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Introduction: The Basic Issues The Trend over Time Motives for Diversification - Growth and risk spreading - Diversification and Shareholder Value: Porters Three Essential Tests. Competitive Advantage from Diversification Diversification and Performance: Empirical Evidence Relatedness in Diversification
Objectives
Define corporate strategy, describe some of the reasons why firms diversify, identify and describe different types of corporate diversification, and assess the advantages and disadvantages associated with each. Identify sources of synergy in diversified firms while also describing why synergies are so difficult to achieve.
Objectives (cont.)
Explore the complex relationship between diversification and firm performance. In particular, explore the influence of managers and managerial thinking on the relationship between diversification and performance.
Introduction
Definition of Corporate Strategy
Address the question: What is the appropriate scale and scope of the enterprise?
Influences how large and how diversified firms will be. Successful corporate strategies are not only the product of successful definition
Also the result of organizational capabilities or competencies that allow firms to exploit potential economies/synergies that large size or diversity can offer.
Introduction (cont.)
Why Firms Diversify
To grow To more fully utilize existing resources and capabilities. To escape from undesirable or unattractive industry environments. To make use of surplus cash flows.
Introduction (cont.)
Horizontal or related diversification
Strategy of adding related or similar product/service lines to existing core business, either through acquisition of competitors or through internal development of new products/services.
Introduction (cont.)
Horizontal or related diversification
Advantages
Opportunities to achieve economies of scale and scope. Opportunities to expand product offerings or expand into new geographical areas.
Introduction (cont.)
Conglomerate or unrelated diversification Firms pursue this strategy for several reasons:
Continue to grow after a core business has matured or started to decline. To reduce cyclical fluctuations in sales revenues and cash flows.
Relatedness in Diversification
Synergy in diversification derives from two main types of relatedness: Operational Relatedness-- synergies from sharing resources across businesses (common distribution facilities, brands, joint R&D) Strategic Relatedness-- synergies at the corporate level deriving from the ability to apply common management capabilities to different businesses. Problem of operational relatedness:- the benefits in terms of economies of scope may be dwarfed by the administrative costs involved in their exploitation.
The Trend Over Time: Diversified Companies among the Fortune 500
70.2 29.8 63.5 36.5 53.7 46.3 53.9 46.1 39.9 60.1 37.0 63.0
1949
1954 1959 1964 1969 1974 Percentage of Specialized Companies (single-business, vertically-integrated and dominant-business) Percentage of Diversified Companies (related-business and unrelated business)
The Score
What is relationship between diversification and firm performance?
Academics, consultants,and financial community have dim view of diversification. Some studies suggest that diversification beyond a core business leads to lower performance.
47 46
46 47
RISK SPREADING
PROFIT
2. The Cost of Entry Test : the cost of entry must not capitalize all future profits.
3. The Better-Off Test: either the new unit must gain competitive advantage from its link with the corporation, or vice-versa. (i.e. synergy must be present)
Must also have well-developed beliefs about how diversification should be managed in order to achieve synergies.
How to coordinate the activities of businesses in order to achieve synergies.
By engaging in a number of acquisitions over time, managers can come to develop an expertise about how the acquisition process should be managed.
Exhibit: Five-Year Stock Market Performance of Four Bank Holding Companies that Are Active Acquirers
Banc One NationsBank Norwest First Bank Wells Fargo
0% 50% 100% 150%
Conclusions
Size alone does not guarantee firms an advantage.
Coordination required to exploit economies of scale and scope is not without cost. Size creates additional challenges and difficulties, including problems of communication and coordination.
Higher levels of diversification are not incompatible with high performance -- nor do they necessarily imply that firms will suffer lower performance levels.
Conclusions (cont.)
Critical factor in determining success is the level of management expertise in formulating and implementing corporate strategy.
More difficult for diversified firms. Managers of large diversified firms possess a variety of well-developed mental models that provide them with powerful understandings of how to manage their firms.