CHAPTER 8

CORPORATE STRATEGY:
Diversification and the Multibusiness Company
 Learning Objectives
1. Understand when and how business diversification
can enhance shareholder value.
2. Gain an understanding of how related diversification
strategies can produce cross-business strategic fit
capable of delivering competitive advantage.
3. Become aware of the merits and risks of corporate
strategies keyed to unrelated diversification.
4. Gain command of the analytical tools for evaluating
a firm’s diversification strategy.
5. Understand a diversified firm’s four main corporate
strategy options for solidifying its diversification
strategy and improving company performance.
Crafting a Diversified Firm’s Overall Or
Corporate Strategy

Step 1 Picking new industries to enter and deciding on the best mode of entry.

Pursuing opportunities to leverage cross-business value chain

Step 2 relationships and strategic fit into competitive advantage.

Establishing investment priorities and steering corporate resources into

Step 3 the most attractive business units.

Initiating actions to boost the combined performance

Step 4 of the cooperation’s collection of businesses.
 WHEN TO DIVERSIFY
• A firm should consider diversifying when:
– It can expand into businesses whose technologies
and products complement its present business.
– Its resources and capabilities can be used as valuable
competitive assets in other businesses.
– Costs can be reduced by cross-business sharing or
transfer of resources and capabilities.
– Transferring a strong brand name to the products of
other businesses helps drive up sales and profits of
those businesses.
 BUILDING SHAREHOLDER VALUE:
THE ULTIMATE JUSTIFICATION FOR
DIVERSIFYING

Testing Whether a Diversification

Move Will Add Long-Term
Value for Shareholders

The industry
The cost-of-entry The better-off
attractiveness
test test
test
Testing Whether Diversification Will Add
Value for Shareholders
• The Attractiveness Test:
– Are the industry’s returns on investment as
good or better than present business(es)?
• The Cost of Entry Test:
– Is the cost of overcoming entry barriers so
great that profitability is too long delayed?
• The Better-Off Test:
– How much synergy will be gained by
diversifying into the industry?
Better Performance through Synergy

Firm A purchases Firm B in

another industry. A and B’s No
profits are no greater than Synergy
what each firm could have (1+1=2)
Evaluating the earned on its own.
Potential for
Synergy
through
Firm A purchases Firm C in
Diversification
another industry. A and C’s
Synergy
profits are greater than what
each firm could have earned (1+1=3)
on its own.
STRATEGIES FOR ENTERING NEW BUSINESSES

Diversifying into
New Businesses

Internal new
Acquisition Joint venture
venture (start-up)
Acquisition of an Existing Business
• Advantages:
– Quick entry into an industry
– Barriers to entry avoided
– Access to complementary resources and capabilities
• Disadvantages:
– Cost of acquisition—whether to pay a premium for a
successful firm or seek a bargain in struggling firm
– Underestimating costs for integrating acquired firm
– Overestimating the acquisition’s potential to deliver
added shareholder value
Internal Development: Corporate Venturing

• Advantages of New Venture Development:

– Avoids pitfalls and uncertain costs of acquisition.
– Allows entry into a new or emerging industry where
there are no available acquisition candidates.
• Disadvantages of Entrepreneurship:
– Must overcome industry entry barriers.
– Requires extensive investments in developing
production capacities and competitive capabilities.
– May fail due to internal organizational resistance to
change and innovation.
When to Engage in Internal Development

Ample time to
develop and
launch business
Availability of in- Cost of acquisition
house skills and is higher than
resources internal entry

Factors Favoring Internal

Development

No head-to-head Added capacity

competition in will not affect
targeted industry supply and
Low resistance demand balance
of incumbent
firms to market
entry
When to Engage in a Joint Venture

Is the opportunity too complex, uneconomical,

or risky for one firm to pursue alone?

Evaluating
Does the opportunity require a broader range
the
of competencies and know-how than the firm
Potential
now possesses?
for a Joint
Venture
Will the opportunity involve operations in a
country that requires foreign firms to have a
local minority or majority ownership partner?
Choosing a Mode of Market Entry

The Question of Critical Resources Does the firm have the resources and
and Capabilities capabilities for internal development?

The Question of
Are there entry barriers to overcome?
Entry Barriers

The Question of Is speed an important factor in the firm’s

Speed chances for successful entry?

The Question of Which is the least costly mode of entry, given

Comparative Cost the firm’s objectives?
CHOOSING THE DIVERSIFICATION
PATH: RELATED VERSUS
UNRELATED BUSINESSES

Which Diversification
Path to Pursue?

Both Related
Related Unrelated
and Unrelated
Businesses Businesses
Businesses
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.
 STRATEGIC FIT AND
DIVERSIFICATION
INTO RELATED BUSINESSES
• Strategic Fit Benefits
– Occur when the value chains of the different
businesses present opportunities for:
• Transfer of resources among businesses.
• Lowering of costs in combining related value
chain activities or resource sharing.
• Use of a potent brand name across businesses.
• Cross-business collaboration to build stronger
competitive capabilities.
Pursuing Related Diversification
• Specialized Resources and Capabilities
– Have very specific applications and their use
is limited to a restricted range of industry and
business types.
• Generalized Resources and Capabilities
– Can be widely applied and can be deployed
across a broad range of industry and
business types.
Identifying Cross-Business Strategic Fit
along the Value Chain
Supply Chain
Activities
R&D and Manufacturing-
Technology Related Activities
Activities

Potential
Cross-Business Fits

Sales and
Marketing Distribution-
Activities Related Activities

Customer
Service Activities
 Strategic Fit, Economies of Scope,
and Competitive Advantage

Using Economies of Scope to Convert

Strategic Fit into Competitive Advantage

Combining Leveraging Using cross-

Transferring
related value brand names business
specialized and
chain activities and other collaboration
generalized skills
to achieve differentiation and knowledge
and\or knowledge
lower costs resources sharing
 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.
DIVERSIFICATION INTO UNRELATED BUSINESSES

Can it meet corporate targets

for profitability and return on
investment?
Evaluating the
acquisition of a
Is it is in an industry with
new business or
attractive profit and growth
the divestiture of
potentials?
an existing
business
Is it is big enough to contribute
significantly to the parent firm’s
bottom line?
 Building Shareholder Value via
Unrelated Diversification

Using an Unrelated Diversification

Strategy to Pursue Value

Cross-Business Acquiring and

Astute Corporate
Allocation of Restructuring
Parenting by
Financial Undervalued
Management
Resources Companies
 Building Shareholder Value via
Unrelated Diversification

Astute Corporate • Provide leadership, oversight, expertise, and guidance.

Parenting by • Provide generalized or parenting resources that lower operating
Management costs and increase SBU efficiencies.

Cross-Business • Serve as an internal capital market.

Allocation of • Allocate surplus cash flows from businesses to fund the capital
Financial
requirements of other businesses.
Resources

Acquiring and • Acquire weakly performing firms at bargain prices.

Restructuring • Use turnaround capabilities to restructure them to increase
Undervalued
their performance and profitability.
Companies
 The Drawbacks of Unrelated
Diversification

Pursuing an Limited
Demanding
Unrelated Competitive
Managerial
Diversification Advantage
Requirements
Strategy Potential

Monitoring and Potential lack of

maintaining cross-business
the parenting strategic-fit
advantage benefits
 EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY

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 firm’s business
units within their respective industries.
3. Checking the competitive advantage potential of cross-
business strategic fit among the firm’s various business
units.
4. Checking whether the firm’s resources fit the requirements of
its present business lineup.
5. Ranking performance prospects of the businesses and
determining the parent firm’s priority for allocating resources
to its businesses.
6. Crafting strategic moves to improve corporate performance.
 8.2 Calculating Weighted Competitive Strength Scores
for a Diversified Company’s Business Units*

* Rating scale: 1 = very weak; 10 = very strong.

Relative market share: the ratio of a business unit’s market share to the market share of its
largest industry rival as measured in unit volumes, not dollars.
 8.3
A Nine-Cell Industry
Attractiveness–
Star
Competitive Strength
Matrix

Cash
cow

Note: Circle sizes are scaled to reflect

the percentage of companywide
revenues generated by the business
unit.
8.4 Identifying the Competitive Advantage Potential
of Cross-Business Strategic Fit