Diversification Strategies for

Managing a Group of
Businesses
Strategic Management

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 line of
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 boost the combined performance of the
businesses the firm has already entered
Corporate parents can help their business subsidiaries by:
- providing financial resources
- supplying missing skills, technological know-how, and 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 turn around efforts in weak performing businesses with
potential
- divest businesses that are no longer attractive or that do not fit
into managements long range plans

Four Facets of Diversified Strategy

3. Pursuing opportunities to leverage cross business value
chain relationships 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 that
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 new products

Four Facets of Diversified Strategy

4.

a)
b)
c)

Establishing investment priorities and steering

corporate resources into most attractive business units
A diversified companys all businesses are not equally
attractive from the 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 business units which are chronically poor
performers or are in an increasingly unattractive
industry

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 expand at an attractive low cost by
diversifyinginto closely related businesses
It has a powerful brand name which can be
transferred 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 it erodes the potential of good profitability

A catch 22 situation prevails 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 be
high in attractive industries

The cost of entry should at least 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 overcome certain entry barriers
Acquiring technological know-how
Inheriting supplier relationships
Becoming big enough to match rivals
efficiency and costs
Not 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 the needed
resources to build a new business
Ample time exists to launch a new business
Internal startup has lower cost
than entry via acquisition
New startup does not have to go
head-to-head against powerful rivals
Incumbents are slow in responding to new entry

Joint Ventures and Strategic Partnerships

Good way to diversify when
It is highly expansive or risky to go it alone
Pooling competencies of two partners provides more
competitive strength
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

Drawbacks of Joint Ventures

Raises questions
Which partner will do what?
Who has effective control?

Potential conflicts
Conflicting objectives
Disagreements over how best to operate the venture
Culture clashes

Related vs. Unrelated

Diversification
Related
Diversification

Unrelated
Diversification

Involves diversifying into

businesses whose value
chains possess
competitively valuable
strategic fits with value
chain of firms present
business

Involves diversifying into

businesses with no
competitively valuable
value chain match-ups or
strategic fits with firms
present business

Strategy Alternatives for a Company Looking to

Diversify

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 businesses 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
Exploiting common use of well known and potent
brand name
Cross business collaboration to create competitively
valuable resource strengths and capabilities

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 risk over a broader base

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
Example
- 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 in 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 an important element of
the companys strategy to diversify into servers, data
storage devices, MP3 players, and LCD Monitors

Types of Strategic Fits

3. Manufacturing-Related Strategic Fits
- expertise in quality manufacturing and cost
efficient methods can be transferred to another
business
- ability to consolidate production into smaller
number of plants and significantly reduce the
overall costs
Example
When Snowmobile maker Bombardier diversified into
motorcycles market, it was able to set up motorcycle
assembly lines in the same plant

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 and retail dealers to access
customers
- the same distribution centers can be used
- using single sales force
- promoted through same web site
Example
Corporates in the FMCG industry like P&G,
Unilever, have been using this strategic fit with
remarkable success

Types of Strategic Fits

5. Strategic Fits in Managerial and Administrative Support
Services
Often different businesses require comparable types of
managerial know-how which can be used in expanding
into new businesses or in new geographic markets
Example
An electric utility company that diversifies into
natural gas,
water, appliance sales, or home
security 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

1)
2)
3)
4)

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 businesses, 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 capabilities

Strategic Fit, Economies of Scope and

Competitive Advantage
Economies of Scope: A path to Competitive Advantage
One of the most important competitive advantages of related
diversification is its ability to produce lower cost than
competitor
Related diversification presents 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 stem
directly from strategic fit efficiencies along the value chains of
related businesses
Greater the cross business economies associated with cost
saving strategic fits, higher 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

1.

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

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

Types of Diversified Firms

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

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 crossbusiness 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

Weight Rating SBU1
SBU2
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

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

Develop GE Matrix
Division

Sales
1 $100

% sales

Profits

% profit

25.0

10

.50

3.2

25

3.5

50.0

I. A. S

C. Strength
3.6

200

2.1

50

12.5

20

2.1

3.1

50

12.5

2.5

1.8

Grand Strategy Matrix

Quadrant II

Rapid Market Growth Quadrant 1

Market Development

Market development

Product Development

Product development

Horizontal Integration

Integration

Divesture/ Liquidation

Related diversification

Weak
Competitive
Position

Quadrant III

Quadrant iv

Retrenchment

Related Diversification

Diversification

Unrelated Diversification

Divesture/ Liquidation

Slow Market Growth

Strong
Competitive
Position

6.4 BCG Portfolio Matrix (Fig. 6.2)

BCG Growth-Share Matrix

22

Stars

Question Marks

Cash Cows

Dogs

Business Growth Rate

(Percent)

20
18
16
14
12
10
8
6
4
2
0.1x

0.2x

0.5x
0.4x
0.3x

1x

2x
1.5x

4x

10x

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

45

BCG Matrix Example

Division

Revenue

Percent
Rev.

Profits

% profit

RMS

% Growth

1
2
3
4
5

$60,000
40,000
40,000
20,000
5,000

37
24
24
12
03

10,000
5,000
2000
8,000
500

39
20
08
31
02

.80
.40
.10
.60
.05

+15
+10
+1
-20
-10

Total

165,000

100

25,500 100

Step 3: Check Competitive Advantage

Potential of Cross-Business Strategic Fits
Objective
Determine competitive advantage potential of crossbusiness 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
MISFIT between critical success factors
and parenting characteristics

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.

57

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 parent 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 SBUs 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 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 industries 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.