits 

– Business risk scattered over different industries 

– Financial resources directed to those industries offering best profit 

prospects 

– Stability of profits : Hard times in one industry may be offset by good 

times in another industry 

– If bargain-priced firms with big profit potential are bought, shareholder 

wealth can be enhanced 

� Potential risks 

– Difficulties of competently managing many diverse businesses 

– Lack of strategic fit which can be leveraged into competitive advantage 

– Consolidated performance of unrelated businesses tends to be no better 

than sum of individual businesses on their own (and it may be worse). “1 

+ 1 = 2”, rather than “1 + 1 =3” 

– Promise of greater sales-profit stability over business cycles seldom 

realized 


28

Theory of unrelated diversification: 

Why an internal capital market can be more efficient 

than the external capital market? 

� Create value by exploiting financial economies: large organizations 

can fund projects more quickly and economically than external market 

– small projects are bundled 

– large projects can be taken on 

– key challenge :find products and markets that provide negatively 

correlated cash flows 

� Reduce funding costs through superior financial resource allocation: 

internal capital market is like a debt market with all the benefits of 

equity ownership 

– resolve borrower-lender problem (“moral hazard”): 

– internal funding allows for information sharing and better control over the 

use of funds by the “lender” 

– less likely that borrower and lender expropriate each other 



29

Theory of unrelated diversification: 

common diversification problems 

� Internal capital markets are less efficient than external ones 

– Higher quality information not guaranteed 

– Individual investors can generally diversify more effectively 

– Capital allocation can quickly stretch abilities of top managers 

� Managers’ personal interests drive diversification decision 

– Top executives’ compensation often based on “peer companies” 

(diversify to increase compensation) : empire building 

– When diversification buffers performance it’s harder for top execs to get 

fired (Reduce employment risk) 

– Poor performance may lead firms to diversify to achieve better returns 

(“the grass is always greener…) 



30

Underrated „good reason“ for unrelated diversification: 

business life cycles 

� All business go through life cycles no matter how good a business is today 

, it will eventually mature and decline 

� Companies in growth industries should devote the majority of their 

management time and attention to exploit the potential 

� Corporations in maturing industries with little diversification and low 

expected long-term growth should introduce growth businesses into their 

portfolio: here most of the benefits of moderate diversification can be 

achieved. 

� Anecdotal evidence: the experience of very old and still very successful 

companies like Haniel or Siemens (all active in several businesses; in most 

cases original business has been shed) 


31

Moderate levels of diversification yield higher levels 

of performance than either limited or extensive 

diversification (1)* 

Performance 

*Source: Palich/ Cardinal/ Chet Miller, 2000 


Single/ 

Dominant 

Business 

Level of Diversification 

Related Unrelated 

32

New Assignment and Outlook next Session 

� Read slides on session 7 on ILIAS 

� Visit company web pages and prepare as team a brief description 

of your companies corporate strategy (degree of relatedness; potential linkages 

among businesses) 

� Topics of next session: 

– Brief page presentation on each company; send in advance per e-mail or bring 

presentation on usb stick 

– Lecture: Corporate Strategy: M&A 


33

Appendix 


34

Remarks-Premises of Corporate Strategy 

� Direct competition occurs at the business unit level 

- Corporations don’t compete; only their business units do 

- Value created at the business unit level, only added at the corporate level 

- Successful corporate strategy must grow out of and reinforce business strategy 

� Corporate Strategy inevitably adds costs and constraints to business units 

- Corporate overhead 

- Costs of coordination and monitoring: communication between headquarter and 

business units 

� Shareholders can easily diversify themselves 

- Shareholders can diversify their own portfolios of stocks, and they can often do it 

more cheaply with less risk than corporations 

- Shareholders can buy shares at market prices and avoid paying large acquisition 

premiums 

Source: Porter, From competitive advantage to corporate strategy 


35

Vertical diversification: Transactions cost exist, 

when there is market failure (market transactions 

inappropriate or too costly), which in turn lead to firms 

vertically integrating 

� A vertical market "fails" when transactions within it are too risky and the contracts designed to 

overcome these risks are too costly (or impossible) to write and administer. Where transaction costs 

are high , the firm is a more efficient means of organization 

� Examples (causes) of“market failures”: 

– One Seller, One Buyer 

– Difficulty in Writing Contracts: Bounded Rationality; Opportunism; Pre – Adverse Selection; Post - -- 

Moral Hazard 

– Asset Specificity 

– Frequency of Transaction: The more frequent a transaction, all else equal, the more likely integration will 

occur 

� By vertically integrating a firm makes its resource decisions internally, using management 

mechanisms, as opposed to using the market . The objective is to adopt the organizational mode that 

best economizes on transaction costs, minimizes the risk of market failure, while taking into account the 

expense of governance costs. Firms must balance transaction costs with the cost of governance. 

� Rapid decline of vertical integration in the last few years: rise of outsourcing 

– advances of computer technology allow for easy cooperation between companies (lowering transaction 

costs and incentive and coordination poblems) 

– increased ability to write more complete and enforceable contracts 

Source: Coase, Ronald. "The Nature of the Firm".; Wikepedia 


36

Vertical diversification: 

The Costs and Benefits of Vertical Integration 

� Benefits 

– Technical economies from integrating processes e.g. iron and steel production 

– Superior coordination 

– Avoids transactions costs of market contracts in situations where there are: 

• small numbers of firms 

• transaction-specific investments 

• opportunism and strategic misrepresentation 

• taxes and regulations on market transactions 

� Costs 

– Differences in optimal scale of operation between different stages prevents balanced vertical 

integration 

– Strategic differences between different vertical stages creates management difficulties 

– Inhibits development of and exploitation of core competencies 

– Limits flexibility 

• in responding to demand cycles 

• in responding to changes in technology, customer preferences, etc. 

• Compounding of risk 



37

Remarks-Theory of unrelated diversification: 

Why an internal capital market can be more efficient 

than the external capital market? 

� Create value by exploiting financial economies: large organizations can fund 

projects more quickly and economically than external market 

– small projects are bundled, large company can borrow more cheaply (company as 

securitized bundle of projects) 

– large projects: diversified firm may take on projects whose risk is too great to be 

taken on by any one or a group of smaller companies 

– key challenge for related diversifiers: find products and markets that can take 

advantage of competitive strengths but at the same time provide negatively 

correlated cash flows 

� Reduce funding costs through superior financial resource allocation: internal 

capital market is like a debt market with all the benefits of equity ownership 

– resolve borrower-lender problem (“moral hazard”): once lending contract is signed 

borrower has an incentive to increase risk of project financed increasing his 

expected return while decreasing that of a lender. Contracts can only imperfectly 

control this risk 

– internal funding allows for information sharing and better control over the use of 

funds by the “lender” 

– less likely that borrower and lender expropriate each other 



38

Remarks-Theory of unrelated diversification: 

common diversification problems 

� Internal capital markets are less efficient than external ones 

– Higher quality information not guaranteed 

– Individual investors can generally diversify more effectively: combined cash flows 

may reduce unique risk (assuming not perfectly correlated) NOT considered a 

benefit to outside equity holders; may be “insurance” for employees, customers, 

suppliers, debt holders 

– Capital allocation can quickly stretch abilities of top managers; additional problem: 

escalation of commitment more likely 

� Managers’ personal interests drive diversification decision 

– Top executives’ compensation often based on “peer companies” (diversify to 

increase compensation) : empire building 

– When diversification buffers performance it’s harder for top execs to get fired 

(Reduce employment risk) 

– Poor performance may lead firms to diversify to achieve better returns (“the grass 

is always greener…) 



39

Empirical results on diversification: Most large firms 

are probably still remarkably diversified, but there 

seems to be somewhat of a a trend to focus on one 

or more „core businesses“ 

Degree of diversification of 250 largest publicly 

listed companies in Germany/Switzerland/Austria* 

Dominant 

*Source: Szeless (2001): page 81-96; data taken from DATASTREAM 

database (original sample of 250 companies reduced to 93 

companies); own calculations 

**Source: Pörner (2003): data based on telephone interviews with Heads 

of Strategic Planning/Corporate Development of 16 out of 30 Dax 

companies 


1991 

27% 

Related 25% 

Unrelated 32% 

1994 

30% 

24% 

29% 

1997 

Single 16% 17% 19% 

27% 

20% 

34% 

Current strategic priorities 

of DAX 30 companies** 

Konzentration auf 

Kerngeschäftsfelder 

Wachstum 

Realisierung von Synergieeffekten 

zwischen den Geschäftsbereichen 

Internationalisierung 

Innovationsstrategie 

Kooperationsstrategien 

Risikoausgleich zwischen den 

einzelnen Geschäftsbereichen 

Finanzielles Gleichgewicht 

zwischen den Geschäftsbereichen 

Kapazitätsabbau/Schrumpfung 

Diversifikation 

3 

4 

4 

Sonstige 4 

EXAMPLES 

9 

10 

12 

14 

14 

13 

13 

40

Empirical results diversification and firm performance: 

moderate levels of diversification yield 

higher levels of performance than either limited 

or extensive diversification (2)* 

� Key results 

– most profitable firms are those that have diversified around a set of resources that 

are specialized enough to confer an advantage in an attractive industry, yet 

fungible enough to be applied in other industries 

– least profitable are those that are broadly diversified and whose strategies are 

built around very general resources that are applied in a wide variety of industries 

but are rarely instrumental in competitive advantage in an attractive industry 

� Limits of diversification 

– Bureaucratic costs place a limit on the amount of diversification that can profitably 

be pursued 

– Arise in large, complex organizations due to managerial inefficiencies (diverse 

businesses in a company’s portfolio; Information overload; coordination among 

businesses) 

*Source: Palich/ Cardinal/ Chet Miller, 2000 


41

Alternative strategy concept for internal analysis: 

Focus on company‘s competencies / capabilities 

and ressoures to explain the underlying factors for 

a competitive advantage (CCR-Framework) 

Resources 

� Tangible 

� Intangible 

Capabilities 

� Teams of 

Resources 

Core Competencies 

Sources of 

Competitive 

Advantage 

Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications 

(5th edition, Blackwell, 2004) 


Above-average returns (€) 

Value 

Chain 

Analysis 

Criteria of 

Sustainable 

Advantages 

42

Core Competencies: 

What a firm does that is strategically valuable 

� What a firm does that is strategically valuable 

– “…the essence of what makes an organization unique in its ability to provide value 

to customers.” 

� Criteria for resource to be a core competency and generate sustained 

competitive advantage 

– Valuable: Capabilities that either help a firm to exploit opportunities in the 

environment to create value or to neutralize threats in the environment 

– Rare: Capabilities possessed by few, if any, current or potential competitors 

– Costly to imitate: Capabilities that other firms cannot develop easily, usually due 

to unique historical conditions, causal ambiguity or social complexity 

– Non substitutable: Capabilities that do not have strategic equivalents, such as 

firm-specific knowledge or trust-based relationships 

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications 



43

Resources: What a firm has 

� Resources 

– What a firm has to work with 

• Its assets, including its people and the value of 

its brand name 

– Represent inputs into a firm’s production process 

and contribute to its ability to provide value 

• Such as capital equipment, employees’ skills 

and knowledge, brand names, finances, 

managerial talent 

– Are observable 

– Are tradeable 

– Contribute to the firm’s market position by 

improving value, by lowering cost or both. 

– Have value if difficult to imitate or substitute 

Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications 



� Tangible resources 

– Financial 

– Physical 

– Organizational 

– Technological 

� Intangible resources 

– Human 

– Innovation 

– Reputation 

44

Capabilities: What a firm does 

� Capabilities 

– Cannot be readily observed 

– Are not tradeable separately from the company. 

– Are developed by a company through coordinated action 

– Become important when they combine resources in unique combinations that 

create economic value and can lead to competitive advantage (Can contribute to 

higher value, lower cost or both.) 

� Firms compete on resources & capabilities as much as they do on products 

– Visible competition – product market competition 

– Invisible competition – resource & capability development and deployment 




45

Core Competencies: ”the roots” of a business 


46

Canon: Products and Core Technical Capabilities 

Precision 

Mechanics 

Micro- 

Electronics 

35mm SLR camera 

Compact fashion camera 

EOS autofocus camera 

Digital camera 

Video still camera 

Mask aligners 

Excimer laser aligners 

Stepper aligners 

Basic fax 

Laser fax 

Calculator 

Notebook computer 




Fine 

Optics 

Plain-paper copier 

Color copier 

Color laser copier 

Laser copier 

Inkjet printer 

Laser printer 

Color video printer

Corporate Strategy Diversification - Prof. Dr. Bernd Venohr

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