Strategy Test 3 chapter 7

1) such that businesses forming the corporate whole are worth more than they would be under independent ownership

2) that equity holders cannot create through portfolio investing

Value chain economies

Economies of scope

• the increase in the value of a firms products or services that results from a firm
• operating in multiple industries or markets.

range of industries or markets served by a diversified firm

when a firm operates in multiple industries or markets simultaneously.

• similarity of industry or market customers, technologies, inputs, distribution channels,
• etc.

operating in multiple industries

operating in multiple geographic markets

operating in multiple industries in multiple geographic markets

• When all or most of a firm’s business activities fall within a single industry and
• geographic market

• When less that 70% of a firm’s revenues come from a single industry and market and
• these industries and markets are linked

• 1) Some economy of scope
• 2) Must create value that outside equity holders can't create on their own

exploiting efficiencies of sharing business activities

*Results in cost sharing across businesses

*Can occur at any stage of a firm’s value chain

• utilizing a core competency developed in one market or business in others
• * Core competencies are complex sets of resources and capabilities that link different
• businesses through managerial or technical know-how. 

*Increases value because multiple core competencies don’t have to be developed

• notion that insiders can allocate capital across division more efficiently than the
• external capital market because managers have better, more detailed information about the earnings prospects and performance of a
• business.

May serve to protect proprietary information – may also result in escalating commitment to bad projects or investments

counter cyclical businesses may provide decreased overall risk

*Usually does not create value that stockholders could not achieve through portfolio diversification

• losses in one division can offset losses in another division – thereby reducing a
• firm’s tax liability

when two or more firms compete simultaneously in multiple markets

• when a firm chooses not to compete aggressively in one market to avoid competition
• in another market

Diversification can facilitate the subsidization of one business by another 

• *This may allow for a firm to engage in predatory pricing in one business in order to
• drive competitors out of that market.

an economy of scope that benefits managers at the expense of equity holder

executive compensation is positively related to firm size (sales) –

Executives make firm-specific investments in their human capital