CHAPTER 8

CORPORATE STRATEGY:Diversification and the Multibusiness Company

McGraw-Hill/IrwinCopyright Copyright ®2012 The McGraw-Hill Companies, Inc.®2012 The McGraw-Hill Companies, Inc.

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1. Understand when and how business diversification can enhance shareholder value.

2. Gain an understanding of how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage.

3. Become aware of the merits and risks of corporate strategies keyed to unrelated diversification.

4. Gain command of the analytical tools for evaluating a firm’s diversification strategy.

5. Understand a diversified firm’s four main corporate strategy options for solidifying its diversification strategy and improving company performance.

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Crafting a Diversified Firm’s Overall Or Corporate Strategy

Step 1 Picking new industries to enter and deciding on the best mode of entry.

Step 2 Pursuing opportunities to leverage cross-business value chain relationships and strategic fit into competitive advantage.

Step 3 Establishing investment priorities and steering corporate resources into the most attractive business units.

Step 4 Initiating actions to boost the combined performanceof the cooperation’s collection of businesses.

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WHEN TO DIVERSIFY

♦ A firm should consider diversifying when:● It can expand into businesses whose technologies

and products complement its present business.● Its resources and capabilities can be used as

valuable competitive assets in other businesses.● Costs can be reduced by cross-business sharing or

transfer of resources and capabilities. ● Transferring a strong brand name to the products of

other businesses helps drive up sales and profits of those businesses.

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BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION FOR DIVERSIFYING

The industry attractiveness

test

The cost-of-entry test

The better-off test

Testing Whether a Diversification Move Will Add Long-Term

Value for Shareholders

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Testing Whether Diversification Will Add Value for Shareholders

♦ The Attractiveness Test:● Are the industry’s returns on investment as

good or better than present business(es)?♦ The Cost of Entry Test:

● Is the cost of overcoming entry barriers so great that profitability is too long delayed?

♦ The Better-Off Test:● How much synergy will be gained by

diversifying into the industry?

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Better Performance through Synergy

Evaluating the Potential for

Synergy through

Diversification

Firm A purchases Firm B in another industry. A and B’s profits are no greater than what each firm could have earned on its own.

Firm A purchases Firm C in another industry. A and C’s profits are greater than what each firm could have earned on its own.

No Synergy(1+1=2)

Synergy(1+1=3)

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STRATEGIES FOR ENTERING NEW BUSINESSES

Acquisition Internal new venture (start-up) Joint venture

Diversifying into New Businesses

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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 seek a bargain in struggling firm● Underestimating costs for integrating acquired firm● Overestimating the acquisition’s potential to deliver

added shareholder value

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Internal Development: Corporate Venturing

♦ Advantages of New Venture Development:● Avoids pitfalls and uncertain costs of acquisition.● Allows entry into a new or emerging industry where

there are no available acquisition candidates.

♦ Disadvantages of Intrapreneurship:● 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.

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When to Engage in Internal Development

Availability of in-house skills and

resources

Ample time to develop and

launch businessCost of acquisition

is higher than internal entry

Added capacity will not affect

supply and demand balanceLow resistance

of incumbent firms to market

entry

No head-to-head competition in

targeted industry

Factors Favoring Internal Development

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When to Engage in a Joint Venture

Evaluating

the Potential

for a Joint Venture

Is the opportunity too complex, uneconomical, or risky for one firm to pursue alone?

Does the opportunity require a broader range of competencies and know-how than the firm now possesses?

Will the opportunity involve operations in a country that requires foreign firms to have a local minority or majority ownership partner?

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Choosing a Mode of Market Entry

The Question of Critical Resources and Capabilities

Does the firm have the resources and capabilities for internal development?

The Question of Entry Barriers Are there entry barriers to overcome?

The Question of Speed

Is speed an important factor in the firm’s chances for successful entry?

The Question of Comparative Cost

Which is the least costly mode of entry, given the firm’s objectives?

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CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES

Related Businesses

Unrelated Businesses

Both Related and Unrelated

Businesses

Which Diversification Path to Pursue?

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CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES

♦ Related Businesses● Have competitively valuable cross-business

value chain and resource matchups.♦ Unrelated Businesses

● Have dissimilar value chains and resource requirements, with no competitively important cross-business relationships at the value chain level.

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STRATEGIC FIT AND DIVERSIFICATIONINTO RELATED BUSINESSES

♦ Strategic Fit Benefits● Occur when the value chains of the different

businesses present opportunities for: Transfer of resources among businesses. Lowering of costs in combining related value

chain activities or resource sharing. Use of a potent brand name across businesses. Cross-business collaboration to build stronger

competitive capabilities.

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Pursuing Related Diversification

♦ Specialized Resources and Capabilities● Have very specific applications and their use

is limited to a restricted range of industry and business types.

♦ Generalized Resources and Capabilities● Can be widely applied and can be deployed

across a broad range of industry and business types.

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8.1 Related Businesses Provide Opportunities to Benefit from Competitively Valuable Strategic Fit

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Identifying Cross-Business Strategic Fitalong the Value Chain

R&D and Technology

Activities

Supply Chain Activities

Manufacturing-Related Activities

Distribution-Related Activities

Customer Service Activities

Sales and Marketing Activities

Potential Cross-Business Fits

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Strategic Fit, Economies of Scope,and Competitive Advantage

Transferring specialized and

generalized skills and\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

Using Economies of Scope to Convert Strategic Fit into Competitive Advantage

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Economies of Scope Differ from Economies of Scale

♦ Economies of Scope● Are cost reductions that flow from cross-

business resource sharing in the activities of the multiple businesses of a firm.

♦ Economies of Scale● Accrue when unit costs are reduced due

to the increased output of larger-size operations of a firm.

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From Competitive Advantage to Added Profitability and Gains in Shareholder Value

Builds more shareholder value

than owning a stock portfolio

Is only possible via a strategy

of related diversification

Yields value in the application of specialized resources and

capabilities

Requires that management take internal actions to

realize them

Capturing the Cross-Business Benefits of Related Diversification

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DIVERSIFICATION INTO UNRELATED BUSINESSES

Evaluating the acquisition of a new business or the divestiture of

an existing business

Can it meet corporate targets for profitability and return on investment?

Is it is in an industry with attractive profit and growth potentials?

Is it is big enough to contribute significantly to the parent firm’s bottom line?

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Building Shareholder Value via Unrelated Diversification

Astute Corporate Parenting by Management

Cross-Business Allocation of

Financial Resources

Acquiring and Restructuring Undervalued Companies

Using an Unrelated Diversification Strategy to Pursue Value

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Building Shareholder Value via Unrelated Diversification

Astute Corporate Parenting by Management

• Provide leadership, oversight, expertise, and guidance.• Provide generalized or parenting resources that lower

operating costs and increase SBU efficiencies.

Cross-Business Allocation of

Financial Resources

• Serve as an internal capital market.• Allocate surplus cash flows from businesses to fund

the capital requirements of other businesses.

Acquiring and Restructuring Undervalued Companies

• Acquire weakly performing firms at bargain prices.• Use turnaround capabilities to restructure them to

increase their performance and profitability.

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The Path to Greater Shareholder Valuethrough Unrelated Diversification

Actions taken by upper management to create value and

gain a parenting advantage

Do a superior job of diversifying into businesses that produce good earnings and returns on investment.

Do an excellent job of negotiating favorable acquisition prices.

Provide managerial oversight and resource sharing, financial resource allocation and portfolio management, and restructure underperforming businesses.

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The Drawbacks of Unrelated Diversification

Pursuing an Unrelated

Diversification Strategy

Limited Competitive Advantage Potential

Demanding Managerial

Requirements

Monitoring and maintaining

the parenting advantage

Potential lack of cross-business

strategic-fit benefits

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Inadequate Reasons for PursuingUnrelated Diversification

Seeking reduction of

business investment risk

Pursuing rapid or continuous growth for its

own sake

Seeking stabilization to avoid cyclical

swings in businesses

Pursuing personal

managerial motives

Poor Rationales for Unrelated Diversification

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COMBINATION RELATED-UNRELATEDDIVERSIFICATION STRATEGIES

Dominant-Business

Enterprises

Narrowly Diversified

Firms

Broadly Diversified

Firms

Multibusiness Enterprises

Related-Unrelated Business Portfolio Combinations

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STRUCTURES OF COMBINATION RELATED-UNRELATED DIVERSIFIED FIRMS

♦ Dominant-Business Enterprises● Have a major “core” firm that accounts for 50 to 80% of total

revenues and a collection of small related or unrelated firms that accounts for the remainder.

♦ Narrowly Diversified Firms● Are comprised of a few related or unrelated businesses.

♦ Broadly Diversified Firms● Have a wide-ranging collection of related businesses,

unrelated businesses, or a mixture of both.

♦ Multibusiness Enterprises● Have a business portfolio consisting of several unrelated

groups of related businesses.

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EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

Diversified Strategy

Attractiveness of industries

Strength of Business Units

Cross-business strategic fit

Fit of firm’s resources

Allocation of resources

New Strategic Moves

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EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

1. Assessing the attractiveness of the industries the firm has diversified into, both individually and as a group.

2. Assessing the competitive strength of the firm’s business units within their respective industries.

3. Checking the competitive advantage potential of cross-business strategic fit among the firm’s various business units.

4. Checking whether the firm’s resources fit the requirements of its present business lineup.

5. Ranking performance prospects of the businesses and determining the parent firm’s priority for allocating resources to its businesses.

6. Crafting strategic moves to improve corporate performance.

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8.2Strategy Alternatives for a Company Pursuing Diversification

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Step 1: Evaluating Industry Attractiveness

Does each industry represent a good market for the firm to be in?

Which industries are most attractive, and which are least attractive?

How appealing is the whole group of industries?

How attractive are the industries in which the firm has business operations?

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Key Indicators of Industry Attractiveness

♦ Social, political, regulatory, environmental factors♦ Seasonal and cyclical factors♦ Industry uncertainty and business risk♦ Market size and projected growth rate♦ Industry profitability♦ The intensity of competition among market rivals♦ Emerging opportunities and threats

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Gauging Industry Attractiveness from the Multibusiness Perspective

The Question of Cross-Industry Strategic Fit

How well do the industry’s value chain and resource requirements match up with the value chain activities of other industries in which the firm has operations?

The Question of Resource Requirements

Do the resource requirements for an industry match those of the parent firm or are they otherwise within the company’s reach?

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8.1 Calculating Weighted Industry Attractiveness Scores*

* Rating scale: 1 = very unattractive to the firm; 10 = very attractive to the firm.

Remember: The more intensely competitive an industry is, the lower the attractiveness rating for that industry!

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The Difficulties of Calculating Industry Attractiveness Scores

Evaluating Industry

Attractiveness

Deciding on appropriate weights for the industry attractiveness measures.

Gaining sufficient knowledge of the industry to assign accurate and objective ratings.

Whether to use different weights for different business units whenever the importance of strength measures differs significantly from business to business.

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Step 2: Evaluating Business-Unit 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.♦ Strategic fit with the firm’s other businesses.♦ Bargaining leverage with key suppliers or customers.♦ Alliances and partnerships with suppliers and/or buyers.♦ Profitability relative to competitors

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

* Rating scale: 1 = very weak; 10 = very strong.

Relative market share: the ratio of a business unit’s market share to the market share of its largest industry rival as measured in unit volumes, not dollars.

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8.3A Nine-Cell Industry Attractiveness–Competitive Strength Matrix

Note: Circle sizes are scaled to reflect the percentage of companywide revenues generated by the business unit.

Star

Cashcow

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8.4 Identifying the Competitive Advantage Potential of Cross-Business Strategic Fit

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Step 4: Checking for Resource Fit

♦ Financial Resource Fit● State of the internal capital market● Using the portfolio approach:

Cash hogs need cash to develop.Cash cows generate excess cash.Star businesses are self-supporting.

♦ Success sequence:● Cash hog Star Cash cow

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Step 4: Checking for Resource Fit

♦ Does the firm have (or can it develop) the specific resources and capabilities needed to be successful in each of its businesses?

♦ Are the firm’s resources being stretched too thinly by the resource requirements of one or more of its businesses?

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Step 5: Ranking Business Unit Performance and Assigning Resource Allocation Priorities

♦ Ranking Factors:● Sales growth● Profit growth● Contribution to company earnings● Return on capital invested in the business● Cash flow

♦ Steer resources to business units with the brightest profit and growth prospects and solid strategic and resource fit.

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8.5 The Chief Strategic and Financial Options for Allocating a Diversified Company’s Financial Resources

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

Stick with the Existing Business

Lineup

Broaden the Diversification Base with New Acquisitions

Divest and Retrench to a Narrower

Diversification Base

Restructure through

Divestitures and

Acquisitions

Strategy Options for a Firm That Is Already Diversified

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8.6A Company’s Four Main Strategic Alternatives After It Diversifies

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Broadening a Diversified Firm’s Business Base

♦ Factors Motivating the Adding of Businesses:● The transfer of resources and capabilities

to related or complementary businesses.● Rapidly changing technology, legislation, or new

product innovations in core businesses.● Shoring up the market position and competitive

capabilities of the firm’s present businesses.● Extension of the scope of the firm’s operations

into additional country markets.

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Divesting Businesses and Retrenching to a Narrower Diversification Base

♦ Factors Motivating Business Divestitures:● Improvement of long-term performance by

concentrating on stronger positions in fewer core businesses and industries.

● Business is now in a once-attractive industry where market conditions have badly deteriorated.

● Business has either failed to perform as expected and\or is lacking in cultural, strategic or resource fit.

● Business has become more valuable if sold to another firm or as an independent spin-off firm.

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♦ What does the growth in both revenues and profits reveal about the success of J&J’s diversification through acquisition strategy?

♦ To what extent is decentralization required when seeking cross-business strategic fit?

♦ What should J&J do to ensure the continued success of its diversification strategy?

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Using Divestitures and Acquisitions to Restructure the Business Lineup

♦ Factors Leading to Corporate Restructuring:● Too many businesses in unattractive industries● Too many competitively weak businesses● Ongoing declines in the market shares of business

units due to more market-savvy competitors● Debt and interest costs that sap profitability● Acquisitions that haven’t lived up to expectations● Reallocation of assets to strengthen the lineup● Businesses with poor resource or strategic fit

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♦ Is VF’s corporate restructuring strategy narrowing or broadening its diversification base?

♦ How did restructuring ensure that VF was better prepared to weather the economic downturn than its competitors?

♦ What actions did VF take after making acquisitions to ensure the success of those acquisitions?