Corporate Diversification Strategy PDF

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Corporate Diversification Strategy Diversification is a form of growth strategy. Growth strategies involve a significant increase in performance objectives (usually sales or market share) beyond past levels of performance. Related and unrelated diversification The link between diversification strategy and firm performance is arguably the most widely researched topic in the field of strategic management (Martinez-Campillo, 2014)

Related Diversification (Horizontal) ● Related to the original business, therefore, the company has a strategic fit with the new business ● E.g. Jonhson & Jonhson providing range of healthcare products, Campbell Soup Company soup, baked goods ● The company is adding or expanding its product line or markets ● Exploiting horizontal relationship ● Achieved through acquisition of competitors or through internal development of new product/services Advantages ●

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Exploit economies of scope - Crossbusiness cost saving opportunities. Occurs whenever it is less costly to perform certain value chain activities for two or more businesses operated under centralised management. Sharing technology, performing R&D together, sharing facilities The greater the economies of scope, the greater the potential of competitive advantage Economies of scale Opportunities to expand product offering and enter geographic areas Capture strategic fit & synergies Strategic fit along value chain - Can convert strategic fit benefits between the value chains of different businesses into competitive advantage over rivals

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Complex V. challenging to co-ordinate different but related businesses

***** Economies of Scope: A Path to Competitive Advantage: One of the most important competitive advantages that a related diversification strategy can produce is lower costs than competitors. Related businesses often present opportunities to consolidate certain value chain activities or use common resources and thereby eliminate costs. Such cost savings are termed economies of scope – a concept distinctly different from economies of scale. Economies of scale are cost savings that accrue directly from a larger-sized operation. Economies of scope stem directly from cost-saving strategic fits along the value chains of related businesses. Most usually, economies of

scope are the result of two or more businesses sharing technology, performing R&D together, using common manufacturing or distribution facilities, sharing a common sales force or distributor/dealer network, or using the same established brand name and/or sharing the same administrative infrastructure. The greater the economies associated with cost-saving strategic fits, the greater the potential for a related diversification strategy to yield a competitive advantage based on lower costs. **Strategic fit exists when the value chains of different businesses present opportunities for crossbusiness resource transfer, lower costs through combining the performance of related value chain activities, cross-business use of a potent brand name, and cross-business collaboration to build new or stronger competitive capabilities.

Unrelated Diversification (conglomerate) ● Business adds a new and unrelated product line and penetrates new markets ● Products/Services are not related ● Risk is spread across diverse businesses ● Willingness to diversify into any industry with a good profit opportunity ● Not searching for strategic fit with the firm’s current business, no meaningful value chain relationships ● Almost always achieved by acquisition rather than forming a startup subsidiary ● Often firms in mature industries pursue this strategy in an effort to continue growth after their core business has matured or started to decline ● Also, to reduce cyclical fluctuations in sales revenues and cash flows ● Firms pursuing unrelated diversification are often referred to as conglomerates Examples ● E.g. Virgin, Textron Inc ● Samsung - LED technology, LCD technology, smartphones, solar cells, biopharmaceuticals, rechargeable batteries for hybrid cars ● Samsung has been successful in diversifying strategy due to a powerful and well- known brand name, advanced technology, extensive distribution network. In horizontal diversification, Company creates or acquires production units for outputs which are alike either complementary or competitive. It is the diversification through establishing structure and systems that are most suitable to itself. The success of the diversification originated from Samsung's creative understanding of Core Competence (Khanna et al., 2011) ● Samsung has become a world leader in R&D https://hbr.org/2011/07/the-globe-theparadox-of-samsungs-rise Advantages ●

Spread business risk- scattered over diverse industries. A superior way to diversify financial risk in comparison to related diversification (less impact if

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The greater the number of businesses a company is in and the more diverse they are, the harder it is for corporate managers to oversee each subsidiary.

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there is a specific industry downturn) Financial resources can be employed to maximum advantage by investing in whatever industries offer the best profit perspectives

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Different competitive environments Cost of entry

Opinions of managers, creditors, and stockholders differ greatly regarding the merits of corporate diversification. For example, managers may want their firm to engage in diversification as a means of reducing firm specific risk that affects the value of their future compensation. Similarly, the firm’s creditors may prefer that the firm diversify its investments to reduce the likelihood of a dip in cash flows that could result in delays in repayment or outright failure to repay loans. At the same time, stockholders who own diversified portfolios of common stocks may not want the firm to diversify if they can do it more cheaply in their individual investment portfolios (Martin & Sayrak, 2001). Related Diversification & cross-business strategic fits along the value chain ● Related diversification involves adding businesses that have value chains that will improve a firm’s competitiveness ● A strategic fit exists when one or more activities along the value chains of different organisations are related ● Strategic fit is all about activities complementing each other in a way to produce a competitive advantage ● Strategic fit offers potential advantages of: - Efficient transfer of key skills, technology or managerial expertise - Lower costs - Ability to share a common brand name - Creation of competitively valuable resource strength and capabilities ● Different types of strategic fit exist - 3 types, ● market related, ● operational and ● management fit R&D and Technology Activities (operational) - Potential for sharing common technology or exploiting the full range of business opportunities associated with a particular technology - Firms with technology sharing benefits can perform better together than apart because of potential cost savings in R&D, shorter times on getting products to market - AT&T’s diversification into cable TV, can provide tv cable service, telephone service and internet access all in one package thanks to diversification

Supply Chain Activities (operational) - Enhanced performance due to skills transfer in procuring materials, greater bargaining power in negotiating with common supply chain partners - Dell and PC component partners Manufacturing Activities (operational) - Can lead to competitive advantage when a company's are expert in quality manufacturing, cost-efficient production or just-in-time inventory practices can be transformed by diversification Distribution Activities (operational) - If they have related distribution activities - possible cost savings in sharing distribution facilities or using the same wholesale distributors or retailers

Market-Related Fits - A variety of cost-saving opportunities (or economies of scope) can arise from market-related strategic fit - Using a single sales force for all related products rather than separate sales forces for each business,advertising related products in the same ads and brochures, using the same brand names, coordinating delivery and shipping, combining after-sale service and repair organizations, coordinating order processing and billing, using common promotional tie-ins (cents-off couponing, free samples and trail offers, seasonal specials, and the like), and combining dealer networks. In addition, market related fit can generate opportunities to transfer selling skills, promotional skills, advertising skills, and product differentiation skills from one business to another Strategic Fits in Managerial and Administrative Support Activities - Often, different businesses require comparable types of skills, competencies, and managerial know-how, thereby allowing know-how in one line of business to be transferred to another. Likewise, different businesses sometimes use the same sorts of administrative support facilities. Unrelated Diversification and shareholder value ● ‘Unrelated diversification is fundamentally a financial approach to creating shareholder value, whereas related diversification is fundamentally strategic’ (Thompson & Strickland, 2001) ● Related diversification is a strategic approach to building shareholder value as it is predicted on exploiting the links between the value chains of different businesses to lower costs, transfer skills and technology expertise across businesses and gain other strategic benefits ● Unrelated d. is predicted on spotting financially attractive business opportunities and entails no cross-business strategic fit opportunities ● A strategy of diversifying into unrelated businesses discounts the value and importance of

the strategic-fit benefits associated with related diversification and instead focuses on building and managing a portfolio of business subsidiaries capable of delivering good financial performance in their respective industry.kkldes ● Companies that pursue a strategy of unrelated diversification generally exhibit a willingness to diversify into any industry where there is potential for a company to realize consistently good financial results. ● The basic premise of unrelated diversification is that any company that can be acquired on good financial terms and that has satisfactory earnings potential represents a good acquisition. ● In order to create shareholder value in unrelated diversification strategists must show favourable financial outcomes ● Diversifying into new businesses that can produce consistently good roi ● Negotiate favorable acquisition prices ● Sell previously acquired businesses at their peak to get premium prices ● Move corporate financial resources out of a business where profit opportunities are dim and into businesses where rapid earning growth and high roi are occuring ● Ways in which the shareholder value has been truly enhanced Building Shareholder Value: The Ultimate Justification for Diversifying ● Diversification must do more for a company than simply spread its risk across various industries. ● In principle, diversification makes good strategic and business sense only if it results in added shareholder value – value shareholders cannot capture through their ownership of different companies in different industries. ● For there to be reasonable expectations that a diversification move can produce added value for shareholders, the move must pass three tests: a. The industry attractiveness test – The industry chosen for diversification must be attractive enough to yield consistently good returns on investment. b. The cost of entry test – The cost to enter the target industry must not be so high as to erode the potential for profitability. c. The better-off test – Diversifying into a new business must offer potential for the company’s existing businesses and the new business to perform better together under a single corporate umbrella than they would perform operating as independent stand-alone businesses. ● Diversification moves that satisfy all three tests have the greatest potential to grow shareholder value over the long term. Diversification moves that can pass only one or two tests are suspect. When to Diversify - Companies that focus on one market - When there are substantial risks that a single business company’s market may dry up or when opportunities to grow revenues and earnings in the industry are decreasing - Managers usually have to make diversifying into other businesses a top consideration. A. Factors that Signal When It is Time to Diversify ● Diversification into other businesses merits strong consideration when:

a. The company is faced with diminishing market opportunities and stagnating sales in its principal business b. It can expand into industries whose technologies and products compliment its present business c. It can leverage existing competencies and capabilities by expanding into businesses where these same resource strengths are valuable competitive assets d. Diversifying into related businesses opens new opportunities for reduced costs e. It has a powerful and well-known brand name that can be transferred to the products of other businesses ● Timing unique to each business situation

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