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CHAPTER 8

CORPORATE STRATEGY:
DIVERSIFICATION AND THE
MULTIBUSINESS COMPANY

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.

Step 4

Initiating actions to boost the combined performance


of the cooperations collection of businesses.

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FIGURE 8.5

The Chief Strategic and Financial Options for Allocating


a Diversified Companys Financial Resources

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WHEN BUSINESS DIVERSIFICATION


BECOMES A CONSIDERATION

A firm should consider diversifying when:


1. It can expand into businesses whose technologies
and products complement its present business.

2. Its resources and capabilities can be used as


valuable competitive assets in other businesses.
3. Costs can be reduced by cross-business sharing
or transfer of resources and capabilities.
4. Transferring a strong brand name to the products
of other businesses helps drive up sales and
profits of those businesses.

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TESTING WHETHER DIVERSIFICATION


ADDS VALUE FOR SHAREHOLDERS

The Attractiveness Test:

The Cost of Entry Test:

Are the industrys profits and return on investment


as good or better than present business(es)?

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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CORE CONCEPT
Creating added value for shareholders via
diversification requires building a multibusiness
company where the whole is greater than the
sum of its partsan outcome known as 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 Bs
profits are no greater than
what each firm could have
earned on its own.

No
Synergy
(1+1=2)

Firm A purchases Firm C in


another industry. A and Cs
profits are greater than what
each firm could have earned
on its own.

Synergy
(1+1=3)

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APPROACHES TO DIVERSIFYING
THE BUSINESS LINEUP

Diversifying into
New Businesses

Acquisition of an
existing business

Internal new
venture (start-up)

Joint
venture

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

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WHEN TO ENGAGE IN
INTERNAL DEVELOPMENT

Availability of
in-house skills
and resources

Ample time to
develop and
launch business

Cost of acquisition
is higher than
internal entry

Factors Favoring
Internal Development
No head-to-head
competition in
targeted industry
Low resistance of
incumbent firms
to market entry

Added capacity
will not affect
supply and
demand balance

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CHOOSING THE DIVERSIFICATION PATH:


RELATED VERSUS UNRELATED
BUSINESSES
Which Diversification
Path to Pursue?

Related
Businesses

Unrelated
Businesses

Both Related
and Unrelated
Businesses

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CHOOSING THE DIVERSIFICATION PATH:


RELATED VERSUS UNRELATED
BUSINESSES

Related Businesses

Have competitively valuable cross-business


value chain and resource matchups.

Unrelated Businesses

Have dissimilar value chains and resource


requirements, with no competitively important
cross-business relationships at the value chain
level.

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CORE CONCEPT
Strategic fit exists whenever one or more
activities constituting the value chains of
different businesses are sufficiently similar as
to present opportunities for cross-business
sharing or transferring of the resources and
capabilities that enable these activities.

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FIGURE 8.1

Related Businesses Provide Opportunities to


Benefit from Competitively Valuable Strategic Fit

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DIVERSIFYING INTO RELATED


BUSINESSES

Strategic Fit Opportunities:

Transferring specialized expertise, technological


know-how, or other resources and capabilities from
one businesss value chain to anothers.

Cost sharing between businesses by combining their


related value chain activities into a single operation.

Exploiting common use of a well-known brand name.

Sharing other resources (besides brands) that


support corresponding value chain activities across
businesses.
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ECONOMIES OF SCOPE DIFFER


FROM ECONOMIES OF SCALE

Economies of Scope

Are cost reductions that flow from cross-business


resource sharing in the activities of the multiple
businesses of a firm.

Economies of Scale

Accrue when unit costs are reduced due to the


increased output of larger-size operations of a firm.

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DIVERSIFICATION INTO
UNRELATED BUSINESSES
Can it meet corporate targets
for profitability and return on
investment?

Evaluating the
acquisition of a
new business or
the divestiture of
an existing
business

Is it is in an industry with
attractive profit and growth
potentials?

Is it is big enough to contribute


significantly to the parent firms
bottom line?

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BUILDING SHAREHOLDER VALUE


VIA UNRELATED DIVERSIFICATION
Astute Corporate
Parenting by
Management
Cross-Business
Allocation of
Financial
Resources
Acquiring and
Restructuring
Undervalued
Companies

Provide leadership, oversight, expertise, and guidance.


Provide generalized or parenting resources that lower
operating costs and increase SBU efficiencies.

Serve as an internal capital market.


Allocate surplus cash flows from businesses to fund
the capital requirements of other businesses.

Acquire weakly performing firms at bargain prices.


Use turnaround capabilities to restructure them to
increase their performance and profitability.

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MISGUIDED REASONS FOR


PURSUING UNRELATED
DIVERSIFICATION
Poor Rationales for
Unrelated Diversification

Seeking a
reduction of
business
investment risk

Pursuing rapid
or continuous
growth for its
own sake

Seeking
stabilization to
avoid cyclical
swings in
businesses

Pursuing
personal
managerial
motives

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STRUCTURES OF COMBINATION RELATEDUNRELATED DIVERSIFIED FIRMS

Dominant-Business Enterprises

Narrowly Diversified Firms

Are comprised of a few related or unrelated businesses.

Broadly Diversified Firms

Have a major core firm that accounts for 50 to 80% of total


revenues and a collection of small related or unrelated firms
that accounts for the remainder.

Have a wide-ranging collection of related businesses,


unrelated businesses, or a mixture of both.

Multibusiness Enterprises

Have a business portfolio consisting of several unrelated


groups of related businesses.
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EVALUATING THE STRATEGY


OF A DIVERSIFIED FIRM
1.

Assessing the attractiveness of the industries the firm has


diversified into, both individually and as a group.

2.

Assessing the competitive strength of the firms business units


within their respective industries.

3.

Evaluating the extent of cross-business strategic fit along the


value chains of the firms various business units.

4.

Checking whether the firms resources fit the requirements of its


present business lineup.

5.

Ranking the performance prospects of the businesses from best


to worst and determining a priority for allocating resources.

6.

Crafting strategic moves to improve corporate performance.

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FIGURE 8.3
A Nine-Cell Industry
Attractiveness
Competitive
Strength Matrix

Note: Circle sizes are scaled to


reflect the percentage of
companywide revenues
generated by the business unit.

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FIGURE 8.6
A Firms Four Main
Strategic Alternatives
After It Diversifies

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CORE CONCEPT
Companywide restructuring (corporate
restructuring) involves making major changes
in a diversified company by divesting some
businesses and/or acquiring others, so as to
put a whole new face on the companys
business lineup.

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