Richard Rumelt Classification

Presented by Hardik Patel Pg-11-97 Khushboo Nisar Pg-11-96 Chirag Nahar Pg-11-95

An electrical engineer by training, Richard Rumelt (born 1942) has been at the Anderson School of Management at the University of California in Los Angeles since 1976, rising to be professor of business and society

His chief area of interest (and of influence) has been corporate strategy. Throughout his long career, Rumelt published little. But his influence grew slowly, and interest in his ideas was reignited in 2007 by a widely read interview published in McKinsey Quarterly

In 1982 he demonstrated that there was a statistical link between corporate strategy and profitability, showing that somewhat diversified companies performed better than highly diversified ones Notable publications Strategy, Structure and Economic Performance, Harvard Business School Press, 1974; revised edn, 1986 Diversity and Profitability, Strategic Management Journal, 1982 How Much Does Industry Matter?, Strategic Management Journal, 1991

When a corporation diversifies , it not only increases its volume of activity and, presumably, its profits, it also increases the complexity of its internal structure and expands the range of issues about which the senior management must remain knowledgeable. A priori arguments can be made on economic or managerial grounds that the diversified corporation should perform better than the less diversified corporation.

Similarly, available theories cannot usefully address the question of whether the decision to diversify is typically triggered by low levels of profitability or whether most diversifies are seeking outlets for higher than normal rates of returns.

What are SIC codes?

Standard Industrial Classification (SIC) codes are four digit numerical codes assigned by the U.S. government to business establishments to identify the primary business of the establishment. The classification was developed to facilitate the collection, presentation, and analysis of data. Reading SIC Codes The first two digits of the code identify the major industry group, the third digit identifies the industry group, and the fourth digit identifies the industry. For example: 20 Food and Kindred Products 209 Miscellaneous Food Preparations and Kindred Products 2096 Potato Chips, Corn Chips, and Similar Snacks

Herfindahl index
The Herfindahl index (also known as HerfindahlHirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law Competition law, known in the United States as antitrust law, is law that promotes or maintains market competition by regulating anticompetitive conduct by companies The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firm. A concentration ratio is a measure of the total output produced in an industry by a given number of firms in the industry.

High, Medium, and Low The Herfindahl index is designed to measure industry concentration, and by inference the degree of market control

The Herfindahl index ranges from a low of 0, indicating perfect competition, to a higher of 10,000, indicating compete monopoly. Greater values mean greater concentration, less competition, and more market control held by individual firms.

No Concentration: At the low end, a 0 Herfindahl index means perfect competition or at the very least monopolistic competitionthat is EXTREMELY competitive. The number of firms is so large that sum of the square of the market shares is 0. Total Concentration: At the high end, a 10,000 Herfindahl index means monopoly.

Between these two extremes, the Herfindahl index can fall into low, medium, and high concentration. Low Concentration: A Herfindahl index of 0 to 1,000 is commonly interpreted as an industry with low concentration. Monopolistic competition falls into the bottom of this with oligopoly emerging near the upper end. While the correspondence is not exactly, generally speaking industries with concentration ratios between 0 percent and 50 percent, have Herfindahl index values between 0 and 1,000.

Medium Concentration: A Herfindahl index of 1,000 to 1,800 percent is considered an industry with medium concentration. These industries are very much oligopoly. This level corresponds with concentration ratios between 50 percent and 80 percent.
High Concentration: An industry with a Herfindahl index of 1,800 to 10,000 percent is viewed as highly concentration. Government regulators are usually most concerned with industries falling into this category. This level corresponds with concentration ratios between 80 percent and 100 percent.

The Herfindahl index is calculated by squaring each market share, then summing all twenty. The square of OmniCola's 23 percent market share is 529. The square of Juice-Up's 17.5 percent market share is 306.25. And the square of the 0.75 percent market share of the twentieth soft drink that almost no one in Shady Valley likes is 0.5625. Summing all twenty squared market shares generates an Herfindahl index of 1177. This places the Shady Valley soft drink industry in the medium concentration range. The top few firms have some market control, but not a whole lot.

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* Methodology for the classification of diversification
Each of this ratio are based upon the proportion of revenues earned from the various business activities. Specialization Ratio (SR) is the fraction of a firms revenues derived from its largest single discrete business. Vertical Ratio (VR) is the fraction of a firms revenues derived from the sale of all end products, joint products, and by-products associated with the processing of a single raw material through a number of stages. Companies with high vertical ratios tend to be in the oil, primary metals, rubber, and forest products industries.

*Related constrained ratio (RCR) is the

fraction of the firms revenues derived from its largest group of constrained related business. Related ratio (RR) is the fraction of a firms revenue derived from its largest group of somehow related businesses (including all linking relationships.

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* RELATED BUSINESS
When businesses share some common resources or draw upon some common skill or competence possessed by the firm.

* UN-RELATED BUSINESS
Where there lies nosharing of common resources or common skills and businesses are highly independent in nature.

* Two types:a) Constrained relatedness:-Share all resources b) Linked Relatedness :-Some portion of resources

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1. Single business (SB)
Firms in which at least 90% of revenues are
derived from a single discrete business (SB > 0.90)

For example, Co. A is in processing of Tea Leaves and more than

90% revenues come from the sales

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Firms which do not fall in the single business category, but
which derive 70% or more of their revenues from a single raw material processing chain (VR 0.70).

Eg. Incase of Sugar Mills, sugarcane is the dominant raw

material and more than 70% of the revenue comes from sale of sugar.

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Firms which are diversified to some extent but which still

depends upon a single discrete business for 70% or more of their revenues, do not fall in the dominant vertical category, and use a predominately related constrained method of diversification

Eg. An I.T. company which is in 3 businesses share common

skills and competency

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Firms deriving between 70% and 90% of their revenues
from a single discrete business, not in the dominant vertical category and whose diversified businesses are predominantly linked-related or unrelated to their main activity

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Firms in which the largest discrete business contributes less
than 70% of revenues derive from the largest group of somehow related businesses and in which constrained relationships predominate

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Firms in which the largest discrete business contributes less
than 70% of revenues, at least 70% of revenues derive from the largest group of somehow related businesses and in which linking relationship predominate

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Firms in which the largest group of related businesses

contributes less than 70% but more than 45% of revenues

Firms which have diversified into unrelated businesses to such an extent that no single group of related businesses contributes more than 45% of revenues

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