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CHAPTER 8

CORPORATE STRATEGY:

DIVERSIFICATION AND THEMULTIBUSINESS COMPANY

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WHAT DOES CRAFTING ADIVERSIFICATION STRATEGY ENTAIL?

Step 1Picking new industries to enter and deciding on the means of

entry.

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

Step 3Establishing investment priorities and steering corporate

resources into the most attractive business units.

Step 4Initiating actions to boost the combined performance

of the cooperations collection of businesses.

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The Chief Strategic and Financial Options for Allocating

a Diversified Companys Financial Resources

FIGURE 8.5

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WHEN BUSINESS DIVERSIFICATIONBECOMES A CONSIDERATION

A firm should consider diversifying when:1. It can expand into businesses whose technologies

and products complement its present business.

2. Its resources and capabilities can be used as

valuable competitive assets in other businesses.

3. Costs can be reduced by cross-business sharing

or transfer of resources and capabilities.

4. Transferring a strong brand name to the productsof other businesses helps drive up sales and

profits of those businesses.

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TESTING WHETHER DIVERSIFICATIONADDS VALUE FOR SHAREHOLDERS

The Attractiveness Test:

Are the industrys profits and return on investment

as good or better than present business(es)?

The Cost of Entry Test:

Is the cost of overcoming entry barriers so great as

to long delay or reduce the potential for profitability?

The Better-Off Test: How much synergy (stronger overall performance)

will be gained by diversifying into the industry?

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CORE CONCEPT

Creating added value for shareholders viadiversification requires building a multibusiness

company where the whole is greater than the

sum of its partsan outcome known as synergy.

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BETTER PERFORMANCETHROUGH SYNERGY

Evaluating thePotential for

Synergy

through

Diversification

Firm A purchases Firm B in

another industry. A and Bs

profits are no greater than

what each firm could have

earned on its own.

Firm A purchases Firm C in

another industry. A and Cs

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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APPROACHES TO DIVERSIFYINGTHE BUSINESS LINEUP

Acquisition of anexisting business

Internal newventure (start-up)

Jointventure

Diversifying into

New Businesses

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CORE CONCEPT

Corporate venturing (or new venturedevelopment) is the process of developing

new businesses as an outgrowth of a firms

established business operations. It is also

referred to as corporate entrepreneurshipor intrapreneurshipsince it requires

entrepreneurial-like qualities within a larger

enterprise.

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WHEN TO ENGAGE ININTERNAL 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-headcompetition in

targeted industry

Factors Favoring

Internal Development

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CHOOSING THE DIVERSIFICATION PATH:RELATED VERSUS UNRELATED

BUSINESSES

RelatedBusinesses

UnrelatedBusinesses

Both Related

and UnrelatedBusinesses

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 chainlevel.

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Related Businesses Provide Opportunities to

Benefit from Competitively Valuable Strategic Fit

FIGURE 8.1

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DIVERSIFYING INTO RELATEDBUSINESSES

Strategic Fit Opportunities:

Transferring specialized expertise, technological

know-how, or other resources and capabilities from

one businesss value chain to anothers. Cost sharing between businesses by combining their

related value chain activities into a single operation.

Exploiting common use of a well-known brand name.

Sharing other resources (besides brands) that

support corresponding value chain activities across

businesses.

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ECONOMIES OF SCOPE DIFFERFROM 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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DIVERSIFICATION INTOUNRELATED 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 contributesignificantly to the parent firms

bottom line?

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BUILDING SHAREHOLDER VALUEVIA 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 andRestructuring

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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MISGUIDED REASONS FORPURSUING UNRELATED

DIVERSIFICATION

Seeking a

reduction of

business

investment risk

Pursuing rapid

or continuous

growth for its

own sake

Seeking

stabilization toavoid cyclical

swings in

businesses

Pursuing

personal

managerial

motives

Poor Rationales for

Unrelated Diversification

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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 STRATEGYOF A DIVERSIFIED FIRM

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 firms business units

within their respective industries.

3. Evaluating the extent of cross-business strategic fit along thevalue chains of the firms various business units.

4. Checking whether the firms resources fit the requirements of its

present business lineup.

5. Ranking the performance prospects of the businesses from bestto worst and determining a priority for allocating resources.

6. Crafting strategic moves to improve corporate performance.

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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.

FIGURE 8.3

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A Firms Four Main

Strategic Alternatives

After It Diversifies

FIGURE 8.6

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CORE CONCEPT

Companywide restructuring (corporaterestructuring) involves making major changes

in a diversified company by divesting some

businesses and/or acquiring others, so as to

put a whole new face on the companysbusiness lineup.