Retrenching to a narrower diversification base

CHAPTER 8 Corporate Strategy: Diversification and the Multibusiness Company

LEARNING OBJECTIVES

THIS CHAPTER WILL HELP YOU UNDERSTAND:

When and how business diversification can enhance shareholder value

How related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage

The merits and risks of unrelated diversification strategies

The analytic tools for evaluating a company’s diversification strategy

What four main corporate strategy options a diversified company can employ for solidifying its strategy and improving company performance

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WHAT DOES CRAFTING A DIVERSIFICATION STRATEGY ENTAIL?

Step 1 Picking new industries to enter and deciding on the means of entry
Step 2 Pursuing opportunities to leverage cross-business value chain relationships and strategic fit into competitive advantage
Step 3 Establishing investment priorities and steering corporate resources into the most attractive business units
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STRATEGIC DIVERSIFICATION OPTIONS

Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses

Broadening the current scope of diversification by entering additional industries

Retrenching to a narrower scope of diversification by divesting poorly performing businesses

Broadly restructuring the entire firm by divesting some businesses and acquiring others to put a whole new face on the firm’s business lineup

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WHEN TO CONSIDER DIVERSIFYING

A firm should consider diversifying when:

Growth opportunities are limited as its principal markets reach their maturity and buyer demand is either stagnating or set to decline.

Changing industry conditions—new technologies, inroads being made by substitute products, fast-shifting buyer preferences, or intensifying competition—are undermining the firm’s competitive position.

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HOW MUCH DIVERSIFICATION?

Deciding how wide-ranging diversification should be

Diversify into closely related businesses or into totally unrelated businesses?

Diversify present revenue and earnings base to a small or major extent?

Move into one or two large new businesses or a greater number of small ones?

Acquire an existing company?

Start up a new business from scratch?

Form a joint venture with one or more companies to enter new businesses?

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OPPORTUNITY FOR DIVERSIFYING

Strategic diversification possibilities

Expand into businesses whose technologies and products complement present business(es).

Employ current resources and capabilities as valuable competitive assets in other businesses.

Reduce overall internal costs by cross-business sharing or transfers of resources and capabilities.

Extend a strong brand name to the products of other acquired businesses to help drive up sales and profits of those businesses.

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BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION FOR DIVERSIFYING

The industry attractiveness test

The cost-of-entry test

The better-off test

Testing Whether Diversification Will Add Long-Term Value for Shareholders

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THREE TESTS FOR BUILDING SHAREHOLDER VALUE THROUGH DIVERSIFICATION

The attractiveness test

Are the industry’s profits and return on investment as good or better than present business(es)?

The cost of entry test

Is the cost of overcoming entry barriers so great as to long delay or reduce the potential for profitability?

The better-off test

How much synergy (stronger overall performance) will be gained by diversifying into the industry?

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Strategic Management Principle (1 of 9)

To add shareholder value, diversification into a new business must pass the three tests of corporate advantage

The industry attractiveness test

The cost of entry test

The better-off test

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Core Concept (1 of 15)

Creating added value for shareholders via diversification requires building a multibusiness company in which the whole is greater than the sum of its parts; such 1 + 1= 3 effects are called synergy.

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BETTER PERFORMANCE THROUGH SYNERGY

Evaluating the Potential for Synergy through Diversification

Firm A purchases Firm B in another industry. A and B’s profits are no greater than what each firm could have earned on its own.

Firm A purchases Firm C in another industry. A and C’s profits are greater than what each firm could have earned on its own.

No Synergy (1+1=2)

Synergy (1+1=3)

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APPROACHES TO DIVERSIFYING THE BUSINESS LINEUP

Existing business acquisition

Internal new venture (start-up)

Joint venture

Diversifying into New Businesses

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DIVERSIFICATION BY ACQUISITION OF AN EXISTING BUSINESS

Advantages:

Quick entry into an industry

Barriers to entry avoided

Access to complementary resources and capabilities

Disadvantages:

Cost of acquisition—whether to pay a premium for a successful firm or seek a bargain in a struggling firm

Underestimating costs for integrating acquired firm

Overestimating the acquisition’s potential to deliver added shareholder value

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Core Concept (2 of 15)

An acquisition premium, or control premium, is the amount by which the price offered exceeds the preacquisition market value of the target company.

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ENTERING A NEW LINE OF BUSINESS THROUGH INTERNAL DEVELOPMENT

Advantages of new venture development

Avoids pitfalls and uncertain costs of acquisition

Allows entry into a new or emerging industry where there are no available acquisition candidates

Disadvantages of intrapreneurship

Must overcome industry entry barriers

Requires extensive investments in developing production capacities and competitive capabilities

May fail due to internal organizational resistance to change and innovation

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Core Concept (3 of 15)

Corporate venturing, or new venture development, is the process of developing new businesses as an outgrowth of a firm’s established business operations. It is also referred to as corporate entrepreneurship or intrapreneurship since it requires entrepreneurial-like qualities within a larger enterprise.