Diversification Strategy

Prof. Arindam Mondal

XLRI Jamshedpur
Integration and Diversification

Integration

Backward Forward

Diversification
Other Current Other
Businesses Businesses Businesses

No Unrelated Related Many

Links Links
 What is Diversification?
Diversification through the development of new products
delivered in new markets (Ansoff, 1957)

Market Diversification
.... development

Another new
market A2

New
market A1

Current Market Product

market A penetration development

Current New Another new New

product X product X1 product X2 .... product Y
Types of Corporate Diversification
At a general level…
Product Diversification:
• operating in multiple industries

Geographic Market Diversification:

• operating in multiple geographic markets

Product-Market Diversification
• operating in multiple industries in multiple
geographic markets
 Advantages and Risks of Single Businesses
•Advantages:
• Less ambiguity about “who we are”
• Less chance resources will be stretched too thinly
• Resources can be focused on building competencies and capabilities
• Higher probability innovative ideas will emerge
• Top executives can maintain hands-on contact with core business
• Important competencies more likely to emerge
• Ability to parlay experience and reputation into:
• Sustainable competitive advantage
• Prominent leadership position
•Risks:
• Putting all the “eggs” in one industry basket
• If market becomes unattractive, a firm’s prospects can quickly dim
• Unforeseen changes can undermine a single business firm’s prospects
• Changing customer needs
• Technological innovation
• New substitutes
 Why Diversify?
• To grow rapidly by expanding operations into new business fields
• To build shareholder value!
1 + 1 = 3 (Synergy)

Diversification is capable of building shareholder value if it passes three

tests:
1. Industry Attractiveness Test — the industry presents good long-term profit
opportunities
2. Cost of Entry Test — the cost of entering is not so high as to spoil the profit
opportunities
3. Better-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 shareholders
 Why Diversify?
Economies of Scope: a case of synergy-combined activities
generate greater value than independent activities

Four Types:

Operational: Sharing Activities

Financial: Internal Capital Market

Anticompetitive: Market Power Economics

Managerial: Coordination and transfer of learnings
 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
• It can reduce the business risk and improve the risk adjusted return to
shareholders
 When Should a Firm Diversify?

Competitive Position
Strong Weak
Strong competitive Weak competitive
position, rapid market position, rapid market
Market Growth

growth -- Not a good growth -- Not a good

time to diversify time to diversify

Strong competitive Weak competitive

position, slow market position, slow market
growth -- Diversification growth --
is top priority Diversification merits
consideration consideration
Strategy Alternatives for a Company Looking to Diversify
Involves diversifying into businesses whose value chains possess competitively
valuable “strategic fits” with value chain(s) of firm’s present business(es)
Involves diversifying into businesses with no competitively valuable value chain
match-ups or strategic fits with firm’s present business(es)
Diversification has demanding Managerial
Requirements
• The greater the number and diversity of businesses, the harder it is for
managers to:
• Discern good businesses from bad ones
• Select capable managers to manage the diverse requirements of each business and
compensate accordingly
• Judge soundness of strategic proposals of business-unit managers
• To take decisions on whether various functional activities such as engineering, finance
and accounting, marketing and sales, production, and research and development should
be centralized at the corporate HQ or be decentralized and operated by SBU managers.
• Know what to do if a business subsidiary stumbles
Diversification and Firm Performance

Performance

Dominant Related Unrelated

Business Business
Level of Diversification
 How to Evaluate a Diversified Company’s
Strategy
Step 1: Assess long-term attractiveness of each industry, the firm is in
Step 2: Assess competitive strength of firm’s business units
Step 3: Check competitive advantage potential of cross-business strategic fits
among business units
Step 4: Check whether firm’s 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
 A Note of Caution: Why Diversification
Efforts can Fail
❑ Trying to replicate a firm’s success in one business and hitting a
second home run in a new business is easier said than done

❑ Transferring resource capabilities to new businesses can be far more

arduous and expensive than expected

❑ Management can misjudge difficulty of overcoming resource strengths

of rivals it will face in a new business
 Conclusions
❑Size alone does not guarantee firms an advantage.
❑Coordination required to exploit economies of scale and scope is not without
cost.
❑Size creates additional challenges and difficulties, including problems of
communication and coordination.

❑Critical factor in determining success is the level of management

expertise in formulating and implementing corporate strategy.
❑More difficult for diversified firms.
❑Those firms with management teams that have more experience at managing
diversification will enjoy higher performance than those firms that do not have
that experience.