Chapter 6: Corporate-Level Strategy 185
6-4 Unrelated Diversification
Firms do not seek either operational relatedness or corporate relatedness when using the
unrelated diversification corporate-level strategy. An unrelated diversification strategy
(see Figure 6.2) can create value through two types of financial economies. Financial
economies are cost savings realized through improved allocations of financial resources
based on investments inside or outside the firm.^66
Efficient internal capital allocations can lead to financial economies. Efficient internal
capital allocations reduce risk among the firm’s businesses—for example, by leading to
the development of a portfolio of businesses with different risk profiles. The second type
of financial economy concerns the restructuring of acquired assets. Here, the diversified
firm buys another company, restructures that company’s assets in ways that allow it to
operate more profitably, and then sells the company for a profit in the external market.^67
Next, we discuss the two types of financial economies in greater detail.
6-4a Efficient Internal Capital Market Allocation
In a market economy, capital markets are believed to efficiently allocate capital. Efficiency
results as investors take equity positions (ownership) with high expected future cash-flow
values. Capital is also allocated through debt as shareholders and debt holders try to
improve the value of their investments by taking stakes in businesses with high growth
and profitability prospects.
In large diversified firms, the corporate headquarters office distributes capital to its
businesses to create value for the overall corporation. As exampled in the Strategic Focus,
GE has used this approach to internal capital allocation among its unrelated business
units. The nature of these distributions can generate gains from internal capital market
allocations that exceed the gains that would accrue to shareholders as a result of capital
being allocated by the external capital market.^68 Because those in a firm’s corporate head-
quarters generally have access to detailed and accurate information regarding the actual
and potential future performance of the company’s portfolio of businesses, they have the
best information to make capital distribution decisions.^69
Compared with corporate office personnel, external investors have relatively limited
access to internal information and can only estimate the performances of individual
businesses as well as their future prospects. Moreover, although businesses seeking cap-
ital must provide information to potential suppliers (e.g., banks or insurance compa-
nies), firms with internal capital markets can have at least two informational advantages.
First, information provided to capital markets through annual reports and other sources
emphasize positive prospects and outcomes. External sources of capital have a limited
ability to understand the operational dynamics within large organizations. Even external
shareholders who have access to information are unlikely to receive full and complete
disclosure.^70 Second, although a firm must disseminate information, that information
also becomes simultaneously available to the firm’s current and potential competitors.
Competitors might attempt to duplicate a firm’s value-creating strategy with insights
gained by studying such information. Thus, the ability to efficiently allocate capital
through an internal market helps the firm protect the competitive advantages it develops
while using its corporate-level strategy as well as its various business-unit–level strategies.
If intervention from outside the firm is required to make corrections to capital allo-
cations, only significant changes are possible because the power to make changes by
outsiders is often indirect (e.g., through members of the board of directors). External
parties can try to make changes by forcing the firm into bankruptcy or changing the top
management team. Alternatively, in an internal capital market, the corporate headquar-
ters office can fine-tune its corrections, such as choosing to adjust managerial incentives
Financial economies are
cost savings realized through
improved allocations of
financial resources based on
investments inside or outside
the firm.