Product‐market competition and resource redeployment in multi‐business firms

• Author: Raffaele Morandi Stagni,Juan Santaló,Marco S. Giarratana
• Date: 01 October 2020
• DOI: http://doi.org/10.1002/smj.3207
• Published date: 01 October 2020

RESEARCH ARTICLE

Product-market competition and resource

redeployment in multi-business firms

Raffaele Morandi Stagni

1

| Juan Santaló

2

|

Marco S. Giarratana

2

1

Department of Business Administration,

Universidad Carlos III de Madrid, Getafe,

Madrid, Spain

2

Calle Alvarez de Baena 4, Strategy

Department, IE Business School/IE

University, Madrid, Spain

Correspondence

Raffaele Morandi Stagni, Calle Madrid

126 - 6.0.37, Department of Business

Administration, Universidad Carlos III de

Madrid, 28903 Getafe (Madrid), Spain.

Email: raffaele.morandi@uc3m.es

Funding information

Fondo Europeo de Desarrollo Regional

(FEDER), Grant/Award Number:

UNC315-EE-3636; Ministerio de Ciencia e

Innovación, Grant/Award Numbers:

ECO2016-78980-P, PGC2018-096316-B-

I00, RTI2018-097033-B-I00

Abstract

Research summary: This article investigates how

diversified firms reallocate internal non-scale free

resources when one of their product business units (BUs)

experiences increased exposure to international competi-

tion driven by a sharp decrease in trade tariffs. On aver-

age, firms tend to fight, by reallocating resources toward

the BU affected by the trade shock and away from other

BUs within the same firm. Two variables moderate this

first-order effect with opposite signs. The level of sunk

costs of the assets allocated to the BU affected by the

shock is a positive moderator of resource reallocation to

it. The presence of technological synergies between the

BU affected and the rest of BUs instead moderates the

relationship negatively. This negative moderation seems

to only take place when competition increases the value

of technology as a competitive resource.

Managerial summary: An important question in the

strategic decision-making process of diversified firms is

how to react to competitive threats that affect one busi-

ness unit but not the others. Should managers allocate

more resources to the affected business or should they

instead reduce their commitment and use the same

resources in the remaining operating sectors? In this

article, we examine firms’reallocation decisions follow-

ing increases in foreign competition due to import tariff

cuts. Our results show that firms tend to allocate more

resources to the business affected by the tariff cut and

Received: 5 July 2017 Revised: 9 April 2020 Accepted: 28 April 2020 Published on: 22 June 2020

DOI: 10.1002/smj.3207

Strat Mgmt J. 2020;41:1799–1836. wileyonlinelibrary.com/journal/smj © 2020 Strategic Management Society 1799

less to the businesses unaffected. Furthermore, we find

evidence that this behavior is positively associated with

performance.

KEYWORDS

competition, diversification, opportunity cost, performance,

resource redeployment

1|INTRODUCTION

Unlike specialized firms, diversifiers can create value by redeploying scarce resources across the

business units (BUs) they use to compete in different product markets (Helfat &

Eisenhardt, 2004). Levinthal and Wu (2010) label resources “non-scale free”if they cannot be

shared simultaneously by two distinct BUs but can be reallocated across BUs in different time

periods by corporate headquarters. The redeployment process for such non-scale free resources

generates intertemporal economies of scope, as long as diversified firms react promptly and effi-

ciently to altered market conditions.

Prior literature illustrates the effects of negative demand-side shocks, for which both theory

and evidence indicate that the optimal response is a reallocation of resources away from the

sector suffering the decline in demand (Levinthal & Wu, 2010; Lieberman, Lee, & Folta, 2017;

Wu, 2013). For example, Lieberman et al. (2017) leverage a theoretical model and descriptive

statistics from the telecommunications industry to show that related diversifiers are more likely

to speed up their exit from businesses that fail to meet demand expectations, through redeploy-

ment. Wu (2013) reports, using hazard and logistic regressions, that firms in cardiovascular

medical device segments exhibit diversification patterns in which they abandon (enter) submar-

kets with declining (growing) demand.

In their work, Levinthal and Wu (2010, p. 784) also point out that opportunity costs in

resource allocation depend not only on demand conditions, but also on “competitive conditions

in alternative product markets”. This in turn raises the question: Are firms’reactions to compet-

itive threats the same as in the case of declining demand? At first sight, the answer should be

affirmative, because both shocks decrease firms’expected future profits. However, in the case of

competitive shocks compelling arguments exist for increasing investments in the sectors

affected. In this article, we consider the effect of increased competition that influences one

product market of a diversified firm on how it subsequently reallocates its resources. As in the

demand case, a firm could fight or flee; if it decides to confront the competitive threat, a BU

could seek to discourage potential entrants by indicating its willingness to engage, for example,

in a price war (Lieberman & Montgomery, 1988), or it might invest in differentiation efforts to

insulate its profit margins from competition (Fernández-Kranz & Santaló, 2010;

Flammer, 2015).

To investigate these potential outcomes, we exploit exogenous changes in product market

competition as a main source of industry variation and study how diversifiers might improve

(or not) their overall performance by redeploying non-scale free resources toward BUs that face

increasing competitive pressure. Our empirical setting features a sharp decrease in import tariff

rates for a particular sector; prior literature has reported that tariff changes impose considerable

impacts on firms’markets and strategies (Flammer, 2015; Frésard, 2010; Frésard & Valta, 2016).

1800 MORANDI STAGNI ET AL.

In this context, we examine the reallocation of financial (cash) resources, for two reasons. First,

financial resources are non-scale free, in that their use in one BU prevents their deployment in

another. Second, cash transfers are visible strategic actions that potential rivals can use as credi-

ble signals that the firm is allocating any type of non-scale free resource toward a particular

BU.

1

As Kim and Bettis (2014, p. 2056) note, “cash is a highly flexible form of credible threat to

deter competitors,”and cash transfers can enhance a BUs ability to compete, such that they

function as effective entry deterrence devices.

We find that after an increase in international competition due to tariff shocks, a firm rede-

ploys financial resources toward the affected BU and away from its other BUs. This strategy is

associated with value creation. Our data indicate that, on average, diversified firms increase

their allocation of resources to a BU directly affected by a reduced trade tariff by 3.4% of their

average segment assets. This increased resource allocation then translates into a 1.6% gain in

the market-to-book value and a 5.9% gain in the market-to-sales value, at the corporate level.

The findings thus suggest that diversified companies respond to competitive shocks by fighting,

which ultimately leads to better corporate performance (e.g., Deb, David, & O'Brien, 2017;

Derfus, Maggitti, Grimm, & Smith, 2008).

We explore two idiosyncratic characteristics of the firm and its BUs that may influence

this first-order effect. First, we test how the amount of sunk assets invested in a BU influ-

ences the strength and direction of a firm's competitive response. Second, we analyze poten-

tial substitution effects between synergies and redeployment. According to Sakhartov and

Folta (2014, p. 1788), “the interdependence between synergy and redeployment is not

expected to be positive because,…if [a firm] redeploys resources to one business, the value

derived from synergy is reduced.”We empirically confirm that these two factors exert oppo-

site effects. That is, the extent of sunk assets invested in the affected BU is a positive moder-

ator of reallocation, whereas the presence of technological synergiesactsasanegative

moderator, but only when competition increases the value of technology as compet itive

resource.

With these analyses, our study explicates resource redeployments by diversified firms under

changed competitive conditions. Among the factors theorized by Levinthal and Wu (2010) in

the case of resource redeployment, we shift research attention away from the exogenous varia-

tion induced by demand dynamics (Lieberman et al., 2017; Wu, 2013) and toward that ignited

by competitive threats. In contrast with classical flight outcomes predicted by demand-based

research, we find instead that diversifiers step up their investments in affected BUs, rather than

reallocating their resources toward other BUs. We also replicate this scenario with an experi-

ment administered to MBA students and we find the same result.

Granted, our theoretical explanation proposes relaxing the conventional assertion that exter-

nal market conditions set the rates of return on resources employed by a focal BU, such that a

negative (positive) shock always would be followed by divestiture (investment) (Helfat &

Eisenhardt, 2004; Levinthal & Wu, 2010). With our complementary view, we propose that firms

also might endogenously increase their marginal returns, through cash reallocation actions. In

this respect, negative demand shocks may imply lower marginal resource returns (Helfat &

Eisenhardt, 2004; Wu, 2013), but increasing competitive pressures could augment the returns,

especially in environments with a constant overall demand, and stiff competition on market

1

If the firm, or its corporate headquarters, allocates more skilled personnel to reinforce the affected BU or assigns it

more marketing power in terms of resources and personnel, it implies more financial expenses for this affected BU, and

we can track them using our subsequently detailed measure of financial resource allocation.

MORANDI STAGNI ET AL.1801