MERGERS & ACQUISITION Strategic issues in Diversification

Pavan R Tiwari (17)

What is Diversification?
A risk management technique that mixes a wide variety of investments within a portfolio. A collection of businesses under one corporate umbrella.

Diversification and Corporate Strategy

A company is diversified when it is in two or more lines of business
Strategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single line-of-business

A diversified company needs a multi-industry, multibusiness strategy A strategic action plan must be developed for several different businesses competing in diverse industry environments

When Does Diversification Make Sense?

Single business strategies have a number of advantages but also a number of risks - all eggs in one basket - creates weak profitability
changes can wipe you out

The logic: to spread corporate risk across multiple industries to enhance shareholder value.

WHEN DOES DIVERSIFICATION START TO MAKE SENSE?

Strong competitive position, rapid market growth -- Not a good time to diversify Strong competitive position, slow market growth -- Diversification is top priority consideration Weak competitive position, rapid market growth -- Not a good time to diversify Weak competitive position, slow market growth -- Diversification merits consideration

When do we diversify?
When a company runs out of growth opportunities in the core business and not before! When diversification results in creation of value

Motives for Diversification

GROWTH --The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco, oil, newspapers). --But, growth satisfies managers, not shareholders. --Growth strategies (esp. by acquisition), tend to destroy shareholder value

RISK SPREADING

--Diversification reduces variance of profit flows --But, doesn't create value for shareholdersthey can hold diversified portfolios of securities. --Capital Asset Pricing Model shows that diversification lowers unsystematic risk not systematic risk.
--For diversification to create shareholder value, then bringing together of different businesses under common ownership & must somehow increase their profitability.

PROFIT

The Major Issues

Diversification decisions involve two basic issues:

How attractive are our current businesses? With these businesses, what is our performance outlook for X years in the future? Can the firm establish a competitive advantage within the industry to be entered? (i.e. what synergies exist between the core business and the new business?)

Basic Issues
Poor understanding of how diversification activities will fit or be coordinated with existing businesses. Differences in organizational cultures Should new business be standalone operation or should it be merged into one of the existing businesses? Problems associated with internal development of new businesses.
-Most problems due to considerable time and investment required to launch new business. -Difficult to assess the risks associated with new investment opportunity.

When to Stop Diversifying

When you achieve acceptable levels of growth and profitability Before complexity outstrips management's ability to manage

Tests For Judging Diversification

Attractiveness Test -The industry must be attractive. Cost of Entry Test

-Is the cost of the diversification worth it?

-Will the diversified firm create enough additional value to justify the cost? -Cost has to be reasonable

Better off Test -Diversification results in a competitive advantage and

creation of value. -Will the company be better off after the diversification than it was before? -How and why?

Methods for Diversification

Acquisition of an existing business- Quick market entry,
Avoids entry barriers

Creation of a new business from within (A START-UP)Appropriate when You have time to launch, Market moves slowly,

Internal entry costs lower than acquisition costs, Target industry is fragmented.

Joint venture with another firm or firms- Achieving

synergy from respective capabilities, Leveraging one anothers experience.

Critical questions for diversification success

What can our company do better than any of its competitors in its current market? What strategic assets do we need in order to succeed in the new market? Can we catch up to or leapfrog competitors at their own games? Player vs winner?

In the business world, the rearview mirror is always clearer than the windshield.

THANK YOU