1. University of Cagliari, Faculty of Economics, a.a. 2012-13
Business Strategy and Policy
A course within the II level degree in
Managerial Economics
year II, semester I, 6 credits
Lecturer:
Dr Alberto Asquer
aasquer@unica.it
Phone: 070 6753399

2. Business Strategy and Policy
Lecture 6
Diversification Strategy

3. Introduction
1. What is diversification?
2. Why do firms diversify?
3. How do firms enter a new business?
4. Where do firms diversify?
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5. Summary

4. 1. What is diversification?
Diversification consists of expanding the range of business activities
carried out by a firm away from the present product line and market
structure
Diversification involves:
Search and selection of new business areas
Formulation and implementation of an entry strategy
Search and activation of synergies between business areas
Definition of priorities for the allocation of resources among business
areas

5. 1. What is diversification?
Diversification through the development of new products delivered in
new markets (Ansoff, 1957)
Market Diversification
.... development
Another new
market A2
New
market A1
Current Market Product
market A penetration development
Current New Another new New
product X product X1 product X2 .... product Y

6. 1. What is diversification?
Diversification may be also directed towards the input market, often
through the acquisition of a supplier (upstream vertical integration)
Input Supplier Supplier
market Supplier Supplier
Supplier
Firm
Upstream integration
e.g., oil refinery into Current Output
oil extraction product X market

7. 1. What is diversification?
Diversification may be also directed towards the output market, often
through the acquisition of a supplier (downstream vertical
integration)
Firm
Output Client Client
market Client Client
Client
Downstream integration
e.g., movie makers into
movie distribution

8. 2. Why do firms diversify?
Diversification allows the firm to grow rapidly by expanding operations
into new business fields
Why is (rapid) growth beneficial?
Economies of scale
Learning and experience curve effects
Lower average unit costs (running at full capacity)
More bargaining power with suppliers and customers
Exploiting differences between diverse geographical areas

9. 2. Why do firms diversify?
Instance: Tiscali (1998-2009)
Diversification
Telecom in Italy and the UK
Product development
Market development
Fixed phone
lines, ADSL
Virtual Mobile
Network Operator
Market entry
Internet (free) access Acquisitions in the EU
1998 1999 2003 2009

10. 2. Why do firms diversify?
Instance: Tiscali (2009-2011)
UK division sold in 2009
Diversification
Telecom in Italy and the UK The opposite of
Product development diversification:
focus strategy
Fixed phone
lines, ADSL
Virtual Mobile
Network Operator
2009 2011

11. 2. Why do firms diversify?
Instance: Tiscali (2000-2011)
(a struggle to protect shareholders' value)

12. 2. Why do firms diversify?
Diversification is sometimes regarded as beneficial to shareholders,
because it allows to spread risk among various businesses (whose
performance presumably are not correlated)
Diversification is sometimes considered as detrimental to
shareholders, because they would be better off if they diversify risk
of their investment portfolio rather than having it done by the
company management
(Note: but diversifying your investment portfolio among various
financial assets is quite different from exploiting synergies between
different product and market lines within the same firm!)

13. 3. How do firms enter a new business?
Acquisitions of other companies that already operate in another
business (a rapid way to acquire assets, employees, know-how,
market presence, access to distribution channels, etc.)
Internal start-ups by developing own business ideas, allocating
capital and other resources, and venturing into a new business (i.e.,
“corporate venturing”)
Joint ventures by partnering with other companies that already
operate in another business and sharing assets, employees, know-
how, etc. – typically by searching for synergies between respective
resources and distinctive capabilities

14. 3. How do firms enter a new business?
Acquisition Internal start-up Joint venture

15. 4. Where do firms diversify?
Two types of diversification:
Related: when the value chains of two businesses that are managed
within the same firm (i.e., the same company or company group)
share cross-linkages that provide opportunities for superior
performance than when they are managed by two independent firms
Unrelated: when the value chains of two businesses do not share any
linkage, i.e., they are completely different and they do not offer any
opportunities for competitive advantage if managed within the same
firm
(Note: this discussion bears some relatedness to issues about why
firms exist, i.e., why higher performance is achieved through
hierarchical organisations rather than market exchange; see
transaction cost economics; Coase, 1937)

16. 4. Where do firms diversify?
Instance of related diversification: Johnson & Johnson
Consumers products
Baby care Wound care
Women's care Medicines
Skin and hair care Oral care
Nutritionals Vision care

17. 4. Where do firms diversify?
When should firms pursue related diversification?
When there is 'strategic fit', that is, opportunities for
Transfer of skills, knowledge, and other competences across
businesses
Economies of scope
Advantages arising from 'umbrella branding'
Developing innovative products and/or processes

18. 4. Where do firms diversify?
Instance of unrelated diversification: General Electrics
Aviation Healthcare
Appliances
Financial services
Consumer products Energy

19. 4. Where do firms diversify?
Instance of unrelated diversification: Virgin
Railways
Radio
Travel agent
Megastore
Airlines
Telecom and media
Soft drinks

20. 4. Where do firms diversify?
When should firms pursue unrelated diversification?
Some scholars (and practitioners) would argue that firms should not
pursue unrelated diversification at anytime (Rumelt, 1974; Teece et
al., 1997) – except when the firm is clearly facing decline in
traditional products and markets
When unrelated diversification is pursued, generally firms have robust
financial resources and are in search for new investments
either the unrelated business presents attractive profitability/risk and
growth prospects
or the unrelated business presents attractive speculative prospects

21. 5. Summary
Main points
Diversification consists of expanding the range of business activities
carried out by a firm away from the present product line and market
structure
Diversification can foster rapid growth and provide better shareholder
value. Sometimes, however, an opposite focus strategy delivers better
results
Diversification can be conducted through internal development of new
businesses, acquisitions, or joint ventures
Diversification may be directed towards related or unrelated business
areas. Generally, related diversification delivers better performance