CHAPTER 8

CORPORATE STRATEGY:
Diversification and the Multibusiness Company

Copyright 2012 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin

8.5 The Chief Strategic and Financial Options for Allocating
a Diversified Companys Financial Resources
 Crafting a Diversified Firms Overall Or
Corporate Strategy

Picking new industries to enter and deciding on the best mode

Step 1 of entry.

Pursuing opportunities to leverage cross-business value chain

Step 2 relationships and strategic fit into competitive advantage.

Establishing investment priorities and steering corporate

Step 3 resources into the most attractive business units.

Initiating actions to boost the combined performance

Step 4 of the cooperations collection of businesses.

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 WHEN TO DIVERSIFY

A firm should consider diversifying when:

It can expand into businesses whose technologies
and products complement its present business.
Its resources and capabilities can be used as
valuable competitive assets in other businesses.
Costs can be reduced by cross-business sharing or
transfer of resources and capabilities.
Transferring a strong brand name to the products of
other businesses helps drive up sales and profits of
those businesses.

84
 Testing Whether Diversification Will Add
Value for Shareholders

The Attractiveness Test:

Are the industrys returns on investment as
good or better than present business(es)?
The Cost of Entry Test:
Is the cost of overcoming entry barriers so
great that profitability is too long delayed?
The Better-Off Test:
How much synergy will be gained by
diversifying into the industry?

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 Better Performance through Synergy

Firm A purchases Firm B in

another industry. A and Bs No
profits are no greater than Synergy
what each firm could have (1+1=2)
Evaluating the earned on its own.
Potential for
Synergy
through
Firm A purchases Firm C in
Diversification
another industry. A and Cs
Synergy
profits are greater than what
each firm could have earned (1+1=3)
on its own.

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CHOOSING THE DIVERSIFICATION
PATH: RELATED VERSUS
UNRELATED BUSINESSES

Which Diversification
Path to Pursue?

Both Related
Related Unrelated
and Unrelated
Businesses Businesses
Businesses

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 CHOOSING THE DIVERSIFICATION
PATH: RELATED VERSUS
UNRELATED BUSINESSES

Related Businesses
Have competitively valuable cross-business
value chain and resource matchups.
Unrelated Businesses
Have dissimilar value chains and resource
requirements, with no competitively important
cross-business relationships at the value
chain level.

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 STRATEGIC FIT AND DIVERSIFICATION
INTO RELATED BUSINESSES

Strategic Fit Benefits

Occur when the value chains of the different
businesses present opportunities for:
Transfer of resources among businesses.
Lowering of costs in combining related value
chain activities or resource sharing.
Use of a potent brand name across businesses.
Cross-businesscollaboration to build stronger
competitive capabilities.

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8.1 Related Businesses Provide Opportunities to Benefit
from Competitively Valuable Strategic Fit

810
 Strategic Fit, Economies of Scope,
and Competitive Advantage

Using Economies of Scope to Convert

Strategic Fit into Competitive Advantage

Transferring Combining Leveraging Using cross-

specialized and related value brand names business
generalized chain activities and other collaboration
skills and\or to achieve differentiation and knowledge
knowledge lower costs resources sharing

811
 Economies of Scope Differ from
Economies of Scale

Economies of Scope
Are cost reductions that flow from cross-
business resource sharing in the activities
of the multiple businesses of a firm.
Economies of Scale
Accrue when unit costs are reduced due
to the increased output of larger-size
operations of a firm.

812
 From Competitive Advantage to Added
Profitability and Gains in Shareholder Value

Capturing the Cross-Business Benefits

of Related Diversification

Builds more Yields value in Requires that

Is only possible
shareholder the application management
via a strategy
value than of specialized take internal
of related
owning a stock resources and actions to
diversification
portfolio capabilities realize them

813
DIVERSIFICATION INTO UNRELATED
BUSINESSES

Can it meet corporate targets

for profitability and return on
investment?
Evaluating the
acquisition of a
Is it is in an industry with
new business or
attractive profit and growth
the divestiture of
potentials?
an existing
business
Is it is big enough to contribute
significantly to the parent firms
bottom line?

814
 Building Shareholder Value via
Unrelated Diversification

Astute Corporate Provide leadership, oversight, expertise, and guidance.

Parenting by Provide generalized or parenting resources that lower
Management operating costs and increase SBU efficiencies.

Cross-Business
Serve as an internal capital market.
Allocation of
Allocate surplus cash flows from businesses to fund
Financial
the capital requirements of other businesses.
Resources

Acquiring and
Acquire weakly performing firms at bargain prices.
Restructuring
Use turnaround capabilities to restructure them to
Undervalued
increase their performance and profitability.
Companies

815
 The Path to Greater Shareholder Value
through Unrelated Diversification

Do a superior job of diversifying into

businesses that produce good
earnings and returns on investment.
Actions taken by
upper management
Do an excellent job of negotiating
to create value and
favorable acquisition prices.
gain a parenting
advantage
Provide managerial oversight and
resource sharing, financial resource
allocation and portfolio management,
and restructure underperforming
businesses.

816
The Drawbacks of Unrelated Diversification

Pursuing an Limited
Demanding
Unrelated Competitive
Managerial
Diversification Advantage
Requirements
Strategy Potential

Monitoring and Potential lack of

maintaining cross-business
the parenting strategic-fit
advantage benefits

817
 Inadequate Reasons for Pursuing
Unrelated Diversification

Poor Rationales for

Unrelated Diversification

Seeking
Seeking Pursuing rapid Pursuing
stabilization to
reduction of or continuous personal
avoid cyclical
business growth for its managerial
swings in
investment risk own sake motives
businesses

818
 STRUCTURES OF COMBINATION RELATED-
UNRELATED DIVERSIFIED FIRMS

Dominant-Business Enterprises
Have a major core firm that accounts for 50 to 80% of total
revenues and a collection of small related or unrelated firms
that accounts for the remainder.
Narrowly Diversified Firms
Are comprised of a few related or unrelated businesses.
Broadly Diversified Firms
Have a wide-ranging collection of related businesses,
unrelated businesses, or a mixture of both.
Multibusiness Enterprises
Have a business portfolio consisting of several unrelated
groups of related businesses.

819
EVALUATING THE STRATEGY
OF A DIVERSIFIED COMPANY

Attractiveness Strength of Cross-business

of industries Business Units strategic fit

Diversified
Strategy

Fit of firms Allocation of New Strategic

resources resources Moves

820
 Key Indicators of Industry Attractiveness

Social, political, regulatory, environmental factors

Seasonal and cyclical factors
Industry uncertainty and business risk
Market size and projected growth rate
Industry profitability
The intensity of competition among market rivals
Emerging opportunities and threats

821
 Step 2: Evaluating Business-Unit
Competitive Strength
Relative market share
Costs relative to competitors costs.
Ability to match or beat rivals on key product attributes.
Brand image and reputation.
Other competitively valuable resources and capabilities.
Strategic fit with the firms other businesses.
Bargaining leverage with key suppliers or customers.
Alliances and partnerships with suppliers and/or buyers.
Profitability relative to competitors

822
 8.3
A Nine-Cell Industry
Attractiveness
Star
Competitive Strength
Matrix

Cash
cow

Note: Circle sizes are scaled to

reflect the percentage of
companywide revenues
generated by the business unit.

823
8.4 Identifying the Competitive Advantage Potential
of Cross-Business Strategic Fit

824
 Checking for Resource Fit

Financial Resource Fit

State of the internal capital market
Using the portfolio approach:
Cash hogs need cash to develop.

Cash cows generate excess cash.

Star businesses are self-supporting.

Success sequence:
Cash hog Star Cash cow

825
 Checking for Resource Fit

Does the firm have (or can it develop) the

specific resources and capabilities needed
to be successful in each of its businesses?
Are the firms resources being stretched too
thinly by the resource requirements of one
or more of its businesses?

826
 Ranking Business Unit Performance
and Assigning Resource Allocation Priorities

Ranking Factors:
Sales growth
Profit growth
Contribution to company earnings
Return on capital invested in the business
Cash flow
Steer resources to business units with the
brightest profit and growth prospects and
solid strategic and resource fit.

827
 8.6
A Companys Four Main
Strategic Alternatives
After It Diversifies

828