Chapter 8 MGMT 4860

Three types of acquisition candidates are usually of interest to companies expanding into unrelated businesses:

(1) businesses that have bright growth prospects but are short on investment capital, (2) undervalued companies that can be acquired at a bargain price, and (3) struggling companies whose operations can be turned around with the aid of the parent company's financial resources and managerial know-how.

Divesting a less-attractive cash hog business is usually the best alternative unless

(1) it has highly valuable strategic fit with other business units or (2) the capital infusions needed from the corporate parent are modest relative to the funds available, and (3) there's a decent chance of growing the business into a solid bottom-line contributor.

Companies that pursue unrelated diversification nearly always enter new businesses by...

acquiring an established company rather than internal development.

Least durable entry option

Joint Venture

Diversification cannot be considered a success unless in results in...

added shareholder value

Economies of scope

are cost reductions stemming from strategic fit along the value chains of related businesses (thereby, a larger scope of operations), whereas economies of scale accrue from a larger operation.

Portfolio Approach

based on the fact that different businesses have different cash flow and investment characteristics.

Creating added value for shareholders via diversification requires...

building a multibusiness company where the whole is greater than the sum of its parts.

Strategic Fit

exists when value chains of different businesses present opportunities for cross-business skills transfer, cost sharing, or brand sharing.

Cash Cow

generates operating cash flows over and above its internal requirements, thereby providing financial resources that may be used to invest in cash hogs, finance new acquisitions, fund share buyback programs, or pay dividends.

Cash Hog

generates operating cash flows that are too small to fully fund its operations and growth; a cash hog must receive cash infusions from outside sources to cover its working capital and investment requirements.

Unrelated Businesses

have dissimilar value chains and resources requirements, with no competitively important cross-business value chain relationships.

Corporate restructuring

involves radically altering the business lineup by divesting businesses that lack strategic fit or are poor performers and acquiring new businesses that offer better promise for enhancing shareholder value.

Related Businesses

possess competitively valuable cross-business value chain and resource matchups

the task of building shareholder value via unrelated diversification ultimately hinges on...

the ability of the parent company to improve its businesses via other means.

Managing by the numbers works if

the heads of the various business units are quite capable and consistently meet their numbers.

Relative market share

the ratio of its market share to the market share held by the largest rival firm in the industry, with market share measured in unit volume, not dollars. For instance, if business A has a market-leading share of 40 percent and its largest rival has 30 percent, A's relative market share is 1.33. If business B has a 15 percent market share and B's largest rival has 30 percent, B's relative market share is 0.5.

Added Shareholder Value

value the shareholders cannot capture on their own by spreading their investments across the stocks of companies in different industries

The big dilemma facing acquisition-minded firms

whether to pay a premium price for a successful company or to buy a struggling company at a bargain price.

As a rule, the more unrelated businesses that a company has diversified into,

the more corporate executives are forced to "manage by the numbers"—that is, keep a close track on the financial and operating results of each subsidiary and assume that the heads of the various subsidiaries have most everything under control so long as the latest key financial and operating measures look good.

Internal development

Starting a new business subsidiary from scratch.

Most popular means of diversifying into another industry...

Acquisition

Starting a subsidiary has its appeal when

(1) the parent company already has in-house most or all of the skills and resources needed to compete effectively; (2) there is ample time to launch the business; (3) internal entry has lower costs than entry via acquisition; (4) the targeted industry is populated with many relatively small firms such that the new start-up does not have to compete against large, powerful rivals; (5) adding new production capacity will not adversely impact the supply-demand balance in the industry; and (6) incumbent firms are likely to be slow or ineffective in responding to a new entrant's efforts to crack the market.

Aside from cash flow considerations, two other factors to consider in assessing the financial resource fit for businesses in a diversified firm's portfolio are:

-Do individual businesses adequately contribute to achieving companywide performance targets? -Does the corporation have adequate financial strength to fund its different businesses and maintain a healthy credit rating?

A simple and reliable analytical tool for gauging industry attractiveness involves calculating quantitative industry attractiveness scores based upon the following measures:

-Market size and projected growth rate. -The intensity of competition -Emerging opportunities and threats -The presence of cross-industry strategic fit. -Resource requirements -Seasonal and cyclical factors -Social, political, regulatory, and environmental factors -Industry profitabiliy -Industry uncertainty and business risk

The following factors may be used in quantifying the competitive strengths of a diversified company's business subsidiaries:

-Relative market share -Costs relative to competitors' costs -Products or services that satisfy buyer expectations -Ability to benefit from strategic fit with sibling businesses -Number and caliber of strategic alliances and collaborative partnerships -Brand image and reputation -Competitively valuable capabilities -Profitability relative tocompetitors

management sometimes undertakes a strategy of unrelated diversification for the wrong reasons:

-Risk Reduction -Growth -Earnings stabilization -Managerial motives

Unrelated diversification strategies have two important negatives that undercut the pluses:

-very demanding managerial requirements -limited competitive advantage potential.

3 Forms of diversifying the business lineup

1. Acquisition 2. Internal development 3. Joint ventures with other companies

The procedure for evaluating the pluses and minuses of a diversified company's strategy and deciding what actions to take to improve the company's performance involves six steps:

1. Assessing the attractiveness of the industries the company has diversified into. 2. Assessing the competitive strength of the company's business units. 3. Evaluating the extent of cross-business strategic fit along the value chains of the company's various business units. 4. Checking whether the firm's resources fit the requirements of its present business lineup. 5. Ranking the performance prospects of the businesses from best to worst and determining a priority for allocating resources. 6. Crafting new strategic moves to improve overall corporate performance.

Checking the competitive advantage potential of cross-business strategic fit involves evaluating how much benefit a diversified company can gain from value chain matchups that present:

1. Opportunities to combine the performance of certain activities, thereby reducing costs and capturing economies of scope. The greater the value of cross-business strategic fit in enhancing a company's performance in the marketplace or the bottom line, the more powerful is its strategy of related diversification. 2. Opportunities to transfer skills, technology, or intellectual capital from one business to another. 3. Opportunities to share use of a well-respected brand name across multiple product and/or service categories.

Four facets of crafting a diversified company's overall strategy

1. Picking new industries to ender and deciding on the means of entry. 2.Pursuing opportunities to leverage cross-business value chain relationships into competitive advantage. 3. Establishing investment priorities and steering corporate resources into the most attractive business units. 4. Initiating actions to boost the combined performance of the corporation's collection fo businesses.

Four categories of action to improve a diversified companies overall perfromance

1. Sticking closely with the existing business lineup and pursuing the opportunities these businesses present. 2. Broadening the company's business scope by making new acquisitions in new industries. 3. Divesting some businesses and retrenching to a narrower base of business operations. 4. Restructuring the company's business lineup and putting a whole new face on the company's business makeup.

Business diversification stands little chance of building shareholder value without passing the following three tests:

1. The industry attractiveness test. 2. The cost-of-entry test. 3. The better-off test.

A joint venture to enter a new business can be useful in at least two types of situations:

1. a joint venture is a good vehicle for pursuing an opportunity that is too complex, uneconomical, or risky for one company to pursue alone. 2. joint ventures make sense when the opportunities in a new industry require a broader range of competencies and know-how than an expansion-minded company can marshal.

Two conditions are necessary for producing valid industry attractiveness scores using this method:

1. deciding on appropriate weights for the industry attractiveness measures. 2.have sufficient knowledge to rate the industry on each attractiveness measure.

The greater the number of businesses a company is in and the more diverse they are, the more difficult it is for corporate managers to:

1.Stay abreast of what's happening in each industry and each subsidiary. 2.Pick business-unit heads having the requisite combination of managerial skills and know-how to drive gains in performance. 3.Tell the difference between those strategic proposals of business-unit managers that are prudent and those that are risky or unlikely to succeed. 4.Know what to do if a business unit stumbles and its results suddenly head downhill.

Resource Fit

A diversified company exhibits resource fit when its businesses add to a company's overall mix of resources and capabilities and when the parent company has sufficient resources to support its entire group of businesses without spreading itself too thin.

Internal Capital Market

A strong internal capital market allows a diversified company to add value by shifting capital from business units generating free cash flow to those needing additional capital to expand and realize their growth potential.

The better-off test:

Diversifying into a new business must offer potential for the company's existing businesses and the new business to perform better together under a single corporate umbrella than they would perform operating as independent, stand-alone businesses. For example, let's say company A diversifies by purchasing company B in another industry.

To succeed with a corporate strategy keyed to unrelated diversification, corporate executives must:

Do a superior job of identifying and acquiring new businesses that can produce consistently good earnings and returns on investment. Do an excellent job of negotiating favorable acquisition prices. Do such a good job overseeing and parenting the firm's businesses that they perform at a higher level than they would otherwise be able to do through their own efforts alone. The parenting activities of corporate executives can take the form of providing expert problem-solving skills, creative strategy suggestions, and first-rate advice and guidance on how to improve competitiveness and financial performance to the heads of the various business subsidiaries.

The cost-of-entry test:

The cost to enter the target industry must not be so high as to erode the potential for good profitability. A Catch-22 can prevail here, however. The more attractive an industry's prospects are for growth and good long-term profitability, the more expensive it can be to enter. It's easy for acquisitions of companies in highly attractive industries to fail the cost-of-entry test.

The industry attractiveness test:

The industry to be entered through diversification must offer an opportunity for profits and return on investment that is equal to or better than that of the company's present business(es).

Performing radical surgery on a company's group of businesses is an appealing corporate strategy when its financial performance is squeezed or eroded by:

Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries. Too many competitively weak businesses. An excessive debt burden with interest costs that eat deeply into profitability. Ill-chosen acquisitions that haven't lived up to expectations.