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Module 7

Corporate Diversification Strategies

Module Outline

• From Single-Business to Diversification

• Building Shareholder Value

• Diversification Strategies

• Related Diversification Strategies

• Unrelated Diversification Strategies

• Divestiture and Liquidation Strategies

• Corporate Turnaround, Retrenchment, and Portfolio Restructuring Strategies

• Multinational Diversification Strategies

• Combination Diversification Strategies

Corporate Diversification and Corporate Strategy

• A diversified firm is an collection of individual businesses

• Diversification makes corporate strategy- making a bigger picture exercise than crafting strategy for a single business

• In a diversified firm, corporate managers must craft a multi-business, multi-industry strategic action plan for a

– Number of different businesses competing in diverse industry environments

Main Tasks in Crafting Corporate Strategy

• Decide on moves to position firm in industries chosen for diversification

• Devise actions to improve long-term performance of corporation’s portfolio of businesses

• Capture strategic fit benefits existing within business units, turning them into competitive advantage

• Evaluate profit prospects of each business unit and steer corporate resources into most attractive strategic opportunities

From Single-Business To Diversification

Stage 1:

Most firm begin as small single- business enterprises serving a local or regional market

Stage 2: Geographical expansion Stage 3: Vertical integration

Stage 4:

As growth slows, strategic options include:

•Take market share from rivals •Focus on diversification

The Growth Matrix

PresentNew

Product

Present

New

Market

Market

Penetration

(Concentration)

Product

Development

Market

Development

Diversification

Major Growth Strategies (The Growth Matrix)

• Growth via Market Penetration (Concentration)

• Growth via Market Development

• Growth via Product Development

• Growth via Diversification

– Related (“Concentric”) Diversification – Unrelated (“Conglomerate”) Diversification

Market Penetration (Same Products, Same Markets)

• When current market are not saturated with your particular products / services

• When the usage rate of present customers could be significantly increased

• When the market shares of some major competitors have been declining while total industry demand has been rising

• When the correlation between sales and marketing expenditures has historically been high

• When increased economies of scale provide major competitive advantages

Market Development (Same Product, New Market)

• When new channels of distribution are available that are reliable, inexpensive, and of good quality

• When an organization is very successful at what it does

• When new untapped or unsaturated markets exist

• When the firm has the needed capital and human resources to manage expanded operations

• When an organization has excess production capacity

• When an organization’s basic industry is rapidly becoming global in scope

Product Development (New Products, Same Markets)

• When the firm has successful products that are in the maturity stage of the product life cycle (i.e., attract satisfied customers to try new, improved products as a result of their prior experiences)

• When an organization competes in an industry that is characterized by rapid technological change

• When major competitors offer better quality products at comparable prices

• When the firm competes in a high-growth industry

• When an organization has especially strong research and development capabilities

Strategic Management Principle

Diversification doesn’t need to become a strategic priority until a company begins to run out of growth opportunities in its core business!

Competitive Strengths of a Single Business Strategy

• Less ambiguity about “who we are”

• Energies of firm directed down one path

• Entrepreneurial efforts focused on keeping strategy responsive to industry change

• Less chance limited resources will be thinly stretched

• Managers maintain hand-on contact with core businesses

Competitive Strengths of a Single Business Strategy

• Dependence on one business provides incentive to capture stronger long-term competitive position

• Full force of firm’s resources used to become better at what firm does

• Important competencies more likely to emerge

• Higher profitability innovative ideas will emerge

Risk of a Single Business Strategy

• Putting all firm’s “egg” in one industry basket

– If industry stagnates, then

• Firm’s growth rate tougher to sustain

• Profits harder to achieve

– Changing customer needs, technological innovation, or new substitutes can

• Undermine a single-business firm

When Does Diversification Start to Make Sense?

When to diversify depends on

– Firm’s competitive position and – Remaining opportunities in home-base industry

When Does Diversification Start to Make Sense?

Strong competitive position, rapid market growth – Not a good time to diversify

Strong competitive position, slow market growth – Diversification is top priority consideration

Weak competitive position, rapid market growth – Not a good time to diversify

Weak competitive position, slow market growth – Diversification merits consideration

Why Diversify?

• To build shareholder value

• A diversification move is capable of increasing shareholder value if it passes 3 tests:

1. Attractiveness Test

2. Cost of Entry Test

3. Better-Off Test

Strategic Management Principle

To create shareholder value, a diversifying firm must get into businesses that can perform better under common management than they could perform operating as independent enterprises!

Diversification Strategies

• Entering new industries

• Related diversification

• Unrelated diversification

• Divestiture and liquidation

• Corporate turnaround, retrenchment, and restructuring

• Multinational diversification

Strategies for Entering New Businesses

1. Acquire existing firm in target industry

2. Start new company internally

3. Form joint venture

Acquiring an Existing Company

• Most popular approach to diversification • Advantages

– Quicker entry into target market – Hurdling certain entry barriers

• Technological inexperience

• Gaining access to reliable suppliers

• Being of a size to match rivals in terms of efficiency and costs

• Getting adequate distribution access

Diversification via Internal Startup

• More attractive when:

– Ample time exists

– Incumbent firms slow in responding

– It involves lower costs than acquiring existing firm

– Firm already has most needed skills – Additional capacity will not adversely impact supply-demand balance in industry

– New start-up does not have to go head-to-head against powerful rivals

Diversification via Joint Ventures

• Good way to diversify when:

– Uneconomical or risky o go it alone

– Pooling competencies of two partners provides more competitive strength

– Foreign partners needed to surmount

• Import quotas

• Tariffs

• Nationalistic political interests

• Cultural roadblocks

Drawbacks of Joint Ventures

• Raises questions about –

– Which partner will do what, and

– Who has effective control

• Potential conflicts

– Sourcing of components

– Exporting

– Whether operations should conform to foreign firm’s standards or to local preferences

– Control over cash flows and profits

What is Related Diversification?

Definition • Diversification is related when a firm has several lines of business that, although distinct, possess some kind of strategic fit

What is Related Diversification?

Principle • What makes related diversification attractive is the opportunity to turn strategic fit into competitive advantage!

Related Diversification and Strategic Fit

Strategic Fit can be based on

– Shared technology

– Common labor skills

– Common distribution channels

– Common suppliers and raw materials sources

– Similar kinds of managerial know-how

– Ability to share common scales force

– Customer overlap

– Any area where meaningful sharing opportunities exist in businesses’ value chains

Common Approaches to Related Diversification

• Entering businesses where sales force, advertising, and distribution activities can be shared

• Exploiting closely related technologies

• Sharing manufacturing facilities

• Transferring know-how and expertise from one business to another

• Transferring firm’s brand name and reputation with customers to a new product / service

• Acquiring new businesses to uniquely help firm’s position in existing businesses

Appeal of Related Diversification

• Allows firm to maintain unity in business activities and gain benefits of skills transfer or cost sharing while

– Spreading risks over broader base

• Exploits what firm does best and allows transfer of core competencies from one business to another

• Helps achieve economies of scope

Appeal of Related Diversification

• Strategic fits among related businesses offer competitive advantage potential of

– Lower costs via sharing common resources and combining related activities

– Efficient transfer of

• Key skills or core competencies

• Technological expertise or

• Managerial know-how

– Common use of same brand name

Concepts: Economies of Scope

• Arise from ability to eliminate costs by operating two or more businesses under same corporate umbrella • Exist whenever it is less costly for two or more businesses to operate under centralized management than to function independently

Cost savings opportunities can stem from interrelationships anywhere along businesses’ value chain

Concept: Strategic Fit

• Exist when different businesses have sufficiently related value chains that permits

– Transferring skills and expertise from one business to another

– Combining performance of related activities so as to reduce costs

• Presence of strategic fit in a diversified firm’s portfolio, along with corporate management’s skill in capturing benefits of the interrelationships

– Makes related diversification capable of being a 2 + 2 = 5 phenomenon

Types of Strategic Fit

Market-Related Fits

Operating Fit

Management Fit

Market-Related Fits

• Arise when value chains of different businesses overlap so products can be

– Used by same customers

– Marketed and promoted in similar ways

– Distributed through common dealers and retailers

Types of Market-Related Fits

• Common sales force to call on customers

• Advertising related products together

• Use of same brand names

• Joint delivery and shipping

• Joint after-sale service and repair work

• Joint order processing and billing

• Joint promotional tie-ins

– Cents-off couponing, trial offers, specials

• Joint dealer networks

Operating Fits

• Arise when different businesses present opportunities for cost-sharing or skills transfer

– Procurement of purchased inputs

– R&D / technology

– Manufacturer and assembly

– Administrative support functions

– Marketing and distribution

Potential Benefits of Operating Fits

• Cost savings

• Tapping into more scale economies and / or economies of scope

• Increased operating efficiency through sharing of related activities

Management Fits

• Emerge when different business units have comparable types of

– Entrepreneurial,

– administrative, or

– Operating problems

• Allow accumulated managerial know-how in one business to be useful in managing another business

Capturing Benefits of Strategic Fit

• Management must take actions to capture benefits

Benefits don’t just happen!

– Businesses with sharing potential must be reorganized so activities to be shared are merged and coordinated – Where skills transfer is cornerstone of strategic fit, a means must be found to make transfer effective

• Management must access that some centralized strategic control is great enough to justify sacrificing business-unit autonomy

What is Unrelated Diversification?

• Unrelated diversification involves no

– Common linkage of strategic fit among a diversified firm’s line of business

– Meaningful value chain interrelationships

• Corporate strategy approach

– Venture into “any industry and any business in which we think we can make a profit”

• Firms pursuing unrelated diversification are referred to as Conglomerates

No unifying strategic theme

Acquisition Criteria: Pursuing Unrelated Diversification

• Can business meet corporate targets for profitability and ROI?

• Will business require substantial infusions of capital?

• Is business big enough to contribute to parent firm’s bottom line?

• Is there potential for union difficulties or adverse government regulations?

• Is industry vulnerable to recession, inflation, high interest rates, or shifts in government policy?

Attractive Acquisition Targets

• Companies with undervalued assets

– Capital gains may be realized

• Companies that are financially distressed

– May be purchased at bargain prices

• Companies with bright prospects, but limited capital

Dominant Philosophy of Unrelated Diversification

Any company that can be acquired on good financial terms and offers good prospects for profitability is a good business to diversify into!

Appeal of Unrelated Diversification

• Business risk scattered over different industries

• Capital resources invested in those industries offering best profit prospects

• Stability of profits – Hard times in one industry may be offset by good times in another industry

• If management is exceptionally astute at spotting bargain-priced firms with big profit potential, then –

– Shareholder wealth can be enhanced

Drawbacks of Unrelated Diversification

• Places big demand on corporate management – More diverse the business, harder it is to

– Oversee each subsidiary and spot problems

– Judge caliber of strategic plans of subsidiaries

• Consolidated performance of unrelated portfolio tends to be

– no better than sum of individual business on their own, and

– It may be worse

• Promises greater sales-profit stability over business cycles, but is seldom realized

How Broadly Should a Company Diversify?

• With unrelated diversification, corporate managers have to be shrewd enough to

– Discern good acquisition from bad ones

– Select capable managers to run many different businesses

– Judge soundness of strategic proposals of business-unit managers

– Know what to do if a subsidiary stumbles

How Broadly Should a Company Diversify?

• Two questions should guide a firm’s unrelated diversification efforts

1. What is the least diversification it will take to achieve acceptable growth and profitability?

2. What is the most diversification that can be managed, given its added complexity?

Diversification and Shareholder Value

Related Diversification

Strategy-Driven approach to create shareholder value

Unrelated Diversification

Finance-Driven approach to create shareholder value

Divestiture and Liquidation Strategies

• Situations arise when one or more subsidiaries have to be sold or shut down

– Misfits cannot be completely avoided

– Industry attractiveness changes over time

– Sub-par performance of some subsidiaries is bound to occur

– Diversification appearing sensible based on strategic fit lacks compatibility of values essential to cultural fit

Strategic Management Principle

A business needs to be considered when it ceases to be an attractive investment or business the company should be in!

Divestiture and Liquidation Strategy Options

• Two types of divestiture options

– Divest business by spinning it off as independent company

– Divest business by selling it

• Liquidation

– Most painful option

– Involves terminating firm’s existence

Turnaround, Retrenchment, and Portfolio Restructuring

Strategic Options for diversified firm with ailing subsidiaries

• Conditions causing poor performance

– Large losses in one or more subsidiaries

– Disproportionate number of businesses in unattractive industries

– Bad economic conditions

– Excessive debt load

– Acquisitions that perform worse than expected

Corporate Turnaround Strategies

Focus

• Restore money-losing businesses to profitability rather than divest them

Objective

• Get whole firm back in the black by curing problems of those businesses in portfolio responsible for pulling down overall performance

Corporate Turnaround Strategies

• Most appropriate where

– Reasons for poor performance are short-term – Ailing businesses are in attractive industries – Divesting money-losers doesn’t make long-term strategic sense

Corporate Retrenchment Strategies

Focus

• Reduce scope of diversification to a smaller number of businesses When to Consider

1. Certain businesses can’ be made profitable

2. Diversification efforts have become too broad and building strong positions in fewer businesses is key to improving long-term performance

Corporate Retrenchment Strategies

Options • Divest business

– Too small to make sizable contribution to earnings – Having little or no strategic fit with firm’s core businesses

Portfolio Restructuring Strategy

Focus • Making radical changes in mix and percentage makeup of types of businesses in portfolio via both

– Divestitures, and

– New acquisitions

Portfolio Restructuring Strategy

When to use

• Long-term performance prospects are unattractive

• Core business unit falls upon hard times

• “Wave of the future” technologies or products emerge and major shakeup is needed to build position in potentially big new industry

• “Unique opportunity” emerges and some existing businesses must be sold to finance new acquisition

• Major businesses in portfolio become unattractive

Comment: Trend in Diversification

The present tend toward narrower diversification has been driven by a growing preference to gear diversification around creating strong competitive positions in a few, well-selected industries as opposed to scattering corporate investments across many industries!

Strategy of Multinational Diversification

Distinguishing Characteristic Diversity of Business and Diversity of National Markets

• Presents a big strategy-making challenge

• Management must conceive and execute substantial number of strategies • At least one for each industry, with as many multinational variations as is appropriate

Multinational Diversification:

The 1960s

MNCs operated autonomous subsidiaries in each host country

• Management tasks at headquarters focused on

– Finance functions

– Technology transfer

– Export coordination

• Primary competitive advantage of an MNC – Ability to transfer certain skills from country to country efficiently and cheaply

MNC’s market position in a country negotiated with host government, not due to pressures of international competition

Multinational Diversification:

The 1970s

• Multi-country strategies based on national responsiveness began to lose effectiveness

• International competition in more industries

• Relevant market arena in many industries shifted from national to global

• Traditional MNCs driven to integrate operations across national borders

• Manufacturing a complete product range in each country became less prevalent

– Instead, plants specialized in making fewer models

Multinational diversification:

The 1970s

• Gains in manufacturing efficiencies from converting to world-scale plants more than offset increased international shipping costs

• In many industries, firms moved to locate plants in low-wage countries to achieve labor cost savings

• MNCs acted to take advantage of country-to- country differences

– Interest and exchange rates

– Favorable credit terms

– Government subsidies

– Export guarantees

Multinational Diversification:

The 1980s

• Another source of competitive advantage emerged

– Using strategic it advantages of related diversification to build a stronger global position

• Often, being a DMNC was competitively superior to an MNC due to economies of scope

• Related diversification produces extra competitive advantage for an MNC where

– Expertise in a core technology was applied in different industries

– Important brand name advantages existed

Competitive Strength of a DMNC in Global Markets

• Competitive advantages hinge upon

– Employing a related diversification strategy based on exploiting a core competence

– Managing related businesses to capture strategic fit benefits

– Using cross-subsidization to win solid footholds in attractive country markets

Competitive Strength of a DMNC in Global Markets

• A DMNC has a strategic arsenal capable of defeating both

– A single-business MNC, and – A single-business domestic firm in a long-term competitive struggle

End of Module 7