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  • Ch15

    1. 1. Diversification Strategy <ul><li>Introduction: The Basic Issues </li></ul><ul><li>The Trend over Time </li></ul><ul><li>Motives for Diversification </li></ul><ul><li> - Growth and R isk Reduction </li></ul><ul><li> - Shareholder Value: Porter’s Essential Tests </li></ul><ul><li>Competitive Advantage from Diversification </li></ul><ul><li>Diversification and Performance: Empirical Evidence </li></ul><ul><li>Relatedness in Diversification </li></ul>OUTLINE
    2. 2. RATE OF PROFIT > COST OF CAPITAL INDUSTRY ATTRACTIVENESS COMPETITIVE ADVANTAGE The Basic Issues in Diversification Decisions Superior profit derives from two sources: <ul><li>Diversification decisions involve these same two issues: </li></ul><ul><li>How attractive is the sector to be entered? </li></ul><ul><li>Can the firm achieve a competitive advantage? </li></ul>
    3. 3. Diversifi cation among the US Fortune 500 , 1949-74 <ul><li>Percentage of Specialized Companies (single-business, </li></ul><ul><li> vertically-integrated and dominant-business) </li></ul><ul><li>Percentage of Diversified Companies (related-business </li></ul><ul><li>and unrelated business) </li></ul><ul><ul><ul><li>Note: During the 1980s and 1990s the trend reversed as large </li></ul></ul></ul><ul><ul><ul><li> companies refocused upon their core businesses </li></ul></ul></ul>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
    4. 4. Diversifi cation among Large UK Corporations, 1950-93
    5. 5. Diversification: The Evolution of Strategy and Management Thinking DEVELOPMENTS IN CORPORATE STRATEGY MANAGEMENT PRIORITIES STRATEGY TOOLS & CONCEPTS Quest for Growth Addressing under-performance of widely-diversified firms Creating shareholder value 1960 1970 1980 1990 2000 2006 <ul><li>Emergence of conglomerates </li></ul><ul><li>Diversification by established companies into related sectors </li></ul>Emphasis on “ related’ & “ concentric” diversification <ul><li>Refocusing on core businesses </li></ul><ul><li>Divesting diversified businesses </li></ul><ul><li>Financial analysis </li></ul><ul><li>Diffusion of M form structures </li></ul><ul><li>Creation of corporate planning depts. </li></ul><ul><li>Economies of scope & synergy” </li></ul><ul><li>Portfolio planning models </li></ul><ul><li>Capital asset pricing model </li></ul><ul><li>Maximization of shareholder wealth </li></ul><ul><li>Core competences </li></ul><ul><li>Dominant logic </li></ul><ul><li>Competitive advantage through speed & flexibility </li></ul><ul><li>Creating opportunities for future growth </li></ul><ul><li>Joint ventures and alliances </li></ul><ul><li>Creating growth options </li></ul><ul><li>through focused </li></ul><ul><li>diversification </li></ul><ul><li>Dynamic capabilities </li></ul><ul><li>Transaction cost analysis </li></ul><ul><li>Real options </li></ul>
    6. 6. Motives for Diversification <ul><li>GROWTH --The desire to escape stagnant or declining industries a powerful motives for diversification ( e.g. tobacco, </li></ul><ul><li> oil, newspapers ). </li></ul><ul><li> -- But , growth satisfies manage rs not shareholder s . </li></ul><ul><li>--Growth strategies (esp. by acquisition), tend to </li></ul><ul><li> destroy shareholder value </li></ul>RISK --Diversification reduces variance of profit flows SPREADING -- But , doesn ’ t create value for shareholders —they c an 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, the n bringing together of different businesses under common ownership & must somehow increase their profitability.
    7. 7. Diversification and Shareholder Value: Porter’s Three Essential Tests <ul><li>If diversification is to create shareholder value, it must meet three tests: </li></ul><ul><li>1. The Attractiveness Test : diversification must be directed towards attractive industries (or have the potential to become attractive) . </li></ul><ul><li>2. The Cost of Entry Test : the cost of entry must not capitalize all future profits. </li></ul><ul><li>3. The Better-Off Test : either the new unit must gain competitive advantage from its link with the co mpany , or vice-versa. (i.e. some form of “ synergy ” must be present) </li></ul>Additional source of value from diversification: Option value
    8. 8. Competitive Advantage from Diversification <ul><ul><ul><ul><ul><li>Predatory pricing/tie-in sales Evidence </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Reciprocal buying of these </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Mutual forbearance is sparse </li></ul></ul></ul></ul></ul>MARKET POWER <ul><ul><ul><ul><ul><li>Sharing tangible resources (research labs, distribution systems) across multiple businesses </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Sharing intangible resources (brands, technology) across multiple businesses </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Transferring functional capabilities (marketing, product development) across businesses </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Applying general management capabilities to multiple businesses </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Economies of scope not a sufficient basis for diversification ----must be supported by transaction costs </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Diversification firm can avoid transaction costs by operating internal capital and labor markets </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Key advantage of diversified firm over external markets--- superior access to information </li></ul></ul></ul></ul></ul>ECONOMIES OF SCOPE ECONOMIES FROM INTERNALIZING TRANSACTIONS
    9. 9. Relatedness in Diversification <ul><li>Economies of scope in diversification derive from two types of relatedness: </li></ul><ul><li>Operational Relatedness -- synergies from sharing resources across businesses (common distribution facilities, brands, joint R&D) </li></ul><ul><li>Strategic Relatedness -- synergies at the corporate level deriving from the ability to apply common management capabilities to different businesses. </li></ul><ul><li>Problem of operational relatedness :- the benefits in terms of economies of scope may be dwarfed by the administrative costs involved in their exploitation. </li></ul>
    10. 10. Branson & the Virgin Companies: Making strategic sense of apparent entrepreneurial chaos <ul><li>KEY RESOURCES </li></ul><ul><li>Virgin brand </li></ul><ul><li>Branson </li></ul><ul><li>-charisma/image </li></ul><ul><li>--PR skills </li></ul><ul><li>-networking skills </li></ul><ul><li>-entrepreneurial flair </li></ul><ul><li>DOMINANT LOGIC </li></ul><ul><li>Seek competitive advantage by start-up cos. </li></ul><ul><li>pursuing innovative differentiation in </li></ul><ul><li>underserved market with sleepy incumbents </li></ul><ul><li>CHARACTERISTICS OF </li></ul><ul><li>MARKETSTHAT CONFORM </li></ul><ul><li>TO THIS LOGIC </li></ul><ul><li>Consumer businesses </li></ul><ul><li>dominant incumbent </li></ul><ul><li>scope for new approaches </li></ul><ul><li>to customer service </li></ul><ul><li>high entry barriers to other </li></ul><ul><li>start-ups </li></ul><ul><li>Branson/Virgin image </li></ul><ul><li>appeals to customers </li></ul><ul><li>DESIGNING A CORPORATE STRATEGY </li></ul><ul><li>& STRUCTURE </li></ul><ul><li>What’s the business model? </li></ul><ul><li>( Does Virgin create value by </li></ul><ul><li>being an entrepreneurial incubator, </li></ul><ul><li>a venture capital fund , a </li></ul><ul><li>diversified corporation , or what? ) </li></ul><ul><li>Which businesses to divest? </li></ul><ul><li>Criteria for future diversification </li></ul><ul><li>What type of structure?— Is there </li></ul><ul><li>a need for greater formalization? </li></ul>