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10Corporate Strategy:

Diversification, Acquisitions, and

Internal New Ventures

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Overview

• Diversification– The process of adding new businesses to the company

that are distinct from its established operations

• Vehicles for diversification– Internal new venturing

• Starting a new business from scratch

– Acquisitions– Joint ventures

• Restructuring– Reducing the scope of diversified operations by exiting

from business areas

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Exercise

• Strategy in Action 10.2: INTEL– Describe how INTEL entered the

communications chip industry and explain why they did it that way?

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Expanding Beyond a Single Industry

• Advantages of staying in a single industry– Focus resources and capabilities on competing

successfully in one area– Focus on what the company knows and does

best

• Disadvantages of being in a single industry– Danger of the industry declining– Missing the opportunity to leverage resources

and capabilities to other activities– Resting on laurels and not continually learning

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Previous Approach to Diversification

• A corporation as a portfolio of businesses– Each industry has its own cycles of ups and downs

• Similar to a strategy to improve one’s investment portfolio – Diversify to reduce business cycle risks

• Sometimes a function of what discipline dominates at a particular point in time– Finance: portfolio approach– Marketing: opportunities to bundle, synergy, etc.

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Concept of Free or Investible Funds

• Profits before dividends and taxes– Less amounts necessary to service debts– Less amounts necessary to maintain existing

business, i.e. reinvest to upgrade equipment, etc.

• If debt is used to acquire, then the amounts necessary to service that debt should be added, with the expectation (hope) that earnings from investments will cover this portion of the corporate debt

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A Company as a Portfolio of Distinctive Competencies

• Reconceptualize the company as a portfolio of distinctive competencies rather than a portfolio of products

• Consider how competencies might be leveraged to create opportunities in new industries

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Establishing a Competency Agenda

Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright © 1994 by Gary Hamel and C. K. Prahalad. All

rights reserved.

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The Multibusiness Model

• Develop a business model for each industry in which the company competes

• Develop a higher-level multibusiness model that justifies entry into different industries in terms of profitability

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Types of Diversification

• Related diversification– Entry into a new business activity in a

different industry that is related to a company’s existing business activity, or activities, by commonalities between one or more components of each activity’s value chain

• Unrelated diversification– Entry into industries that have no obvious

connection to any of a company’s value chain activities in its present industry or industries

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Transfer of Competencies at Philip Morris

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Sharing Resources at Proctor & Gamble

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Tale of Two Companies

• Coca Cola acquiring Taylor Wines (New York-based winery)– Consumer products– Taste tests?

• United acquired Marriott and Hertz– Complementary businesses – Bundled products for traveller

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Increasing Profitability Through Diversification

• Transferring competencies– Taking a distinctive competence developed in

one industry and applying it to an existing business in another industry

– The competencies transferred must involve activities that are important for establishing competitive advantage

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Increasing Profitability Through Diversification (cont’d)

• Leveraging competencies– Taking a distinctive competency developed by

a business in one industry and using it to create a new business in a different industry

• Sharing resources: economies of scope– Cost reductions associated with sharing

resources across businesses

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Increasing Profitability Through Diversification (cont’d)

• Managing rivalry: multipoint competition– Diversifying into an industry in order to hold a

competitor in check that has either entered its industry or has the potential to do so

– Multipoint competition: companies competing against each other in different industries

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Increasing Profitability Through Diversification (cont’d)

• Exploiting general organizational competencies– Competencies that transcend individual

functions or businesses and reside at the corporate level in the multibusiness enterprise

– Entrepreneurial capabilities– Effective organization structure and controls– Superior strategic capabilities

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The Limits of Diversification

• Related diversification is only marginally more profitable than unrelated diversification

• Extensive diversification tends to depress rather than improve profitability

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Bureaucratic Costs and Diversification Strategy

• The costs increases that arise in large, complex organizations due to managerial inefficiencies

• Number of businesses in a company’s portfolio– Information overload

• Coordination among businesses– Inability to identify the unique profit contribution of

a business unit that shares resources with another unit

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Coordination Among Related Business Units

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Bureaucratic Costs and Diversification Strategy (cont’d)

• Limits of diversification– Bureaucratic costs place a limit on the amount

of diversification that can profitably be pursued

• Related or unrelated diversification?– Related diversified companies can create

value in more ways than unrelated companies, but they have to bear higher bureaucratic costs

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Diversification That Dissipates Value

• Diversifying to pool risks– Stockholders can diversify their own portfolios

at lower costs than the company can– Research suggests that corporate

diversification is not an effective way to pool risks

• Diversifying to achieve greater growth– Growth on its own does not create value

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Entry Strategy: Internal New Ventures—Attractions

• To execute corporate-level strategies when a company has a set of valuable competencies in its existing businesses that can be leveraged to enter the new business area

• When entering a newly emerging or embryonic industry

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Entry Strategy: Internal New Ventures—Pitfalls

• Scale of entry– Large-scale entry is initially more expensive

than small-scale entry, but it brings higher returns in the long run

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Scale of Entry, Profitability, and Cash Flow

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Entry Strategy: Internal New Ventures—Pitfalls (cont’d)

• Commercialization– Technological possibilities should not

overshadow market needs and opportunities

• Poor implementation– Demands on cash flow– Clear strategic objectives are needed– Anticipating time and costs

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Guidelines for Successful Internal New Venturing

• Structured approach to managing internal new venturing– Research research aimed at advancing basic science

and technology– Development research aimed at finding and refining

commercial applications for the technology– Foster close links between R&D and marketing;

between R&D and manufacturing– Selection process for choosing ventures– Monitor progress

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Innovation to Commercialization

• Basic research

• Product research

• Development of prototypes for testing

• Product launch commercialization– Production– Marketing

• After sales support

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Entry Strategy: Acquisitions—Attractions

• To achieve horizontal integration• To achieve diversification when the

company lacks important competencies• To move quickly• Perceived as less risky than internal new

ventures• When the new industry is well established

and enterprises enjoy protection from barriers to entry

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Entry Strategy: Acquisitions—Pitfalls

• Difficulty with postacquisition integration

• Overestimating economic benefits

• The expense of acquisitions

• Inadequate preacquisition screening

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Guidelines for Successful Acquisition

• Target identification and preacquisition screening

• Bidding strategy– Hostile vs. friendly takeover

• Integration

• Learning from experience

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Entry Strategy: Joint Ventures—Attractions

• Helps avoid the risks and costs of building a new operation up from the ground floor

• Teaming with another company that has complementary skills and assets may increase the probability of success

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Entry Strategy: Joint Ventures—Pitfalls

• Requires the sharing of profits if the new business succeeds

• Venture partners must share control; conflicts on how to run the joint venture can cause failure

• Runs the risk of giving critical know-how away to joint venture partner

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GM and Toyota Joint Venturemid ’80s

• Based on an old GM plant in California

• Manufacture cars based on the Toyota Corolla platform

• For Toyota, access to US production

• For GM, learn production techniques from Toyota

• Other, newer ones: Toyota Matrix and Pontiac Vibe

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Exercise

• Closing Case: AT&T– Answer the first question at end of case

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Restructuring

• Reducing the scope of the company by exiting business areas

• Why restructure?– Diversification discount: investors see highly

diversified companies as less attractive • Complexity and lack of transparency in financial statements• Too much diversification or for the wrong reasons

– Response to failed acquisitions– Innovations have diminished the advantages of

vertical integration or diversification

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Restructuring Strategies

• Exit strategies– Divestment

• Spinoff• Selling to another company• Management buyout (MBO)

– Harvest– Liquidation