Chapter 10

GARETH R. JONES /CHARLES W. L.
HILL
Theory of Strategic Management 10th ed.
Corporate-Level
Chapter
Strategy: Related and
10 Unrelated
Diversification
Student Version
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as Prepared by C. Douglas Cloud
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Professor Emeritus of Accounting
Pepperdine University
Learning Objective: After reading this chapter,
you should be able to differentiate between
multibusiness models based on related and
unrelated diversification.
INCREASING PROFITABILITY
THROUGH DIVERSIFICATION
 Diversification is the process of entering new

industries, distinct from a company’s core or
original industry, to make new kinds of
products that can be sold profitable.
 A diversified company is one that makes and
sells in two or more distinct industries.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
INCREASING PROFITABILITY
THROUGH DIVERSIFICATION
 The managers of most companies often

consider diversification when they are
generating free cash flow, that is, cash in
excess of that required:
 to fund new investments in the company’s
current business and
 to meet debt commitments.
 In theory, any free cash flow belongs to the
shareholders; thus, a diversification strategy is
not consistent with maximizing returns to
shareholders.
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10-3
Learning Objective: After reading this
chapter, you should be able to explain the
five primary ways in which diversification can
increase company profitability.
TRANSFERRING COMPETENCIES
 Transferring competencies involves taking a

distinctive competency developed by a new
business unit in one industry and implanting it in
a business unit operating in another industry.
 Companies that base their diversification
strategy on transferring competencies tend to
acquire new business related to their existing
business activities.
TRANSFERRING COMPETENCIES-
 A commonality is some kind of skill or attribute,

which, when it is shared or used by two or more
business units:
 allows both businesses to operate more
effectively and efficiently,
 and create more value for customers.
 To increase profitability, the competencies
transferred must involve value-chain activities
that gives the business unit competitive
advantage in the future.
LEVERAGING COMPETENCIES
 Leveraging competencies involves taking a

distinctive competency developed by a business
unit in one industry and using it to create a new
business unit or division of a different industry.
 The difference between leveraging competencies
and transferring competencies is that leveraging
competencies means a new business is being
created.
 Transferring competencies involves the sharing
of competencies between two existing
businesses.
SHARING RESOURCES AND CAPABILITIES
 Economies of scope arise when one or more of

a diversified company’s business units are able
to realize cost-saving or differentiation synergies.
 Companies can more effectively pool, share, and
utilize expensive resources or capabilities.
 Sharing resources or capabilities across
business units lowers a company’s cost structure
compared to companies that operate in only one
industry.
USING PRODUCT BUNDLING
 In search of new ways to differentiate products,

more and more companies are entering into
industries that provide customers with new
products connected or related to existing products.
 This product bundling allows a company to
expand the range of products it produces to
provide customers a complete package of related
products.
 The goal is to bundle products to offer customers
lower prices and/or a superior product or service.
UTILIZING GENERAL ORGANI-
ZATIONAL COMPETENCIES
 General organizational competencies are the
result of the skills of a company’s top managers
and functional experts.
Entrepreneurial Capabilities
x To promote entrepreneurship, a company must:
1) Encourage managers to take risks.
2) Give them the time and resources to pursue novel
ideas.
3) Not punish managers when a new idea fails.
4) Not pursue too many risky new ventures that have
a low probability of generating a profit.
Capabilities of Organizational Design
 Organizational design skills are a result of a

manager’s ability to create a structure, culture,
and control systems.
 Effective organizational structure and controls
create incentives that encourage business unit
managers to maximize efficiency and
effectiveness of their units.
 Good organizational design helps prevent
missing out on profitable new opportunities.
Superior Strategic Management Capabilities
 For diversification to increase profitability, a

company’s top managers must have superior
capabilities in strategic management.
x
They must possess the intangible skills that are
required to manage different business units in a
way that enables these units to perform better
than they would if they were independent
companies.
 These skills are a rare and valuable capability.
Superior Strategic Management Capabilities

 There are several ways to improve the
performance of an acquired company:
1) Replace top managers of the acquired company with a
x more aggressive top management team.
2) Sell off expensive assets and terminates managers and
employees to reduce the cost structure.
3) The new management team works to devise new
strategies to improve performance of the operations of
the acquired company.
4) Offer bonuses to motivate managers and employees.
5) Set challenging goals at all levels (stretch goals).
Learning Objective: After reading this
chapter, you should be able to discuss the
conditions that lead managers to pursue
related diversification versus unrelated
diversification and explain why some
companies pursue both strategies.
RELATED DIVERSIFICATION
 Related diversification is a corporate-level
strategy that is based on the goal of establishing a
business unit in a new industry that is related to a
company’s existing business units by:
 some form of commonality or linkage between value-
chain functions of the existing and new business
units.
RELATED DIVERSIFICATION
 The greater the number of linkages that can be

formed among business units, the greater the
potential to realize the profit-enhancing benefits
of diversifying.
 Diversification allows a company to use any
general organizational competency it possesses
to increase the overall performance of all its
different industry divisions.
 Strategic managers may strive to create a
structure and culture that encourages
entrepreneurship across divisions.
UNRELATED DIVERSIFICATION
 Unrelated diversification is a corporate-level

strategy based on a multibusiness model with a
goal to increase profitability through:
 the use of general organizational
competencies, and
 increase the performance of all the company’s
business units.
 Companies pursuing this strategy are often called
conglomerates; that is, business organizations
that operate in many diverse industries.
THE LIMITS AND DISADVANTAGES
OF DIVERSIFICATION
Changes in the Industry or Company
 When the managers who possess hard-to-define

skills leave, they often take their visions with them.
 A company’s new leader may lack the competency
or commitment necessary to pursue diversification
successfully over time.
 The environment often changes rapidly and
unpredictably over time.
 The future success of any business is hard to
predict when using diversification.
OF DIVERSIFICATION
Diversification for the Wrong Reasons
 Although they know they should divest unprofitable

businesses, managers “make up” reasons why they
should keep their businesses together.
 In the past, one widely used (and false) justification
for diversification was that the strategy would allow
a company to obtain the benefits of risk pooling.
 When a company’s core business is in trouble,
some think diversification will rescue it and lead to
long-term growth and profitability.
OF DIVERSIFICATION
The Bureaucratic Costs of Diversification
 Bureaucratic costs are the costs associated with

solving the transaction difficulties that arise
between a company’s business unit and between
the business unit and corporate headquarters, as
the company attempts to obtain the benefits from
transferring, sharing, and leveraging competencies.
 The greater the number of business units, the more
difficult it is for corporate managers to remain
informed about each business.
OF DIVERSIFICATION
Choosing a Strategy
 Related diversification is preferred when (1) the

company’s competencies can be applied across a
greater number of industries, and (2) the company
has superior strategic capabilities that allow it to
keep bureaucratic costs under control.
 Unrelated diversification is preferred when (1) top
managers are skilled at raising the profitability of a
poorly run business, and (2) superior management
is able to keep costs under control.
Learning Objective: After reading this chapter, you
should be able to describe the three methods
companies use to enter new industries: internal new
venturing, acquisitions, and joint ventures. Then be
able to discuss the advantages and disadvantages
associated with each of these methods.
ENTERING NEW INDUSTRIES:

INTERNAL NEW VENTURING
 Internal new venturing is the process of
transferring resources to and creating a new
business unit or division in a new industry.
 A company may use internal venturing to enter a
newly emerging or embryonic industry.
ENTERING NEW INDUSTRIES:
INTERNAL NEW VENTURING
 Reasons given to explain the high failure rate
(33% to 60%) of internal new ventures include:
1) Market entry on too small a scale.
2) Poor commercialization of the new-venture product.
3) Poor corporate management of the new venture
division.
 Steps taken to ensure good science ends with
good, commercially viable products.
1) Put research in the hands of skilled managers.
2) Encourage managers to work with R&D scientists.
3) Foster a close link between R&D and marketing.
ENTERING NEW INDUSTRIES: ACQUISITIONS
 A company is particularly likely to use acquisitions

when it needs to move fast to establish a presence
in an industry.
 Entering a new industry through internal venturing
is a relatively slow process. Acquisition is a much
quicker way for a company to establish a significant
market presence.
 Acquisitions are often perceived as being less risky
than internal new ventures because they involve
less commercial uncertainty.
 It is an attractive way to enter an industry that is
protected by high barriers to entry.
ENTERING NEW INDUSTRIES: ACQUISITIONS
 Acquisitions may fail to raise the performance of

the acquiring companies for the following reasons:
1) Management problems
2) Overestimating the potential economic benefits
3) Acquisitions tend to be expensive (no profit increases)
4) Poor screening results in not seeing major problems
 Guidelines for successful acquisition:
1) Target identification and preacquisition screening
2) Bidding strategy
3) Integration
4) Learning from experience
ENTERING NEW INDUSTRIES: JOINT VENTURES
 Joint ventures involve two or more companies

agreeing to pool their resources to create new
businesses.
 It frequently becomes the most appropriate method
to enter a new industry because it allows a
company to share the risks and costs associated
with establishing a business unit in the new
industry with another company.
 The joint ventures approach is most appropriate
when the companies share complementary skills or
distinctive companies because this increases the
probability of a joint venture’s success.
ENTERING NEW INDUSTRIES: JOINT VENTURES
 Disadvantages of entering a joint venture:

1) While it allows companies to share the risks and costs
of developing a new business, it also requires that
they share in the profits if they succeed.
2) If one partner’s skills are more important than the
other partner’s skills, the partner with more valuable
skills will have to “give away” profits to the other party
because of the 50/50 agreement.
3) Problems can arise if the partners’ business models
conflict.
4) A company runs the risk of giving away important
company-specific knowledge to its partner.

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GARETH R. JONES /CHARLES W. L.

Theory of Strategic Management 10th ed.

 Diversification is the process of entering new

 The managers of most companies often

 Transferring competencies involves taking a

 A commonality is some kind of skill or attribute,

 Leveraging competencies involves taking a

 Economies of scope arise when one or more of

 In search of new ways to differentiate products,

Capabilities of Organizational Design

 Organizational design skills are a result of a

Superior Strategic Management Capabilities

 For diversification to increase profitability, a

Superior Strategic Management Capabilities

 The greater the number of linkages that can be

 Unrelated diversification is a corporate-level

Changes in the Industry or Company

 When the managers who possess hard-to-define

Diversification for the Wrong Reasons

 Although they know they should divest unprofitable

The Bureaucratic Costs of Diversification

 Bureaucratic costs are the costs associated with

 Related diversification is preferred when (1) the

ENTERING NEW INDUSTRIES:

 A company is particularly likely to use acquisitions

 Acquisitions may fail to raise the performance of

 Joint ventures involve two or more companies

 Disadvantages of entering a joint venture:

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