module 3

Reasons for Diversification

1. Enter new businesses with greater growth potential than that which current business lines offer. 2. Enter businesses with different product life-cycle consideration. 3. Reduce the inherent risks of remaining in only one line of business. 4. Increase vertical integration, thereby reducing costs. 5. Gain a market presence in a new business area more quickly than by creating one internally.

Overdiversification

Diversification strategies, whether related or unrelated, can lead to performance improvements by diversifying away some of the risk inherent in remaining a single business. However, some firms can become overdiversified to the point where performance suffers. One reason for this is that information processing increases as the firm diversifies; the firm is forced to track multiple businesses. In some cases, firms are believed to have diversified beyond their area of expertise — they can find themselves operating in areas so far from their core business that managerial focus becomes spread too thin. Another reason is the tendency for acquisitions to become substitutes for innovation. In some cases (especially in the pharmaceutical industry), a firm might errantly take the mindset that acquisition of new products lines is easier than innovation through in-house research and development. Once a pattern of acquisitions is started, firms might overlook their own ability to innovate and their R & D departments begin to atrophy. Another reason for overdiversification is that of managerial hubris. Managerial hubris is the unrealistic belief that one can better manage a target business than its present management. In many well documented cases, managerial (especially CEO) hubris results in paying too much for the target firm and thus no long-term economic gain will come from the acquisition. Hubris is not necessarily the norm, but research suggests that a number of diversification activities have been driven by hubris. Acquisition is one way to grow a company's asset base and revenues. Such growth could lead to increased CEO compensation. Therefore, in addition to overconfidence, a CEO might pursue acquisitions for personal gain - for example increased compensation. There is also an intangible characteristic in diversification called dominant logic. Dominant logic is a common way of thinking about strategy across multiple business units. When managers possess this logic, they are able to see relatedness among business units and find ways to gain competitive advantage by sharing activities among the various units. Overdiversification can dilute dominant logic thereby rendering a cloudy mindset of the organization's mission. Regardless of the reason(s) that a conglomerate has been deemed to be overdiversified, a common solution to the problem is through refocusing. Refocusing occurs through business segment divestiture. The segments that should be considered for pruning are those that are losing money, dilute dominant logic, or otherwise don't seem to fit with the other business segments in the portfolio.

The General Electric 9-Cell Matrix

This matrix, developed by McKinsey & Company at General Electric, is also called the industry attractiveness-business strength matrix. This matrix uses several factors to assess industry attractiveness and business strength rather than employ the two measures used in the BCG matrix. industry attractiveness considers several factors including market growth rate, market size, industry profitability, industry rivalry, and globalization opportunities, Business unit strength also uses multiple factors including market share, market share growth, brand equity, distribution access, production capacity, and profitability relative to competitors. ------------business unit strength industry/ attractiveness Grow and build (cells 1, 2, 4) Including: -Product development -Market development or penetration -Integration, any type -Strategic Alliances -Joint Ventures Selective investment (cells 3, 5, 7) -Product development -Related diversification Harvest (cells 6, 8, 9) -Divestiture -Retrenchment -Turnaround

Question marks

are businesses in high growth rate markets, but presently have relatively low market share. Such business lines can become cash guzzlers due to their cash needs to keep pace in a rapid growth industry. Their small market share results in little positive cash flow. One option might be an effort to increase their market share and move into the star group; this would require extra corporate resources. If moving a question mark to star seems unlikely, divesting the question mark might be in order.

stars

are businesses in rapidly growing markets with strong market shares. These businesses are likely the best long-run opportunities in the firm's portfolio. They require substantial investment to expand their dominant position in a growing market. These businesses require an excess of funds that they can generate. Therefore, these businesses are priority users of corporate resources.

Dogs

are businesses with low market share in a low market growth industry segment. Given the maturity of the given market, intense competition and low profit margins prevail. are harvested for short-term cash flow to supplement an organization's resource needs in other areas. Eventually, dogs are usually divested or liquidated once this harvesting has been maximized.

Cash cows

are businesses with strong market share in low-growth business segments. Because of their strong competitive positions and their minimal cash sustainment needs, these businesses often generate excess cash. Therefore, they are often "milked" as a source of corporate funds for use elsewhere (to fund stars and question marks). usually yesterday's stars and now a corporation's core product. They provide the cash needed to pay corporate overhead and dividends. They are managed to maintain their strong market share in the hopes of continuing to generate resources for other corporate uses.

Grand Strategy Matrix

can also be used in managing a diversified business portfolio. All businesses/ product lines can be positioned in one of the matrix's four quadrants. Construction of the matrix is fairly straightforward. The X axis is competitive position; the range is from weak to strong. The Y axis is market growth, ranging from slow to rapid. Businesses/ product lines that fall in Quadrant I are deemed to be in an excellent strategic position. Businesses in Quadrant II are those that likely need to re-evaluate their present approach to the market. Product lines in Quadrant III show little promise under the present strategy. Business segments in Quadrant IV have strong a competitive presence, but are in a slow growth industry. It is very important to note that each quadrant prescribes specific strategies for the business segments and product lines that the strategist assigns to the given quadrant. 2 --- 1 3 --- 4 Rapid market growth weak cp . . . . |. . . . strong competitive position Slow market growth

Market growth rate

expected rate of growth for the market being served by a particular business. Usually measured as the percentage increase in a market's sales or unit volume over the two most recent years, this rate serves as an indicator of the relative attractiveness of the markets served by each business in the firm's portfolio of businesses. (side)

Relative market share

is calculated as the current market share of a business segment divided by the market share of the largest competitor. (top)

The Boston Consulting Group (B C G)

pioneered an approach called portfolio techniques that help strategists "balance" the flow of cash among various lines of business while also identifying their basic strategic purpose within the overall portfolio. When using, strategists plot each of the company's businesses according to market growth rate (side) and relative market share (top) -----------market share (cash generation) growth rate (usage) stars - question marks cash cows - dogs