Chapter 9: Diversification Strategies for Managing a Group of Businesses

DiversificationStrategies for Managing a Group of Businesses 9ChapterScreen graphics created by:Jana F. Kuzmicki, Ph.D.Troy State University-Florida and Western Region Chapter RoadmapWhen to DiversifyStrategies for Entering New BusinessesChoosing the Diversification Path: Related versus Unrelated BusinessesThe Case for Diversifying into Related BusinessesThe Case for Diversifying into Unrelated BusinessesCombination Related-Unrelated Diversification StrategiesEvaluating the Strategy of a Diversified CompanyAfter a Company Diversifies: The Four Main Strategy Alternatives Diversification andCorporate Strategy A company is diversified when it is in two or more lines of business that operate in diverse market environmentsStrategy-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,multi-business strategyA strategic action plan must be developedfor several different businesses competingin diverse industry environmentsWhen Should a Firm Diversify?It is faced with diminishing growth prospects in present businessIt has opportunities to expand into industries whose technologies and products complement its present businessIt can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factorsIt can reduce costs by diversifyinginto closely related businessesIt has a powerful brand name it cantransfer to products of other businesses toincrease sales and profits of these businessesWhy Diversify?To build shareholder value!Diversification is capable of building shareholder value if it passes three tests:Industry Attractiveness Test—the industry presents good long-term profit opportunitiesCost of Entry Test—the cost of entering is not so high as to spoil the profit opportunitiesBetter-Off Test—the company’s different businesses should perform better together than as stand-alone enterprises, such that company A’s diversification into business B produces a 1 + 1 = 3 effect for shareholders1 + 1 = 3Strategies for EnteringNew BusinessesAcquire existing companyInternal start-upJoint ventures/strategic partnershipsAcquisition of anExisting CompanyMost popular approach to diversificationAdvantages Quicker entry into target marketEasier to hurdle certain entry barriersAcquiring technological know-howEstablishing supplier relationshipsBecoming big enough to match rivals’efficiency and costsHaving to spend large sums onintroductory advertising and promotionSecuring adequate distribution access Internal StartupMore attractive whenParent firm already has most of needed resources to build a new businessAmple time exists to launch a new businessInternal entry has lower coststhan entry via acquisitionNew start-up does not have to gohead-to-head against powerful rivalsAdditional capacity will not adversely impact supply-demand balance in industry Incumbents are slow in responding to new entryJoint Ventures andStrategic PartnershipsGood way to diversify whenUneconomical or risky to go it alonePooling competencies of two partners provides more competitive strengthOnly way to gain entry into a desirable foreign marketForeign partners are needed toSurmount tariff barriers and import quotasOffer local knowledge aboutMarket conditionsCustoms and cultural factorsCustomer buying habitsAccess to distribution outletsRelated vs. Unrelated DiversificationRelated DiversificationInvolves diversifying into businesses whose value chains possess competitively valuable “strategic fits” with value chain(s) of firm’s present business(es)Unrelated DiversificationInvolves diversifying into businesses with no competitively valuable value chain match-ups or strategic fits with firm’s present business(es)Fig. 9.1: Strategy Alternatives fora Company Looking to DiversifyWhat Is Related Diversification?Involves diversifying into businesses whose valuechains 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 phenomenonCore Concept: Strategic FitExists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for Transferring competitively valuableexpertise or technological know-howfrom one business to anotherCombining performance of commonvalue chain activities to achieve lower costsExploiting use of a well-known brand nameCross-business collaboration to create competitively valuable resource strengths and capabilitiesFig. 9.2: Value ChainRelationships for Related BusinessesTypes of Strategic FitsCross-business strategic fits can exist anywhere along the value chainR&D and technology activitiesSupply chain activitiesManufacturing activitiesDistribution activitiesSales and marketing activitiesManagerial and administrative support activitiesCore Concept:Economies of ScopeStem from cross-business opportunities to reduce costsArise when costs can be cutby operating two or more businessesunder same corporate umbrellaCost saving opportunities can stem from interrelationships anywhere along the value chains of differentbusinessesWhat Is Unrelated Diversification?Involves diversifying into businesses withNo strategic fitNo meaningful value chainrelationshipsNo unifying strategic themeBasic approach – Diversify intoany industry where potential existsto realize good financial results While industry attractiveness and cost-of-entry tests are important, better-off test is secondaryFig. 9.3: Value Chainsfor Unrelated BusinessesAppeal of Unrelated DiversificationBusiness risk scattered over different industriesFinancial resources can be directed to thoseindustries offering best profit prospectsIf bargain-priced firms with big profit potential are bought, shareholder wealth can be enhancedStability of profits – Hard times in one industrymay be offset by good times in another industryKey Drawbacks ofUnrelated DiversificationDemanding Managerial RequirementsLimitedCompetitive Advantage PotentialCombination Related-Unrelated Diversification StrategiesDominant-business firmsOne major core business accounting for 50 - 80 percent of revenues, with several small related or unrelated businesses accounting for remainderNarrowly diversified firmsDiversification includes a few (2 - 5) related or unrelated businessesBroadly diversified firmsDiversification includes a wide collection of either related or unrelated businesses or a mixtureMultibusiness firmsDiversification portfolio includes several unrelated groups of related businessesRelated DiversificationA strategy-driven approachto creating shareholder valueUnrelated DiversificationA finance-driven approachto creating shareholder valueDiversification andShareholder ValueFig. 9.4: Identifying aDiversified Company’s StrategyHow to Evaluate aDiversified Company’s StrategyStep 1: Assess long-term attractiveness of each industry firm is inStep 2: Assess competitive strength of firm’s business unitsStep 3: Check competitive advantage potential of cross-business strategic fits among business units Step 4: Check whether firm’s resources fit requirements of present businessesStep 5: Rank performance prospects of businesses and determine priority for resource allocation Step 6: Craft new strategic moves to improve overall company performanceFig. 9.5: Industry Attractiveness-Competitive Strength MatrixFig. 9.6: Identify Competitive Advantage Potential of Cross-Business Strategic FitsFig. 9.7: Strategic and Financial Options for Allocating Financial ResourcesFig. 9.8: Strategy Options for aCompany Already DiversifiedStrategies to Broaden a Diversified Company’s Business BaseConditions making this approach attractiveSlow grow in current businessesVulnerability to seasonal or recessionary influences or to threats from emerging new technologiesPotential to transfer resources and capabilities to other related businessesRapidly-changing conditions in one or more core industries alter buyer requirementsComplement and strengthen market position of one or more current businessesDivestiture Strategies Aimed at Retrenching to a Narrower Diversification BaseStrategic optionsRetrenchmentDivestitureSell itSpin it off asindependent companyLiquidate it (close it downbecause no buyers can be found)Retrench ?Divest ?Sell ?Close ?Retrenchment StrategiesObjectiveReduce scope of diversification to smaller number of “core “ businessesStrategic options involvedivesting businessesHaving little strategic fitwith core businessesToo small to contributeto earningsStrategies to Restructure a Company’s Business LineupObjectiveMake radical changes in mixof businesses in portfolio via bothDivestitures and New acquisitions in order to put on whole new face on the company’s business makeupConditions That Make Portfolio Restructuring AttractiveToo many businesses in unattractive industriesToo many competitively weak businessesOngoing declines in market shares of oneor more major business unitsExcessive debt loadIll-chosen acquisitions performing worse than expectedNew technologies threaten survival of one or more core businessesAppointment of new CEO who decides to redirect company“Unique opportunity” emerges and existing businesses must be sold to finance new acquisitionMultinationalDiversification StrategiesDistinguishing characteristicDiversity of businesses and diversity of national marketsPresents a big strategy-making challengeStrategies must be conceived and executedfor each business, with as manymultinational variations as appropriate