Diversification and Performance: Empirical Evidence

Diversification trends have been driven by beliefs rather than evidence:- 1960s and 70s diversification believed to be profitable; 1980s onwards diversification seen as value destroying. Empirical evidence inconclusive-- no consistent findings on impact of diversification on profitability, or on related vs. unrelated diversification. Some evidence that high levels of diversification detrimental to profitability 3 Diversifying acquisitions, on average, destroy share2 holder value for acquirers 1 1 2 3 4 5 6 Refocusing generates index of product diversity positive shareholder returns
return on net assets (%)

Motives for Diversification

GROWTH --The desire to escape stagnant or declining industries has been one of the most powerful motives for diversification (tobacco, oil, defense). --But, growth satisfies management not shareholder goals. --Growth strategies (esp. by acquisition), tend to destroy shareholder value

RISK SPREADING

--Diversification reduces variance of profit flows --But, does not normally create value for shareholders, since shareholders can hold diversified portfolios. --Capital Asset Pricing Model shows that diversification lowers unsystematic risk not systematic risk.
--For diversification to create shareholder value, the act of bringing different businesses under common ownership must somehow increase their profitability.

PROFIT

Crucial Role of Managers

Successful diversification strategies result from the ability of managers to develop skill and competency at MANAGING diversification.
Those firms with management teams that have more experience at managing diversification will enjoy higher performance than those firms that do not have that experience.

Crucial Role of Managers (cont.)

Managers must develop two important types of mental models:
Must have well-developed understandings of their firms diversity and relatedness that define their companies.
Understandings of how their firms businesses are related are important for 2 reasons:
They will influence how managers describe their organizations to important stakeholders. Managers understandings also describe or suggest how their businesses are related to each other.

Crucial Role of Managers (cont.)

Must also have well-developed beliefs about how diversification should be managed in order to achieve synergies.
How to coordinate the activities of businesses in order to achieve synergies. How to allocate resources to the various businesses in a diversified firm. Whether various functional activities such as engineering, finance and accounting, marketing and sales, production, and research and development should be centralized at the corporate HQ or be decentralized and operated by SBU managers. How to compensate and reward business unit managers so that their goals and objectives are best aligned with those of the organization.

Marketing strategies for growth

Ansoffs Matrix helps to analyse marketing strategy options
Market penetration selling more of existing products into existing markets Product development developing new products or services for existing markets Market development selling existing products/ services into new markets Diversification - new products into new markets at the same time - the highest risk strategy