Diversification Strategies for Managing a Group of BusinessesStrategic Management

Diversification and Corporate Strategy A company is diversified when it is in two or more lines of business that operate in diverse market environmentsStrategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single line of business A diversified company needs a multi-industry, multi-business strategyA strategic action plan must be developed for several different businesses competing in diverse industry environments

Four Facets of Diversified Strategy Picking new industries to enter and deciding on the means of entry- what industry to get in- starting a new business from the ground up- acquiring a company already in the target industry- forming a joint venture or strategic alliance with another company- diversify narrowly in few industries or broadly into many industries

Four Facets of Diversified Strategy2. Initiating actions to boost the combined performance of the businesses the firm has already enteredCorporate parents can help their business subsidiaries by:- providing financial resources- supplying missing skills, technological know-how, and managerial expertise to better perform key value chain activities- providing new avenues for cost reduction- can acquire another company in the same industry and merge the two operations into a stronger business- can acquire new businesses that strongly complement existing businessTypically, a company will pursue:- rapid growth strategies in its most promising businesses- initiate turn around efforts in weak performing businesses with potential- divest businesses that are no longer attractive or that do not fit into managements long range plans

Four Facets of Diversified Strategy3. Pursuing opportunities to leverage cross business value chain relationships and strategic fits into competitive advantageCompetitive advantage of businesses that diversify with value chain matchups vs. those with unrelated value chain activitiesCapturing this competitive advantage requires that corporate strategies capitalize on:- transferring skills or technology- reducing costs via sharing common facilities and resources- using well known brand names and distribution muscle to grow the sales of new products

Four Facets of Diversified StrategyEstablishing investment priorities and steering corporate resources into most attractive business unitsA diversified companys all businesses are not equally attractive from the stand point of investing fundsIt is incumbent on corporate management to:Decide on priorities for investing capital in the companys different businesses Channel resources into areas where earning potentials are higher and away from areas where they are lowerDivest business units which are chronically poor performers or are in an increasingly unattractive industry

It is faced with diminishing growth prospects in present businessIt has opportunities to expand into industries whose technologies and products complement its present businessIt can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factorsIt can expand at an attractive low cost by diversifyinginto closely related businessesIt has a powerful brand name which can be transferred to products of other businesses to increase sales and profits of these businessesWhen Should a Firm Diversify?

Why Diversify?To build shareholder value!

A move to diversify into new business must pass three testsThe industry attractiveness test- must be attractive to yield consistently good returns on investment- industry and competitive conditions conducive for earning good or better profits and ROI than the company is earning in its present situation 1 + 1 = 3

Why Diversify?2. Cost of entry testThe cost to enter the target market should not be so high that it erodes the potential of good profitabilityA catch 22 situation prevails here:The more attractive the industry prospects are for growth and long term profitability, the more expensive it can be to get intoEntry barriers for start-up companies are likely to be high in attractive industriesThe cost of entry should at least assure the targeted ROI

Why Diversify?3. The better-off testThe companys different businesses should perform better together than as stand-alone enterprises, such that company As diversification into business B produces a 1 + 1 = 3 effect for shareholders

Strategies for EnteringNew Businesses

Acquisition of an Existing CompanyMost popular approach to diversificationAdvantages Quicker entry into target marketEasier to overcome certain entry barriersAcquiring technological know-howInheriting supplier relationshipsBecoming big enough to match rivals efficiency and costsNot having to spend large sums on introductory advertising and promotionSecuring adequate distribution access

Internal StartupMore attractive whenParent firm already has most of the needed resources to build a new businessAmple time exists to launch a new businessInternal startup has lower cost than entry via acquisitionNew startup does not have to go head-to-head against powerful rivalsIncumbents are slow in responding to new entry

Good way to diversify whenIt is highly expansive or risky to go it alonePooling competencies of two partners provides more competitive strengthGain entry into a desirable foreign marketForeign partners are needed toSurmount tariff barriers and import quotasOffer local knowledge aboutMarket conditionsCustoms and cultural factorsCustomer buying habitsAccess to distribution outletsJoint Ventures and Strategic Partnerships

Raises questionsWhich partner will do what? Who has effective control?Potential conflictsConflicting objectivesDisagreements over how best to operate the ventureCulture clashesDrawbacks of Joint Ventures

Related DiversificationInvolves diversifying into businesses whose value chains possess competitively valuable strategic fits with value chain of firms present business

Unrelated DiversificationInvolves diversifying into businesses with no competitively valuable value chain match-ups or strategic fits with firms present businessRelated vs. Unrelated Diversification

Strategy Alternatives for a Company Looking to Diversify

The Case for Diversifying into Related Businesses Transferring competitively valuable expertise, technological know-how, or other capabilitiesCombining the related value chain activities of separate businesses into single operations to achieve lower costs- manufacture products of different businesses in a single plant- use the same warehouse for shipping and distribution- have a single sales force for the products of different businesses because they are marketed to the same type of customers Exploiting common use of well known and potent brand name Cross business collaboration to create competitively valuable resource strengths and capabilities

Exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for Transferring competitively valuable expertise or technological know-how from one business to anotherCombining performance of common value chain activities to achieve lower costsExploiting use of a well-known brand nameCross-business collaboration to create competitively valuable resource strengths and capabilitiesCore Concept: Strategic Fit

Related Businesses Possess Related ValueChain Activities and Competitively Valuable Strategic Fits

Strategic Appeal of Related DiversificationReap competitive advantage benefits ofSkills transferLower costsCommon brand name usageStronger competitive capabilitiesSpread investor risk over a broader baseAchieve consolidated performance greater than the sum of what individual businesses can earn operating independently (1 + 1 = 3 outcomes)

Types of Strategic FitsStrategic fits in R&D and Technology Activities- sharing common technology-exploiting the full range of business activities with a particular technology and its derivates- transferring technological know-how from one business to another- cost savings in R&D- shorter times in getting new products to the marketExample - technological innovations being the driver behind the efforts of cable TV companies to diversify into high speed internet access via the use of cable modems

Types of Strategic FitsStrategic Fits in Supply Chain Activities- potential for skill transfer in procuring materials- greater bargaining power in negotiating with common suppliers- added leverage with shippers in securing volume discounts on inbound logistics- added collaborations with common supply chain partnersExample Dell Computers strategic partnership with leading suppliers of microprocessors, motherboards, disc drives, memory chips etc. have been an important element of the companys strategy to diversify into servers, data storage devices, MP3 players, and LCD Monitors

Types of Strategic Fits3. Manufacturing-Related Strategic Fits- expertise in quality manufacturing and cost efficient methods can be transferred to another business- ability to consolidate production into smaller number of plants and significantly reduce the overall costsExampleWhen Snowmobile maker Bombardier diversified into motorcycles market, it was able to set up motorcycle assembly lines in the same plant

Types of Strategic FitsDistribution-Related Strategic Fits- potential cost saving in sharing the same distribution facilities- using many of the same wholesale distributors and retail dealers to access customers- the same distribution centers can be used- using single sales force- promoted through same web siteExampleCorporates in the FMCG industry like P&G, Unilever, have been using this strategic fit with remarkable success

Types of Strategic Fits5. Strategic Fits in Managerial and Administrative Support ServicesOften different businesses require comparable types of managerial know-how which can be used in expanding into new businesses or in new geographic marketsExampleAn electric utility company that diversifies into natural gas, water, appliance sales, or home security can use the same: - customer data network,- customer call centers and local offices- billing and customer accounting systems- customer service infrastructure

Strategic Fit, Economies of Scope and Competitive Advantage Strategic FitThe opportunity to convert cross business strategic fits into competitive advantage over business rivals makes related diversification an attractive strategyThe greater the relatedness among diversified companys sister businesses, the bigger the window for converting strategic fits into competitive advantage via:Skills transferCombining related value chain activities to achieve lower costsLeveraging use of a well respected brand nameCross business collaboration to create new resource strengths and capabilities

Strategic Fit, Economies of Scope and Competitive AdvantageEconomies of Scope: A path to Competitive AdvantageOne of the most important competitive advantages of related diversification is its ability to produce lower cost than competitorRelated diversification presents opportunities to eliminate or reduce costs of performing certain value chain activities; such cost savings are termed economies of scope Economies of Scope are cost reductions that flow from operating in multiple businesses; such economies stem directly from strategic fit efficiencies along the value chains of related businessesGreater the cross business economies associated with cost saving strategic fits, higher the potential for related diversification strategy to yield a competitive advantage based on lower costs than rivals.

Strategic Fit, Economies of Scope and Competitive advantageFrom Competitive Advantage to Added Profitability and Gains in Shareholder value There are three things to bear in mind:Capturing cross-business strategic fits via a strategy of related diversification builds share holder value in ways that share holder cannot undertake by simply owning a portfolio of stocks in different companies The capture of cross-business strategic fit benefits is possible only via a strategy of related diversificationThe benefits of cross-business strategic fits are not automatically realized when a company diversifies into related businesses; the benefits materialize only after management has successfully pursued internal actions to capture them

Involves diversifying into businesses withNo strategic fitNo meaningful value chain relationshipsNo unifying strategic themeBasic approach Diversify into any industry where potential exists to realize good financial results While industry attractiveness and cost-of-entry tests are important, better-off test is secondaryWhat Is Unrelated Diversification?

Fig. 9.3: Unrelated Businesses Have Unrelated Value Chains and No Strategic Fits

Acquisition Criteria For Unrelated Diversification StrategiesCan business meet corporate targets for profitability and ROI?Is business in an industry with growth potential?Is business big enough to contribute to parent firms bottom line?Will business require substantial infusions of capital?Is there potential for union difficulties or adverse government regulations?Is industry vulnerable to recession, inflation, high interest rates, or shifts in government policy?

Business risk scattered over different industriesFinancial resources can be directed to those industries offering best profit prospectsIf bargain-priced firms with big profit potential are bought, shareholder wealth can be enhancedStability of profits hard times in one industry may be offset by good times in another industryAppeal of Unrelated Diversification

Key Drawbacks ofUnrelated DiversificationDemanding Managerial RequirementsLimited Competitive Advantage Potential

Dominant-business firmsOne major core business accounting for 50 - 80 percent of revenues, with several small related or unrelated businesses accounting for remainderNarrowly diversified firmsDiversification includes a few (2 - 5) related or unrelated businessesBroadly diversified firmsDiversification includes a wide collection of either related or unrelated businesses or a mixtureTypes of Diversified Firms

Fig. 9.4: Identifying a Diversified Companys Strategy

How to Evaluate aDiversified Companys StrategyStep 1: Assess long-term attractiveness of each industry firm is inStep 2: Assess competitive strength of firms business unitsStep 3: Check competitive advantage potential of cross-business strategic fits among business units Step 4: Check whether firms resources fit requirements of present businessesStep 5: Rank performance prospects of businesses and determine priority for resource allocation Step 6: Craft new strategic moves to improve overall company performance

Step 1: Evaluate Industry AttractivenessAttractiveness of eachindustry in portfolioEach industrys attractiveness relative to the othersAttractiveness of allindustries as a group

Evaluating Industry Attractiveness Relative to others

Industry Attractiveness FactorWeightRatingRating ARating BMarket Size and projected growthIntensity of competitionEmerging opportunities and threatsSeasonal cyclical factorsResource requirementsPresence of cross industry strategic fits and resource fitsIndustry profitabilitySocial, regulatory and environmental factorsIndustry uncertainty and business fits

ObjectivesAppraise how well each business is positioned in its industry relative to rivalsEvaluate whether it is or can be competitively strong enough to contend for market leadershipStep 2: Evaluate Each Business-Units Competitive Strength

Competitive Strength of Each of the Companys Business Units

Competitive strength measureWeightRatingSBU1SBU2Relative market shareCosts relative to competitorsAbility to match rivals on key product attributesBargaining leverage with suppliers/ buyersStrategic-fit relationships with sister businessesTechnology and innovation capabilitiesHow well resources are matched to industry key success factorsBrand name reputation/imageDegree of profitability relative to competitors

Fig. 9.5: A Nine-Cell Industry Attractiveness-Competitive Strength Matrix

Develop GE MatrixDivisionSales % salesProfits% profitI. A. SC. Strength$100 25.0 10 .50 3.2 3.6 2 200 50.0 5 25 3.5 2.1 3 50 12.5 4 20 2.1 3.1 4 50 12.5 1 5 2.5 1.8

Grand Strategy MatrixSlow Market GrowthWeak Competitive PositionRapid Market GrowthStrong Competitive PositionQuadrant 1Market developmentProduct developmentIntegrationRelated diversificationQuadrant ivRelated DiversificationUnrelated DiversificationQuadrant IIMarket DevelopmentProduct DevelopmentHorizontal IntegrationDivesture/ Liquidation

Quadrant IIIRetrenchmentDiversificationDivesture/ Liquidation

Prentice Hall, 2000Chapter 6*BCG Growth-Share MatrixSource: B. Hedley, Strategy and the Business Portfolio, Long Range Planning (February 1997), p. 12. Reprinted with permission.

Chapter 6

BCG Matrix Example

DivisionRevenuePercent Rev.Profits% profitRMS% Growth12345$60,00040,00040,00020,0005,000372424120310,0005,00020008,000 5003920083102.80.40.10.60.05+15+10+1-20-10

Total165,00010025,500100

ObjectiveDetermine competitive advantage potential of cross-business strategic fits among portfolio businessesExamine strategic fit based onWhether one or more businesses have valuable strategic fits with other businesses in portfolioWhether each business meshes well with firms long-term strategic directionStep 3: Check Competitive Advantage Potential of Cross-Business Strategic Fits

Fig. 9.6: Identifying Competitive AdvantagePotential of Cross-Business Strategic Fits

ObjectiveDetermine how well firms resources match business unit requirementsGood resource fit exists when:A business adds to a firms resource strengths, either financially or strategicallyFirm has resources to adequately support requirements of its businesses as a groupStep 4: Check Resource Fit

Internal cash flows are inadequate to fully fund needs for working capital and new capital investmentParent company has to continually pump in capital to feed the hogStrategic optionsAggressively invest in attractive cash hogsDivest cash hogs lacking long-term potentialCharacteristics of Cash Hog Businesses

Generate cash surpluses over what is needed to sustain present market positionSuch businesses are valuable because surplus cash can be used to Pay corporate dividendsFinance new acquisitionsInvest in promising cash hogsStrategic objectivesFortify and defend present market positionKeep the business healthyCharacteristics of Cash Cow Businesses

Step 5: Rank Business Units Based onPerformance and Priority for Resource Allocation Factors to consider in judging business-unit performanceSales growthProfit growthContribution to company earningsReturn on capital employed in businessEconomic value addedCash flow generationIndustry attractiveness and business strength ratings

Fig. 9.7: The Chief Strategic and Financial Options for Allocating a Diversified Companys Financial Resources

Stick closely with existing business lineup and pursue opportunities it presentsBroaden companys business scope by making new acquisitions in new industriesDivest certain businesses and retrench to a narrower base of business operationsRestructure companys business lineup, putting a whole new face on business makeupPursue multinational diversification, striving to globalize operations of several business unitsStep 6: Craft New StrategicMoves Strategic Options

Fig. 9.8: A Companys Four Main Strategic Alternatives After It Diversifies

Corporate ParentingMulti-business companies create value by influencing or parenting businesses they own. The best parent companies create more value than any of their rivals would if they owned the same businesses. These companies have parenting advantageCorporate parenting generates corporate strategy by focusing on the core competencies of the parent corporation and on the value created from relationship between the parent and its businessesIf there is a good fit between the parents skills and resources and the needs and opportunities of the business units, the corporation is likely to create value. If there is not a good fit the corporation is likely to destroy the valueThis approach to corporate strategy is useful in deciding : (1) What new business to acquire, (2) choosing how each existing business unit should be managedThe primary job of corporate headquarters is to obtain synergy among the business units, transferring skills and capabilities among the units

Prentice Hall, 2000Chapter 6*Parenting-Fit MatrixEdge of HeartlandHeartlandAlien TerritoryLowHighHighLowFIT between parenting opportunities and parenting characteristicsMISFIT between critical success factors and parenting characteristicsBallastValue TrapSource:Adapted from M. Alexander, A. Campbell, and M. Goold, A New Model for Reforming the Planning Review Process, Planning Review (January/February 1995), p. 17. Reprinted by permission.

Chapter 6

Parenting Mix MatrixHeartland BusinessHeartland businesses have opportunities for improvement by the parent, and parent understands their strategic factors well. Their business should have priority for all corporate activitiesEdge-of HeartlandSome parenting characteristics fit the business, but others do notParent may not really understand all of the strategic factorsSuch business units are likely to consume much of the parents attention Parents need to know when to interfere in business unit activities and strategies and when to keep at arms length

Parenting-Fit MatrixBallast businessFit very well with the parent corporation but contains very few opportunities to be improved by the parentUnits that have been with the corporation for many years and have been very successful Parents may have added value in the past, but it can no longer find opportunitiesLike cash cows they may be important sources of stability and earningsThey can also be a drag on the corporations as a whole by slowing growth and distracting parent from more productive activities

Parenting-Fit MatrixAlien Territory BusinessesHave little opportunity to be improved by the corporate parent A misfit exists between the parenting characteristics and units strategic factorsLittle opportunity for value creation but high potential for value destruction on the part of parentValue Trap BusinessesFit well with the parenting opportunities, but are misfits with the parents understanding of units strategic factorsCorporate head quarters mistakes what it sees as an opportunity for ways to improve the SBUs profitability or competitive position

Difference Between Corporate Parenting and Portfolio Analysis The basic difference between these two approaches to corporate strategy lies in the questions they attempt to answer. Portfolio analysis attempts to answer the following two questions:1. How much of our time and money should we spend on our best products and business units in order to ensure that they continue to be successful?2. How much of our time and money should we spend developing new, costly products, most of which will never be successful?

Difference Between Corporate Parenting and Portfolio Analysis The basic theme of portfolio analysis is its emphasis on cash flow Portfolio analysis attempts to answer these questions by examining the attractiveness of various industries and by managing business units for cash flow, that is, by using cash generated from mature units to build new product lines Portfolio analysis fails to deal with the question of what industries a corporation should enter or how a corporation can attain synergy among its product lines and business units. As suggested by its name, portfolio analysis tends to primarily take a financial point of view and views business units and product lines as if they were separate and independent investments

Difference Between Corporate Parenting and Portfolio Analysis Corporate parenting, in contrast, views the corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units. The central job of corporate headquarters is not to be a banker, but to coordinate diverse units to achieve synergy This is especially important in a global industries in which a corporation must manage interrelated business units for global advantage. Corporate parenting is similar to portfolio analysis in that it attempts to manage a set of diverse product lines/business units to achieve better overall corporate performance.

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