TESTBANK: CHAPTER 13

Diversification Strategy

True/False Questions

1. Diversification has been a key source of value creation for most of the firms that have dared to
expand beyond the boundaries of their own industry.
[See p.342]
a. T
*b. F

2. The dominant trend of the past two decades has been for companies to expand beyond their core
businesses.
[See p.342]
a. T
*b. F

3. Diversification decisions by firms involve two key issues: how attractive is the industry to be
entered and can the firm establish a competitive advantage within it?
[See p.342]
*a. T
b. F

4. Harold Geneen’s statement that: “Telephones, hotels, insurance—it’s all the same. If you know
the numbers inside out, you know the company inside out” reflects the belief that industry specific
knowledge was not important to the corporate management of diversified firms.
[See p.341]
*a. T
b. F

5. The history of diversification features two periods: 1950 to 1980, when the trend was to
diversify, and 1980 to today when most large firms refocused on their core businesses
[See p.344]
*a. T
b. F

6. A major reason for the trend to corporate refocusing after 1980 was a shifting of corporate goals
from growth to profitability.
[See p.344]
*a. T
b. F

7. The primary motive for diversification during the period 1960-1980 was the quest to create
shareholder value.
[See p.344]
a. T
*b. F

©2016 Robert M. Grant 13-1

8. Corporate diversification that reduces the unsystematic risk of a company’s securities will result
in those securities being higher valued by the stock market.
[See p.344]
a. T
*b. F

9. Diversification that reduces the risk of bankruptcy is more beneficial to shareholders than to
managers.
[See p.344]
a. T
*b. F

10. According to Michael Porter, industry attractiveness is a sufficient justification for

diversification.
[See p.347]
a. T
*b. F

11. The critical test of whether diversification will create shareholder value is whether it will
contribute to competitive advantage.
[See p.347]
*a. T
b. F

12. When a firm is diversifying through acquiring a firm in another issue, the critical issue is
whether the synergies that can be realized will offset the acquisition premium paid.
[See p.347]
*a. T
b. F

13. Economies of scope may be viewed as economies of scale that are exploited over multiple
products.
[See p.348]
*a. T
b. F

14. If a utility company supplies both gas and electricity to its customers, it can exploit economies
of scope in billing and customer service.
[See p.348]
*a. T
b. F

15. The potential to exploit economies of scope in common resources is an adequate justification
for diversification.
[See pp.349-350]
a. T
*b. F

©2016 Robert M. Grant 13-2

16. If a company can exploit economies of scope in its intellectual property either through
licensing or through diversification, the transaction costs of licensing are likely to be a major
factor in its choice between the two.
[See p.350]
*a. T
b. F

17. Economies of scope in organizational capabilities can be exploited as effectively through

contractual agreements with firms in anther industry as through diversifying into that industry.
[See p.350]
a. T
*b. F

18. In principle, the information advantages of a diversified company mean that internal capital
markets are more efficient than external capital markets, but in practice internal capital markets
tend to allocate funds to subsidise poor performing subsidiaries.
[See p.351-352]
*a. T
b. F

19. A critical advantage of diversified over specialized firms is in their allocation of human
resources where diversified firms can utilize their superior information on their employees to
allocate individuals according to their proven abilities.
[See p.352]
*a. T
b. F

20. The continuing dominance of conglomerate firms in many emerging countries reflects the
underdeveloped capital and labor markets of these countries.
[See p.353]
*a. T
b. F

21. Empirical evidence on the relationship between diversification and profitability shows that
diversification has a negative impact on profitability.
[See pp.353-354]
a. T
*b. F

22. Empirical studies of the outcomes of corporate refocusing initiatives show that divesting
diversified businesses increases profitability and generates positive returns for shareholders.
[See p.354]
*a. T
b. F

23. One reason for the inconsistent findings over the relative performance of related
diversification and unrelated diversification is uncertainty and imprecision over what constitutes
related diversification
[See p.354]
*a. T

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b. F

24. Tata Group, the Virgin Group, and Berkshire Hathaway each seem to comprise independent
businesses with few relationships with one another, Hence these companies lack strategic logic.
[See p.355]
a. T
*b. F

Multiple Choice Questions

25. Tyco International’s decision to split into three separate companies was motivated by:
[See p.341]
a. The scandal involving its former CEO
*b. The belief that Tyco’s businesses could achieve greater flexibility and growth as independent
companies than as subsidiaries of Tyco
c. The belief that the synergies among Tyco’s businesses were outweighed by the costs of Tyco’s
corporate HQ
d. The recognition that Tyco was subject to a “conglomerate discount.”

26. Diversification decisions by firms involve the following key issues:

[See p.342]
*a. The attractiveness of the industry to be entered and the potential for competitive advantage.
b. The potential for the diversification to increase growth and reduce risk.
c. The opportunities for exploiting economies of scope in resources and capabilities.
d. The benefits of synergy relative to the costs or coordination.

27. The key drivers of diversification during the period 1950-80 were:
[See p.344]
a. Shareholder value maximization.
*b. The quest for growth and risk reduction.
c. The desire to escape mature sectors and enter new, technology-based industries.
d. The quest to exploit economies of scope.

28. The emergence of “conglomerates”—widely diversified companies—during the 1960s and

1970s was a result of:
[See p.344]
a. The desire of companies to escape low growth industries.
*b. The belief that the tools of strategic and financial management could be applied to any type of
business.
c. The willingness of some CEOs to ignore shareholder interests and order to build large corporate
empires.
d. Loose monetary policies that increased the availability of corporate finance.

29. Diversification whose sole impact is to reduce the variability of profits does not create value
for shareholders because:
[See p.346]
a. Shareholders are interested in return more than in risk.
b. The most important risks (such as a global financial crisis or the collapse of the Euro) are
systemic in nature, against which diversification offers little protection.

©2016 Robert M. Grant 13-4

c. The risk which is relevant to stock market valuations is perceived risk--this bears little
relationship to profit variability.
*d. If investors can spread risk by diversifying their portfolios, diversification adds no additional
value in terms of risk spreading.

30. Porter’s “three essential tests” help to determine:

[See pp.346-347]
a. The likely impact of diversification upon risk.
*b. The potential for diversification to create shareholder value.
c. The impact of diversification on stakeholders.
d. How the financial markets would react to a diversification.

31. When diversification combines two businesses in different industrial sectors, the key
determinant of whether the diversification creates value is whether the diversification:
[See p.347]
a. Changes the debt/equity ratio of the combined company.
b. Is between culturally-compatible businesses.
c. Causes management to lose its focus on its core business.
*d. Enhances the competitive advantage of either or both of the two businesses.

32. The continuing prominence of large, highly diversified business groups in many emerging
market countries (e.g. Tata Group in India) is mainly the result of:
[See p.353]
a. The political connections of a few leading business leaders
*b. High transaction costs in capital and labor markets in these countries which favor the
deployment of resources within large diversified corporations ○
c. Barriers to direct investment which protect these companies from overseas competition
d. The failure of emerging market business leaders to appreciate the benefits of refocusing

33. When a company in industry A acquires a company in industry B, Porter’s “better-off” test is
satisfied when:
[See p.347]
a. The competitive advantage of the business B is increased
b. The competitive advantage of business A is increased
*c. The competitive advantage of either or both businesses in increased
d. There are shared resources and capabilities between the two businesses

34. The key difference between economies of scale and economies of scope:
[See p.353
a. Economies of scale relate to manufacturing activities; economies of scope relate to a wide range
of functions.
*b. Economies of scale relate to expanding the output of a single product; economies of scope
relate to expansion across multiple products.
c. There is no practical difference.
d. Scale economies are relevant to business strategy; economies of scope to corporate strategy.

35. Which of the following is not an example of an economy of scope from diversification?
[See pp.348-349]
a. Samsung Group applying its Samsung brand name across a wide range of products.

©2016 Robert M. Grant 13-5

*b. Royal Dutch Shell engaging in forest development in order to offset some of the carbon
dioxide produced by its petroleum business.
c. Amazon using its server capacity to enter cloud computing and web hosting.
d. Fuji Film applying its thin-film, coatings, and polymer technologies not only to photographic
film, but also to cosmetics.

36. The British fashion company, Burberry, is considering diversifying into the hotel business. Its
optimal strategy is to:
[See p.350]
a. Set up its own luxury hotel chain—that way it can appropriate all the profits from the venture
*b. License its brand to an existing hotel operator—that way it can avoid the costs and risks of
having to invest in all the resources and capabilities required by the hotel business
c. Stay away from hotels all together since this business is unrelated to Burberry’s core fashion
business
d. Establish a separate start-up company, Burberry Hotels, in which Burberry Group retains a
minority equity holding

37. Despite the heterogeneity of the goods and services supplied by General Electric (e.g.
locomotives and consumer credit), we can consider GE’s diversification to be into strategically
related industries because:
[See p.355]
a. Most products are supplied under the GE brand.
*b. It applies similar general management capabilities across all its businesses.
c. It operates a balanced portfolio of cash generating and cash using businesses.
d. It is continually looking for opportunities to generate additional revenues from cross-selling and
product bundling.

38. Where do general management capabilities generally reside within the diversified firm?
[See p.355]
*a. At the corporate level
b. At the divisional level
c. At the operational entity level
d. All of these

39. An alternative approach to Porter’s “three essential tests” in evaluating the value-adding
potential of diversification is:
[See p.356
a. The Boston Consulting Group growth-share matrix.
*b. Goold, Campbell and Alexander’s “corporate parenting” framework.
c. The Ansoff matrix.
d. Porter’s value chain analysis.

40. The failure of empirical research to find unambiguous evidence that related diversification
outperforms unrelated evidence points to:
[See p.354]
a. The fact that firm performance is the outcome of many factors of which diversification strategy
is only one.
b. Reverse causation: it may be that poorly performing firms are more likely to take the risk of
unrelated diversification.
c. Difficulties in determining whether diversification is related or unrelated.

©2016 Robert M. Grant 13-6

*d. All of these.

41. What does the expression “conglomerate discount” mean?

[See p.353-354]
a. The ability of a widely diversified firm to exploit economies of scope to reduce its overall costs.
b. The willingness of stock exchanges to offer discounted listing fees in order to attract highly
diversified firms.
*c. The stock market tends to value diversified companies at less than their break-up value.
d. The lower rates of return that highly diversified companies offer to their shareholders.

42. The statement: “Economies of scope in shared resources do not provide a sufficient
justification for diversification” is:
[See pp.349-350]
a. Correct: Cost savings form shared resources are of little value unless there are also
organizational capabilities that can be transferred between the businesses.
*b. Correct: to justify diversification economies of scope need to be supported by transactions
costs in the market for the particular resources.
c. Incorrect: economies of scope are sufficient grounds for diversification on their own.
d. Incorrect: the benefits from economies of scope need to exceed the administrative costs of the
corporate HQ.

43. Which is a more efficient mechanism for allocating capital among different businesses: the
internal capital allocation of diversified firms or the external capital market?
[See p.351]
a. The internal capital allocation process of diversified firms.
b. The external capital market.
c. It depends on the effectiveness of the specific firm’s capital allocation process.
*d. It depends on the effectiveness of the specific firm’s capital allocation process and the
efficiency of the capital market in the country where the firm is located.

44. The internal labor market provides a large, diverse firm with the chance to make savings, by:
[See p.352]
a. Developing senior managers with wide experience
b. Relying less on external recruitment consultants
c. Having first-hand knowledge of a large pool of internal recruits for transfer between businesses
*d. All of these

45. Several decades of empirical evidence indicates that the relationship between diversification
and performance:
[See pp.353-354]
a. Varies between countries
b. Is mainly positive
*c. Is neither consistent nor systematic
d. Is negative unless it is diversification between closely related industries

46. To determine whether a firm’s diversification is related or unrelated, we need to consider:

[See pp.355-356]
a. Whether the businesses are within the same two-digit class of the Standard Industrial
Classification.
b. Whether the two businesses have either common customers or utilize a common technology.

©2016 Robert M. Grant 13-7

*c. Whether the two businesses share some of the same resources and capabilities.
d. Whether the two businesses are in the same stages of their industry life cycles.

47. “Strategic relatedness” (as distinct from “operational relatedness”) in diversification refers to:
[See p.355]
a. The ability to use very different marketing strategies that fit with different countries
b. The ability to sell similar products
*c. The ability to apply similar strategies, resource allocation procedures, and control systems
across the businesses
d. The ability to maximize the allocation of financial resources across the businesses

©2016 Robert M. Grant 13-8