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(G1) [ABS] (week3) Diversification Strategy (Operational Reasons to…
(G1) [ABS] (week3) Diversification Strategy
Strategic Reasons to Diversify
1.Eliminate competition by subsidizing a price war
Caution
Maybe an antitrust violation (e.g. Microsoft)
Argument
Competitors have limited access to capital
2.Raise rival's costs (e.g. vertical foreclosure)
Argument
Exert power through backward and forward integration
Caution
A near monopoly position must be maintained in the upstream or downstream activity
4.Minimize transaction cost of using markets
Argument
Often costly (impossible) to write complete contract, leading to "hold-up" by partners
Caution
Assumes that trust is difficult in market exchange
3.Reduce rivalry through mutual forbearance
Argument
Multi point competition ( competitors are in similar markets) reduces incentives to fight
Caution
Complexity makes such tacit collusion difficult
When price wars do break out, they tend to be severe
Introduction to Competing across Industries
Diversification types
Low
Single Business
95% revenue from single business
e.g. : Google, Coca-Cola
Dominant Business
75%-95% revenue from single business
e.g. : Pepsi
High
Related
Sharing value chain
e.g. : Disney
Unrelated
No clear value sharing
a.k.a Conglomerate
e.g. General Electric
Strategy
Business Strategy
How to compete in individual lines of business?
Corporate Strategy
How to compete across lines of business
Firm Scope
Diversification to gain economic rents in individual businesses
Potential benefit > costs?
Financial Reasons to Diversify
2.Capitalize opportunities in related markets
Argument
Have privileged information about profitable opportunities
Critique
Few evidence that internal markets are more efficient
1.Capitalize on opportunities in unrelated markets
Argument
Reinvest retained earnings
Achieve growth targets
Critique
Shareholders can choose where they want to invest
3.Reduce volatility by diversifying assets
Critique
Shareholders can diversify by themselves
Argument
Reduce volatility of earnings
4.Reduce risk by diversifying assets
Argument
Reduce some of costs
Critique
Combining units can compound risks across units , raising the risk
Operational Reasons to Diversify
Reasons 2: Transfer or leverage rent generating assets
Share underlying technology and know-how
Reasons 3: Improve coordination among businesses
Create broad incentives for cooperation and information exchange
Reasons 1: Exploit various economies of scale and scope
Lower costs by reducing duplicate effort
Caution
Synergies are hard to realize in practice
Synergies can be achieved through contracts, rather than integration
Alternatives
Outsourcing activity
Formal alliances
Synergy
Benefits the individual lines of business
The Right Degree of Diversification
analyze each's strategy
valuable competitive position?
thinking about the synergies and the value
creation
holding this portfolio together
Team Members
Jamie
Joanna
May
Miki
Cindy
Andri
Limits on Firm Scope
government
reduce monopoly powers
prevent the ability to such large organizations there for good policy reasons
firm
increase bureaucratic costs
Decision making becomes slower and inflexible
Coordinating between layers of management becomes more difficult
less able to adapt to market changes
agency costs
Why Firms Exist: Theory of the Firm
Why is all economic activity not organised through markets?
Theory of the Firm
All economic activity is a series of transactions between independent economic actors.
Ownership impacts residual rights of control
Ability to choose course
Minimising risk/frictions
Creates common incentives/mechanisms
