Chapter 8 Corporate Strategy: Diversification and the Multibusiness Company
Chapter 8 Corporate Strategy: Diversification and the Multibusiness Company
Learning Objectives
Explain when and how business diversification can enhance shareholder value.
Describe how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage.
Identify the merits and risks of unrelated diversification strategies.
Use the analytic tools for evaluating a firm’s diversification strategy.
Understand the four main corporate strategy options a diversified firm can employ to improve its performance.
Crafting a Diversification Strategy
Steps Involved
Step 1: Picking new industries to enter and deciding on the means of entry.
Step 2: Pursuing opportunities to leverage cross-business value chain relationships and strategic fit into competitive advantage.
Step 3: Initiating actions to boost the combined performance of the corporation’s collection of businesses.
When to Consider Diversifying
A firm should consider diversifying when:
Growth opportunities are limited, as its principal markets reach their maturity and buyer demand is either stagnating or set to decline.
Changing industry conditions—new technologies, inroads being made by substitute products, fast-shifting buyer preferences, or intensifying competition—are undermining the firm’s competitive position.
Strategic Diversification Options
Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses.
Broadening the current scope of diversification by entering additional industries.
Retrenching to a narrower scope of diversification by divesting poorly performing businesses.
Broadly restructuring the entire firm by divesting some businesses and acquiring others to put a whole new face on the firm’s business lineup.
How Much Diversification?
Deciding how wide-ranging diversification should be:
Diversify into closely related businesses or into totally unrelated businesses?
Diversify present revenue and earnings base to a small or major extent?
Move into one or two large new businesses or a greater number of small ones?
Acquire an existing company?
Start up a new business from scratch?
Form a joint venture with one or more firms to enter new businesses?
Opportunity for Diversifying
Strategic Diversification Possibilities
Expand into businesses whose technologies and products complement present business(es).
Employ current resources and capabilities as valuable competitive assets in other businesses.
Reduce overall internal costs by cross-business sharing or transfers of resources and capabilities.
Extend a strong brand name to the products of other acquired businesses to help drive up sales and profits of those businesses.
Building Shareholder Value
The Ultimate Justification for Diversifying
Testing whether diversification will add long-term value for shareholders:
Industry attractiveness test: Are the industry’s profits and return on investment as good or better than present business(es)?
Cost-of-entry test: Is the cost of overcoming entry barriers so great as to cause delay or reduce the potential for profitability?
Better-off test: How much synergy (stronger overall performance) will be gained by diversifying into the industry?
Evaluating Potential for Synergy
No Synergy: Firm A purchases Firm B. Profits are no greater than what each firm could have earned on its own. (1 + 1 = 2)
Synergy: Firm A purchases Firm C. Profits are greater than what each firm could have earned on its own. (1 + 1 = 3)
Approaches to Diversifying the Business Lineup
Diversifying into New Business
Existing business acquisition.
Internal new venture (start-up).
Joint venture.
Diversification by Acquisition of an Existing Business
Advantages:
Quick entry into an industry.
Barriers to entry avoided.
Access to complementary resources and capabilities.
Disadvantages:
Cost of acquisition—whether to pay a premium for a successful firm or pay a bargain price for a struggling firm.
Underestimating costs for integrating acquired firm.
Overestimating the acquisition’s potential for added shareholder value.
Entering a New Line of Business through Internal Development
Advantages:
Avoids pitfalls and uncertain costs of acquisition.
Allows entry into a new or emerging industry where there are no available acquisition candidates.
Disadvantages:
Must overcome industry entry barriers.
Requires extensive investments in developing production capacities and competitive capabilities.
May fail due to internal organizational resistance to change and innovation.
Factors Favoring Internal Development
Low resistance of incumbent firms to market entry.
Ample time to develop and launch business.
Availability of in-house skills and resources.
Cost of acquisition higher than internal entry.
Added capacity does not adversely impact supply-demand balance in the industry.
Using Joint Ventures to Achieve Diversification
Advantages of Joint Ventures:
Too large, complex, uneconomical, or risky for one firm to pursue alone.
Require a broader range of competencies and know-how than a firm possesses or can develop quickly.
Located in a foreign country that requires local partner participation or ownership.
Risks of Diversification by Joint Venture
Conflicting objectives and expectations of venture partners.
Disagreements among or between venture partners over operations.
Cultural clashes among and between partners.
Dissolution of the venture when one partner seeks to go their own way.
Choosing a Mode of Market Entry
Key Considerations
Critical resources and capabilities: Does the firm have the resources and capabilities for internal development?
Entry barriers: Are there strong barriers to entry?
Speed to market entry: Is speed crucial for successful entry?
Comparative cost: Which is the least costly mode of entry given the firm’s objectives?
Choosing the Diversification Path
Related vs. Unrelated Businesses
Related Businesses
Unrelated Businesses
Both Related and Unrelated Businesses
Diversification into Related Businesses
Strategic Fit Opportunities
Transferring specialized expertise, technological know-how, or resources and capabilities from one business’s value chain to another’s.
Sharing costs by combining related value chain activities of different businesses into a single operation.
Exploiting common use of a well-known brand name.
Sharing other resources that support corresponding value chain activities across businesses.
Engaging in cross-business collaboration and knowledge sharing to create new competitively valuable resources and capabilities.
Pursuing Related Diversification
Generalized resources and capabilities: Can be deployed widely across a broad range of industries and business types.
Specialized resources and capabilities: Have very specific applications, restricting their use to a narrow range of industry and business types, typically leveraged only in related diversification situations.
Identifying Cross-Business Strategic Fits
Potential Cross-Business Fits
Sales and marketing activities.
R&D technology activities.
Supply chain activities.
Manufacturing-related activities.
Distribution-related activities.
Customer service activities.
Strategic Fit, Economies of Scope, and Competitive Advantage
Using economies of scope to convert strategic fit into competitive advantage can entail:
Transferring specialized and generalized skills or knowledge.
Combining related value chain activities to achieve lower costs.
Leveraging brand names and other differentiation resources.
Using cross-business collaboration and knowledge sharing.
Economies of Scope vs. Economies of Scale
Economies of Scope: Cost reductions from cross-business resource sharing in the activities of the multiple businesses of a firm.
Economies of Scale: Accrue when variable costs decrease due to the greater efficiency of operating a larger-size operation.
Illustrative Example: Related Diversification Strategy
Questions to Consider
Which company is focusing on growth by acquisition, by internal growth, and by cross-business fits?
Is the successful pursuit of growth by a single form of related diversification likely to lead to sustainable competitive advantage?
How is the scale and scope of the strategic fits related to their success in the markets?
From Strategic Fit to Competitive Advantage
Capturing Cross-Business Strategic Fit Benefits
Builds more shareholder value than owning a stock portfolio.
Only possible via a strategy of related diversification.
Yields value in the application of specialized resources and capabilities.
Requires management to take internal actions to realize them.
The Effects of Cross-Business Fit
Fit builds more value than owning a portfolio of firms in different industries.
Strategic-fit benefits are possible only via related diversification.
The stronger the fit, the greater its effect on the firm’s competitive advantages.
Diversification into Unrelated Businesses
Evaluation Considerations
Can it meet corporate targets for profitability and return on investment?
Is it in an industry with attractive profit and growth potentials?
Is it significant enough to contribute to the parent firm's bottom line?
Building Shareholder Value via Unrelated Diversification
Astute corporate parenting by management: Leadership, oversight, expertise, and guidance provided by centralized management.
Cross-business allocation of financial resources: Serves as an internal capital market allocating surplus cash flows from businesses.
Acquiring and restructuring undervalued companies: Acquire weakly performing firms at bargain prices and use turnaround capabilities to increase their performance.
The Drawbacks of Unrelated Diversification
Demanding Managerial Requirements.
Limited Competitive Advantage Potential.
Monitoring and maintaining the parenting advantage.
Lack of cross-business strategic-fit benefits.
Misguided Reasons for Pursuing Unrelated Diversification
Seeking to reduce business investment risk.
Pursuing rapid or continuous growth for its own sake.
Seeking stabilization of earnings to avoid cyclical swings in businesses.
Pursuing personal managerial motives.
Combination Related-Unrelated Diversification Strategies
Suitable For
Dominant-business enterprises.
Narrowly diversified firms.
Broadly diversified firms.
Multibusiness enterprises.
Structures of Combination Related-Unrelated Diversified Firms
Dominant-business enterprises: Have a major core firm accounting for 50% to 80% of total revenues.
Narrowly diversified firms: Are comprised of a few related or unrelated businesses.
Broadly diversified firms: Have a wide-ranging collection of related or unrelated businesses.
Multibusiness enterprises: Have several unrelated groups of related businesses.
Steps in Evaluating the Strategy of a Diversified Firm
Assess the attractiveness of the industries the firm has diversified into.
Assess the competitive strength of the firm’s business units.
Evaluate the extent of cross-business strategic fit along the value chains of the business units.
Check whether the firm’s resources fit the requirements of its present business lineup.
Rank the performance prospects of the businesses from best to worst to determine resource allocation priorities.
Craft strategic moves to improve corporate performance.
Step 1: Evaluating Industry Attractiveness
Key Measures
Market size and projected growth rate.
Intensity of competition among market rivals.
Emerging opportunities and threats.
Presence of cross-industry strategic fit.
Resource requirements.
Social, political, regulatory, environmental factors.
Industry profitability.
Calculating Industry-Attractiveness Scores
Decide on weights for industry attractiveness measures.
Assign accurate and objective ratings based on industry knowledge.
Consider weighted scores for different business units when importance differs significantly.
Step 2: Evaluating Business Unit’s Competitive Strength
Calculating Competitive Strength
Relative market share.
Costs relative to competitors’ costs.
Ability to match or beat rivals on key product attributes.
Brand image and reputation.
Other competitively valuable resources and capabilities.
Benefits from strategic fit with the firm’s other businesses.
Profitability relative to competitors.
Step 3: Determining the Competitive Value of Strategic Fit
Assessing the degree of strategic fit across its businesses is central to evaluating a firm’s related diversification strategy.
Step 4: Checking for Good Resource Fit
Financial Resource Fit
State of the internal capital market: E.g., cash hogs need cash, cash cows generate excess cash, stars are self-supporting.
Nonfinancial Resource Fit
Have or can develop specific resources and capabilities needed?
Are resources being stretched too thin by any business's requirements?
Success Sequence
Cash hog to Star to Cash cow.
Step 5: Ranking Business Units and Assigning a Priority for Resource Allocation
Ranking Factors
Sales growth.
Profit growth.
Contribution to company earnings.
Return on capital invested.
Cash flow.
Strategic Priorities
Steer resources to business units with strong profit and growth prospects and resource fit.
Step 6: Crafting New Strategic Moves
Strategy Options for Already Diversified Firms
Stick with the present business lineup.
Broaden the diversification with new acquisitions.
Divest some businesses to retrench.
Restructure through divestitures and new acquisitions.
Broadening a Diversified Firm’s Business Base
Factors Motivating the Addition of More Businesses
The transfer of resources to related or complementary businesses.
Rapidly changing technology, legislation, or product innovations in core businesses.
Strengthening the market position of present businesses.
Extending operations into additional country markets.
Divesting Businesses and Retrenching
Factors Motivating Divestiture
Improving long-term performance by concentrating on fewer core businesses.
Deterioration of market conditions in a once-attractive industry.
Poor performance or lack of cultural/strategic/resource fit.
Potential for greater value if sold or spun-off.
Restructuring a Diversified Company’s Business Lineup
Factors Driving Corporate Restructuring
Mismatch between resources and pursued diversification type.
Too many businesses in unattractive industries.
Declines in market shares of major business units.
Excessive debt burden impacting profitability.
Acquisitions not meeting expectations.
Illustration Capsule: Restructuring for Better Performance
Case of VF Corporation
Expected benefits of splitting into two firms?
Recognition of industry changes and necessity for transformation?
How can internal growth create a lack of strategic fit?