Chapter 8 Learning Objectives - Business Strategy Game ... · PDF fileChapter 8 PowerPoint Slides ... Assessing multiple industry environments ... Industry Attractiveness Test —Industry

STRATEGY

Core Concepts and Analytical Approaches

Chapter 8

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Copyright © 2012 GLO-BUS Software, Inc. Page 1

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Chapter 8 Learning ObjectivesChapter 8 Learning Objectives

1.1. Understand what diversification is and when and how it Understand what diversification is and when and how it

can enhance shareholder value.can enhance shareholder value.

2.2. Learn the strategic difference between related and Learn the strategic difference between related and

unrelated diversification strategies.unrelated diversification strategies.

3.3. Gain an understanding of the pros and cons of related Gain an understanding of the pros and cons of related

and unrelated diversification strategies.and unrelated diversification strategies.

4.4. Gain command of the analytical approaches to Gain command of the analytical approaches to

evaluating a company’s diversification strategy.evaluating a company’s diversification strategy.

5.5. Become familiar with a diversified company’s principal Become familiar with a diversified company’s principal

strategic options after it has diversified.strategic options after it has diversified.

Copyright © 2012 by Glo-Bus Software, Inc. 8–5

Chapter 8 RoadmapChapter 8 Roadmap

�� What Does Crafting a Diversification Strategy Entail?What Does Crafting a Diversification Strategy Entail?

�� When and Why Diversification Makes Good Strategic When and Why Diversification Makes Good Strategic

SenseSense

�� Choosing the Diversification Path: Related versus Choosing the Diversification Path: Related versus

Unrelated BusinessesUnrelated Businesses

�� The Case for Diversifying into Related BusinessesThe Case for Diversifying into Related Businesses

�� The Case for Diversifying into Unrelated BusinessesThe Case for Diversifying into Unrelated Businesses

�� Evaluating a Diversified Company’s StrategyEvaluating a Diversified Company’s Strategy——The Six The Six

Analytical StepsAnalytical Steps


What Is Meant by “Diversification”?What Is Meant by “Diversification”?

�� A firm is A firm is diversified when it is in two or more lines of diversified when it is in two or more lines of business that are inbusiness that are in distinctly different distinctly different industriesindustries

►► A firm is not diversified if it produces two brands of soft drinks (both A firm is not diversified if it produces two brands of soft drinks (both

products are in the same industry) or operates two kinds of fast products are in the same industry) or operates two kinds of fast food chains (all fast food chains are part of the fast food industryfood chains (all fast food chains are part of the fast food industry——having different menu selections does not equate to being in a having different menu selections does not equate to being in a

different line of business)different line of business)

�� Since a diversified firm is a collection of individual Since a diversified firm is a collection of individual

businesses, the strategybusinesses, the strategy--making task is more complicated making task is more complicated

because it requiresbecause it requires

►► Assessing multiple industry environments Assessing multiple industry environments

►► Developing Developing a set of business strategiesa set of business strategies, one for each industry , one for each industry

arena (or line of business) in which the diversified firm operatesarena (or line of business) in which the diversified firm operates


What Does Crafting a Diversification What Does Crafting a Diversification Strategy Entail?Strategy Entail?

�� StrategyStrategy--making in a diversified company has four facets:making in a diversified company has four facets:

1.1. Picking new industries to enter and deciding whether to enter the Picking new industries to enter and deciding whether to enter the

industry by starting a new business from the ground up, acquiring industry by starting a new business from the ground up, acquiring a firm already in the target industry, or forming a joint venture or a firm already in the target industry, or forming a joint venture or

strategic alliance with another firm strategic alliance with another firm

2.2. Initiating actions to boost the combined performance of the Initiating actions to boost the combined performance of the

businesses the firm has enteredbusinesses the firm has entered

3.3. Pursuing opportunities to leverage crossPursuing opportunities to leverage cross--business value chain business value chain relationships and strategic fits into competitive advantage relationships and strategic fits into competitive advantage

4.4. Evaluating the growth and profitability prospects for each business Evaluating the growth and profitability prospects for each business

and then investing aggressively in businesses with the best and then investing aggressively in businesses with the best prospects, investing cautiously in businesses with just average prospects, investing cautiously in businesses with just average

prospects, and divesting businesses with unacceptable prospectsprospects, and divesting businesses with unacceptable prospects

Copyright © 2012 by Glo-Bus Software, Inc. 8–8 8–9

8.1 Identifying a Diversified Company’s StrategyFigure

Copyright © 2012 by Glo-Bus Software, Inc.

STRATEGY


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When Does It Make Sense When Does It Make Sense for a Firm to Diversify?for a Firm to Diversify?

�� If a singleIf a single--business firm has its hands full trying to capitalize on profitable business firm has its hands full trying to capitalize on profitable growth opportunities in its present industry, there is no urgency to diversify growth opportunities in its present industry, there is no urgency to diversify into other businessesinto other businesses

►► But the big risk to the firm is in keeping all of its eggs in one industry basketBut the big risk to the firm is in keeping all of its eggs in one industry basket

►► Thus, diversification always merits strong consideration at singleThus, diversification always merits strong consideration at single--business firms business firms

when industry conditions turn sour and are expected to be longwhen industry conditions turn sour and are expected to be long--lastinglasting

�� A firm becomes a prime candidate for diversifying when:A firm becomes a prime candidate for diversifying when:

►► It spots opportunities It spots opportunities to expand to expand into industries whose into industries whose technologies and technologies and products complementproducts complement its present businessits present business

►► It It can leverage existing competencies and capabilities can leverage existing competencies and capabilities by expanding into by expanding into businesses where its resource strengths are key success factors and valuable businesses where its resource strengths are key success factors and valuable

competitive assetscompetitive assets

►► Diversifying into closely related businesses opens avenues Diversifying into closely related businesses opens avenues for reducing costs for reducing costs

►► It has It has a powerful brand name a powerful brand name that can be transferred to the products of other that can be transferred to the products of other businesses to drive up sales and profits in these businessesbusinesses to drive up sales and profits in these businesses


Diversification PossibilitiesDiversification Possibilities

�� There are many ways for a company to pursue There are many ways for a company to pursue

diversification:diversification:

►► Diversify into closely related businesses or into totally unrelated Diversify into closely related businesses or into totally unrelated

businessesbusinesses

►► Diversify the present revenue and earning base to a small extent Diversify the present revenue and earning base to a small extent or to a major extentor to a major extent

►► Move into one or two large new businesses or a greater number Move into one or two large new businesses or a greater number

of small onesof small ones

►► Achieve multibusiness/multiAchieve multibusiness/multi--industry status by acquiring an industry status by acquiring an

existing firm already in a business/industry it wants to enterexisting firm already in a business/industry it wants to enter

►► Form a new business subsidiary to enter a promising industryForm a new business subsidiary to enter a promising industry

►► Form a joint venture with one or more other firms to enter new Form a joint venture with one or more other firms to enter new

businessesbusinesses


Core ConceptCore Concept

Creating added longCreating added long--term value for term value for shareholders shareholders via diversification via diversification requires building a requires building a multibusiness multibusiness firm firm where the whole is where the whole is greater than greater than the sum of its the sum of its parts.parts.

88––1212Copyright © 2012 by GloCopyright © 2012 by Glo--Bus Software, Inc.Bus Software, Inc.

Will Diversification Produce Added Will Diversification Produce Added LongLong--Term Value for Shareholders?Term Value for Shareholders?


The CostThe Cost--ofof--Entry Entry TestTest

The Industry The Industry Attractiveness TestAttractiveness Test

The BetterThe Better--Off Off TestTest

Diversifying in Ways Diversifying in Ways That Build LongThat Build Long--Term Value Term Value

for Shareholdersfor Shareholders

The CostThe Cost--ofof--Entry Entry TestTest

The Industry The Industry Attractiveness TestAttractiveness Test

The BetterThe Better--Off Off TestTest

Diversifying in Ways Diversifying in Ways That Build LongThat Build Long--Term Value Term Value

for Shareholdersfor Shareholders

Moves to Diversify into a New Business Moves to Diversify into a New Business Should Pass Three Tests Should Pass Three Tests

�� A firm’s move to diversify into a new business is not successful A firm’s move to diversify into a new business is not successful

unless it results in unless it results in added longadded long--term economic value for term economic value for shareholdersshareholders

�� For there to be reasonable expectations of producing added longFor there to be reasonable expectations of producing added long--term shareholder value, a move to diversify into a new business term shareholder value, a move to diversify into a new business

must pass three tests:must pass three tests:

1.1. Industry Attractiveness TestIndustry Attractiveness Test——Industry conditions must be conducive Industry conditions must be conducive

to good profitabilityto good profitability

2.2. CostCost--ofof--Entry TestEntry Test——Cost of entering cannot be so high as to spoil the Cost of entering cannot be so high as to spoil the profit opportunitiesprofit opportunities

3.3. BetterBetter--Off TestOff Test——Diversifying must offer Diversifying must offer potentialpotential for the firm’s existing for the firm’s existing businesses and the new business businesses and the new business to perform better together to perform better together under a under a single corporate umbrella single corporate umbrella than they would perform operating as than they would perform operating as independent standindependent stand--alone businessesalone businesses


Why The “BetterWhy The “Better--Off” Test Is So ImportantOff” Test Is So Important

�� Creating added longCreating added long--term value for shareholders via diversification term value for shareholders via diversification

requires building a multirequires building a multi--business firm business firm where the whole is greater where the whole is greater than the sum of its parts.than the sum of its parts.

�� Suppose Firm A diversifies by purchasing Firm B in another industry. Suppose Firm A diversifies by purchasing Firm B in another industry.

►► If A and B’s consolidated future profits are no greater than what each If A and B’s consolidated future profits are no greater than what each

could have earned on its own, then A’s diversification produces a could have earned on its own, then A’s diversification produces a 1 + 1 = 2 result which does not provide its shareholders with added value 1 + 1 = 2 result which does not provide its shareholders with added value because A’s shareholders could have achieved the same 1 + 1 = 2 result because A’s shareholders could have achieved the same 1 + 1 = 2 result

by merely purchasing stock in B. by merely purchasing stock in B.


RuleRuleRuleRule

Diversification does not produce added long-term value for shareholders unless it produces a 1 + 1 = 3 effect where sister businesses perform better together as part of

the same firm than as independent enterprises.

STRATEGY


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Related DiversificationRelated Diversification

Involves diversifying into Involves diversifying into

businesses businesses whose value whose value

chains possess chains possess

competitively valuable competitively valuable

“strategic fits”“strategic fits” with value with value

chain(s) of the firm’s chain(s) of the firm’s

present business(es)present business(es)

Unrelated DiversificationUnrelated Diversification

Involves diversifying into Involves diversifying into

businesses businesses with with nono

competitively valuable value competitively valuable value

chain matchchain match--ups or strategic ups or strategic

fits fits with value chain(s) of with value chain(s) of

the firm’s present the firm’s present

business(es)business(es)

Choosing the Diversification Path: Choosing the Diversification Path: Related versus Unrelated BusinessesRelated versus Unrelated Businesses



Related businesses Related businesses possess possess competitively competitively valuable valuable crosscross--business value chain matchupsbusiness value chain matchups..

Unrelated Unrelated businesses businesses have have such dissimilar value such dissimilar value chains that chains that no competitively no competitively useful crossuseful cross--business business

relationships exist.relationships exist.


8–18

8.2 Fundamental Alternatives for Pursuing a Diversification Strategy

Figure


Strategies for Diversifying into Strategies for Diversifying into Related BusinessesRelated Businesses

�� Related diversification involves building the firm around businesses with Related diversification involves building the firm around businesses with

value chains that have value chains that have competitively valuable strategic fitscompetitively valuable strategic fits

�� Strategic fits Strategic fits among the value chains of different businesses present among the value chains of different businesses present opportunities for:opportunities for:

►► Transferring competitively valuable expertise, technological knowTransferring competitively valuable expertise, technological know--how, or how, or

other valuable resources from one business to anotherother valuable resources from one business to another

►► Combining related value chain activities of separate businesses into a single Combining related value chain activities of separate businesses into a single

operation to achieve lower costs through economies of scale and scope .operation to achieve lower costs through economies of scale and scope .

►► Exploiting the use of a wellExploiting the use of a well--known and potent brand nameknown and potent brand name

►► CrossCross--business collaboration to create competitively valuable resource business collaboration to create competitively valuable resource

strengths and capabilitiesstrengths and capabilities

�� Related diversification represents an attractive opportunity to convert Related diversification represents an attractive opportunity to convert

crosscross--business strategic fits into business strategic fits into a competitive advantage a competitive advantage over rivals over rivals

whose operations do not offer comparable strategic fit benefits.whose operations do not offer comparable strategic fit benefits.



The The value chains value chains of different of different businesses businesses possess possess strategic strategic fit fit when they contain when they contain opportunities opportunities for for

�� crosscross--business transfer of competitively business transfer of competitively valuable resources,valuable resources,

�� lowering costs by lowering costs by combining the performance combining the performance of of related value related value chain activities, chain activities,

�� crosscross--business business use use of a of a potent brand name, potent brand name, and/orand/or

�� crosscross--business collaboration business collaboration to build new or to build new or stronger stronger competitive capabilitiescompetitive capabilities..

88––2020Copyright © 2012 by GloCopyright © 2012 by Glo--Bus Software, Inc.Bus Software, Inc. 8–21

8.3 Related Businesses Possess Related Value Chain Activities

and Competitively Valuable Cross-Business Strategic Fits

Figure


STRATEGY


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Economies of scopeEconomies of scope are cost are cost savings that accrue savings that accrue from successful managerial efforts to squeeze out from successful managerial efforts to squeeze out

operating efficiencies by combining or revamping operating efficiencies by combining or revamping how certain value chain activities of separate how certain value chain activities of separate

businesses are being performed.businesses are being performed.

�� Economies of scope can be achieved only if a diversified Economies of scope can be achieved only if a diversified company operates in two or more businesses with company operates in two or more businesses with costcost--related strategic fitsrelated strategic fits. .

�� When economies of scope exist,When economies of scope exist, sister businesses can sister businesses can be operated more costbe operated more cost--efficiently as part of the same efficiently as part of the same company company than they could operate as standthan they could operate as stand--alone alone businesses.businesses.


Economies of Economies of ScopeScope Are DifferentAre Different

from Economies of from Economies of ScaleScale

�� Economies of scopeEconomies of scope are cost reductions that flow from operating are cost reductions that flow from operating

in multiple businesses. They are achieved by capturing in multiple businesses. They are achieved by capturing costcost--saving strategic fitssaving strategic fits along the value chains of related businesses along the value chains of related businesses that allow multiple businesses to operate more cost efficiently by:that allow multiple businesses to operate more cost efficiently by:

►► Sharing use of the same manufacturing facilities Sharing use of the same manufacturing facilities and/orand/or

►► Sharing use of the same distribution centers Sharing use of the same distribution centers and/orand/or

►► Sharing use of a common sales force Sharing use of a common sales force and/orand/or

►► Sharing use of the same administrative infrastructure Sharing use of the same administrative infrastructure

�� Economies of scale Economies of scale are cost savings that occur because a largeare cost savings that occur because a large--

scale operation is more costscale operation is more cost--efficient than a small one.efficient than a small one.


Why Achieving Economies of Scope in Related Why Achieving Economies of Scope in Related

Businesses Is Competitively ValuableBusinesses Is Competitively Valuable

�� The greater the costThe greater the cost--savings associated with savings associated with strategic fits among the value chains of sister strategic fits among the value chains of sister businesses, the greater the potential for a businesses, the greater the potential for a related diversification strategy to related diversification strategy to yield a lowyield a low--cost competitive advantage overcost competitive advantage over

►► Undiversified competitors Undiversified competitors

►► Competitors whose own diversification efforts Competitors whose own diversification efforts

do not offer equivalent costdo not offer equivalent cost--saving benefitssaving benefits


Strategic Fit and Competitive Advantage: Keys to Strategic Fit and Competitive Advantage: Keys to Added Profitability and Greater Shareholder ValueAdded Profitability and Greater Shareholder Value

�� The greater the relatedness among a diversified firm’s The greater the relatedness among a diversified firm’s sister businesses, the bigger a firm’s window for sister businesses, the bigger a firm’s window for converting strategic fits into competitive advantage converting strategic fits into competitive advantage viavia

►► CrossCross--business transfer of competitively valuable skills and business transfer of competitively valuable skills and technologytechnology

►► The capture of costThe capture of cost--saving efficiencies along the value saving efficiencies along the value chains of related businesseschains of related businesses

►► CrossCross--business use of a wellbusiness use of a well--respected brand name, and/or respected brand name, and/or

►► CrossCross--business collaboration to create new resource business collaboration to create new resource

strengths and capabilities. strengths and capabilities.

�� The competitive advantage potential that flows from the The competitive advantage potential that flows from the capture of strategiccapture of strategic--fit benefits is fit benefits is what enables a firm what enables a firm

pursuing related diversification to achieve 1 + 1 = 3 financial pursuing related diversification to achieve 1 + 1 = 3 financial performance and the expected gains in shareholder value.performance and the expected gains in shareholder value.



Diversifying into related businesses Diversifying into related businesses where where competitively competitively valuable strategic valuable strategic fit benefits can be fit benefits can be

captured puts sister businesses in captured puts sister businesses in position to position to perform better perform better financially financially as part of the as part of the same firm same firm

than than they could have performed they could have performed as independent as independent enterprises, thus providing enterprises, thus providing a clear a clear avenue for avenue for boosting boosting longlong--term shareholder term shareholder valuevalue..


Strategies for Diversifying into Strategies for Diversifying into Unrelated Unrelated BusinessesBusinesses

��Unrelated diversification strategies involve entering Unrelated diversification strategies involve entering any any industry industry and operating and operating any business any business where senior where senior managers see managers see opportunityopportunity to realize consistently good to realize consistently good

financial resultsfinancial results

►► There is no deliberate effort to diversify only into businesses with There is no deliberate effort to diversify only into businesses with strategic fitsstrategic fits

►►New businesses are usually entered by acquiring an established New businesses are usually entered by acquiring an established

firm rather than forming a new startfirm rather than forming a new start--up subsidiary to enter a new up subsidiary to enter a new business or collaborating in a joint venture with other companies to business or collaborating in a joint venture with other companies to

get into a new businessget into a new business

►►An acquisition is deemed attractive if it passes the industry An acquisition is deemed attractive if it passes the industry

attractiveness and costattractiveness and cost--ofof--entry tests and if it has good prospects entry tests and if it has good prospects for attractive financial performancefor attractive financial performance


STRATEGY


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The basic premise of The basic premise of unrelated unrelated diversificationdiversification is is that any that any firm firm or business that can or business that can be acquired be acquired on on

good good financial financial terms and that terms and that has satisfactory has satisfactory growth and earnings growth and earnings potential represents potential represents a good a good

acquisition and a acquisition and a good business good business opportunity.opportunity.

88––2828Copyright © 2012 by GloCopyright © 2012 by Glo--Bus Software, Inc.Bus Software, Inc. 8–29

8.4 Unrelated Businesses Have Unrelated Value Chains and No Cross-Business Strategic Fits

Figure


What Is Appealing about What Is Appealing about Unrelated Diversification? Unrelated Diversification?

�� Business risk is scattered over a set of truly Business risk is scattered over a set of truly diversediverse industries industries

�� The firm’s financial resources can be employed to maximum advantage by: The firm’s financial resources can be employed to maximum advantage by:

►► Investing in Investing in whatever industries whatever industries offer the best profit prospects offer the best profit prospects

►► Diverting cash flows from the firm’s businesses with lower growth and profit Diverting cash flows from the firm’s businesses with lower growth and profit prospects to acquiring and expanding businesses with higher growth and profit prospects to acquiring and expanding businesses with higher growth and profit

potentialspotentials

�� If corporate managers spot bargainIf corporate managers spot bargain--priced firms with big upside profit priced firms with big upside profit potential, shareholder wealth can be enhanced by potential, shareholder wealth can be enhanced by

►► Buying distressed businesses at a low priceBuying distressed businesses at a low price

►► Turning their operations around fairly quickly with infusions of cash and managerial Turning their operations around fairly quickly with infusions of cash and managerial knowknow--how supplied by the parent companyhow supplied by the parent company

►► Enjoying the resulting profit increasesEnjoying the resulting profit increases

�� The firm’s profitability may prove somewhat more stable over the course of The firm’s profitability may prove somewhat more stable over the course of economic upswings and downswings because market conditions in all economic upswings and downswings because market conditions in all

industries do not move upward or downward simultaneouslyindustries do not move upward or downward simultaneously


Building Shareholder Value via Building Shareholder Value via Unrelated DiversificationUnrelated Diversification

�� To succeed in using a strategy of unrelated diversification to produce To succeed in using a strategy of unrelated diversification to produce companywide financial results above and beyond what the businesses could companywide financial results above and beyond what the businesses could

generate operating as standgenerate operating as stand--alone entities, corporate executives must: alone entities, corporate executives must:

►► Do a superior job of diversifying into new businesses that can produce good earnings Do a superior job of diversifying into new businesses that can produce good earnings and returns on investment (to satisfy the attractiveness test) and returns on investment (to satisfy the attractiveness test)

►► Negotiate favorable acquisition prices (to satisfy the costNegotiate favorable acquisition prices (to satisfy the cost--ofof--entry test)entry test)

►► Do such a good job overseeing the businesses and contributing to how they are Do such a good job overseeing the businesses and contributing to how they are

managed that the businesses perform at a higher level (a possible way to satisfy the managed that the businesses perform at a higher level (a possible way to satisfy the

betterbetter--off test)off test)

►► Be shrewd in identifying when to shift resources out of businesses with dim prospects Be shrewd in identifying when to shift resources out of businesses with dim prospects and into businesses with good prospectsand into businesses with good prospects

►► Be good at discerning when a business needs to be sold (because it is on the verge of Be good at discerning when a business needs to be sold (because it is on the verge of probable declines in longprobable declines in long--term profitability) and then finding buyers who will pay a price term profitability) and then finding buyers who will pay a price

higher than the firm’s net investment in the business (so that the sale of divested higher than the firm’s net investment in the business (so that the sale of divested

businesses will result in capital gains for shareholders rather than capital losses)businesses will result in capital gains for shareholders rather than capital losses)


The Drawbacks The Drawbacks of of Unrelated DiversificationUnrelated Diversification


Limited Competitive Limited Competitive Advantage PotentialAdvantage Potential

Demanding Managerial Demanding Managerial RequirementsRequirements

Likely outcome is 1 + 1 = 2,Likely outcome is 1 + 1 = 2,rather than 1 + 1 = 3!rather than 1 + 1 = 3!

Unrelated Unrelated Diversification StrategyDiversification Strategy

Limited Competitive Limited Competitive Advantage PotentialAdvantage PotentialLimited Competitive Limited Competitive Advantage PotentialAdvantage Potential







The Demanding Managerial The Demanding Managerial Requirements Are a Serious IssueRequirements Are a Serious Issue

�� The greater the number and diversity of businesses, The greater the number and diversity of businesses, the harder it is for top executives to:the harder it is for top executives to:

►► Discern good acquisitions from bad onesDiscern good acquisitions from bad ones

►► Have inHave in--depth knowledge about each of the businessesdepth knowledge about each of the businesses

•• Hard to judge soundness of strategic proposals of businessHard to judge soundness of strategic proposals of business--unit managersunit managers

•• Select capable managers to manage the diverse requirements of each businessSelect capable managers to manage the diverse requirements of each business

•• Know what to do if a business stumblesKnow what to do if a business stumbles

►► Avoid big mistakes Avoid big mistakes

•• Misjudging the importance of certain competitive forces or the impact of driving Misjudging the importance of certain competitive forces or the impact of driving

forces or key success factorsforces or key success factors

•• Discovering that the problems of a newly acquired business will require more Discovering that the problems of a newly acquired business will require more time and money to correct than expectedtime and money to correct than expected

•• Being too optimistic about a newly acquired firm’s future prospectsBeing too optimistic about a newly acquired firm’s future prospects

Best to avoid casting a wide netBest to avoid casting a wide net——a few unrelated businesses a few unrelated businesses is often better than many unrelated businessesis often better than many unrelated businesses


STRATEGY


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Limited Competitive Advantage Limited Competitive Advantage Potential Is a Major ShortcomingPotential Is a Major Shortcoming

�� Unrelated diversification’s lack of crossUnrelated diversification’s lack of cross--business business

strategic fits reduces its competitive advantage potential strategic fits reduces its competitive advantage potential to what each separate business can generate on its own to what each separate business can generate on its own

�� Without crossWithout cross--business strategic fits, it is hard for the business strategic fits, it is hard for the consolidated performance of an unrelated group of consolidated performance of an unrelated group of

businesses to be any better than the sum of what the businesses to be any better than the sum of what the individual business units could achieve independentlyindividual business units could achieve independently

�� 1 + 1 = 2 is far more likely result than 1 + 1 = 31 + 1 = 2 is far more likely result than 1 + 1 = 3


Unrelated Diversification Strategies Unrelated Diversification Strategies

Do Not Have Much AppealDo Not Have Much Appeal

Without the added competitive Without the added competitive advantage advantage potential that potential that crosscross--business strategic business strategic fit fit provides, provides,

it is it is hard for hard for the consolidated performance of an the consolidated performance of an unrelated group unrelated group of businesses to be any better of businesses to be any better

than the sum than the sum of what of what the individual business units the individual business units could achieve could achieve if they if they were independentwere independent..


StrategyStrategyLessonLessonStrategyStrategyLessonLesson

It is very hard to build long-term shareholder value by pursuing a strategy of unrelated diversification.

It is very hard to build long-term shareholder value by pursuing a strategy of unrelated diversification.

Related versus Unrelated Related versus Unrelated Diversification Strategies Diversification Strategies

CONCLUSION:CONCLUSION:

Relying solely on the expertise of corporate Relying solely on the expertise of corporate executives to wisely manage a set of unrelated executives to wisely manage a set of unrelated businesses is businesses is a much weaker foundation for a much weaker foundation for enhancing shareholder valueenhancing shareholder value than is a strategy than is a strategy of related diversification (where the presence of of related diversification (where the presence of strategic fits presents many opportunities to build strategic fits presents many opportunities to build longlong--term economic value for shareholders).term economic value for shareholders).


Combination RelatedCombination Related--Unrelated Unrelated Diversification StrategiesDiversification Strategies

RealReal--world companies have diversified in a variety of ways: world companies have diversified in a variety of ways:

�� DominantDominant--business firmsbusiness firms

►► Have one major core business accounting for 50Have one major core business accounting for 50--80 percent of total 80 percent of total revenues, with several small related or unrelated businesses accounting revenues, with several small related or unrelated businesses accounting for the remainder of total revenuesfor the remainder of total revenues

�� Narrowly diversified firmsNarrowly diversified firms

►► Have a few (2Have a few (2--5) related or unrelated businesses5) related or unrelated businesses

�� Broadly diversified firmsBroadly diversified firms

►► Have a wide collection of either related or unrelated businesses or a Have a wide collection of either related or unrelated businesses or a

mixturemixture

�� Firms that have diversified into unrelated areas but have a collection Firms that have diversified into unrelated areas but have a collection of related businesses within each areaof related businesses within each area

►► Have several unrelated groups of related businessesHave several unrelated groups of related businesses


Evaluating a Diversified Firm’s StrategyEvaluating a Diversified Firm’s Strategy

Step 1:Step 1: Assess longAssess long--term attractiveness of each industry in which the term attractiveness of each industry in which the

firm has a businessfirm has a business

Step 2:Step 2: Assess competitive strength of each of the firm’s business Assess competitive strength of each of the firm’s business unitsunits

Step 3:Step 3: Check competitive advantage potential of crossCheck competitive advantage potential of cross--business business strategic fits among the various business units strategic fits among the various business units

Step 4:Step 4: Check whether firm’s resources fit requirements of its present Check whether firm’s resources fit requirements of its present businessesbusinesses

Step 5:Step 5: Rank performance prospects of businesses and determine Rank performance prospects of businesses and determine priority for resource allocation priority for resource allocation

Step 6:Step 6: Craft new strategic moves to improve overall company Craft new strategic moves to improve overall company performanceperformance


Step 1: Evaluating Industry AttractivenessStep 1: Evaluating Industry Attractiveness

�� A principal consideration in evaluating a diversified A principal consideration in evaluating a diversified

firm’s business makefirm’s business make--up and the caliber of its strategy up and the caliber of its strategy is the is the attractiveness of the industries in which it attractiveness of the industries in which it has business operations.has business operations.

�� Answers to three questions are required: Answers to three questions are required:

1.1. Does each industry the firm has diversified into represent a Does each industry the firm has diversified into represent a

good industry to be in? good industry to be in?

2.2. Which industries are most attractive and which are least Which industries are most attractive and which are least

attractive? attractive?

3.3. How appealing is the whole group of industries in which the How appealing is the whole group of industries in which the firm has businesses? firm has businesses?

The more attractive the industries a diversified firm is in, The more attractive the industries a diversified firm is in, the better its prospects for good longthe better its prospects for good long--term performanceterm performance..


STRATEGY


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Factors to Consider in Calculating Factors to Consider in Calculating Industry Attractiveness ScoresIndustry Attractiveness Scores

�� Market size and projected growthMarket size and projected growth

�� Intensity of industry competitionIntensity of industry competition

�� Emerging opportunities and threatsEmerging opportunities and threats

�� Presence of crossPresence of cross--industry strategic fits industry strategic fits

�� Resource requirementsResource requirements

�� Seasonal and cyclical factorsSeasonal and cyclical factors

�� Social, political, regulatory, and environmental factorsSocial, political, regulatory, and environmental factors

�� Industry profitabilityIndustry profitability

�� Industry uncertainty and business riskIndustry uncertainty and business risk


Calculating Attractiveness Scores Calculating Attractiveness Scores for Each Industryfor Each Industry

�� Once the measures of industry attractiveness are Once the measures of industry attractiveness are

selected, quantitative industry attractiveness scores selected, quantitative industry attractiveness scores are calculated according to the following procedure:are calculated according to the following procedure:

►► Assign importance weights to each industry attractiveness Assign importance weights to each industry attractiveness

measure (the measures are unlikely to be equally important) measure (the measures are unlikely to be equally important)

•• Sum of weights must equal 1.0Sum of weights must equal 1.0

►► Rate each industry on each attractiveness measure, using a Rate each industry on each attractiveness measure, using a

scale of 1 to 10 (where 1 = very unattractive to the company, 5 = scale of 1 to 10 (where 1 = very unattractive to the company, 5 = average attractiveness, and 10 = very attractive to the company)average attractiveness, and 10 = very attractive to the company)

►► Multiply the importance weight by the assigned attractiveness Multiply the importance weight by the assigned attractiveness

rating to obtain a weighted attractiveness scorerating to obtain a weighted attractiveness score

►► Sum the weighted ratings for each industry to obtain an overall Sum the weighted ratings for each industry to obtain an overall

industry attractiveness scoreindustry attractiveness score


8–42

8.1 Calculating Weighted Industry Attractiveness ScoresTable


Rating scale:

1 = Very unattractive to company10 = Very attractive to company

Interpreting the Industry Attractiveness ScoresInterpreting the Industry Attractiveness Scores

�� Industries with a score Industries with a score below 5.0 below 5.0 do not pass the attractiveness testdo not pass the attractiveness test

►► The group of industries a firm is in takes on a decidedly lower The group of industries a firm is in takes on a decidedly lower

degree of attractiveness as the number of industries with scores degree of attractiveness as the number of industries with scores below 5.0 increases (especially if industries with low scores below 5.0 increases (especially if industries with low scores

account for a sizable fraction of the firm’s revenues)account for a sizable fraction of the firm’s revenues)

�� If a firm’s industry attractiveness scores are all If a firm’s industry attractiveness scores are all above 5.0above 5.0, the group , the group

of industries the firm operates in is attractive as a wholeof industries the firm operates in is attractive as a whole

�� To be a To be a strong performerstrong performer, a diversified firm’s , a diversified firm’s principal principal businesses should be in attractive industriesbusinesses should be in attractive industries——those withthose with

►► A good outlook for growthA good outlook for growth

andand

►► AboveAbove--average profitabilityaverage profitability


Step 2: Evaluating Each Business Unit’s Step 2: Evaluating Each Business Unit’s Competitive StrengthCompetitive Strength

�� Doing an appraisal of each business unit’s strength and Doing an appraisal of each business unit’s strength and

competitive position in its industry competitive position in its industry

►► Reveals each business’s chances for industry success Reveals each business’s chances for industry success

►► Provides a basis for ranking the units from competitively Provides a basis for ranking the units from competitively strongest to competitively weakest and sizing up the competitive strongest to competitively weakest and sizing up the competitive strength of all the business units as a group.strength of all the business units as a group.

�� The procedure involves selecting a set of measures of The procedure involves selecting a set of measures of competitive strength and calculating quantitative competitive strength and calculating quantitative

competitive strength scores using a similar methodology competitive strength scores using a similar methodology as for the industry attractiveness scores as for the industry attractiveness scores


Potential Measures of BusinessPotential Measures of Business--Unit Unit Competitive StrengthCompetitive Strength

�� RelativeRelative market sharemarket share

�� Costs relative to competitorsCosts relative to competitors

�� Ability to match or beat rivals on key product attributesAbility to match or beat rivals on key product attributes

�� Ability to benefit from strategic fits with sister businessesAbility to benefit from strategic fits with sister businesses

�� Ability to exercise bargaining leverage with key suppliers Ability to exercise bargaining leverage with key suppliers

or customersor customers

�� Brand image and reputationBrand image and reputation

�� Competitively valuable capabilities Competitively valuable capabilities

�� Profitability relative to competitorsProfitability relative to competitors


STRATEGY


Chapter 8

PowerPoint Slides


What Is “Relative Market Share” What Is “Relative Market Share” and How Is It Calculated?and How Is It Calculated?

�� A business unit’s A business unit’s relative market sharerelative market share is defined as the is defined as the

ratio of its market share to the market share held by the ratio of its market share to the market share held by the

largest rival firm in the industry, with market share largest rival firm in the industry, with market share

measured in unit volume, not dollars. measured in unit volume, not dollars. ►► If business A has a 15 percent market share and A’s largest rival If business A has a 15 percent market share and A’s largest rival

has 30 percent, A’s relative market share is 0.5.has 30 percent, A’s relative market share is 0.5.

�� If a firm is the market leader, then its relative market share If a firm is the market leader, then its relative market share

equals its market share divided by the market share of the equals its market share divided by the market share of the

next largest rival. next largest rival. ►► If business B has a marketIf business B has a market--leading share of 40 percent and its leading share of 40 percent and its

largest rival has 30 percent, B’s relative market share is 1.33.largest rival has 30 percent, B’s relative market share is 1.33.

►► Only market share leaders in their respective industries can have Only market share leaders in their respective industries can have

relative market shares greater than 1.0.relative market shares greater than 1.0.Copyright © 2012 by Glo-Bus Software, Inc. 8–46

Relative Market Share Is an Important Relative Market Share Is an Important Measure of Competitive StrengthMeasure of Competitive Strength

�� The further below 1.0 a business unit’s The further below 1.0 a business unit’s relative relative market sharemarket share is, the weaker its competitive is, the weaker its competitive

strength and market position visstrength and market position vis--àà--vis rivals.vis rivals.

►► A business unit with a 10% market share is not in a A business unit with a 10% market share is not in a competitively strong market position if the leader’s competitively strong market position if the leader’s

market share is 50% (because the business unit’s market share is 50% (because the business unit’s relative market share is only 0.20)relative market share is only 0.20)

►► But a business unit with a 10% market share is in a But a business unit with a 10% market share is in a competitively strong market position when the market competitively strong market position when the market

leader’s share is only 12 % (and the business unit’s leader’s share is only 12 % (and the business unit’s

relative market share is 0.83)relative market share is 0.83)


Relative Market Share Is an Important Relative Market Share Is an Important Measure of Competitive Measure of Competitive Strength Strength (cont’d)(cont’d)

�� A business unit with an industryA business unit with an industry--leading market leading market share is in a much stronger competitive position share is in a much stronger competitive position visvis--àà--vis rivals the greater its relative market vis rivals the greater its relative market share is above 1.0.share is above 1.0.

►► A business unit with a 30% market share has A business unit with a 30% market share has

considerably more competitive strength when its next considerably more competitive strength when its next largest rival only has a market share of 10% (which largest rival only has a market share of 10% (which

means the leader’s relative market share is 3.0) as means the leader’s relative market share is 3.0) as compared to when its nextcompared to when its next--largest rival has a market largest rival has a market

share of 25% (which means the leader’s relative share of 25% (which means the leader’s relative

market share is 1.2). market share is 1.2).


Conclusions: Relative Market Share Versus Conclusions: Relative Market Share Versus

Percentage Percentage MMarket Sharearket Share

Using Using relative market share relative market share as a measure of a as a measure of a business unit’s competitive strength visbusiness unit’s competitive strength vis--àà--vis rivals vis rivals is is analytically superior to using analytically superior to using straightstraight--percentage percentage market market shareshare..

Relative market share is a very telling measure of a Relative market share is a very telling measure of a business unit’s competitive strength visbusiness unit’s competitive strength vis--àà--vis rival vis rival companies (and should usually be assigned a high companies (and should usually be assigned a high importance weight in determining its competitive importance weight in determining its competitive strength)strength)


Calculating Calculating Competitive Strength Competitive Strength Scores Scores for Each for Each Business UnitBusiness Unit

�� Once the measures of competitive strength are Once the measures of competitive strength are

selected, quantitative competitive strength scores selected, quantitative competitive strength scores are calculated according to the following procedure:are calculated according to the following procedure:

►► Assign importance weights to each competitive strength Assign importance weights to each competitive strength

measure (the measures are unlikely to be equally important) measure (the measures are unlikely to be equally important)

•• Sum of weights must equal 1.0Sum of weights must equal 1.0

►► Rate each business unit on each strength measure relative to Rate each business unit on each strength measure relative to

rival firms, using a scale of 1 to 10 (where 1 = very weak, 5 = rival firms, using a scale of 1 to 10 (where 1 = very weak, 5 = average or on a par, and 10 = very strong) average or on a par, and 10 = very strong)

►► Multiply the importance weight by the assigned strength rating to Multiply the importance weight by the assigned strength rating to obtain a weighted scoreobtain a weighted score

►► Sum the weighted scores for each business unit to obtain a Sum the weighted scores for each business unit to obtain a

weighted overall competitive strength scoreweighted overall competitive strength score

Copyright © 2012 by Glo-Bus Software, Inc. 8–50 8–51

8.2 Calculating Weighted Competitive Strength Scores for a Diversified Company’s Business Units

Table


Rating scale:

1 = Very weak10 = Very strong

STRATEGY


Chapter 8

PowerPoint Slides


Interpreting the Competitive Strength ScoresInterpreting the Competitive Strength Scores

�� Business units with ratings Business units with ratings above 6.7 above 6.7 are strong market contendersare strong market contenders

►► The more such business units with high scores, the better are a diversified The more such business units with high scores, the better are a diversified firm’s prospects for good financial performance (unless these businesses firm’s prospects for good financial performance (unless these businesses are in unattractive industries) are in unattractive industries)

�� Businesses with ratings in the Businesses with ratings in the 3.3 to 6.7 3.3 to 6.7 range have moderaterange have moderatecompetitive strength viscompetitive strength vis--àà--vis rivalsvis rivals

�� Business units with ratings Business units with ratings below 3.3 below 3.3 are in competitively weak are in competitively weak

market positionsmarket positions

►► As the number of business units with scores below 5.0 increases, there is As the number of business units with scores below 5.0 increases, there is reason to question whether a diversified firm can be a strong performer reason to question whether a diversified firm can be a strong performer with so many of its businesses in relatively weak competitive positions, with so many of its businesses in relatively weak competitive positions, especially if such businesses account for a large share of the firm’s especially if such businesses account for a large share of the firm’s revenuesrevenues


Using a NineUsing a Nine--Cell Matrix to Simultaneously Portray Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive StrengthIndustry Attractiveness and Competitive Strength

�� The industry attractiveness scores (Table 8.1) and competitive The industry attractiveness scores (Table 8.1) and competitive

strength scores (Table 8.2) can be used to portray the strategic strength scores (Table 8.2) can be used to portray the strategic

positions of each business in a diversified firm. positions of each business in a diversified firm.

►► Industry attractiveness scores are plotted on the vertical axisIndustry attractiveness scores are plotted on the vertical axis

►► Competitive strength scores are plotted on the horizontal axis.Competitive strength scores are plotted on the horizontal axis.

►► A nineA nine--cell grid emerges from dividing the vertical axis into three cell grid emerges from dividing the vertical axis into three regions (high, medium, and low attractiveness) and the horizontal axis regions (high, medium, and low attractiveness) and the horizontal axis into three regions (strong, average, and weak competitive strength). into three regions (strong, average, and weak competitive strength).

�� Each business unit’s industry attractiveness and competitive Each business unit’s industry attractiveness and competitive

strength scores determine its location on the matrix, shown as a strength scores determine its location on the matrix, shown as a

circle or circle or “bubble”“bubble”

►► Size of each business unit bubble is scaled to represent the individual Size of each business unit bubble is scaled to represent the individual percentage of total corporate revenues that each business generatespercentage of total corporate revenues that each business generates


8–54

8.5Figure


A Nine-Cell Industry Attractiveness–Competitive Strength Matrix

Note: Circle sizes are scaled to reflect the

percentage of companywide revenues generated by the business unit.

Interpreting the AttractivenessInterpreting the Attractiveness--Strength Strength MatrixMatrix

�� The locations of the business units on the attractivenessThe locations of the business units on the attractiveness––strength strength

matrix provide guidance in deploying corporate resourcesmatrix provide guidance in deploying corporate resources

�� A diversified firm’s prospects for good overall performance are A diversified firm’s prospects for good overall performance are enhanced by concentrating corporate resources and strategic enhanced by concentrating corporate resources and strategic attention on its business units having the greatest competitive attention on its business units having the greatest competitive strength and positioned in highly attractive industriesstrength and positioned in highly attractive industries

►► Businesses in the three upper left (orange) cells merit top priorityBusinesses in the three upper left (orange) cells merit top priority

►► Businesses in the three diagonal (gray) cells merit medium priorityBusinesses in the three diagonal (gray) cells merit medium priority

►► Businesses in the three lower right (green) cells merit the lowest priority Businesses in the three lower right (green) cells merit the lowest priority

and are candidates to be divested (sold to other firms) or else managed and are candidates to be divested (sold to other firms) or else managed

in a manner calculated to produce the maximum cash flows from in a manner calculated to produce the maximum cash flows from operationsoperations


Step 3: Checking the Competitive Advantage Step 3: Checking the Competitive Advantage

Potential of CrossPotential of Cross--Business Strategic FitsBusiness Strategic Fits

�� This step can be skipped for firms with unrelated diversification This step can be skipped for firms with unrelated diversification

strategies, but is quite important in evaluating a related diversification strategies, but is quite important in evaluating a related diversification

strategystrategy

�� Involves evaluating how much benefit a diversified firm can gain from Involves evaluating how much benefit a diversified firm can gain from

value chain matchups that present opportunities to:value chain matchups that present opportunities to:

►► Reduce costs and capture economies of scope by combining the Reduce costs and capture economies of scope by combining the performance of certain activitiesperformance of certain activities

►► Transfer skills, technology, or intellectual capital from one business to Transfer skills, technology, or intellectual capital from one business to

boost the performance of another businessboost the performance of another business

►► Share the use of a highly regarded brand nameShare the use of a highly regarded brand name

►► Create new competitive capabilities via crossCreate new competitive capabilities via cross--business collaboration business collaboration

among sister businessesamong sister businesses

The greater the competitive value of crossThe greater the competitive value of cross--business strategic fits, the business strategic fits, the more competitively powerful is a firm’s related diversification strategymore competitively powerful is a firm’s related diversification strategy


Core ConceptsCore Concepts

The appeal of a firm’s The appeal of a firm’s related diversification strategy related diversification strategy derives from derives from

�� TThe presence of competitively he presence of competitively valuable strategic valuable strategic fits fits

among its businessesamong its businesses

�� Aggressive management efforts to actually capture Aggressive management efforts to actually capture the the potential benefits and opportunities potential benefits and opportunities afforded by the afforded by the various crossvarious cross--business strategic fitsbusiness strategic fits

The The greater the value of greater the value of crosscross--business strategic fits business strategic fits in in enhancing a enhancing a firm’s performance in firm’s performance in the marketplace or on the marketplace or on

the bottom linethe bottom line, the , the more competitively powerful is its more competitively powerful is its strategy of related diversification.strategy of related diversification.


STRATEGY


Chapter 8

PowerPoint Slides


Step 4: Checking for Resource FitStep 4: Checking for Resource Fit

�� A diversified company’s collection of A diversified company’s collection of businesses exhibit businesses exhibit resource fit resource fit when when

►► The various sister businesses The various sister businesses addadd to a diversified to a diversified firm’s overall resource strengths firm’s overall resource strengths

►► A diversified firm has A diversified firm has adequate resources to adequate resources to support its entire group of businessessupport its entire group of businesses without without

spreading itself too thin.spreading itself too thin.



Sister businesses possess Sister businesses possess resource resource fitfit when they when they add to a add to a diversified company’s diversified company’s overall overall resource resource

strengths strengths and when a company has and when a company has adequate adequate resources resources to support their requirementsto support their requirements..

There are two types of resource fit:There are two types of resource fit:

�� Financial resource fitFinancial resource fit

�� Nonfinancial resource fitNonfinancial resource fit



A A cash hog cash hog business generates cash business generates cash flows that flows that are too small to fully fund its are too small to fully fund its operations and operations and growth; a cash hog business requires growth; a cash hog business requires cash cash infusions infusions to provide additional working to provide additional working capital and capital and finance finance new capital investmentnew capital investment..

A A cash cow cash cow business generates cash business generates cash flows over flows over and above its internal requirements, and above its internal requirements, thus thus providing providing a corporate parent with funds a corporate parent with funds for for investing investing in cash hog businesses, in cash hog businesses, financing new financing new acquisitionsacquisitions, or paying dividends., or paying dividends.


Financial Resource Fits: Financial Resource Fits: Cash Cows versus Cash HogsCash Cows versus Cash Hogs

�� An important dimension of financial resource fit concerns whether a An important dimension of financial resource fit concerns whether a diversified firm can generate diversified firm can generate internal cash flows internal cash flows sufficient to fund the sufficient to fund the

capital requirements of its businesses, pay dividends, meet its debt capital requirements of its businesses, pay dividends, meet its debt

obligations, and otherwise remain financially healthyobligations, and otherwise remain financially healthy

�� A A cash hog business cash hog business generates cash flows that are too small to fully fund generates cash flows that are too small to fully fund

its operations and growth; a cash hog business requires cash infusions to its operations and growth; a cash hog business requires cash infusions to

provide additional working capital and finance new capital investmentprovide additional working capital and finance new capital investment

�� A A cash cow business cash cow business generates cash flows over and above its internal generates cash flows over and above its internal

requirements, thus providing a corporate parent with funds for investing in requirements, thus providing a corporate parent with funds for investing in cash hog businesses, financing new acquisitions, or paying dividends cash hog businesses, financing new acquisitions, or paying dividends

A diversified firm’s businesses exhibit good financial resource fit A diversified firm’s businesses exhibit good financial resource fit when the excess cash generated by its cash cow businesses is when the excess cash generated by its cash cow businesses is

sufficient to fund the investment requirements of promising sufficient to fund the investment requirements of promising cash hog businesses. cash hog businesses.


What To Do with Cash Hog BusinessesWhat To Do with Cash Hog Businesses

�� Does it make good financial and strategic sense Does it make good financial and strategic sense to keep pouring new money into a business that to keep pouring new money into a business that continually needs cash infusions?continually needs cash infusions?

�� Strategic Options:Strategic Options:

►► InvestInvest in promising cash hogs to grow them into in promising cash hogs to grow them into star star businesses businesses (strong, profitable market contenders)(strong, profitable market contenders)

►► DivestDivest cash hogs with questionable promise (either cash hogs with questionable promise (either

because of low industry attractiveness or a weak because of low industry attractiveness or a weak

competitive position)competitive position)

►► Redeploy resources Redeploy resources to to better advantage better advantage elsewhere elsewhere


Why Cash Cow Businesses Are ValuableWhy Cash Cow Businesses Are Valuable

�� The surplus cash flows they generate can be used to: The surplus cash flows they generate can be used to:

►► Pay corporate dividendsPay corporate dividends

►► Finance acquisitionsFinance acquisitions

►► Provide funds for investing in the firm’s promising cash hogs Provide funds for investing in the firm’s promising cash hogs

�� It makes good financial and strategic sense for It makes good financial and strategic sense for diversified companies to keep cash cows in healthy diversified companies to keep cash cows in healthy condition so that they are able to:condition so that they are able to:

►► Fortify and defend their market position Fortify and defend their market position

►► Preserve their cashPreserve their cash--generating capabilities over the long term to generating capabilities over the long term to

provide an ongoing source of financial resources to deploy provide an ongoing source of financial resources to deploy elsewhereelsewhere


STRATEGY


Chapter 8

PowerPoint Slides


Other Financial Resource Other Financial Resource Fit ConsiderationsFit Considerations

�� Two other financial considerations are pertinent Two other financial considerations are pertinent in determining financial resource fit:in determining financial resource fit:

1.1. Does the firm have adequate financial strength to Does the firm have adequate financial strength to

fund its different businesses and maintain a healthy fund its different businesses and maintain a healthy credit rating?credit rating?

2.2. Do any of the firm’s individual businesses not Do any of the firm’s individual businesses not contribute adequately to achieving firmcontribute adequately to achieving firm--wide wide

performance targets?performance targets?


Nonfinancial Resource FitsNonfinancial Resource Fits

�� A diversified firm needs a big enough and deep enough A diversified firm needs a big enough and deep enough

pool of managerial, administrative, and competitive pool of managerial, administrative, and competitive capabilities to support all of its different businesses.capabilities to support all of its different businesses.

�� Two questions help reveal whether a diversified firm has Two questions help reveal whether a diversified firm has adequate nonfinancial resources:adequate nonfinancial resources:

1.1. Does the firm have or can it develop the specific resource Does the firm have or can it develop the specific resource

strengths and competitive capabilities needed to be successful strengths and competitive capabilities needed to be successful

in each of its businesses?in each of its businesses?

2.2. Are the firm’s nonfinancial resources being stretched too thinly Are the firm’s nonfinancial resources being stretched too thinly

by the managerial, administrative, or competitive capability by the managerial, administrative, or competitive capability requirements of one or more of its businesses?requirements of one or more of its businesses?


Step 5: Ranking the Performance Prospects Step 5: Ranking the Performance Prospects of Business Units and Assigning a Priority of Business Units and Assigning a Priority

for Resource Allocationfor Resource Allocation

�� This step entails using the prior analysis to rank the performance This step entails using the prior analysis to rank the performance prospects of the businesses from best to worst prospects of the businesses from best to worst

�� As a rule, As a rule, business units with the brightest profit and growth business units with the brightest profit and growth prospects, attractive positions in the nineprospects, attractive positions in the nine--cell matrix, and solid cell matrix, and solid strategic and resource fits should receive top priority for allocation strategic and resource fits should receive top priority for allocation of corporate resourcesof corporate resources

�� But it is also wise to consider each business’s past performanceBut it is also wise to consider each business’s past performance

►► Sales and profit growthSales and profit growth

►► Contribution to company earningsContribution to company earnings

►► Return on capital invested in businessReturn on capital invested in business

►► Cash flows from operationsCash flows from operations

�� Medium priority should go to businesses with satisfactory prospects for Medium priority should go to businesses with satisfactory prospects for growth and profitability (usually those in the three diagonal cells of the growth and profitability (usually those in the three diagonal cells of the

attractivenessattractiveness--strength matrix and cash cow businesses in the lowerstrength matrix and cash cow businesses in the lower--right right

cells of the attractivenesscells of the attractiveness--strength matrix) strength matrix)


The Importance of Resource AllocationThe Importance of Resource Allocation

For a For a firm firm to make the best use of its to make the best use of its limited pool limited pool of resources, both of resources, both financial financial and and nonfinancial, top nonfinancial, top executives must be diligent in executives must be diligent in

�� Steering resources to Steering resources to those businesses with the those businesses with the best best opportunities and performance prospectsopportunities and performance prospects

�� Allocating Allocating few, if anyfew, if any, resources , resources to businesses with to businesses with weak prospectsweak prospects..

Focusing corporate resources on a few core Focusing corporate resources on a few core and and

mostly mostly related businesses avoids the related businesses avoids the mistake of mistake of diversifying diversifying so broadly so broadly that resources that resources and and

management management attention are stretched too thin.attention are stretched too thin.88––6767Copyright © 2012 by GloCopyright © 2012 by Glo--Bus Software, Inc.Bus Software, Inc.

8–68

8.6 The Chief Strategic and Financial Options for Allocating

a Diversified Company’s Financial Resources

Figure


Step 6: Crafting New Strategic Moves to Step 6: Crafting New Strategic Moves to Improve Overall Corporate PerformanceImprove Overall Corporate Performance

�� Strategic options to improve a diversified firm’s overall Strategic options to improve a diversified firm’s overall

performance fall into five broad categories of actions: performance fall into five broad categories of actions:

►► Sticking closely with the existing business lineup and pursuing Sticking closely with the existing business lineup and pursuing the opportunities these businesses presentthe opportunities these businesses present

►► Broadening the firm’s business scope by making new Broadening the firm’s business scope by making new acquisitions in new industriesacquisitions in new industries

►► Divesting certain businesses and retrenching to a narrower base Divesting certain businesses and retrenching to a narrower base of business operationsof business operations

►► Restructuring the firm’s business lineup and putting a whole new Restructuring the firm’s business lineup and putting a whole new face on the firm’s business makeupface on the firm’s business makeup

►► Pursuing multinational diversification and striving to globalize the Pursuing multinational diversification and striving to globalize the

operations of several of the firm’s business unitsoperations of several of the firm’s business units


STRATEGY


Chapter 8

PowerPoint Slides


Sticking with the Existing Business LineupSticking with the Existing Business Lineup

�� This option makes sense when the firm’s present This option makes sense when the firm’s present

businesses:businesses:

►► Offer attractive growth opportunities Offer attractive growth opportunities

►► Can be counted on to generate good earnings and cash flows. Can be counted on to generate good earnings and cash flows.

�� If existing businesses have good strategic and/or If existing businesses have good strategic and/or

resource fits (along with good future prospects), then resource fits (along with good future prospects), then

rocking the boat with major changes in the business rocking the boat with major changes in the business lineup is usually unnecessary lineup is usually unnecessary

�� Corporate executives can concentrate their attention on Corporate executives can concentrate their attention on

►► Getting the best performance from each of its businessesGetting the best performance from each of its businesses

►► Steering corporate resources into those areas of greatest Steering corporate resources into those areas of greatest

potential and profitabilitypotential and profitability


Broadening the Firm’s Business ScopeBroadening the Firm’s Business Scope

�� Factors motivating firms to building positions in new Factors motivating firms to building positions in new

related or unrelated industries: related or unrelated industries:

►► Sluggish growth prospects in existing businessesSluggish growth prospects in existing businesses

►► The potential for transferring resources and capabilities to other The potential for transferring resources and capabilities to other

related or complementary businessesrelated or complementary businesses

►► Rapidly changing conditions (either favorable or unfavorable) in Rapidly changing conditions (either favorable or unfavorable) in

one or more of a firm’s core businesses that make it desirable to one or more of a firm’s core businesses that make it desirable to expand into other industries expand into other industries

►► The addition of certain new businesses will complement and The addition of certain new businesses will complement and

strengthen the market position and competitive capabilities of strengthen the market position and competitive capabilities of one or more present businesses one or more present businesses


Retrenching to a Narrower Diversification BaseRetrenching to a Narrower Diversification Base

�� Retrenching to a narrower diversification base is considered when: Retrenching to a narrower diversification base is considered when:

►► Diversification has ranged too far afield, resources are stretched too thin, Diversification has ranged too far afield, resources are stretched too thin,

performance can only be improved by building stronger positions in fewer core performance can only be improved by building stronger positions in fewer core

businesses and industriesbusinesses and industries

►► Market conditions in a onceMarket conditions in a once--attractive industry have badly deteriorated attractive industry have badly deteriorated

►► A business lacks a cultural, strategic or resource fit or is a cash hog with poor longA business lacks a cultural, strategic or resource fit or is a cash hog with poor long--term potential or is weakly positioned in its industry with little prospect that the term potential or is weakly positioned in its industry with little prospect that the

corporate parent will realize a decent return on its investment in the businesscorporate parent will realize a decent return on its investment in the business

►► An acquired business has not worked out as profitableAn acquired business has not worked out as profitable——some mistakes will be some mistakes will be

made because it is hard to foresee how a new line of business will actually evolve made because it is hard to foresee how a new line of business will actually evolve

►► Subpar performance in some business units raises questions of whether to divest Subpar performance in some business units raises questions of whether to divest them or keep them and attempt a turnaroundthem or keep them and attempt a turnaround

►► Certain businesses, despite adequate financial performance, do not mesh well with Certain businesses, despite adequate financial performance, do not mesh well with

the rest of the firm’s businesses the rest of the firm’s businesses

A useful guide to determine whether or when to divest a business subsidiary is to A useful guide to determine whether or when to divest a business subsidiary is to ask, “If we were not in this business today, would we want to get into it now?” ask, “If we were not in this business today, would we want to get into it now?”

When the answer is no or probably not, divestiture should be considered. When the answer is no or probably not, divestiture should be considered.


Restructuring a Firm’s Business LineupRestructuring a Firm’s Business Lineup

�� Restructuring involves divesting some businesses and acquiring Restructuring involves divesting some businesses and acquiring

others so as to put a whole new face on the firm’s business lineup others so as to put a whole new face on the firm’s business lineup

�� Performing radical surgery on a firm’s business lineup is appealing Performing radical surgery on a firm’s business lineup is appealing when a firm’s financial performance is being weakened by:when a firm’s financial performance is being weakened by:

►► Too many businesses in slowToo many businesses in slow--growth, declining, lowgrowth, declining, low--margin, or margin, or otherwise unattractive industries otherwise unattractive industries

►► Too many competitively weak businessesToo many competitively weak businesses

►► The emergence of new technologies that threaten the survival of one or The emergence of new technologies that threaten the survival of one or

more important businessesmore important businesses

►► Ongoing declines in the market shares of one or more major business Ongoing declines in the market shares of one or more major business

units that are falling prey to more marketunits that are falling prey to more market--savvy competitors savvy competitors

►► An excessive debt burden with interest costs that eat deeply into An excessive debt burden with interest costs that eat deeply into profitabilityprofitability

►► IllIll--chosen acquisitions that have not lived up to expectations chosen acquisitions that have not lived up to expectations


Pursuing Multinational DiversificationPursuing Multinational Diversification

�� Offers Offers two major avenues two major avenues for growing for growing revenues and profits:revenues and profits:

►► Growth by entering additional businesses Growth by entering additional businesses

►► Growth by extending the operations of existing Growth by extending the operations of existing businesses into additional country markets businesses into additional country markets

�� Pursuing both growth avenues at the same time Pursuing both growth avenues at the same time

can provide a diversified firm with exceptional can provide a diversified firm with exceptional competitive advantage potential competitive advantage potential


Building Competitive Advantage through Building Competitive Advantage through Multinational DiversificationMultinational Diversification

Multinational diversification offer five paths to competitive Multinational diversification offer five paths to competitive

advantage (if a company is pursuing related diversification):advantage (if a company is pursuing related diversification):�� Full capture of economies of scale and learning/experience curve effects.Full capture of economies of scale and learning/experience curve effects.

►►The ability to drive down unit costs by expanding sales to additional country markets The ability to drive down unit costs by expanding sales to additional country markets

is one reason why a diversified company may seek to acquire a business and then is one reason why a diversified company may seek to acquire a business and then

rapidly expand its operations into more and more countriesrapidly expand its operations into more and more countries

�� Opportunities to capture economies of scope arising from costOpportunities to capture economies of scope arising from cost--saving strategic saving strategic fits among related businessesfits among related businesses

�� Opportunities to transfer competitively valuable resources both from one Opportunities to transfer competitively valuable resources both from one business to another and from one country to another.business to another and from one country to another.

�� Opportunities to leverage a wellOpportunities to leverage a well--known and powerful brand nameknown and powerful brand name

�� Opportunities to develop and leverage competitively valuable resources and Opportunities to develop and leverage competitively valuable resources and capabilities via crosscapabilities via cross--business collaborationbusiness collaboration

All five paths to competitive advantage can be pursued simultaneouslyAll five paths to competitive advantage can be pursued simultaneously


STRATEGY


Chapter 8

PowerPoint Slides



No other diversification strategy offers more No other diversification strategy offers more builtbuilt--in potential for competitive advantage than in potential for competitive advantage than does a does a

strategy of multinational strategy of multinational diversification.diversification.

Any and all of five approaches to competitive advantage Any and all of five approaches to competitive advantage

can be pursued simultaneously when a company’s can be pursued simultaneously when a company’s

strategy is one of related diversification:strategy is one of related diversification:�� Increased capture of economies of scaleIncreased capture of economies of scale

�� Increased capture of economies of scopeIncreased capture of economies of scope�� CrossCross--business and crossbusiness and cross--country resource transfercountry resource transfer

�� Exploitation of a competitively powerful brand nameExploitation of a competitively powerful brand name

�� CrossCross--business collaboration to develop/leverage business collaboration to develop/leverage valuable resource capabilitiesvaluable resource capabilities


Documents

Chapter 8 Learning Objectives - Business Strategy Game ... · PDF fileChapter 8 PowerPoint Slides ... Assessing multiple industry environments ... Industry Attractiveness Test —Industry