Ch.6 Diversification
add value by diversification:Efficient Management
General Electric Do you object when people use the word conglomerate to describe GE? "Hate it. I went to business school learning how companies like GE couldn't exist. We run a multi-business company with common cultures, with common management...where the whole is always greater than the sum of its parts. Culture counts." Jeff Immelt
Prior to Diversification: Are we sufficiently organized to learn and take advantage of synergies between businesses?
General Electric Regular meetings to search for cross-business synergies Senior executives may suggest areas of collaborations and individual business managers have to attend the meetings, but nobody is forced to collaboration Incentives for division managers and employees Self-interest (individual) versus mixed incentives (group & individual) Rotation of managers "The way we use a business like appliances is, it's a great place to train people. It's a great way for managers to go there and learn what a recession is like... So you learn unbelievable management skills at businesses like that."
Issues to Consider Prior to Diversification: What can our company do better than any of its competitors in its current market?
Identify unique competitive strengths Realistic identification of strategic assets Blue Circle British firm, one of the world's leading cement producer Business of making products related to home building: real estate, bricks, waste management, gas stoves, bath tubs, lawn mowers—logic—you need a lawn mower for your garden, which after all is next to your house.
add value by diversificationEconomies of Scope
(sharing activities or inputs) P&G in disposable diaper and paper towel businesses common distribution system and sales force Cost (iron + steel) < Cost (iron) + Cost (steel) thermal economies Volkswagen's Golf, Skoda, Beetle, and Audi TT share platforms
Low Levels of Diversification:Dominant-business
70% to 95% of revenue ... Hershey Foods (chocolate and non-chocolate items, other grocery products like syrups, milk, cocoa mix etc.)
Low Levels of Diversification: Single business
95% + of revenue come from a single business unit UPS
Value reduction through diversification:Growth maximization and diversifying managerial employment risk
Downside Implication Shareholder value is reduced With firm size management compensation increases Diversification that reduces variance of returns is not justified when capital markets function efficiently Upside Implication Diversification may encourage managerial commitment by reducing managerial risk
Moderate Levels of Diversification Related-diversified:
Less than 70% of revenues come from a single business Many product, technology, and distribution linkages between businesses - Related diversification Procter & Gamble (soaps, shampoos) Limited linkages PepsiCo (drinks and snacks)
add value by diversification:Market power
Multi-point competition A firm that faces the same rival in two industries will be more cooperative
Value reduction through diversification:Growth Trap
Neutrogena took its current product into new distribution channels Maytag sold new products in its current distribution channels
add value by diversification:Using the firm as an internal capital/resource market
Only when external capital market is inefficient Conglomerates more typical in developing countries Mexico (Carlos Slim's Groupo Carso) India (Tata Group) To keep knowledge and new ideas proprietary Technology-intensive businesses
Examples of Diversification
Pepsi: bottled water Walt Disney: cruise lines Sony: Sony Pictures British Petroleum moving "Beyond Petroleum"
Value reduction through diversification:Diversification as portfolio management—1960s and 1970s
Risk spreading with unrelated diversification PepsiCo's acquisition of North American Van Lines in 1968 Shareholders can diversify their investment risk "Interrelationships between businesses are the essence of corporate-level strategy. Without synergy, a diversified company is a little more than a mutual fund." Michael Porter
Vertical Integration
Saturn builds car engines in house (backward vertical integration) Coca-Cola buys its bottlers (forward vertical integration)
How do you diversify?
Sell your current product in a new distribution channel Sell a new product in your current distribution channels Sell a new product in a new distribution channel It is not necessary to do a M&A to diversify
Diversification
Small car maker Saturn enters the SUV market
add value by diversification:Developing New Competencies
Stretching core competencies Laidlaw Inc. (school buses, ambulances, emergency rooms) UPS (messenger business to common carrier business to overnight delivery to logistics services)
Bottom line
Ultimately, diversity can only be worthwhile if corporate management adds value in some way To add value, diversification should enable a company, or one of its business units, to perform one or more of the value creation functions at a lower cost, or in a way which supports a differentiation advantage. The test of a corporate strategy must be that the businesses in the portfolio are worth more under the management of the company in question than they would be under other ownership.
High Levels of Diversification
Unrelated-diversification Business units not closely related Conglomerates
add value by diversification:Transferring Core Competencies
Walt Disney using its capability for family entertainment to enter into the cruise ship industry
Prior to Diversification:What can a company learn by diversifying?
What can a company learn by diversifying? Will the diversification move allow us to learn competencies that can be reapplied in existing businesses? Canon Copier business: learned how to develop and manufacture a reliable electrostatic-printing engine Laser printer business-similar capabilities
Diversification Strategy
involves creating value through the configuration and coordination of multi-market activities.
Diversification
is a value creating strategy only if the corporate whole adds up to more than sum of its business unit parts