Diversification: Strategies for Managing a Group of Businesses

Chapter 9

Diversification and Corporate Strategy

A company is diversified when it is in two or more lines of business that operate in diverse market environments Strategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single lineof-business A diversified company needs a multi-industry, multi-business strategy A strategic action plan must be developed for several different businesses competing in diverse industry environments

Four Facets of Diversified strategy

1. Picking new industries to enter and deciding on the means of entry - what industry to get in - starting a new business from the ground up - acquiring a company already in the target industry - forming a joint venture or strategic alliance with another company - diversify narrowly in few industries or broadly into many industries

Four Facets of Diversified strategy

2. Initiating actions to boast the combined performance of the businesses the firm has entered Corporate parents can help their business subsidiaries by: - providing financial resources - supplying missing skills or technological know how, or managerial expertise to better perform key value chain activities - providing new avenues for cost reduction - can acquire another company in the same industry and merge the two operations into a stronger business - can acquire new businesses that strongly complement existing business Typically, a company will pursue - rapid growth strategies in its most promising businesses - initiate a turn around efforts in a weak performing businesses with potential - divest businesses that re no onger attractive or that dont fit into managements long range plans

Four Facets of Diversified strategy

3. Pursuing opportunities to leverage cross business value chain relationship and strategic fits into competitive advantage Competitive advantage of businesses that diversify with value chain matchups vs. those with unrelated value chain activities Capturing this competitive advantage requires corporate strategies capitalize on; - transferring skills or technology - reducing costs via sharing common facilities and resources - using well known brand names and distribution muscle to grow the sales of newly acquired products

Four Facets of Diversified strategy

4. a) b) Establishing investment priorities and steering corporate resources into most attractive business units A diversified companys all businesses are not equally attractive from stand point of investing funds It is incumbent on corporate management to; Decide on priorities for investing capital in the companys different businesses Channel resources into areas where earning potentials are higher and away from areas where they are lower Divest businesses units that are chronically poor performers or are in an increasingly unattractive industry

c)

When Should a Firm Diversify?

It is faced with diminishing growth prospects in present business It has opportunities to expand into industries whose technologies and products complement its present business It can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factors It can reduce costs by diversifying into closely related businesses It has a powerful brand name it can transfer to products of other businesses to increase sales and profits of these businesses

Why Diversify?

To build shareholder value!

1+1=3

A move to diversify into new business must pass three tests 1. The industry attractiveness test - must be attractive to yield consistently good returns on investment - industry and competitive conditions conducive for earning good or better profits and ROI than the company is earning in its present situation

Why Diversify?
2. Cost of entry test The cost to enter the target market should not be so high that erode the potential of good profitability A catch 22 situation prevail here a) The more attractive the industry prospects are for growth and long term profitability, the more expensive it can be to get into b) Entry barriers for start-up companies are likely to e high in attractive industry The cost of entry should atleast assure the targeted ROI

Why Diversify?
3. The better off test The companys different businesses should perform better together than as stand-alone enterprises, such that company As diversification into business B produces a 1 + 1 = 3 effect for shareholders

Strategies for Entering New Businesses

Acquire existing company

Internal start-up

Joint ventures/strategic partnerships

Acquisition of an Existing Company

Most popular approach to diversification Advantages
Quicker entry into target market
Easier to hurdle certain entry barriers Acquiring technological know-how

Establishing supplier relationships

Becoming big enough to match rivals efficiency and costs

Having to spend large sums on introductory advertising and promotion

Securing adequate distribution access

Internal Startup
More attractive when
Parent firm already has most of needed resources to build a new business Ample time exists to launch a new business Internal entry has lower costs than entry via acquisition New start-up does not have to go head-to-head against powerful rivals Additional capacity will not adversely impact supply-demand balance in industry Incumbents are slow in responding to new entry

Joint Ventures and Strategic Partnerships Good way to diversify when

Uneconomical or risky to go it alone Pooling competencies of two partners provides more competitive strength Only way to gain entry into a desirable foreign market

Foreign partners are needed to

Surmount tariff barriers and import quotas Offer local knowledge about

Market conditions Customs and cultural factors Customer buying habits Access to distribution outlets

 Raises questions

Drawbacks of Joint Ventures

Which partner will do what Who has effective control

Potential conflicts
Conflicting objectives

Disagreements over how to best operate the venture

Culture clashes

Related vs. Unrelated Diversification

Related Diversification
Involves diversifying into businesses whose value chains possess competitively valuable strategic fits with value chain(s) of firms present business(es)

Unrelated Diversification
Involves diversifying into businesses with no competitively valuable value chain match-ups or strategic fits with firms present business(es)

Strategy Alternatives for a Company Looking to Diversify

What Is Related Diversification?

Involves diversifying into businesses whose value chains possess competitively valuable strategic fits with the value chain(s) of the present business(es) Capturing the strategic fits makes related diversification a 1 + 1 = 3 phenomenon

The Case for Diversifying into Related Businesses

1. 2. Transferring competitively valuable expertise, technological know how, or other capabilities Combining the related value chain activities of separate businesses into single operations to achieve lower costs - manufacture products of different business in a single plant - use the same warehouse for shipping and distribution - have a single sales force for the products of different businesses because they are marketed to the same type of customers (Sony) Exploiting common use of well known and potent brand name ( Honda, Cannon, Sony) Cross business collaboration to create competitively valuable resource strengths and capabilities

3. 4.

Core Concept: Strategic Fit

Exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for Transferring competitively valuable expertise or technological know-how from one business to another Combining performance of common value chain activities to achieve lower costs

Exploiting use of a well-known brand name

Cross-business collaboration to create competitively valuable resource strengths and capabilities

Related Businesses Possess Related Value Chain Activities and Competitively Valuable Strategic Fits

Strategic Appeal of Related Diversification

Reap competitive advantage benefits of
Skills transfer

Lower costs
Common brand name usage Stronger competitive capabilities

Spread investor risks over a broader base Preserve strategic unity across businesses Achieve consolidated performance greater than the sum of what individual businesses can earn operating independently (1 + 1 = 3 outcomes)

Types of Strategic Fits

1. Strategic fits in R&D and Technology Activities - sharing common technology -exploiting the full range of business activities with a particular technology and its derivates - transferring technological know-how from one business to another - cost savings in R&D - shorter times in getting new products to the market Examples - technological innovations being the driver behind the efforts of cable TV companies to diversify into high speed internet access via the use of cable modems

Types of Strategic Fits

2. Strategic Fits in supply Chain activities - potential for skill transfer procuring materials - greater bargaining power in negotiating with common suppliers - added leverage with shippers in securing volume discounts on inbound logistics - added collaborations with common supply chain partners Example :Dell computers strategic partnership with leading suppliers of microprocessors, motherboards, disc drives, memory chips etc have been important element of the companys strategy to diversify into servers, data storage devices,MP3 players, and LCD TVs

Types of Strategic Fits

3. Manufacturing Related Strategic Fits - diversifier expertise in quality manufacture and cost efficient methods can be transferred in another business - ability to consolidate production into smaller number of plants and significantly reduce the overall costs Example : snowmobile maker Bombardier diversified into motorcycle business was able to set up motorcycle assembly lines in the same assembly line

Types of Strategic Fits

4. Distribution-Related Strategic Fits - potential cost saving in sharing the same distribution facilities - using many of the same wholesale distributors an retail dealers to access customers 5. Strategic Fits in Sales and Marketing - the same distribution centers can be used - using single sales force - promoted through same Web site - after sales service and repair for the products can be consolidated into single business operations

Types of Strategic Fits

6. Strategic Fits in managerial and Administrative Support Services Often different businesses require comparable types managerial know-how in one line of business to be transferred to another - experience of expanding into new geographic market Electric utility that diversifies into natural gas, water, appliance sales, home security service can use the same: - customer data network, - customer call centers and local offices, - billing and customer accounting systems - customer service infrastructure

Strategic Fit, Economies of Scope and Competitive advantage

Strategic Fit The opportunity to convert cross business strategic fits into competitive advantage over business rivals makes related diversification an attractive strategy The greater the relatedness among diversified companys sister business, the bigger the window for converting strategic fits into competitive advantage via: Skills transfer Combining related value chain activities to achieve lower costs Leveraging use of a well respected brand name Cross business collaboration to create new resource strengths and capablities

1) 2)

3) 4)

Strategic Fit, Economies of Scope and Competitive advantage

Economies of Scope: A path to Competitive Advantage One of the most important competitive advantage of related diversification is its ability to produce lower cost than competitor Related diversification present opportunities to eliminate or reduce costs of performing certain value chain activities, such cost savings are termed economies of scope Economies of Scope are cost reductions that flow from operating in multiple businesses; such economies stern directly from strategic fit efficiencies along the value chains of related businesses The greater the cross business economies associated with cost saving strategic fits, the greater the potential for related diversification strategy to yield a competitive advantage based on lower costs than rivals.

Strategic Fit, Economies of Scope and Competitive advantage

From Competitive Advantage to Added Profitability and Gains in Shareholder value

Diversifying into related business where competitively valuable

strategic fit benefits can be captured puts sister business in position to perform better financially as parts of the same company than they should have performed as independent enterprises, thus providing a clear avenue for boosting shareholder value. 1 + 1 = 3 There are three things to bear in mind: Capturing cross-business strategic fits via a strategy of related diversification builds share holder value in ways that share holder cannot undertake by simply owning a portfolio of stocks in different companies The capture of cross-business strategic fit benefits is possible only via a strategy of related diversification The benefits of cross-business strategic fits 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

1.

2. 3.

What Is Unrelated Diversification?

Involves diversifying into businesses with
No strategic fit No meaningful value chain relationships No unifying strategic theme

Basic approach Diversify into any industry where potential exists to realize good financial results While industry attractiveness and cost-of-entry tests are important, better-off test is secondary

Fig. 9.3: Unrelated Businesses Have Unrelated Value Chains and No Strategic Fits

Acquisition Criteria For Unrelated Diversification Strategies

Can business meet corporate targets for profitability and ROI? Is business in an industry with growth potential? Is business big enough to contribute to parent firms bottom line? Will business require substantial infusions of capital? Is there potential for union difficulties or adverse government regulations? Is industry vulnerable to recession, inflation, high interest rates, or shifts in government policy?

Appeal of Unrelated Diversification

Business risk scattered over different industries Financial resources can be directed to those industries offering best profit prospects

If bargain-priced firms with big profit potential are bought, shareholder wealth can be enhanced
Stability of profits Hard times in one industry may be offset by good times in another industry

Key Drawbacks of Unrelated Diversification

Demanding Managerial Requirements Limited Competitive Advantage Potential

Combination Related-Unrelated Diversification Strategies

Dominant-business firms One major core business accounting for 50 - 80 percent of revenues, with several small related or unrelated businesses accounting for remainder Narrowly diversified firms Diversification includes a few (2 - 5) related or unrelated businesses Broadly diversified firms Diversification includes a wide collection of either related or unrelated businesses or a mixture Multibusiness firms Diversification portfolio includes several unrelated groups of related businesses

Fig. 9.4: Identifying a Diversified Companys Strategy

How to Evaluate a Diversified Companys Strategy

Step 1: Assess long-term attractiveness of each
industry firm is in Step 2: Assess competitive strength of firms business units

Step 3: Check competitive advantage potential of cross-business strategic fits among business units Step 4: Check whether firms resources fit requirements of present businesses
Step 5: Rank performance prospects of businesses and determine priority for resource allocation Step 6: Craft new strategic moves to improve overall company performance

Step 1: Evaluate Industry Attractiveness

Attractiveness of each industry in portfolio Each industrys attractiveness relative to the others Attractiveness of all industries as a group

Evaluating Industry Attractiveness Relative to others

Industry Attractiveness Factor Market Size and projected growth Intensity of competition Emerging opportunities and threats Seasonal cyclical factors Resource Requirements Presence of cross industry strategic fits and resource fits Industry profitability Social, regulatory and environmental factors Industry uncertainty and business fits Weight Rating Rating A Rating B

Step 2: Evaluate Each BusinessUnits Competitive Strength

Objectives
Appraise how well each business is positioned in its industry relative to rivals Evaluate whether it is or can be competitively strong enough to contend for market leadership

Competitive Strength of each of the companys Business Units Competitive strength measure
Relative Market Share Costs relative to competitors Ability to match rivals on key product attributes Bargaining leverage with suppliers/ buyers Strategic-fit relationships with sister businesses Technology and innovation capabilities How well resources are matched to industry key success factors Brand name reputation/image Degree of profitability relative to competitors Weight Rating SBU1 SBU2

Fig. 9.5: A Nine-Cell Industry Attractiveness-Competitive Strength Matrix

Develop GE Matrix
Division Sales % sales Profits % profit I. A. S C. strength

1 $100
2 3 4 200 50 50

.25.0
.50.0 12.5 12.5

10
5 4 1

.50
25 20 5

3.2
3.5 2.1 2.5

3.6
2.1 3.1 1.8

Grand Strategy Matrix

Quadrant II MKT. Development Product Development Horizontal Integration

Rapid Market Growth Quadrant 1

MKT development Product development Integration Related diversification

Weak Competitive Position

Divesture/ Liquidation

Quadrant III Retrenchment Diversification Divesture/ liquidation

Quadrant iv
Related Diversification

Strong Competitive Position

Unrelated Diversification

Slow Market Growth

6.4

BCG Portfolio Matrix (Fig. 6.2)

BCG Growth-Share Matrix

22 20 18 16 14 12 10 8 6 Cash Cows Dogs Stars Question Marks

4
2 0
Source: B. Hedley, Strategy and the Business Portfolio, Long Range Planning (February 1997), p. 12. Reprinted with permission.

Relative Competitive Position

Prentice Hall, 2000

Chapter 6

46

BCG Matrix Example

Division 1 2 3 4 5 Total Revenue $60,000 40,000 40,000 20,000 5,000 165,000 Percent Rev. 37 24 24 12 03 100 Profits 10,000 5,000 2000 8,000 500 % profit 39 20 08 31 02 RMS .80 .40 .10 .60 .05 % Growth +15 +10 +1 -20 -10

25,500 100

Step 3: Check Competitive Advantage Potential of Cross-Business Strategic Fits

Objective
Determine competitive advantage potential of cross-business strategic fits among portfolio businesses Examine strategic fit based on Whether one or more businesses have valuable strategic fits with other businesses in portfolio Whether each business meshes well with firms long-term strategic direction

Fig. 9.6: Identifying Competitive Advantage

Potential of Cross-Business Strategic Fits

Step 4: Check Resource Fit

Objective
Determine how well firms resources match business unit requirements

Good resource fit exists when

A business adds to a firms resource strengths, either financially or strategically Firm has resources to adequately support requirements of its businesses as a group

Characteristics of Cash Hog Businesses

Internal cash flows are inadequate to fully fund needs for working capital and new capital investment
Parent company has to continually pump in capital to feed the hog Strategic options Aggressively invest in attractive cash hogs Divest cash hogs lacking long-term potential

Characteristics of Cash Cow Businesses

Generate cash surpluses over what is needed to sustain present market position Such businesses are valuable because surplus cash can be used to

Pay corporate dividends

Finance new acquisitions Invest in promising cash hogs

Strategic objectives
Fortify and defend present market position Keep the business healthy

Step 5: Rank Business Units Based on Performance and Priority for Resource Allocation

Factors to consider in judging business-unit performance

Sales growth

Profit growth
Contribution to company earnings Return on capital employed in business Economic value added Cash flow generation

Industry attractiveness and business strength ratings

Fig. 9.7: The Chief Strategic and Financial Options for Allocating a Diversified Companys Financial Resources

Step 6: Craft New Strategic Moves Strategic Options

Stick closely with existing business lineup and pursue opportunities it presents Broaden companys business scope by making new acquisitions in new industries

Divest certain businesses and retrench to a narrower base of business operations

Restructure companys business lineup, putting a whole new face on business makeup Pursue multinational diversification, striving to globalize operations of several business units

Fig. 9.8: A Companys Four Main Strategic Alternatives After It Diversifies

Corporate Parenting
Multi-business companies create value by influencing or parenting businesses they own. The best parent companies create more value than any of their rivals would if they owned the same businesses. These companies have parenting advantage Corporate parenting generates corporate strategy by focusing on the core competencies of the parent corporation and on the value created from relationship between the parent and its businesses If there is a good fit between the parents skills and resources and the needs and opportunities of the business units, the corporation is likely to create value. If there is not a good fit the corporation is likely to destroy the value This approach to corporate strategy is useful in deciding : (1) What new business to acquire, (2) choosing how each existing business unit should be managed The primary job of corporate headquarters is to obtain synergy among the business units, transferring skills and capabilities among the units

6.7

Parenting-Fit Matrix (Fig. 6.5)

Parenting-Fit Matrix
Low Heartland Ballast Edge of Heartland

Alien Territory Value Trap High Low FIT between parenting opportunities and parenting characteristics Prentice Hall, 2000 Chapter 6 High
Source: Adapted from M. Alexander, A. Campbell, and M. Goold, A New Model for Reforming the Planning Review Process, Planning Review (January/February 1995), p. 17. Reprinted by permission.

58

Parenting Mix Matrix

1. Heartland Business Heartland businesses have opportunities for improvement by the parent, and parent understands their strategic factors well. Their business should have priority for all corporate activities 2. Edge-of Heartland Some parenting characteristics fit the business, but others do not Parent may not really understand all of the strategic factors Such business units are likely to consume much of the parents attention Parents need to know when to interfere in business unit activities and strategies and when to keep at arms length

Parenting-Fit Matrix
3. Ballast business Fit very well with the parent corporation but contains very few opportunities to be improved by the parent Units that have been with the corporation for many years and have been very successful Parents may have added value in the past, but it can no longer find opportunities Like cash cows they may be important sources of stability and earnings They can also be a drag on the corporations as a whole by slowing growth and distracting present from more productive activities

Parenting-Fit Matrix
4. Alien Territory Businesses
Have little opportunity to be improved by the corporate parent A misfit exists between the parenting characteristics and units strategic factors Little opportunity for value creation but high potential for value destruction on the part of parent 5. Value Trap Businesses Fit well with the parenting opportunities, but are misfits with the parents understanding of units strategic factors Corporate head quarters mistakes what it sees as an opportunity for ways to improve the S.B.U.s profitability or competitive position

Difference Between Corporate Parenting and Portfolio analysis

The basic difference between these two approaches to corporate strategy lies in the questions they attempt to answer. Portfolio analysis attempts to answer the following two questions: 1. How much of our time and money should we spend on our best products and business units in order to ensure that they continue to be successful? 2. How much of our time and money should we spend developing new costly products, most of which will never be successful?

Difference Between Corporate Parenting and Portfolio analysis

The basic theme of portfolio analysis is its emphasis on cash flow Portfolio analysis attempts to answer these questions by examining the attractiveness of various industries and by managing business units for cash flow, that is, by using cash generated from mature units to build new product lines Portfolio analysis fails to deal with the question of what industries a corporation should enter or with how a corporation can attain synergy among its product lines and business units. As suggested by its name, portfolio analysis tends to primarily take a financial point of view and views business units and product lines as if they were separate and independent investments

Difference Between Corporate Parenting and Portfolio analysis

Corporate parenting, in contrast, views the corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units. The central job of corporate headquarters is not to be a banker, but to coordinate diverse units to achieve synergy This is especially important in a global industry in which a corporation must manage interrelated business units for global advantage. Corporate parenting is similar to portfolio analysis in that it attempts to manage a set of diverse product lines/business units to achieve better overall corporate performance.