To accompany contemprory strategy analysis concepts techiniques application chapter15slides

Diversification Strategy• Introduction: The Basic Issues • The Trend over Time • Motives for Diversification - Growth and Risk Reduction - Shareholder Value: Porter’s Essential Tests..

Diversification Strategy

• Introduction: The Basic Issues

• The Trend over Time

• Motives for Diversification

- Growth and Risk Reduction

- Shareholder Value: Porter’s Essential Tests.

• Competitive Advantage from Diversification

• Diversification and Performance: Empirical Evidence

• Relatedness in Diversification

OUTLINE

RATE OF PROFIT

> COST OF CAPITAL

INDUSTRY ATTRACTIVENESS

COMPETITIVE ADVANTAGE

The Basic Issues in Diversification Decisions

Superior profit derives from two sources:

Diversification decisions involve these same two issues:

• How attractive is the sector to be entered?

•Can the firm achieve a competitive advantage?

Diversification among the US Fortune 500, 1949-74

Percentage of Specialized Companies (single-business,

vertically-integrated and dominant-business)

Percentage of Diversified Companies (related-business

and unrelated business)

Note: During the 1980s and 1990s the trend reversed as large

companies refocused upon their core businesses

1949 1954 1959 1964 1969 1974 70.2 63.5 53.7 53.9 39.9 37.0

29.8 36.5 46.3 46.1 60.1 63.0

10

20

30

40

50

60

70

1950 1960 1970 1983 1993

Single business

Dominant business Related business

Unrelated business

Diversification among Large UK

Corporations, 1950-93

Diversification among Large UK

Corporations, 1950-93

COMPANY

DEVELOPMENTS

MANAGEMENT

GOALS

STRATEGY TOOLS

& CONCEPTS

1950 1960 1970 1980 1990

Financial problems of conglomerates

Refocusing on shareholder value

Rise of conglomerates Related diversification

by industrial firms

Emphasis on“related’

& “concentric”

diversification

Refocusing on core businesses Divestment

Diffusion of

M form structures

Analysis of economies of scope &

“synergy”

Value based management

Capital asset pricing model

Portfolio planning models

Core competences

Transaction cost analysis

Development of corporate planning systems

Diversification: The Evolution of Management

Thinking and Management Practice

Diversification: The Evolution of Management

Thinking and Management Practice

Joint ventures, Alliance, corporate venturing

Competitive advantage through Speed, flexibility, and capability

Dynamic capability

Quest for Growth

Financial Analysis

Dominant logic

Motives for Diversification

GROWTH The desire to escape stagnant or declining industries

a powerful motives for diversification (e.g tobacco, oil, newspapers).

But, growth satisfies managers not shareholders.

Growth strategies (esp by acquisition), tend to destroy shareholder value

RISK Diversification reduces variance of profit flows

SPREADING But, doesn’t create value for shareholders—they can

hold diversified portfolios of securities.

Capital Asset Pricing Model shows that diversification

lowers unsystematic risk not systematic risk.

PROFIT For diversification to create shareholder value, then

bringing together of different businesses under common ownership & must somehow increase their profitability.

Diversification and Shareholder Value:

Porter’s Three Essential Tests

Diversification and Shareholder Value:

Porter’s Three Essential Tests

If diversification is to create shareholder value, it must meet three tests:

1 The Attractiveness Test: diversification must be directed

towards attractive industries (or have the potential to

become attractive).

2 The Cost of Entry Test : the cost of entry must not capitalize

all future profits.

3 The Better-Off Test: either the new unit must gain

competitive advantage from its link with the company, or

vice-versa (i.e some form of “synergy” must be present)

Additional source of value from diversification: Option value

Competitive Advantage from Diversification

• Predatory pricing/tie-in sales Evidence

• Reciprocal buying of these

• Mutual forbearance is sparse

MARKET

POWER

• Sharing tangible resources (research labs, distribution

systems) across multiple businesses

• Sharing intangible resources (brands, technology) across

multiple businesses

• Transferring functional capabilities (marketing, product

development) across businesses

• Applying general management capabilities to multiple

businesses

• Economies of scope not a sufficient basis for

diversification must be supported by transaction costs

• Diversification firm can avoid transaction costs by

operating internal capital and labor markets

• Key advantage of diversified firm over external markets -

superior access to information

ECONOMIES

OF

SCOPE

ECONOMIES

FROM

INTERNALIZING

TRANSACTIONS

Competitive Advantage from Diversification

• Predatory pricing Evidence

• Reciprocal buying of these

• Mutual forbearance is sparse

MARKET

POWER

• Sharing tangible resources (research labs, distribution

systems) across multiple businesses

• Sharing intangible resources (brands, technology) across

multiple businesses

• Transferring functional capabilities (marketing, product

development) across businesses

• Applying general management capabilities to multiple

businesses

• Economies of scope not a sufficient basis for

diversification—must be supported by transaction costs

• Diversification firm can avoid transaction costs by

operating internal capital and labor markets

• Key advantage of diversified firm over external markets -

superior access to information

ECONOMIES

OF

SCOPE

ECONOMIES

FROM

INTERNALIZING

TRANSACTIONS

Relatedness in Diversification

Economies of scope in diversification derive from two

types of relatedness:

• Operational Relatedness synergies from sharing

resources across businesses (common distribution

facilities, brands, joint R&D)

• Strategic Relatedness synergies at the corporate level

deriving from the ability to apply common management capabilities to different businesses.

Problem of operational relatedness:- the benefits in terms

of economies of scope may be dwarfed by the

administrative costs involved in their exploitation.

Branson & the Virgin Companies: Making strategic

sense of apparent entrepreneurial chaos

Branson & the Virgin Companies: Making strategic

sense of apparent entrepreneurial chaos

KEY RESOURCES

•Virgin brand

•Branson

-charisma/image

PR skills

-networking skills

-entrepreneurial flair

DOMINANT LOGIC

•Seek competitive advantage by start-up cos.

pursuing innovative differentiation in underserved market with sleepy incumbents

CHARACTERISTICS OF MARKETSTHAT CONFORM

TO THIS LOGIC

•consumer

•dominant incumbent

•scope for new approaches

to customer service

•high entry barriers to other

start-ups

•Branson/Virgin image

appeals to customers

DESIGNING A CORPORATE STRATEGY

& STRUCTURE

• What’s the business model?

(Does Virgin create value by

being an entrepreneurial incubator,

a venture capital fund, a

diversified corporation, or what?)

• Which businesses to divest?

• Criteria for future diversification

• What type of structure?—Is there

a need for greater formalization?