Module 6, Quiz 6 - Sharon Watson PDF

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Sharon Watson...

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Lecture -Module 6: Diversification ● Corporate Strategy & Diversification ○ Why Diversify? ■ To enhance firm value ● Are businesses worth more together than they would be apart? ● Does corporate management add value in some way? ○ Unrelated & Related Diversification ○ Evaluating Diversification Strategies ■ Industry Attractiveness -Business Strength Portfolio Matrix ■ Value Chain Cost Sharing/Skill Transfer ○ Going to discuss companies that compete in multiple different businesses --corporate strategy Diversification and Firm Value: ● Unrelated Diversification ○ Finance driven, approach to creating value ○ No common linkage sought among firm’s businesses ○ Corporate strategy: Acquire any businesses that will generate profits ○ Acquire, restructure, keep or sell off for a profit ○ Conglomerates -companies made up of different businesses with little or no relation between them ○ Advantages of unrelated diversification ■ Risk minimization ■ Can invest capital in industries with best profit prospects ■ Shareholder wealth can be enhanced through restructuring -Bargains with big profit potential ○ Disadvantages of unrelated diversification ■ Big demand on corporate management ● Diversity of industries/business needs, bureaucratic costs ■ Performance tends to be no better than sum of individual businesses, usually worse ■ Stability over businesses is seldom realized ●

Portfolio Analysis -for unrelated diversification ○ Tool for evaluating the set of businesses in a company’s portfolio ■ Matrix analysis ■ Various types ■ BCG growth-share matrix

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Attractiveness of industry ○ Market size, growth rate, profit margin, competition/rivalry, tech & capital requirement, social trends, regulation, barriers to exit/entry, opportunities & threats ○ Rating as highly attractive, moderately attractive or low in attractiveness Business strength ○ Market share, profit margin, product/service offerings, relative costs, knowledge, technology, management skills compared to competitors in the industry ○ Rate strength as strong, average or weak Each business then plotted on matrix depending on attractiveness of industry and business strength:

Businesses falling if they should grow ot let go -depend where other companies in the business falls ○ If many companies are in harvest region, might want to grow ○ If many companies are strong or selective growth, might want to let go Gives management idea of what to do in its businesses Weaknesses of matrix analysis ○ Difficult to manager large set of diver businesses ○ Misleading simplification ○ Evaluates each business in isolation ○ Does not address how value is created across businesses Related diversification

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Strategy driven, approach to creating value Building value through synergy (-total greater than sum of the parts) ■

Synergy through cost sharing ● Operations Related Opportunities ○ Joint procurement common suppliers ○ Common materials handling ○ Shared manufacturing facilities ● Management Related Opportunities ○ Shared R&D activities ○ Shared corporate infrastructure ■ Legal, HR (recruiting, training benefits), Accounting & Finance ● Market Related Opportunities ○ Shared brand name ■ Ex: Disney -theme parks, media networks, retail stores, film studios -most but not all share brand name “Disney” -shares cost of branding across businesses ○ Shared distribution channels ■ Pepsico -owns frito lay and quaker oats and gatorade, etc. sells products in same retail outlets so share distribution channels ○ Shared sales force ○ Shared order processing ○ Shared promotional activities ■ Ex: pepsico advertises pepsi and frito products in same ads especially during sports game

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Synergy through skill transfer ● Transferring a valuable skill/knowledge across businesses ○ Quality/production methods ○ Low costs methods ○ Corporate culture/employee management techniques ○ Government relations -especially in international businesses ○ Knowledge of a foreign culture from doing business there ○ Marketing concepts and ideas

Value Chain Analysis

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Cost sharing vs. skill transfer Potential opportunities across business for synergy -cost sharing or skill transfer: ■ Ex: 1 corporation made up fo 5 business units, can share different activities that they have in common -are they better of together or should they be 2 separate companies ● Technology -if it is widely held-not a competitive advantage and might perform better if taking operational components as 1 company separate from others that do not ● Or if technology very unique to company might work better together as one to keep that skill and knowledge

Capturing the Benefits of Strategic Fit ● Management actions to capture potential synergies ● Reorganize to merge activities across businesses ● Personnel to facilitate transfer of skills ● Very difficult to achieve why many mergers fail Enhancing Corporate performance through diversification ● Combine portfolio analysis with value chain ‘fits’ analysis ● Alter strategic plans for one, or all businesses ○ Resource allocation ○ Add new businesses ○ Diver businesses -weak performing units, those that lack strategic fit ● Businesses should ○ Contribute to corporate objectives -financially or strategically ○ Enhance firm’s overall worth ● Quiz 6

Why diversify? To enhance firm value

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To create value for shareholders via diversification, a company must ○ Diversify into businesses that can perform better under a single corporate umbrella than they could perform operating as independent, stand alone businesses Diversification merits strong consideration whenever a single-business company ○ Is faced with diminishing market opportunities and stagnating sales in its principal business Businesses are said to be “related” when ○ Their value chains possess competitively valuable cross business relationships that present opportunities to transfer skills and capabilities from one business to another, share resources or facilities to reduce costs, share use of a well known brand name and or create mutually useful resource strengths and capabilities The essential requirements for different businesses to be related is that ○ Their value chains possess competitively valuable cross-business fit relationships Which of the following is not likely to command much strategic attention from the top executives of companies pursuing an unrelated diversification strategy? ○ Looking for new businesses that present good opportunities for achieving economies of scope Which of the following is NOT one of the suggested appeals of an unrelated diversification strategy? ○ Superior top management ability to cope with the wide variety of problems encountered in managing a broadly diversified group of businesses Which of the following is not a major consideration in evaluating the pluses and minuses of a diversified company’s strategy ○ Scruitizing each industry/business to determine where driving forces are strongest/weakest and how many profitable strategic groups the company has diversified into Cross-business strategic fits can be found ○ Anywhere along the respective value chains of related businesses When industry attractiveness ratings are calculated for each of the industries a multibusiness company has diversified into, the results help indicate ○ Which industries appear to be the most and least attractiveness from the standpoint of the company’s long term performance The businesses in a diversified company’s lineup exhibit good resource fit when ○ Individual businesses add to a company’s resource strengths and when a company has the resources to adequately support the requirements of its businesses as a group without spreading itself too thin

Chapter 8-Textbook:

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Crafting a Diversification Strategy -What does that entail? ○ A diversified company’s overall corporate strategy involved 3 distinct facets: 1. Picking new industries to enter and deciding on the means of entry 2. Pursuing opportunities to leverage cross business value chain relationships, where there is strategic fit, into competitive advantage 3. Initiating actions to boost the combined performance of the corporation’s collection of businesses When to consider diversifying ○ No urgency as long as company has plentiful opportunities for profitable growth in its present industry ○ Growth opportunities often limited in mature industries and markets where buyer demand is flat or declining ○ Changing industry conditions -new technology, inroads by substitute products, fast shifting buyer preferences or intensifying competition can undermine ability to deliver ongoing gains in revenues and profits ■ Ex: phone providers -AT&T whenever a single business company encounters diminishing market opportunities and stagnating sales in principle business ● can diversify into closely related businesses or totally unrelated businesses Building shareholder value ○ Diversification must do more than just spread its business risk across various industries ○ Is not justifiable unless it results in: added long term economic value for shareholders -value shareholders can’t capture on their own by purchasing stock in companies in different industries or investing in mutual funds to spread investments Test of corporate advantage: 1. Industry attractiveness test 2. The cost of entry test 3. The better off test Approaches to diversifying ○ 3 forms: acquisition, internal startup, join ventures with other companies Acquisition ○ Quicker than trying to launch a new operation ○ Effective way to hurdle entry barriers -acquire technological know-how, establish supplier relationships, achieve scale economies, build brand awareness, secure adequate distribution, access resources and capabilities ○ Allows buyer to move directly to building a strong market position in target industry rather than trying to develop the knowledge, experience, scale of operation, market reputation to be an effective competitors ○ Acquisition premium / control premium: amount by which price offered excess the pre acquisition market value or stock price of target company Internal Development

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Starting new business subsidiary from scratch ■ Is generally time consuming, uncertain process ■ Avoids pitfalls via acquisitions and may result in greater profits in the end ■ Viable means of entering a new or emerging industry where there are no good acquisition candidates Corporate venture or new venture development: process of developing new businesses as an outgrowth of a company’s established business operations. Referred to as corporate entrepreneurship or intrapreneurship since it requires entrepreneurial like qualities within a larger enterprise Risks/disadvantages ■ Entry barriers, invest in new production capacity, develop sources of supply, hire and train employees, build channels of distribution, grow customer base, etc. Appeal for internal development when: ■ Parent company already has in house resources and capabilities needed ■ Ample time to launch ■ Internal costs of entry lower than cost via acquisition ■ Adding new production capacity will not adversely impact supply demand balance in industry ■ Incumbent firms likely to be slow or ineffective in responding to new entrants efforts

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Joint Ventures ○ To pool resources and competencies of two or more company scan be wiser and less risky in some cases ○ Useful when: ■ Good vehicle for pursuing an opportunities too complex, uneconomical of risky for 1 company alone ■ When opportunities in new industry require broader range of competencies and know how than on its own ■ Many of the opportunities in satellite-based telecommunications, biotechnology and network based systems that blend hardware, software, and services call for coordinated development of complementary innovations to tackle financial, technical, political and regulatory factors simultaneously ■ When diversification moves entails having operations in a foreign country ○ Risks/disadvantages: ■ How to best conflicting objectives, operate the venture, culture clashes, etc.

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How to choose best way to enter a new businesses depends on 4 questions:

1. Does the company have all resources and capabilities required to enter business through internal development or is it lacking some critical resources? 2. Are there entry barriers to overcome? 3. Is speed an important factor in the firm’s chances for successful entry? 4. Which is the least costly mode of entry, given company objectives? ●

Related vs. Unrelated Businesses Diversification ○ Related Businesses: possess competitively valuable cross-business value chain and resource commonalities ■ Building company around businesses where there is a good strategic fit across corresponding value chain activities ■ Strategic fit: exists whenever one or more activities constituting the value chains of different businesses are sufficiently similar to present opportunities for cross business sharing or transferring of resources and capabilities that enable these activities ○ Cross Business Strategic Fit ■ Can exist anywhere along the value chain -in R&D and technology activities, supply chain activities and relationships with suppliers, manufacturing, sales and marketing, distribution activities, customer service activities ● Economies of scope and competitive advantage: ○ Cost savings that flow from operating in multiple businesses (a larger scope of operation) They stem directly from strategic fit along value chains of related businesses ○ (distinctly different from economies of scale -cost savings that accrue directly from larger sized operation) ○

Unrelated Businesses: have dissimilar value chains and resource requirements, with no competitively important cross-business commonalities at the value chain level ■ Often exhibit a willingness to diversify into any business in any industry where senior managers see an opportunity to realize consistently good financial results ■ Conglomerates -business interests range broadly across diverse industries -nearly always enter new business by acquiring established company rather than internal development or joint venture ■ Key to success: to create economic value for shareholders ■ Acquisition potential if passes industry-attractiveness and cost of entry tests and if it has good prospects for attractive financial performance. Will evaluate using criteria such as: ● Whether business can meet corporate targets for profitability and return on investment

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Whether business in an industry with attractive growth potential Whether business is big enough to contribute significantly to parent firm’s bottom line ■ Better- off test ● Requires growth in profits beyond what could be achieved by a mutual fund of holding company that owns shares of the business without adding any value Corporate parenting: ■ Refers to role that a diversified corporation plays in nurturing its component businesses through provision of top management, expertise, disciplined control, financial resources and other types of general resources and capabilities such as long-term planning systems, business development skills, management development processes and incentive systems Umbrella brand ■ Corporate brand name that can be applied to a wide assortment of business types. Type of general resource that can be leveraged in unrelated diversification Greater shareholder value through unrelated diversification ■ Tests of Corporate Advantage: 1. Diversify into industries where businesses can product consistently good earnings and returns on investment (satisfy industry attractiveness test) 2. Negotiate favorable acquisition prices (satisfy cost of entry test) 3. Do a superior job of corporate parenting via high level managerial oversight and resource sharing, financial resource allocation and portfolio management, and or restructuring of underperforming businesses (satisfy better-off test)

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Parenting advantage ○ When company is more able than others to boost combined performance of its individual business through high level guidance, general oversight and other corporate-level contributions

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Disadvantages/drawbacks of unrelated diversification ○ Challenging and very difficult ○ Problems arise if things start to go awry in a business and corporate management has to get deeply involved in problems of a business it does not know much about ○ Relying solely on leveraging general resources and expertise of corporate executives to wisely manage a set of unrelated business is a much weaker foundation for enhancing shareholder value than is a strategy of related diversification Misguided reasons for pursuing unrelated diversification ○ Risk reduction

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Growth Stabilization Managerial motives ■ Only profitably growth-the kind that comes from creating added value for shareholders-can justify a strategy of unrelated diversification

Evaluating strategy of a diversified company ○ Procedure for evaluating pluses and minuses of a diversified company’s strategy and deciding what actions to take to improve a company’ performance involves 6 steps: Assessing attractiveness of industries company has diversified into, both individually and as a group a. Does each industry the company has diversified into represent a good market for the company? Does it pass the industry attractiveness test? Which industries are most attractive/which are least attractive? How appealing is the whole group of industries in which company has invested? Assessing competitive strength of company’s business units and drawing a nine-cell matrix to simultaneously portray industry attractiveness and business unit competitive strength a. Relative market share, cost relative competitor;s cost, ability to match or beat rivals on key product attributes, brand image and reputation, other competitively valuable resources and capabilities, ability to benefit from strategic fit with other business units, ability to exercise bargaining leverage with key suppliers or customers, profitability relative to competitors Evaluating extent of cross-business strategic fit along value chains of company’s various business units a. How much competitive value can be generated from whatever strategic fit exists Checking where firm’s resources fit requirements of present business lineup a. Good Resource Fit for related businesses : when firm’s businesses have wellmatched specialized resource requirements at points along their value chain i. For unrelated businesses: when company has solid parenting capabilities or resources of general nature that it can share or transfer to its component business b. Financial resource fit- if company can generate internal cash flows sufficient to fund capital requirements i. Internal capital market: allows diversified company to add value by shifting capital from business units generating free cash flow to those needing additional capital to expand and realize their growth potential ii. Portfolio approach: based on different businesses have different cash flow and investment characteristics iii. Cash hog: business generates cash flows that are too small to fully fund its growth; requires cash infusions to provide additional working capital and finance new capital investment

5. Ranking performance prospects of businesses from best to worst and determining what corporate parent’s priorities should be in allocating resources to its various businesses a. Business subsidiaries with brightest profit and growth prospects, attractive positions in nine-cell matrix and solid strategic and resource fit should receive top priority for allocat...