GS BUSA 439 CH 8 Diversification and the Multibusiness Company
The Path to Greater Shareholder Value through Unrelated Diversification For a strategy of unrelated diversification to produce companywide financial results above and beyond what the businesses could generate operating as standalone entities, corporate executives must do three things to pass the three Tests of Corporate Advantage
1. Diversify into industries where the businesses can produce consistently good earnings and returns on investment (to satisfy the industry-attractiveness test). 2. Negotiate favorable acquisition prices (to satisfy the cost of entry test). 3. Do a superior job of corporate parenting via high-level managerial oversight and resource sharing, financial resource allocation and portfolio management, and/or the restructuring of under performing businesses (to satisfy the better-off test).
Approaches to Diversifying the Business Lineup
1. Existing business acquisition 2. Internal new venture (start-up) 3. Joint venture
When to consider diversifying
1. Growth opportunities are limited as its principal markets reach their maturity and buyer demand is either stagnating or set to decline. 2. Changing industry conditions—new technologies, inroads being made by substitute products, fast-shifting buyer preferences, or intensifying competition—are undermining the firm's competitive position. In every case, however, the decision to diversify must start with a strong economic justification for doing so.
Evaluating the Strategy of a Diversified Company Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance 2. Broadening the company's business scope by making new acquisitions in new industries. Diversified companies sometimes find it desirable to build positions in new industries, whether related or unrelated. Several motivating factors are in play. Another important avenue for expanding the scope of a diversified company is to grow by extending the operations of existing businesses into additional country markets. Expanding a company's geographic scope may offer an exceptional competitive advantage potential by facilitating the full capture of economies of scale and learning- and experience-curve effects.
1. One is sluggish growth that makes the potential revenue and profit boost of a newly acquired business look attractive. 2. A second is the potential for transferring resources and capabilities to other related or complementary businesses. 3. A third is rapidly changing conditions in one or more of a company's core businesses, brought on by technological, legislative, or demographic changes. 4. A fourth, and very important, motivating factor for adding new businesses is to complement and strengthen the market position and competitive capabilities of one or more of the company's present businesses.
Tests of Corporate Advantage
1. The industry attractiveness test The industry to be entered through diversification must be structurally attractive (in terms of the five forces), have resource requirements that match those of the parent company, and offer good prospects for growth, profitability, and return on investment 2. The cost of entry test. The cost of entering the target industry must not be so high as to exceed 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. 3. 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—an effect known as synergy.
Generally, internal development of a new business has appeal only when The risks associated with internal startups can be substantial, and the likelihood of failure is often high. Moreover, the culture, structures, and organizational systems of some companies may impede innovation and make it difficult for corporate entrepreneurship to flourish.
1. The parent company already has in-house most of the resources and capabilities it needs to piece together a new business and compete effectively, 2. There is ample time to launch the business; 3. The internal cost of entry is lower than the cost of entry via acquisition; 4. Adding new production capacity will not adversely impact the supply-demand balance in the industry; and 5. Incumbent firms are likely to be slow or ineffective in responding to a new entrant's efforts to crack the market.
Evaluating the Strategy of a Diversified Company Step 4: Checking for Good Resource Fit (continued) • Financial Resource Fit (continued) Aside from cash flow considerations, there are two other factors to consider in assessing whether a diversified company's businesses exhibit good financial fit: 1. Do any of the company's individual businesses present financial challenges with respect to contributing adequately to achieving companywide performance targets? A business exhibits poor financial fit if it soaks up a disproportionate share of the company's financial resources, while making subpar or insignificant contributions to the bottom line.
2. Does the corporation have adequate financial strength to fund its different businesses and maintain a healthy credit rating? A diversified company's strategy fails the resource-fit test when the resource needs of its portfolio unduly stretch the company's financial health and threaten to impair its credit rating.
Which are examples of opportunities for strategic fit? (Choose every correct answer.)
Exploiting the common use of a well-known brand name Transferring specialized expertise from the value chain of one business to another Sharing costs between businesses by combining their related value chain activities into a single operation
True or false: The benefits of cross-business strategic fit follow naturally once a company can diversify into related businesses.
False
Which of the following are drawbacks of acquisition? (Choose every correct answer.)
Integration of the company into the existing firm can be time consuming. There can be high integration costs. There are often excessive premiums.
Which of the following are among the four questions that need to be asked when determining how best to enter a new business? (Choose every correct answer.)
Is speed an important factor in the firm's chances for successful entry? Which is the least costly mode of entry, given the company's objectives? Are there entry barriers to overcome?
Which statement is true concerning strategic fit?
It allows cross-business sharing of resources that enable value chain activities.
Which of the following are true of the nine-cell attractiveness-strength matrix? (Choose every correct answer.)
It identifies the industry attractiveness of businesses. It identifies the business strength of businesses. It helps diversified companies allocate resources among their businesses.
Which of the following are benefits of acquisition? (Choose every correct answer.)
It is a useful way to get over entry barriers, such as building brand awareness. It allows access to hard-to-find resources and capabilities that work well with those of the acquiring company. It is quicker than trying to launch a new operation.
Internal development of a new business is a good idea when which of the following conditions are met? (Choose every correct answer.)
It is cheaper to enter internally than through an acquisition. There is plenty of time to start the business. The parent company has the in-house resources needed to launch the company.
Which of the following statements are true about a successful diversification effort? (Choose every correct answer.)
It must add long-term economic value for shareholders. It must give shareholders value that they cannot get by purchasing different stocks on their own.
Which statements are true concerning restructuring a business? (Choose every correct answer.)
It often entails transferring experienced managers to the newly acquired business. It generally involves liquidating underutilized assets. It usually occurs when a diversified company acquires a new business that is underperforming.
Which of the following are the ways a company can enter a new business? (Choose every correct answer.)
Joint ventures Internal startup Acquisition
Which of the following are steps in creating a diversified company's corporate strategy? (Choose every correct answer.)
Leveraging cross-business value chain relationships into competitive advantage Initiating actions to boost the combined performance of the company's collection of businesses Picking new industries to enter and the means for entering them
In order to pass the three tests of corporate advantage, what must executives do? (Choose every correct answer.)
Negotiate favorable acquisition prices Do a superior job of corporate parenting via high-level managerial oversight Diversify into industries where the businesses can produce consistently good earnings and return on investment
Only profitable growth—the kind that comes from creating added value for shareholders
can justify a strategy of unrelated diversification. Because unrelated diversification strategies at their best have only a limited potential for creating long-term economic value for shareholders, it is essential that managers not compound this problem by taking a misguided approach toward unrelated diversification, in pursuit of objectives that are more likely to destroy shareholder value than create it.
Determining whether the premium required to make an acquisition will be worth the extra value gained is an example of answering the question of
comparative cost.
In calculating industry attractiveness scores, ______.
competition intensity should be heavily weighted
Related businesses possess
competitively valuable cross-business value chain and resource commonalities; unrelated businesses have dissimilar value chains and resource requirements, with no competitively important cross-business commonalities at the value chain level.
Economies of scope are
cost reductions that flow from operating in multiple businesses (a larger scope of operation). This is in contrast to economies of scale, which accrue from a larger-sized operation.
Strategic Fit in Customer Service Activities Strategic fit with respect to customer service activities can enable
cost savings or differentiation advantages, just as it does along other points of the value chain. • consolidating after-sale service and repair organizations for the products of closely related businesses into a single operation • can often use the same customer service infrastructure. Through the transfer of best practices in customer service across a set of related businesses or through the sharing of resources such as proprietary information about customer preferences, a multibusiness company can also create a differentiation advantage through higher-quality customer service.
Determining whether the materials needed to start a business can be readily obtained by a company is an example of answering the strategy-based question of
critical resources and capabilities.
Choosing how best to enter a new business
depends partially on determining the least costly mode of entry.
Companies that pursue a strategy of unrelated diversification often exhibit a willingness to
diversify into any business in any industry where senior managers see an opportunity to realize consistently good financial results. Such companies are frequently labeled conglomerates because their business interests range broadly across diverse industries.
Determining if there are obstacles that block a new company from gaining a foothold and thriving in an industry is an example of answering the strategy-based question of
entry barriers.
Resources whose use is applied across a wide range of industry types are known as _____.
general resources
A diversified company can add value by shifting capital from business units generating free cash flow to those needing capital to grow by having a strong ______.
internal capital market
In order for a diversified company to perform well, ______.
much of its revenues and profits should be derived from business units with comparatively high attractiveness scores
Companies practicing unrelated diversification overwhelmingly enter new businesses by ______.
obtaining an established company
In order to be a good market for a company to be in, an industry should ______.
pass the industry attractiveness test
Diversifying into related businesses where competitively valuable strategic- fit benefits can be captured puts a company's businesses in
position to perform better financially as part of the company than they could have performed as independent enterprises, thus providing a clear avenue for increasing shareholder value and satisfying the better-off test.
Distribution-Related Strategic Fit Businesses with closely related distribution activities can perform better together than apart because of
potential cost savings in sharing the same distribution facilities or using many of the same wholesale distributors and retail dealers.
After a evaluating the strength, attractiveness, and fit of a diversified company's strategy, the next move is to ______.
rank the performance potential of the businesses
Corporate parenting
refers to the role that a diversified corporation plays in nurturing its component businesses through the provision of top management expertise, disciplined control, financial resources, and other types of general resources and capabilities such as long-term planning systems, business development skills, management development processes, and incentive systems. The parenting activities of corporate executives may also include recruiting and hiring talented managers to run individual businesses.
When a firm with a related diversification strategy has businesses that match specialized resource requirements at points along their value chains that are critical for the business's market success, they are said to have
resource fit.
If a company has poorly chosen acquisitions that are underperforming expectations, it is a good idea to ______.
restructure its business lineup
The process of overhauling and streamlining the operations of a business is referred to as
restructuring.
When a company's management decides that it needs to concentrate on a smaller number of businesses, it is a good strategy to ______.
retrench to a narrower diversification base
Related diversification involves
sharing or transferring specialized resources and capabilities. Specialized resources and capabilities have very specific applications and their use is limited to a restricted range of industry and business types, in contrast to general resources and capabilities, which can be widely applied and can be deployed across a broad range of industry and business types.
Determining how rapidly an industry is changing is crucial to answering the question of ______ when choosing a mode of entry.
speed
Unrelated diversification strategies
tend to have more overall failures than successes.
Evaluating the Strategy of a Diversified Company Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance 4. Restructuring the company's business lineup and putting a whole new face on the company's business makeup. Restructuring a diversified company on a companywide basis (corporate restructuring) involves divesting some businesses and/or acquiring others, so as to put a whole new face on the company's business lineup. On occasion, corporate restructuring can be prompted by special circumstances—such as when a firm has a unique opportunity to make an acquisition so big and important that it has to sell several existing business units to finance the new acquisition or when a company needs to sell off some businesses in order to raise the cash for entering a potentially big industry with wave-of-the-future technologies or products. • aligning the remaining business units into groups with the best strategic fit and then • redeploying the cash flows from the divested businesses to either pay down debt or • make new acquisitions to strengthen the parent company's business position in the industries it has chosen to emphasize.
Performing radical surgery on a company's business lineup is appealing when its financial performance is being squeezed or eroded by • A serious mismatch between the company's resources and capabilities and the type of diversification that it has pursued. • Too many businesses in slow-growth, declining, low- margin, or otherwise unattractive industries. • Too many competitively weak businesses. • The emergence of new technologies that threaten the survival of one or more important businesses. • Ongoing declines in the market shares of one or more major business units that are falling prey to more market-savvy competitors. • An excessive debt burden with interest costs that eat deeply into profitability. • Ill-chosen acquisitions that haven't lived up to expectations.
Strategic fit exists whenever one or more activities constituting the value chains of different businesses are sufficiently similar to present opportunities for cross-business sharing or transferring of the resources and capabilities that enable these activities
Prime examples of such opportunities include: • Transferring specialized expertise, technological know-how; or other competitively valuable strategic assets from one business's value chain to another's • Sharing costs between businesses by combining their related value chain activities into a single operation. • Exploiting the common use of a well-known brand name. • Sharing other resources (besides brands) that support corresponding value chain activities across businesses • Engaging in cross-business collaboration and knowledge sharing to create new competitively valuable resources and capabilities.
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains in Shareholder Value The cost advantage from economies of scope is due to the fact that resource sharing allows a multibusiness firm to spread resource costs across its businesses and to avoid the expense of having to acquire and maintain duplicate sets of resources—one for each business. But related diversified companies can benefit from strategic fit in other ways as well.
Sharing or transferring valuable specialized assets among the company's businesses can help each business perform its value chain activities more proficiently. This translates into competitive advantage for the businesses in one or two basic ways: 1. The businesses can contribute to greater efficiency and lower costs relative to their competitors, and/or 2. they can provide a basis for differentiation so that customers are willing to pay relatively more for the businesses' goods and services.
Which are examples of strategic fit in supply chain activities? (Choose every correct answer.)
Sharing resources and capabilities in logistics Transferring skills in procuring materials
What are example of strategic fit in distribution-related activities? (Choose every correct answer.)
Sharing the same wholesale distributors Making use of the same distribution facilities
An umbrella brand is ex. General Electric, for example, successfully applied its GE brand to such unrelated products and businesses as medical products and health care (GE Healthcare), jet engines (GE Aviation), and power and water technologies (GE Power and Water).
a corporate brand name that can be applied to a wide assortment of business types. As such, it is a type of general resource that can be leveraged in unrelated diversification. Utilizing a well-known corporate name (GE) in a diversified company's individual businesses has the potential not only to lower costs (by spreading the fixed cost of developing and maintaining the brand over many businesses) but also to enhance each business's customer value proposition by linking its products to a name that consumers trust.
Diversified companies that are able to create more value in their businesses than other diversified companies have what is called
a parenting advantage.
When a company's existing businesses provide opportunities for growth and produce economic value for shareholders, it makes sense to ______.
adhere to the existing business lineup
The decision to diversify should begin with ______.
an economic justification
A spin-off is
an independent company created when a corporate parent divests a business either by selling shares to the public via an initial public offering or by distributing shares in the new company to shareholders of the corporate parent.
Strategic Fit in Supply Chain Activities Businesses with strategic fit with respect to their supply chain activities can perform
better together because of the potential for • transferring skills in procuring materials, • sharing resources and • capabilities in logistics, • collaborating with common supply chain partners, • and/or increasing leverage with shippers in securing volume discounts on incoming parts and components.
The potential for an existing company and a new business to function better together following diversification than they would individually is part of the ______.
better-off test
Creating added value for shareholders via diversification requires
building a multibusiness company in which the whole is greater than the sum of its parts; such 1 + 1 = 3 effects are called synergy.
Strategic analysis of diversified companies _____.
builds on the same ideas and techniques used for analyzing single-business companies
A related diversification strategy involves building the company around
businesses where there is good strategic fit across corresponding value chain activities.
Unrelated diversification strategy
can create only a small amount of competitive advantage beyond that which can be created by the individual businesses acting alone.
Businesses are said to be related when ______.
their value chains exhibit competitively important cross-business commonalities
A willingness to diversify into any business in any industry is unlikely to
to result in successful unrelated diversification. The key to success even for unrelated diversification is to create economic value for shareholders.
Corporate brands that do not have a connotation of any specific type of product are known as ______.
umbrella brands
Corporate parents effectively contribute to the success of their unrelated businesses by ___.
utilizing an umbrella brand
Related diversification is based on
value chain match ups with respect to key value chain activities—those that play a central role in each business's strategy and that link to its industry's key success factors. Such match ups facilitate the sharing or transfer of the resources and capabilities that enable the performance of these activities and underlie each business's quest for competitive advantage. By facilitating the sharing or transferring of such important competitive assets, related diversification can elevate each business's prospects for competitive success.
Combination related-unrelated diversification strategies have particular appeal for companies
with a mix of valuable competitive assets, covering the spectrum from general to specialized resources and capabilities. There's nothing to preclude a company from diversifying into both related and unrelated businesses.
Diversification is not really viewed as a success unless it _____.
yields added long-term economic value for shareholders
The crafting of strategic moves to improve a diversified company's overall performance ______.
can be placed into four broad categories of action
Which are examples of strategic fit in manufacturing? (Choose every correct answer.)
The consolidation of production into a smaller number of plants The transfer of expertise in quality control The sharing of cost-efficient production methods
Which statement about the diversification of a company is correct?
A company can diversify into related businesses, unrelated businesses, or both.
Which of the following are circumstances that indicate a poor fit of non financial resources in a diversified company? (Choose every correct answer.)
A mismatch exists between a diversifying company's competitive assets and the key success factors of an industry into which it is expanding. A core business lacks accumulated resources to deal with the competitive environment of the businesses into which it has diversified. A company's resources are stretched thin in order to assimilate and oversee many new businesses in a short time.
Which are factors that can be used to quantify the competitive strengths of a diversified company's business subsidiaries? (Choose every correct answer.)
Ability to match or beat rivals on key product attributes Costs relative to competitors' costs Relative market share
The Question of Comparative Cost Often, companies pay hefty fees to investment banking firms, lawyers, and others to advise them and assist with the deal-making process. Finally, the true cost must take into account the costs of integrating the acquired company into the parent company's portfolio of businesses. Joint ventures may provide a way to conserve on such entry costs. But even here, there are organizational coordination costs and transaction costs that must be considered, including settling on the terms of the arrangement
Acquisition can be a high-cost mode of entry due to the need to pay a premium over the share price of the target company. Whether it is worth it to pay that high a price will depend on how much extra value will be created by the new combination of companies in the form of synergies Moreover, the true cost of an acquisition must include the transaction costs of identifying and evaluating potential targets, negotiating a price, and completing other aspects of deal making.
A good resource fit would include solid parenting capabilities in companies that pursue which of the following?
An unrelated diversification strategy
Evaluating the Strategy of a Diversified Company Step 5: Ranking Business Units and Assigning a Priority for Resource Allocation The next step is to rank the performance prospects of the businesses from best to worst Such ranking helps top-level executives assign each business a priority for resource support and capital investment.
As a rule, business subsidiaries with the brightest profit and growth prospects, attractive positions in the nine-cell matrix, and solid strategic and resource fit should receive top priority for allocation of corporate resources. However, in ranking the prospects of the different businesses from best to worst, it is usually wise to also take into account each business's past performance in regard to • sales growth, • profit growth, • contribution to company earnings, • return on capital invested in the business, and • cash flow from operations.
Which of the following ratings concerning interpretation of competitive-strength scores are correct? (Choose every correct answer.)
Businesses with ratings in the 3.3 to 6.7 range have moderate competitive strength. Businesses with ratings below 3.3 are in competitively weak market positions. Business units with ratings above 6.7 are strong market contenders in their industries.
1 of 3 : Approaches to Diversifying : Diversifying by Acquisition of an Existing Business Cons Acquiring an existing business can prove quite expensive Realizing the potential gains from an acquisition requires a successful integration of the acquired company into the culture, systems, and structure of the acquiring firm. This can be a costly and time consuming operation. Acquisitions can also fail to deliver long-term shareholder value if the acquirer overestimates the potential gains and pays a premium in excess of the realized gains.
Costs include not only the acquisition price but also • the costs of performing the due diligence to ascertain the worth of the other company, • the costs of negotiating the purchase transaction, and • the costs of integrating the business into the diversified company's portfolio
What are the three strategy options for pursuing diversification? (Choose every correct answer.)
Diversifying into unrelated businesses Diversifying into both related and unrelated businesses Diversifying into related businesses
Which statements are true about the nine-cell matrix? (Choose every correct answer.)
Each axis is divided into three regions. Competitive strength is plotted on the horizontal axis. Industry attractiveness is plotted on the vertical axis.
What can the calculation of quantitative industry-attractiveness scores be based on? (Choose every correct answer.)
Emerging threats and opportunities The presence of cross-industry strategic fit Market size and projected growth rate
Which of the following statements are true of a nine-cell matrix?
Overall attractiveness and strength scores are used to plot business units, which are displayed as bubbles. The vertical axis is divided into regions for high, medium, and low attractiveness. The horizontal axis is divided into regions for strong, average, and weak competitive strength.
What does unrelated diversification provide? (Choose every correct answer.)
Performance that is rarely better than the sum of what the individual business units could have achieved independently Very general, low-value resources for the subsidiaries A limited potential for competitive advantage
Which are examples of strategic fit in sales and marketing? (Choose every correct answer.)
Reducing billing costs by using common promotional tie-ins Using a single sales force Promoting products on the same website
Which of the following would be misguided reasons for pursuing unrelated diversification? (Choose every correct answer.)
Risk reduction Boosting managerial compensation Reducing earnings volatility
Which of the following allow businesses with strategic fit in supply chain activities perform better together? (Choose every correct answer.)
Sharing logistical resources Cooperating with common supply chain partners Obtaining volume discounts on incoming components
What are examples of strategic fit in customer service? (Choose every correct answer.)
Sharing proprietary information about customer preferences for higher-quality service Transferring best practices in customer service across related businesses Consolidating after-sale service organizations and infrastructure
Evaluating the Strategy of a Diversified Company Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance 3. Divesting certain businesses and retrenching to a narrower base of business operations. A number of diversified firms have had difficulty managing a diverse group of businesses and have elected to exit some of them. Selling a business outright to another company is far and away the most frequently used option for divesting a business. Sometimes a business selected for divestiture has ample resources and capabilities to compete successfully on its own. In such cases, a corporate parent may elect to spin off the unwanted business as a financially and managerially independent company, either by selling shares to the public via an initial public offering or by distributing shares in the new company to shareholders of the corporate parent. A useful guide to determine whether or when to divest a business subsidiary is to ask, "If we were not in this business today, would we want to get into it now?"
Retrenching to a narrower diversification base is usually undertaken when top management concludes that its diversification has ranged too far afield and that the company can improve long-term performance by concentrating on a smaller number of businesses. But there are other important reasons for divesting • market conditions in a once-attractive industry have badly deteriorated • the business lacks adequate strategic or resource fit • because it is a cash hog with questionable long-term potential • remedying its competitive weaknesses is too expensive relative to the likely gains in profitability • businesses that, down the road, just do not work out as expected even though management has tried its best • may not mesh as well with the rest of the firm as was originally thought On occasion, a diversification move that seems sensible from a strategic-fit standpoint turns out to be a poor cultural fit.
When does it makes sense to stick closely with a diversified company's present business lineup? (Choose every correct answer.)
The existing business lineup provides ample opportunity for growth. The company's existing businesses match the company's diversification strategy. The current lineup reliably creates economic value for shareholders.
Which of the following is true of economies of scope?
They come directly from strategic fit along the value chains of related businesses.
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive Strength The industry-attractiveness and business-strength scores can be used to portray the strategic positions of each business in a diversified company Industry attractiveness is plotted on the vertical axis and competitive strength on the horizontal axis. A nine-cell grid emerges from dividing the vertical axis into three regions (high, medium, and low attractiveness) and the horizontal axis into three regions (strong, average, and weak competitive strength).
The locations of the business units on the attractiveness-strength matrix provide valuable guidance in deploying corporate resources. • Businesses positioned in the three cells in the upper left portion of the attractiveness-strength matrix (like business A) have both favorable industry attractiveness and competitive strength. • Next in priority come businesses positioned in the three diagonal cells stretching from the lower left to the upper right (like business C). Such businesses usually merit intermediate priority in the parent's resource allocation ranking. • Businesses in the three cells in the lower right corner of the matrix (like business B) have comparatively low industry attractiveness and minimal competitive strength, making them weak performers with little potential for improvement. At best, they have the lowest claim on corporate resources and may be good candidates for being divested (sold to other companies).
Which of the following are true in using cross-business strategic fit to create gains in profitability and shareholder value? (Choose every correct answer.)
The more a company's businesses are related, the greater the company's opportunity to turn strategic fit into competitive advantage. It builds shareholder value in ways that are not possible through stock ownership in a variety of industries. Cross-business strategic fit benefits are possible only through a strategy of related diversification.
Which of the following statements are true of specialized resources? (Choose every correct answer.)
Their value is evident only when they are used in very specific businesses and industries. They are leveraged in related diversification. Their usefulness is limited in applications beyond those which they were created to serve.
Which of the following is true about joint ventures?
They are usually short-lived, ending as soon as the partners decide to part ways.
Which of the following are true statements concerning related businesses? (Choose every correct answer.)
They can be combined to perform better than the sum of the individual businesses. They have similar resources and capabilities. They have compatible value chain activities.
True or false: One method of broadening a company's diversification base is to add businesses that will complement and strengthen the market position of businesses in industries where the company already has a stake.
True
True or false: Strategic uses of corporate resources should usually take precedence over financial options.
True
Which are broad categories of action for crafting strategic moves to improve a diversified company's overall performance? (Choose every correct answer.)
Widening the company's business scope by making new acquisitions in new industries Sticking closely with the existing business lineup and pursuing opportunities that those businesses present Divesting certain businesses and retrenching to a narrower base of business operations
In a diversified company, the strategy- making challenge involves assessing multiple industry environments and developing
a set of business strategies, one for each industry arena in which the diversified company operates. Top executives at a diversified company must still go one step further and devise a companywide (or corporate) strategy for improving the performance of the company's overall business lineup and for making a rational whole out of its diversified collection of individual businesses.
Business units with competitive-strength ratings ______.
above 6.7 are strong market contenders in their industries
Companies engaged in unrelated diversification nearly always enter new businesses by
acquiring an established company rather than by forming a startup subsidiary within their own corporate structures or participating in joint ventures.
A diversified company's base can be broadened by ______.
acquiring more businesses and building positions in new industries
If the question of speed determines that fast movers can grab long-term advantages, the preferred mode of diversification is likely to be
acquisition
The means of entering a new business by buying an existing business is referred to as ______.
acquisition
If the question of entry barriers demonstrates that barriers against a company entering an industry cannot be readily overcome, the company will probably choose entry via
acquisition.
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.
In principle, diversification cannot be considered wise or justifiable unless it results in
added long-term economic value for shareholders—value that shareholders cannot capture on their own by purchasing stock in companies in different industries or investing in mutual funds to spread their investments across industries
The Question of Critical Resources and Capabilities If a firm has all the resources it needs to start up a new business or will be able to easily purchase or lease any missing resources, it may choose to enter the business via
internal development However, if missing critical resources cannot be easily purchased or leased, a firm wishing to enter a new business must obtain these missing resources through either acquisition or joint venture. This type of entry mode has the added advantage of spreading the risk of entering a new business, an advantage that is particularly attractive when uncertainty is high.
If the question of critical resources and capabilities demonstrates that a company has or can easily lease all of the materials necessary to start a new business, it will probably do so by
internal development.
The redistribution of excess cash flow by parent companies from some businesses to others
is especially important when credit is tight.
Determining the competitive value of strategic fit in diversified companies ______.
is important in evaluating their related diversification strategies
Which statement is true concerning the pursuit of growth through unrelated diversification?
is only good growth if it is economic growth (or something like that)
Corporate venturing (or new venture development) is
is the process of developing new businesses as an outgrowth of a company's established business operations. It is also referred to as corporate entrepreneurship or intrapreneurship since it requires entrepreneurial- like qualities within a larger enterprise.
A diversified company has a parenting advantage when
it is more able than other companies to boost the combined performance of its individual businesses through high-level guidance, general oversight, and other corporate-level contributions.
The resources and capabilities that are leveraged in related diversification are specialized resources and capabilities. By this we mean
that they have very specific applications; their use is restricted to a limited range of business contexts in which these applications are competitively relevant. Because they are adapted for particular applications, specialized resources and capabilities must be utilized by particular types of businesses operating in specific kinds of industries to have value; they have limited utility outside this designated range of industry and business applications. This is in contrast to general resources and capabilities (such as general management capabilities, human resource management capabilities, and general accounting services), which can be applied usefully across a wide range of industry and business types.
An acquisition premium, or control premium, is
the amount by which the price offered exceeds the preacquisition market value or stock price of the target company. Premiums are paid in order to convince the shareholders and managers of the target company that it is in their financial interests to approve the deal. The average premium paid by U.S. companies over the last 15 years was more often in the 20 to 25 percent range.
Specialized resources and capabilities drive
the key value-creating activities that both connect the businesses (at points along their value chains where there is strategic fit) and link to the key success factors in the markets where they are competitively relevant. It is important to recognize that even though general resources and capabilities may be also shared by multiple business units, such resource sharing alone cannot form the backbone of a strategy keyed to related diversification.
Two other commonly employed ways for corporate parents to add value to their unrelated businesses are: 1. Judicious Cross-Business Allocation of Financial Resources By reallocating surplus cash flows from some businesses to fund the capital requirements of other businesses—in essence, having the company serve as an internal capital market—corporate parents may also be able to create value. • particularly important in times when credit is unusually tight • or in economies with less well developed capital markets A parent company's ability to function as its own internal capital market enhances overall corporate performance and increases shareholder value to the extent that 1. its top managers have better access to information about investment opportunities internal to the firm than do external financiers or 2. it can provide funds that would otherwise be unavailable due to poor financial market conditions.
2. Acquiring and Restructuring Undervalued Companies Another way for parent companies to add value to unrelated businesses is by acquiring weakly performing companies at a bargain price and then restructuring their operations in ways that produce sometimes dramatic increases in profitability. Restructuring refers to • overhauling and streamlining the operations of a business— ○ combining plants with excess capacity, ○ selling off underutilized assets, ○ reducing unnecessary expenses, ○ revamping its product offerings, ○ consolidating administrative functions to reduce overhead costs, ○ and otherwise improving the operating efficiency and profitability of a company Restructuring generally involves transferring seasoned managers to the newly acquired business, either to replace the top layers of management or to step in temporarily until the business is returned to profitability or is well on its way to becoming a major market contender.
Evaluating the Strategy of a Diversified Company Step 4: Checking for Good Resource Fit • Non financial Resource Fit Just as a diversified company must have adequate financial resources to support its various individual businesses, it must also have a big enough and deep enough pool of managerial, administrative, and other parenting capabilities to support all of its different businesses. 1. Does the parent company have (or can it develop) the specific resources and capabilities needed to be successful in each of its businesses? Sometimes the resources a company has accumulated in its core business prove to be a poor match with the competitive capabilities needed to succeed in the businesses into which it has diversified.
2. Are the parent company's resources being stretched too thinly the resource requirements of one or more of its businesses? A diversified company must guard against its resources and capabilities, a condition that can arise when • it goes on an acquisition spree and management is called on to assimilate and oversee many new businesses very quickly or • it lacks sufficient resource depth to do a creditable job of transferring skills and competencies from one of its businesses to another. Plus, the more a company's diversification strategy is tied to transferring know-how or technologies from existing businesses to newly acquired businesses, the more time and money that has to be put into developing a deep-enough resource pool to supply these businesses with the resources and capabilities they need to be successful
Evaluating the Strategy of a Diversified Company Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance The conclusions flowing from the five preceding analytic steps set the agenda for crafting strategic moves to improve a diversified company's overall performance. The strategic options boil down to four broad categories of actions (see Figure 8.6): 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 certain 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.
What does crafting a diversification strategy entail? The task of crafting a diversified company's overall corporate strategy falls squarely in the lap of top-level executives and involves three distinct facets: 1. Picking new industries to enter and deciding on the means of entry • whether to enter by starting a new business from the ground up, • by acquiring a company already in the target industry, or by forming a joint venture or strategic alliance with another company • choice of industries depends upon on the strategic rationale (or justification) for diversifying and the type of diversification being pursued 2. Pursuing opportunities to leverage cross-business value chain relationships where there is strategic fit, into competitive advantage • determine whether there are opportunities to strengthen a diversified company's businesses by such means as ○ transferring competitively valuable resources and capabilities from one business to another, ○ combining the related value chain activities of different businesses to achieve lower costs, ○ sharing resources, such as the use of a powerful and well- respected brand name or an R&D facility, across multiple businesses, and ○ encouraging knowledge sharing and collaborative activity among the businesses
3. Initiating actions to boost the combined performance of the corporation's collection of businesses. • 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 either poorly performing businesses or those that no longer fit into management's long range plans, and 4. broadly restructuring the entire company by divesting some businesses, acquiring others, and reorganizing, to put a whole new face on the company's business lineup.
Misguided Reasons for Pursuing Unrelated Diversification Companies sometimes pursue unrelated diversification for reasons that are entirely misguided. These include the following: 1. Risk reduction. Spreading the company's investments over a set of diverse industries to spread risk cannot create long-term shareholder value since the company's shareholders can more flexibly (and more efficiently) reduce their exposure to risk by investing in a diversified portfolio of stocks and bonds. 2. Growth. While unrelated diversification may enable a company to achieve rapid or continuous growth, firms that pursue growth for growth's sake are unlikely to maximize shareholder value. Only profitable growth—the kind that comes from creating added value for shareholders—can justify a strategy of unrelated diversification
3. Stabilization. Managers sometimes pursue broad diversification in the hope that market downtrends in some of the company's businesses will be partially offset by cyclical upswings in its other businesses, thus producing somewhat less earnings volatility In actual practice, however, there's no convincing evidence that the consolidated profits of firms with unrelated diversification strategies are more stable or less subject to reversal in periods of recession and economic stress than the profits of firms with related diversification strategies. 4. Managerial motives. Unrelated diversification can provide benefits to managers such as higher compensation (which tends to increase with firm size and degree of diversification) and reduced their unemployment risk. Pursuing diversification for these reasons will likely reduce shareholder value and violate managers' fiduciary responsibilities.
Evaluating the Strategy of a Diversified Company 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, both individually and as a group. 2. Assessing the competitive strength of the company's business units and drawing a nine-cell matrix to simultaneously portray industry attractiveness and business unit competitive strength. 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 what the corporate parent's priorities should be in allocating resources to its various businesses. 6. Crafting new strategic moves to improve overall corporate performance.
Converting the competitive advantage potential into greater profitability is what fuels 1 + 1 = 3 gains in shareholder value—the necessary outcome for satisfying the better off-test and proving the business merit of a company's diversification effort. There are five things to bear in mind here: 1. Capturing cross-business strategic-fit benefits via a strategy of related diversification builds shareholder value in ways that shareholders cannot undertake by simply owning a portfolio of stocks of companies in different industries. 2. The capture of cross-business strategic-fit benefits is possible only via a strategy of related diversification. 3. The greater the relatedness among a diversified company's businesses, the bigger the company's window for converting strategic fit into competitive advantage for its businesses.
4. The benefits of cross-business strategic fit come from the transferring or sharing of competitively valuable resources and capabilities among the businesses—resources and capabilities that are specialized to certain applications and have value only in specific types of industries and businesses. 5. The benefits of cross-business strategic fit are not automatically realized when a company diversifies into related businesses; the benefits materialize only after management has successfully pursued internal actions to capture them
Which of the following statements are true concerning whether a company has sufficient non financial resources? (Choose every correct answer.)
A company's resources can be overtaxed by making many acquisitions and calling on management to oversee many businesses quickly. If a company's strategy is closely tied to moving technologies from existing businesses to new ones, it must develop more resources to supply them. The broader the diversification, the greater the concern that corporate executives are overburdened trying to parent too many companies.
Evaluating the Strategy of a Diversified Company Step 1: Evaluating Industry Attractiveness A principal consideration in evaluating the caliber of a diversified company's strategy is the attractiveness of the industries in which it has business operations. Several questions arise: 1. Does each industry the company has diversified into represent a good market for the company to be in—does it pass the industry attractiveness test? 2. Which of the company's industries are most attractive, and which are least attractive? 3. How appealing is the whole group of industries in which the company has invested? Industries with a score much below 5 probably do not pass the attractiveness test. If a company's industry-attractiveness scores are all above 5, it is probably fair to conclude that the group of industries the company operates in is attractive as a whole. For a diversified company to be a strong performer, a substantial portion of its revenues and profits must come from business units with relatively high attractiveness scores. It is particularly important that a diversified company's principal businesses be in industries with a good outlook for growth and above-average profitability
A simple and reliable analytic tool for gauging industry attractiveness involves calculating quantitative industry-attractiveness scores based on the measures: • Market size and projected growth rate • The intensity of competition • Emerging opportunities and threats. • The presence of cross-industry strategic fit • Resource requirements • Social, political, regulatory, and environmental factors • Industry profitability Each attractiveness measure is then assigned a weight reflecting its relative importance in determining an industry's attractiveness Finally, each industry is rated on each of the chosen industry-attractiveness measures, using a rating scale of 1 to 10 Weighted attractiveness scores are then calculated by multiplying the industry's rating on each measure by the corresponding weight.
Which of the following are true concerning the interpretation of industry-attractiveness scores? (Choose every correct answer.)
A strongly performing diversified company's primary businesses should be in industries with high growth potential. If a company's scores are all above 5, it probably operates in an attractive group of industries. Industries that score much less than five are unlikely to be attractive.
Which of the following statements are true of unrelated diversification? (Choose every correct answer.)
A very small number of unanticipated problems or mistakes can have a major negative effect on corporate earnings. Most management teams are not capable of effectively managing a diversified group of unrelated businesses. Problems can occur when corporate management makes decisions for businesses they do not know well.
The Question of Speed Speed is another determining factor in deciding how to go about entering a new business. But, in other cases, it can be better to enter a market after the uncertainties about technology or consumer preferences have been resolved and learn from the missteps of early entrants. In these cases, when it is more advantageous to be a second-mover, joint venture or internal development may be preferred.
Acquisition is a favored mode of entry when speed is of the essence, as is the case in rapidly changing industries where fast movers can secure long-term positioning advantages. • Speed is important in industries where early movers gain experience-based advantages that grow ever larger over time as they move down the learning curve. • It is also important in technology-based industries where there is a race to establish an industry standard or leading technological platform.
What questions can be answered by determining the competitive value of strategic fit in diversified companies? (Choose every correct answer.)
Are the cost savings associated with economies of scope likely to give one or more businesses a cost-based advantage? How much competitive value will come from the cross-business transfer of skills, technology, or intellectual capital? Will leveraging a potent umbrella brand or corporate image strengthen the businesses and increase sales?
Identifying Cross-Business Strategic Fit along the Value Chain
Cross-business strategic fit can exist anywhere along the value chain—in R&D and technology activities, in supply chain activities and relationships with suppliers, in manufacturing, in sales and marketing, in distribution activities, or in customer service activities.
Which of the following actions should a company consider, according to the nine-cell attractiveness-strength matrix? (Choose every correct answer.)
Concentrate resources in businesses that possess higher degrees of attractiveness and competitive strength Be cautious about investing in companies located intermediately on the grid Remove resources from ventures that are low in attractiveness and strength unless they offer superior profit or cash flow opportunity
Which of the following statements are true concerning the cross-business allocation of financial resources by parent companies? (Choose every correct answer.)
Cross-business allocation can be especially advantageous during times of financial market crises. There is increased opportunity to add shareholder value because managers are privy to internal information unavailable to external financiers. Parent companies can deliver funds that would otherwise be unavailable owing to poor market conditions.
Steps involved in assessing the positive and negative aspects of a diversified company's strategy and determining how to improve performance include which of the following? (Choose every correct answer.)
Determining the competitive strength of the company's business units Evaluating the individual and group attractiveness of the industries the company has diversified into Determining if the firm's resources fit the requirements of its current business lineup
In answering the question of comparative costs, acquisition transaction costs include which of the following? (Choose every correct answer.)
Evaluating potential targets Negotiating a price Identifying potential targets
Which of the following statements are true concerning the ranking of a diversified company's business units from best to worst? (Choose every correct answer.)
Future revenue and earnings for fast-growing industries usually look superior to those for slow-growing industries. The rankings help high-level executives prioritize businesses for resource support and capital investment. The position of different businesses in the nine-cell matrix is a good criteria for identifying high-opportunity and low-opportunity businesses.
Retrenching to a narrower diversification base can include which of the following? (Choose every correct answer.)
Getting out of businesses that are competitively weak Eliminating businesses that have poor strategic fit Focusing corporate resources on businesses in a few, carefully selected industries
Where can cross-business strategic fit exist? (Choose every correct answer.)
In supply chain activities At various points along the value chain In customer service activities
What are the three Tests of Corporate Advantage? (Choose every correct answer.)
Industry attractiveness test Better-off test Cost of entry test
Which of the following are strategic options for allocating company financial resources? (Check all that apply.)
Investing in ways to strengthen or grow existing businesses Making acquisitions to establish positions in new industries or to complement existing businesses Funding long-range R&D ventures aimed at opening market opportunities in new or existing businesses
After reading this chapter, you should be able to: LO 8-1 Explain when and how business diversification can enhance shareholder value. LO 8-2 Describe how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage. LO 8-3 Identify the merits and risks of unrelated diversification strategies.
LO 8-4 Use the analytic tools for evaluating a company's diversification strategy. LO 8-5 Understand the four main corporate strategy options a diversified company can employ to improve company performance
The Drawbacks of Unrelated Diversification Unrelated diversification strategies have two important negatives that undercut the pluses: 1. very demanding managerial requirements and 2. limited competitive advantage potential. Demanding Managerial Requirements Successfully managing a set of fundamentally different businesses operating in fundamentally different industry and competitive environments is a challenging and exceptionally difficult proposition. Headquarters executives • remain heavily dependent on briefings from business unit heads • managing by the numbers • problems arise if things start to go awry in a business and corporate management has to get deeply involved in the problems of a business it does not know much about
Limited Competitive Advantage Potential The second big negative is that unrelated diversification offers only a limited potential for competitive advantage beyond what each individual business can generate on its own. • unrelated diversification provides no cross-business strategic-fit benefits that allow each business to perform its key value chain activities in a more efficient and effective manner • has little to add in the way of enhancing the competitive strength of its individual business units • general resources that support unrelated diversification tend to be relatively low value, for the simple reason that they are more common Without the competitive advantage potential of strategic fit in competitively important value chain activities, consolidated performance of an unrelated group of businesses may not be very much more than the sum of what the individual business units could achieve if they were independent, in most circumstances.
Evaluating the Strategy of a Diversified Company Step 4: Checking for Good Resource Fit The businesses in a diversified company's lineup need to exhibit good resource fit. In firms with a related diversification strategy, good resource fit exists when the firm 's businesses have well-matched specialized requirements at points along their value chains that are critical for the businesses' market success. • Financial Resource Fit
Matching resource requirements are important in related diversification because they facilitate resource sharing and low-cost resource transfer. Resource fit exists when • the company has solid parenting capabilities or resources of a general nature that it can share or transfer to its component businesses A company pursuing related diversification exhibits resource fit when its businesses have matching specialized resource requirements along their value chains; a company pursuing unrelated diversification has resource fit when the parent company has adequate corporate resources (parenting and general resources) to support its businesses' needs and add value
Which are examples of strategic fit in R&D and technology activities? (Choose every correct answer.)
More innovative products Cost savings in R&D Innovation in production processes
Which of the following are terms that refer to diversification by starting a new business subsidiary from scratch? (Choose every correct answer.)
New venture development Internal development Corporate venturing
Using Joint Ventures to Achieve Diversification Joint ventures are generally the least durable of the entry options, usually lasting only until the partners decide to go their own ways.
Situations call for a joint venture when: 1. Pursuing the expansion opportunity is too -complex, uneconomical, or risky to go it alone. 2. The opportunities in a new industry require a broader range of competencies and know-how than an expansion-minded firm can marshal. In such cases, pooling the resources and competencies of two or more companies is a wiser and less risky way to proceed 3. When the diversification move entails having operations in a foreign country Drawbacks: • Potential for conflicting objectives • Operational and control disagreements • Culture clashes
Which of the following statements are true of multibusiness diversification strategies? (Choose every correct answer.)
Some multibusiness enterprises are diversified into unrelated areas but have a group of related businesses within each area. Combination related-unrelated diversification strategies are attractive to companies with a mix of valuable competitive assets. Some companies are narrowly diversified around two to five related or unrelated businesses.
Which of the following are strategic options for increasing a corporation's overall success? (Choose every correct answer.)
Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses Broadening the scope of diversification by entering additional industries Retrenching to a narrower scope of diversification by divesting poorly performing businesses
Choosing a Mode of Entry
The Question of.. 1. Does the company have all of the resources and capabilities it requires to enter the business through internal development, or is it lacking some critical resources? 2. Are there entry barriers to overcome? 3. Is speed an important factor in the firm's chances for successful entry? 4. Which is the least costly mode of entry, given the company's objectives?
A company has good financial resource fit when which of the following conditions are met? (Choose every correct answer.)
The company can create enough internal cash flow to provide the capital required by its businesses. Each individual business sufficiently contributes to meeting companywide performance targets. The company can adequately fund all its businesses while keeping a good credit rating.
Evaluating the Strategy of a Diversified Company Step 2: Evaluating Business Unit Competitive Strength The second step in evaluating a diversified company is to appraise the competitive strength of each business unit in its respective industry. Provides a basis for ranking the units from competitively strongest to competitively weakest and sizing up the competitive strength of all the business units as a group. Business units with competitive-strength ratings above 6.7 (on a scale of I to 10) are strong market contenders in their industries. Businesses with ratings in the range have moderate competitive strength via-à-vis rivals. Businesses with ratings below 3.3 have a competitively weak standing in the marketplace.
The following factors are used in quantifying the competitive strengths of a diversified company's business subsidiaries: • Relative market share. A business unit's relative market share is defined as 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. • Costs relative to competitors' costs. • Ability to match or beat rivals on key product attributes. • Brand image and reputation. • Other competitively valuable resources and capabilities. • Ability to benefit from strategic fit with other business units. • Ability to exercise bargaining leverage with key suppliers or customers • Profitability relative to competitors In the that the available information is too limited to confidently assign a rating value to a business unit on a particular strength measure, it is usually best to use a score of 5—this avoids biasing the overall score either up or down.
Which of the following is true concerning relative market share?
The further below 1 a business unit's relative market share is, the weaker its competitive strength and market position vis-à-vis its rivals.
Evaluating the Strategy of a Diversified Company Step 3: Determining the Competitive Value of Strategic Fit in Diversified Companies *While this step can be bypassed for diversified companies whose businesses are all unrelated (since, by design, strategic fit is lacking), assessing the degree of strategic fit across a company's businesses is central to evaluating its related diversification strategy.* But more than just checking for the presence of strategic fit is required here. The real question is how much competitive value can be generated from whatever strategic fit exists
The greater the value of cross-business strategic fit in enhancing the performance of a diversified company's businesses, the more competitively powerful is the company's related diversification strategy. Figure 8.4 illustrates the process of comparing the value chains of a company's businesses and identifying opportunities to exploit competitively valuable cross-business strategic fit
Evaluating the Strategy of a Diversified Company Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance 1. Sticking closely with the existing business lineup and pursuing the opportunities these businesses present.
The option of sticking with the current business lineup makes sense when the company's existing businesses offer attractive growth opportunities and can be counted on to create economic value for shareholders. As long as the company's set of existing businesses have good prospects and are in alignment with the company's diversification strategy, then major changes in the company's business mix are unnecessary.
Which of the following statements are true concerning the portfolio approach to ensuring financial fit? (Choose every correct answer.)
The portfolio approach relies on the premise that cash flow and investment traits vary among different businesses. Cash cows have limited growth but are a valuable financial resource. Business units in quickly expanding industries are often cash hogs.
In an unrelated diversification strategy, managers must make sure acquisition candidates have which of the following characteristics? (Choose every correct answer.)
They meet corporate targets for profitability and return on investment. They are in an industry with attractive growth potential. They are big enough to significantly contribute to the parent company's bottom line.
Which of the following statements are true of economies of scope? (Choose every correct answer.)
They result from strategic fit among related businesses, allowing the sharing of resources among diversified businesses. They are a distinct concept from economies of scale. They are available only to firms engaging in related diversification.
The best corporate parents understand the nature and value of the kinds of resources at their command and know how to leverage them effectively across their businesses. Those that are able to create more value in their businesses than other diversified companies have what is called a parenting advantage.
When a corporation has a parenting advantage, its top executives have the best chance of being able to craft and execute an unrelated diversification strategy that can satisfy all three Tests of Corporate Advantage and truly enhance long term economic shareholder value.
Entering a new business via a joint venture can be useful in which of the following situations? (Choose every correct answer.)
When an opportunity is too complicated or risky for one company to attempt alone When diversification entails operations in a foreign country When an opportunity in a new industry requires more know-how than one company has alone
For which of the following conditions is restructuring a diversified company's business lineup an attractive course of action? (Choose every correct answer.)
When the company has too many businesses in slowly growing or declining industries When the market shares of one or more major business units are decreasing because of superior competition When the interest owed on large debts is greatly reducing profitability
Which of the following are questions to ask when evaluating industry attractiveness? (Choose every correct answer.)
Which of the company's industries are most attractive? How appealing is the whole group of industries in which the company has invested? Does each industry the company has diversified into represent a good market for the company to be in?
Capturing the benefits of strategic fit along the value chains of its related businesses gives a diversified company a
a clear path to achieving competitive advantage over undiversified competitors and competitors whose own diversification efforts don't offer equivalent strategic-fit benefits
Restructuring is often undertaken when
a diversified company acquires a new business that is performing well below levels that the corporate parent believes are achievable. Diversified companies that have proven turnaround capabilities in rejuvenating weakly performing companies can often apply these capabilities in a relatively wide range of unrelated industries. Successful unrelated diversification strategies based on restructuring require the parent company to have considerable expertise in identifying under performing target companies and in negotiating attractive acquisition prices so that each acquisition passes the cost of entry test.
Manufacturing-Related Strategic Fit Cross-business strategic fit in manufacturing-related activities can be exploited when
a diversifier's expertise in quality control and cost efficient production methods can be transferred to another business. Another benefit of production-related value chain commonalities is the ability to consolidate production into a smaller number of plants and significantly reduce overall production costs.
A diversified company in which one core business accounts for 50% to 80% of total revenues and other businesses account for the remainder is known as ______.
a dominant-business enterprise
Evaluating the Strategy of a Diversified Company Step 4: Checking for Good Resource Fit • Financial Resource Fit (continued) The most important dimension of financial resource fit concerns whether a diversified company can A portfolio approach to ensuring financial fit among a firm's businesses is based on the fact that different businesses have different cash flow and investment characteristics. ○ A cash hog business generates cash flows that are too small to fully fund Its growth; It thereby requires cash infusions to provide additional working capital and finance new capital investment. ○ A cash cow business generates cash flows over and above its internal requirements, thus providing a corporate parent with funds for investing in cash hog businesses, financing new acquisitions, or paying dividends.
can generate the internal cash flows sufficient to fund the capital requirements of its businesses, pay its dividends, meet its debt obligations, and otherwise remain financially healthy. The greater the extent to which a diversified company is able to fund investment in its businesses through internally generated cash flows rather than from equity issues or borrowing, the more powerful its financial resource fit and the less dependent the firm is on external financial resources. This can provide a competitive advantage over single business rivals when credit market conditions are tight, as they have been in the United States and abroad in recent years.
The portfolio approach to financial fit revolves around the fact that ______.
cash flow and investment characteristics vary among businesses
Transaction costs are the costs of
completing a business agreement or deal, over and above the price of the deal. They can include the costs of searching for an attractive target, the costs of evaluating its worth, bargaining costs, and the costs of completing the transaction.
Diversifying into new industries
should be explored when a single-business company encounters dwindling opportunities in its principal business.
Evaluating the Strategy of a Diversified Company Step 5: Ranking Business Units and Assigning a Priority for Resource Allocation • Allocating Financial Resources Figure 8.5 shows the chief strategic and financial options for allocating a diversified company's financial resources. Ideally, a diversified company will have sufficient financial resources to strengthen or grow its existing businesses, make any new acquisitions that are desirable, fund other promising business opportunities, pay off existing debt, and periodically increase dividend payments to shareholders and/or repurchase shares of stock.
• Divesting businesses with the weakest future prospects and businesses that lack adequate strategic fit and/or resource fit • Free cash flows from cash cow businesses also add to the pool of funds that can be usefully redeployed Strategic uses of corporate financial resources should usually take precedence over strictly financial considerations unless there is a compelling reason to strengthen the firm's balance sheet or better reward shareholders.
Strategic Fit, Economies of Scope, and Competitive Advantage Strategic fit in the value chain activities of a diversified corporation's different businesses opens up opportunities for economies of scope—a concept distinct from economies of scale
• Economies of scale are cost savings that accrue directly from a larger-sized operation In contrast, economies of scope are cost savings that flow from operating in multiple businesses (a larger scope of operation). They stem directly from strategic fit along the value chains of related businesses, which in turn enables the businesses to share resources or to transfer them from business to business at low cost. Significant scope economies are open only to firms engaged in related diversification, since they are the result of related businesses performing • R&D together, • transferring managers from one business to another, • using common manufacturing or distribution facilities, • sharing a common sales force or dealer network, • using the same established brand name, and the like.
Building Shareholder Value via Unrelated Diversification Given the absence of cross-business strategic fit with which to create competitive advantages, building shareholder value via unrelated diversification ultimately hinges on the ability of the parent company to improve its businesses (and make the combination better off) via other means Critical to this endeavor is the role that the parent company plays as a corporate parent
• capabilities that involve nurturing, guiding, grooming, and governing constituent businesses—a corporate parent can propel its businesses forward and help them gain ground over their market rivals • Corporate parents also contribute to the competitiveness of their unrelated businesses by sharing or transferring general resources and capabilities across the businesses Examples of the kinds of general resources that a corporate parent leverages in unrelated diversification include • the corporation's reputation, credit rating, and access to financial markets; • governance mechanisms; management training programs; a corporate ethics program; • a central data and communications center, shared administrative resources such as public relations and legal services; and • common systems for functions such as budgeting, financial reporting, and quality control.
The decision to diversify presents wide-ranging possibilities
• diversify into closely related businesses or into totally unrelated businesses • diversify its present revenue and earnings base to a small or major extent • move into one or two large new businesses or a greater number of small ones • acquiring an existing company, starting up a new business from scratch, or forming a joint venture with one or more companies to enter new businesses
The Benefits of Astute Corporate Parenting One of the most important ways that corporate parents contribute to the success of their businesses is by offering high-level oversight and guidance. The top executives of a large diversified corporation have among them
• many years of accumulated experience in a variety of business settings and • can often contribute ○ 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 company's various business subsidiaries. Corporate parents can also create added value for their businesses by providing them with other types of general resources that lower the operating costs of the individual businesses or that enhance their operating effectiveness. They typically include ○ legal services, accounting expertise and tax services, ○ and other elements of the administrative infrastructure, such as risk management capabilities, information technology resources, and public relations capabilities.
Strategic Fit in R&D and Technology Activities Businesses with strategic fit in R&D or technology development perform better together than apart because of
• potential cost savings in R&D, • shorter times in getting new products to market, and • more innovative products or processes. Moreover, technological advances in one business can lead to increased sales for both.
1 of 3 : Approaches to Diversifying : Diversifying by Acquisition of an Existing Business Acquisition is a popular means of diversifying into another industry Buying an ongoing operation allows the acquirer to move directly to the task of building a strong market position in the target industry rather than getting bogged down in trying to develop the knowledge, experience, scale of operation, and market reputation necessary for a startup entrant to become an effective competitor.
• quicker than trying to launch a new operation • effective way to hurdle such entry barriers as ○ acquiring technological know-how, ○ establishing supplier relationships, ○ achieving scale economies, ○ building brand awareness, and ○ securing adequate distribution Acquisitions are also commonly employed to access resources and capabilities that are complementary to those of the acquiring firm and that cannot be developed readily internally
Strategic Fit in Sales and Marketing Activities Various cost-saving opportunities spring from diversifying into businesses with closely related sales and marketing activities. When the products are sold directly to the same customers, sales costs can often be
• reduced by using a single sales force instead of having two different salespeople call on the same customer • products of related businesses can be promoted at the same website and included in the same media ads and sales brochures • be opportunities to reduce costs by consolidating order processing and billing and by using common promotional tie-ins A second category of benefits arises when different businesses use similar sales and marketing approaches. In such cases, there may be competitively valuable opportunities to transfer selling, merchandising, advertising, and product differentiation skills from one business to another.