Diversification As a Strategy

GROUP 2 ROSELINE DMARY | ROHIT JHARIA | ALOK SINGH NITIN I HARINATH BABU | ROHAN PAUNIKAR | YESHWANTHI AC

DIVERSIFICATION
Developmental Diversification Functional diversification Product diversification Customer diversification Geographic diversification Financial diversification Based on specialization ratio Serve similar markets and use similar distribution system Employ similar production technologies Exploit similar science-based research

Rumelts three major categories of diversified companies

Dominant Business Companies
70-95% of sales from a single business or vertical integration of chain of businesses Ex: GM, IBM, Texaco

Related Business Companies

adding activities that are tangibly related to the collective skills and strengths possessed by the company adding activities that are tangibly related to the collective skills and strengths possessed by the company Ex: DU Pont, GE,GF

Unrelated Business companies

conglomerates Ex: Litton, Rockwell International, ABG, TATA

Performance of Diversified companies (Studies)

1. Accounting-based performance studies (1950-1970)

Corporate

business

growth rates: Unrelated business

> Related

business > Dominant

Capital

productivity: Related business > Dominant business > Unrelated business

2. Capital market performance studies: confirms Rumelts findings 3. Forbes and Business week:

Unrelated Average Gulf

business: volatile capital productivity due to extensive use of financial leverage PE ratio < Market PE ratio & Western companies which has divested operations showed debt reduced pe ratio increased

COMPONENTS OF STRATEGY FOR A DIVERSIFIED COMPANY

Concept of fit among businesses Corporate Goals Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Concept of fit among businesses Corporate Goals

Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Corporate Goals: These are broad corporate level goals which are made to achieve economic and non-economic objectives They reflect how top management intends to create economic value for investors These include areas such as profitability, growth, financial stability and social responsibility

Concept of fit among businesses Corporate Goals

Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Concept of fit among businesses: This explains the relation between individual businesses Various possible range of fits: Unrelated businesses integrated by financial criteria Highly related businesses sharing assets and skills

Concept of fit among businesses Corporate Goals

Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Concept of assembly of the portfolio: Approach of finding and acquiring new business units to the corporate portfolio Levels: Broadest level: Creation of a mix of internal development of new businesses, acquisitions, venture capital subsidiaries and joint ventures Operational level: Approach and mechanism for assembling new businesses Finally, company must have an organizational mechanism in place to carry out its concept of assembly

Concept of fit among businesses Corporate Goals

Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Concept of corporate management of businesses units: Range of concepts of management Individual units having complete autonomy (unrelated diversifier) Business units have more autonomy regarding strategy and divisional issues Involvement of corporate management in divisional affairs (related diversifier) Corporate management plays a key role in R&D, divisional strategy formulation and personnel selection

Concept of fit among businesses

Corporate Goals

Concept of corporate management of business units

Concept of assembly of the portfolio

Generic Functional policies

Generic Functional policies: Corporate wide philosophies or approaches to managing functional areas of businesses Functional areas exist in areas of: Finance: capital structure, cash reserves etc. Labor: desirability of unionization, collective bargaining

Value Creation and Strategic Fit

Strategy of a diversified company is fit or relationship among distinct businesses in the portfolio

Fit can take variety of different forms and lead to a variety of economic benefits

Strategic fit can be diversified in terms of financial, generic functional skills, complementary strategic assets, compatible management styles

Goal of fit is to create real economic value for shareholders

Shareholders interests in value creation must be prioritized over others in order to retain economic and social values of the company

Value Creation and Strategic Fit continued

How diversifying company create real economic value for its shareholders ? How does notion of strategic fit relate to value creation ? Comparison between Corporate diversification on shareholders behalf & independent portfolio diversification on investors part

Questions can be answered when skills & resources of 2 businesses satisfies at least one of the following conditions : 1. An income stream > portfolio investment in 2 companies

Trade-offs between risk and return achieved by diversified company is superior than that of single business

In efficient capital markets, unsystematic risk is irrelevant in equity valuation process

2. Reduction in variability of income stream > portfolio investment in 2 business

A diversifying company can create value only when its riskreturn trade-offs include benefits unavailable through simple portfolio diversification

Seven principal ways:

SYNERGY:

Google acquired Andriod Inc. in 2005

Skills

Resources

REDUCE AVERAGE COST

Investment in closely related current operations field

P&G invested in I.T. infrastructure and achieved cost saving

Related Diversification

EXPANSION IN COMPETENCE AREA

Investment to closely related diversifying acquisitions

Walmart

REDUCE SYSTEMATIC RISK

Diversifying by acquiring a company reduce its tech, marketing risk Translate into less variable income stream
M&M acquired Punjab Tractors Ltd. (PTL)

Seven principal ways contd

BALANCING THE CYCLICAL WORKING CAPITAL REQUIREMENTS

Route cash from units operating wit surplus to deficit Reducing need for working capital funds from outside

Unrelated Diversification

IMPROVE LONG RUN PROFITABILITY

RISK POOLING

Diversified company can have lower cost of capital

Conclusion
In related diversification, skills and resources are transferable. Knowledge from one can be applied to problem and opportunity facing by other. In unrelated and conglomerate diversification, efficient corporate management leads to a larger return for corporate investors. Only financial benefits can be achieved after the unrelated diversifying acquisition.

Thank You