Chapter 8 - Diversification strategies
What are the diversification strategy options?
- Related Diversification - Unrelated Diversification - Both related and Unrelated Diversification
Interpreting Competitive Strength Scores
-ratings above 6.7 are strong market contenders in their industries -ratings 3.3 -6.7 have moderate strength -ratings below 3.3 are in competitively weak market positions
What Is "Relative Market Share" and How Is It Calculated?
-the ratio of its market share to its largest rival's market share, with market share measured in unit volume, not dollars - For a market-leader firm, relative market share equals its market share divided by the next largest rival's market share
The Drawbacks of Unrelated Diversification
1. Demanding Managerial Requirements 2. Limited Competitive Advantage Potential **Likely outcome of trying to manage a large number of diverse businesses is 1 + 1 = 2, rather than 1 + 1 = 3
A diversified firm's collection of businesses exhibit resource fit when
1. Each company business had adequate access to the resources it needs to be competitively successful 2. The parent company has sufficient financial resources and parenting capabilities to support its entire group of businesses without spreading itself too thin.
What is meant by "diversification"?
A firm is diversified when it operates in two or more lines of business that are in distinctly different industries
Why does Diversification complicates the strategy-making task?
Because It requires: ► Assessing the multiple industry environments of a collection of individual businesses ► Developing a separate business strategy for each industry arena (or line of business) in which the diversified firm operates ► Devising a companywide (or corporate) strategy for improving the attractiveness and performance of the company's overall business lineup and for making a rational whole out of its diversified collection of individual businesses and individual business strategies
cash hogs
Business units in rapidly growing industries are often cash hogs—the cash flows they are able to generate from internal operations aren't big enough to fund their operations and capital requirements for growth
cash cows
Business units with leading market positions in mature industries may be cash cows in the sense that they generate substantial cash surpluses over what is needed to adequately fund their operations
What To Do with Cash Hog Businesses?
Strategic options for cash cow businesses: ► Invest in promising cash hogs to grow them into star businesses (strong, profitable market contenders) ► Divest cash hogs with questionable promise (either because of low industry attractiveness or a weak competitive position) and redeploy the resources elsewhere
Cost-of-entry test
The cost to enter the target industry must not be so high it erodes the potential for good profitability
Which Is Likely to Perform Better— A Related or an Unrelated Diversification Strategy?
There is a high likelihood that a strategy of related diversification will add more shareholder value than a strategy of unrelated diversification
The greater the cost-savings associated with cost-related strategic fits among the value chains of sister businesses, the greater the potential for
a related diversification strategy to yield a lowcost competitive advantage over ► Undiversified competitors ► Competitors whose own diversification efforts do not offer equivalent cost-saving benefits
Industry attractiveness test
attractive depends on the presence of industry and competitive conditions conducive to earning as good or better profits and return on investment than the company is earning in its present business(es) and good opportunities for long-term growth
Creating added long-term value for shareholders via diversification requires:
building a multi-business enterprise where the whole is greater than the sum of its parts — such 1 + 1 = 3 effects are called synergy.
Is it better to diversify into a few or many unrelated businesses?
diversifying into a few unrelated businesses often results in better overall firm performance than diversifying into many unrelated businesses
Unrelated Diversification
diversifying into businesses having no competitively valuable value chain match-ups or strategic fits with the value chain(s) of the firm's present business(es)
to remain financially healthy a diversified firm must :
generate internal cash flows sufficient to fund the capital requirements of its various business units, pay dividends, meet its debt obligations, and otherwise remain financially healthy
Economies of scope
stem from successful managerial efforts to capture cost-saving strategic fits along the value chains of related businesses
Who has responsibility for crafting and executing business-level?
the heads of each business segment
what is added long-term economic value for shareholders
value that shareholders cannot capture on their own
wo major avenues for growing revenues and profits:
► Growth by entering additional businesses ► Growth by extending the operations of existing businesses into additional country markets **Pursuing both growth avenues at the same time can provide a diversified firm with exceptional competitive advantage potential
Unrelated Diversification Strategies Often Result in:
"Ho-Hum" Performance
Strategic options for improving the corporation's overall performance include
(1) sticking closely with the existing business lineup and pursuing opportunities presented by these businesses, (2) broadening the scope of diversification by entering additional industries, (3) retrenching to a narrower scope of diversification by divesting poorly performing businesses that are no longer attractive or that don't fit into management's long-range plans, and (4) broadly restructuring the entire company by divesting some businesses and acquiring others so as to put a whole new face on the company's business lineup
What Is Appealing about Unrelated Diversification?
- Business risk is scattered over a set of truly diverse industries. - The company's financial resources can be employed to maximum advantage by: ► Investing in whatever industries offer the best profit prospects ► Diverting cash flows from company businesses with low growth and profit prospects to acquiring and expanding firms with higher growth and profit potentials - To the extent that corporate managers are exceptionally astute at spotting bargain-priced companies with big upside profit potential, shareholder wealth can be enhanced by ► Buying distressed businesses at a low price, turning their operations around fairly quickly with infusions of cash and managerial know-how supplied by the parent company ► Then either riding the crest of the profit increases generated by newly-turned around businesses or else enjoying the capital gains of selling a once-distressed business for an amount far above its purchase price.
Factors to Consider in Calculating Industry Attractiveness Scores
- Market size and projected growth rate - Intensity of competition - Emerging opportunities and threats - Presence of cross-industry strategic fits - Resource requirements - Seasonal and cyclical factors - Social, political, regulatory, and environmental factors - Industry profitability - Industry uncertainty and business risk
Potential Measures of Business-Unit Competitive Strength
- Relative market share - Costs relative to competitors - Ability to match or beat rivals on key product attributes - Ability to benefit from strategic fits with sister businesses - Ability to exercise bargaining leverage with key suppliers or customers - Brand image and reputation - Other competitively valuable resources and capabilities - Profitability relative to competitors
How can a company diversify?
-related or unrelated businesses -earning base to a small or major extent -1 large new businesses or many small ones -Acquiring an existin firm in a business/industry it wants to enter -forming a new business subsidiary or forming a joint venture to enter new businesses
A move to diversify into a new business stands little chance of producing added long-term shareholder value unless it can pass three tests:
1. Industry attractiveness test 2. Cost-of-entry test 3. Better-off test
What Does Crafting a Diversification Strategy Entail?
1. Picking new industries to enter and the means of entry. 2. Pursuing opportunities to leverage cross-business value chain relationships and strategic fits into competitive advantage. 3. Evaluating the growth and profitability prospects for each business, establishing investment priorities for each business, and then using these priorities to steer corporate resources to individual businesses. 4. Initiating actions to boost the combined performance of the corporation's collection of businesses.
Strategic options to improve a diversified firm's overall performance fall into five broad categories of actions
1. Sticking closely with the existing business lineup and pursuing the opportunities these businesses present 2. Broadening the firm's business scope by making acquisitions in new industries 3. Divesting underperforming businesses and/or "non-core" businesses and retrenching to a narrower diversification base 4. Restructuring the firm's business lineup and putting a whole new face on the firm's business makeup 5. Pursuing multinational diversification and striving to globalize the operations of several of the firm's business units
Better-off test
Diversifying must offer potential for the firm's businesses to perform better together under a single corporate umbrella than they would perform as independent stand-alone businesses
very telling measure of a firm's competitive strength vis-à-vis rival firms (and should be assigned a high importance weight in determining its competitive strength
Relative market share
Evaluating and Improving a Diversified Firm's Strategy: The Six Steps
Step 1: Assess the attractiveness of the industries the company has diversified into Step 2: Assess the competitive strength of the company's business units (and draw a nine-cell matrix to simultaneously portray industry attractiveness and business unit competitive strength) Step 3: Evaluate the competitive value of cross-business strategic fits along the value chains of the company's various business units Step 4: Check whether firm's resources fit the requirements of its present business lineup Step 5: Rank the performance prospects of the businesses from best to worst and determining what the corporate parent's priorities should be in allocating resources to its various businesses Step 6: Craft new strategic moves to improve overall corporate performance
Economies of scale
are cost savings that occur because a large scale operation is more cost-efficient than a small-scale operation
Given the demanding requirements it takes to successfully manage a sizable collection of unrelated businesses, pursuing a strategy of unrelated diversification is
chancy and unreliable—it is far tougher than it might seem to achieve 1 + 1 = 3 results
Resource fit and two types
concerns whether each company business has adequate access to the resources needed to be competitively successful and whether the corporate parent has adequate financial means and parenting capabilities to support its entire group of businesses 1. Financial resource fit 2. Nonfinancial resource fit
these are examples of what? ► Production-related strategic fits that enable two or more related businesses to use the same manufacturing facility to perform their production activities (using a single plant is likely to be more cost-effective than having multiple plants) and/or ► Distribution-related strategic fits that enable two or more related businesses to share use of the same distribution centers (utilizing a single distribution center is cheaper than having multiple distribution centers) and/or ► Sales- and customer-related strategic fits that enable two or more related businesses to use a common sales force to sell their products to customers (a single sales force is more cost-efficient than having separate sales forces) and/or ► The ability of two or more related businesses to share use of the same
cost-saving efficiencies derived by economies of scope
Related Diversification
diversifying into businesses whose value chains possess competitively valuable "strategic fits" with the value chain(s) of the firm's present business(es)
Strategic fit
exists when the value chains of different businesses present opportunities for cross-business resource transfer, lower costs through combining the performance of related value chain activities, cross business use of a potent brand name, and/or cross business collaboration to build new or stronger competitive capabilities.
Diversifcation is not jusitifable unless:
it offers good prospects of added long-term economic value for shareholders
Any and all of five approaches to competitive advantage can be pursued simultaneously when a firm's multinational diversification strategy is keyed to:
related diversification
What makes related diversification an attractive strategy?
the opportunity to convert cross-business strategic fits into a competitive advantage over business rivals whose operations do not offer comparable strategic fit benefits
The further a firm's relative market share falls below 1.0....
the weaker its competitive strength and market position vis-à-vis the industry leader.
When does a diversified company has a parenting advantage?
when it has superior corporate parenting capabilities relative to other diversified companies and thus can boost the combined performance of its individual businesses through high-level oversight, timely advice, and contributions of needed resource support.
when to consider diversifying?
► Conditions in its present industry turn sour and are expected to be long-lasting ► There are attractive opportunities to expand into industries whose technologies and products complement its present business ► Its current competencies and capabilities are key success factors and valuable competitive assets for competing in another business/industry ► Diversifying into closely related businesses opens new avenues for reducing costs ► It has a powerful and well-known brand name that can be transferred to the products of other businesses
Building Shareholder Value via Unrelated Diversification — Benefits of Astute Corporate Parenting
► Corporate executives committed to a strategy of unrelated diversification can aid efforts to achieve companywide financial results above and beyond what the individual businesses could achieve as stand-alone entities ► Corporate executives of financially strong diversified companies can create added value by astutely allocating financial resources across the company's businesses
Great diversity in a business makes it harder for top executives to:
► Discern good acquisitions from bad ones ► Have in-depth knowledge about each of the businesses ► Avoid big mistakes
what is the only way economies of scope can be achieved?
► Economies of scope can be achieved only if a diversified firm operates in two or more related businesses with cost-related strategic fits in one or more value chain activities. ► Often these cost-saving efficiencies are captured by combining the cost-related value chain activities of related businesses into a single, more cost-efficient operation. ► When economies of scope exist, sister businesses can be operated more cost-efficiently as part of the same firm than they could operate as stand-alone businesses.
Unrelated diversification strategies involve
► Entering any industry and operating any business where there is opportunity to realize consistently good financial results ► No deliberate effort to diversify into businesses with strategic fits ► Acquiring a firm rather than forming a start-up subsidiary or collaborating in a joint venture to get into a new business ► Acquiring only those companies (or entering only those industries) that can pass both the industry attractiveness and cost-of-entry tests and that present good prospects for achieving attractive levels of financial performance
Interpreting the Industry Attractiveness Scores
► Industries with a score much below 5.0 probably do not pass the attractiveness test ► If a firm's industry attractiveness scores are all above 5.0, the industry group in which the firm operates is attractive as a whole
The Five Paths to Pursuing Competitive Advantage via a Multinational Diversification Strategy
► Path 1: More fully capture all available economies of scale and learning/experience curve effects ► Path 2: Capture economies of scope associated with cost-saving strategic fits among related businesses ► Path 3: Transfer competitively valuable resources both from one business unit to another and from one country to another ► Path 4: Leverage a well-known and powerful brand name ► Path 5: Pursue an expanded set of opportunities for sister businesses to collaborate in developing and leveraging competitively valuable resources and capabilities
business make-up of diversified companies varies by
►Dominant-business firms - one major core business accounting for 50-80 percent of total revenues, with several small related or unrelated businesses accounting for the remainder of total revenues ► Narrowly diversified firms - Have a few (2-5) related or unrelated businesses ► Broadly diversified firms - Have a wide-ranging collection of either related or unrelated businesses or a mixture of both ► Diversified firms that have diversified into unrelated areas but have a collection of related businesses within each area— thus giving them a portfolio of several unrelated groups of related businesses
