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CHAPTER 8

CORPORATE STRATEGY:
Diversification and
the Multibusiness Company

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THIS CHAPTER WILL HELP YOU UNDERSTAND:
LO 1 When and how business diversification
can enhance shareholder value.
LO 2 How related diversification strategies can produce cross-
business strategic fit capable of delivering competitive
advantage.
LO 3 The merits and risks of unrelated diversification strategies.
LO 4 The analytic tools for evaluating a companys diversification
strategy.
LO 5 What four main corporate strategy options a diversified
company can employ for solidifying its strategy and
improving company performance.

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WHAT DOES CRAFTING A
DIVERSIFICATION STRATEGY ENTAIL?

Picking new industries to enter and deciding on the means of


Step 1 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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STRATEGIC DIVERSIFICATION OPTIONS

Sticking closely with the existing business lineup and


pursuing opportunities presented by these businesses.
Broadening the current scope of diversification by
entering additional industries.
Retrenching to a narrower scope of diversification by
divesting poorly performing businesses
Broadly restructuring the entire firm by divesting some
businesses and acquiring others to put a whole new
face on the firms business lineup.

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WHEN TO CONSIDER DIVERSIFYING

A firm should consider diversifying when:


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

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BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING

Testing Whether Diversification


Will Add Long-Term
Value for Shareholders

The industry The The


attractiveness cost-of-entry better-off
test test test

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BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING

The Attractiveness Test:


Are the industrys profits and return on investment
as good or better than present business(es)?
The Cost of Entry Test:
Is the cost of overcoming entry barriers so great as
to long delay or reduce the potential for profitability?
The Better-Off Test:
How much synergy (stronger overall performance)
will be gained by diversifying into the industry?

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CORE CONCEPT

To add shareholder value, a move to


diversify into a new business must pass
the three Tests of Corporate Advantage:
1. The Industry Attractiveness Test
2. The Cost of Entry Test
3. The Better-off Test

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CORE CONCEPT

Creating added value for shareholders via


diversification requires building a
multibusiness company in which the
whole is greater than the sum of its parts
such 1 + 1= 3 effects are called
synergy.

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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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APPROACHES TO DIVERSIFYING
THE BUSINESS LINEUP

Diversifying into
New Businesses

Existing business Internal new Joint


acquisition venture (start-up) venture

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DIVERSIFICATION BY ACQUISITION
OF AN EXISTING BUSINESS

Advantages:
Quick entry into an industry
Barriers to entry avoided
Access to complementary resources and capabilities
Disadvantages:
Cost of acquisitionwhether to pay a premium for a
successful firm or seek a bargain in struggling firm
Underestimating costs for integrating acquired firm
Overestimating the acquisitions potential to deliver
added shareholder value
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CORE CONCEPT

An acquisition premium is the amount


by which the price offered exceeds the
preacquisition market value of the target
firm.

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ENTERING A NEW LINE OF BUSINESS THROUGH
INTERNAL DEVELOPMENT

Advantages of New Venture Development:


Avoids pitfalls and uncertain costs of acquisition.
Allows entry into a new or emerging industry where
there are no available acquisition candidates.
Disadvantages of Intrapreneurship:
Must overcome industry entry barriers.
Requires extensive investments in developing
production capacities and competitive capabilities.
May fail due to internal organizational resistance to
change and innovation.
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CORE CONCEPT

Corporate venturing (or new venture


development) is the process of
developing new businesses as an
outgrowth of a firms established
business operations. It is also referred to
as corporate entrepreneurship
or intrapreneurship since it requires
entrepreneurial-like qualities within a
larger enterprise.

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WHEN TO ENGAGE IN INTERNAL DEVELOPMENT

Ample time to
develop and
launch business
Availability of Cost of acquisition
in-house skills is higher than
and resources internal entry

Factors Favoring
Internal Development

Low resistance of Added capacity


incumbent firms does affect supply
to market entry and demand balance
Low resistance of
incumbent firms
to market entry

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WHEN TO ENGAGE IN A JOINT VENTURE

Is the opportunity too complex, uneconomical,


or risky for one firm to pursue alone?

Evaluating
Does the opportunity require a broader range
the Potential
of competencies and know-how than the firm
for a Joint now possesses?
Venture

Will the opportunity involve operations in a


country that requires foreign firms to have a
local minority or majority ownership partner?

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USING JOINT VENTURES TO ACHIEVE
DIVERSIFICATION

Joint ventures are advantageous when


diversification opportunities:
Are too large, complex, uneconomical, or
risky for one firm to pursue alone.
Require a broader range of competencies
and know-how than a firm possesses or can
develop quickly.
Are located in a foreign country that requires
local partner participation and/or ownership.

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DIVERSIFICATION BY JOINT VENTURE

Joint ventures have the potential for developing


serious drawbacks due to:
Conflicting objectives and expectations of
venture partners.
Disagreements among or between venture
partners over how best to operate the venture.
Cultural clashes among and between the
partners.
The venture dissolving when one of the
venture partners decides to go their own way.
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CHOOSING A MODE OF MARKET ENTRY

The Question of Critical Does the firm have the resources and
Resources and Capabilities capabilities for internal development?

The Question of
Are there entry barriers to overcome?
Entry Barriers

Is speed of the essence in the firms


The Question of Speed chances for successful entry?

The Question of Which is the least costly mode of entry,


Comparative Cost given the firms objectives?

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STRATEGIC MANAGEMENT PRINCIPLE

Transaction costs are the costs of completing


a business agreement or deal of some sort,
over and above the price of the deal. They can
include the costs of searching for an attractive
target, the costs of evaluating its worth,
bargaining costs, and the costs of completing
the transaction.

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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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CORE CONCEPTS

Related businesses possess


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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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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CORE CONCEPT

Strategic fit exists whenever one or


more activities constituting the value
chains of different businesses are
sufficiently similar as to present
opportunities for cross-business sharing
or transferring of the resources and
capabilities that enable these activities.

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DIVERSIFICATION INTO RELATED BUSINESSES

Strategic Fit Opportunities:


Transferring specialized expertise, technological know-how,
or other resources and capabilities from one businesss
value chain to anothers.
Sharing costs by combining related value chain activities
into a single operation.
Exploiting common use of a well-known brand name.
Sharing other resources (besides brands) that support
corresponding value chain activities across businesses.
Engaging in cross-business collaboration and knowledge
sharing to create new competitively valuable resources and
capabilities.

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PURSUING RELATED DIVERSIFICATION

Related diversification involves sharing or


transferring specialized resources and
capabilities.
Specialized Resources and Capabilities
Have very specific applications and their
use is limited to a restricted range of
industry and business types.

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CORE CONCEPTS
Specialized Versus Generalized Resources
and Capabilities
Specialized resources and capabilities
have very specific applications and their use is
limited to a restricted range of industry and
business types.
Leveraged in related diversification
General resources and capabilities can be
widely applied and can be deployed across a
broad range of industry and business types.
Leveraged in unrelated and related diversification

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

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IDENTIFYING CROSS-BUSINESS STRATEGIC FITS
ALONG THE VALUE CHAIN

Supply
Chain
Activities
R&D and Manufacturing-
Technology Related
Activities Activities

Potential
Cross-Business
Fits
Sales and Distribution-
Marketing Related
Activities Activities
Customer
Service
Activities

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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

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CORE CONCEPT

Economies of scope are cost reductions


that flow from operating in multiple
businesses (a larger scope of operation).
Economies of scale accrue from a
larger-size operation.

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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.

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FROM STRATEGIC FIT TO COMPETITIVE
ADVANTAGE, ADDED PROFITABILITY AND
GAINS IN SHAREHOLDER VALUE

Capturing the Cross-Business Strategicfit


Benefits of Related Diversification

Builds more Is only possible Yields value in Requires that


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

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STRATEGIC MANAGEMENT PRINCIPLE

Diversifying into related businesses where


competitively valuable strategic-fit benefits can
be captured puts a firms businesses in position
to perform better financially as part of the firm
than they could have performed as
independent enterprises, thus providing a clear
avenue for boosting shareholder value and
satisfying the better-off test.

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ILLUSTRATION Microsofts Acquisition of Skype: Pursuing
CAPSULE 8.1
the Benefits of Cross-Business Strategic Fit

What does the acquisition of Skype reveal


about the importance of Microsofts efforts
to execute a successful cross-business
acquisition strategy?
To what extent is decentralization required
when seeking cross-business strategic fit?
What should Microsoft do to ensure the
continued success of its strategy?
How will Microsoft keep Skypes user base
from moving to competing providers?

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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?

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BUILDING SHAREHOLDER VALUE
VIA UNRELATED DIVERSIFICATION

Using an Unrelated Diversification


Strategy to Pursue Value

Cross-business Acquiring and


Astute corporate
allocation of restructuring
parenting by
financial undervalued
management
resources companies

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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

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CORE CONCEPT

Corporate parenting is the role that a


diversified corporation plays in nurturing
its component businesses through the
provision of:
top management expertise
disciplined control
financial resources
Other types of generalized resources and
capabilities such as long-term planning
systems, business development skills,
management development processes,
and incentive systems.
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CORE CONCEPT

A diversified firm has a parenting


advantage when it is more able than
other firms to boost the combined
performance of its individual businesses
through high-level guidance, general
oversight, and other corporate-level
contributions.

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STRATEGIC MANAGEMENT PRINCIPLE

An umbrella brand is a corporate brand name


that can be applied to a wide assortment of
business types. As such, it is a generalized
resource that can be leveraged in unrelated
diversification.

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CORE CONCEPT

Restructuring refers to overhauling and


streamlining the activities of a business
combining plants with excess capacity,
selling off underutilized assets, reducing
unnecessary expenses, and otherwise
improving the productivity and
profitability of the firm.

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THE PATH TO GREATER SHAREHOLDER VALUE
THROUGH UNRELATED DIVERSIFICATION

The attractiveness test Diversify into businesses that can


produce consistently good earnings
and returns on investment

Actions taken by upper


management to create The cost-of-entry test Negotiate favorable
value and gain a acquisition prices
parenting advantage

Provide managerial oversight and


resource sharing, financial resource
The better-off test allocation and portfolio management,

and restructure underperforming


businesses

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THE DRAWBACKS OF UNRELATED
DIVERSIFICATION

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

Monitoring and Potential lack of


maintaining cross-business
the parenting strategic-fit
advantage benefits

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MISGUIDED REASONS FOR PURSUING
UNRELATED DIVERSIFICATION

Poor Rationales for


Unrelated Diversification

Seeking
Seeking a 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

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STRATEGIC MANAGEMENT PRINCIPLE

Relying solely on leveraging general resources


and the expertise of corporate executives to
wisely manage a set of unrelated businesses is
a much weaker foundation for enhancing
shareholder value than is a strategy of related
diversification.
Only profitable growththe kind that comes
from creating added value for shareholders
can justify a strategy of unrelated
diversification.

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COMBINATION RELATED-UNRELATED
DIVERSIFICATION STRATEGIES

Related-Unrelated Business
Portfolio Combinations

Dominant- Narrowly Broadly


Multibusiness
Business Diversified Diversified
Enterprises
Enterprises Firms Firms

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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.
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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

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EVALUATING THE STRATEGY
OF A DIVERSIFIED FIRM

1. Assessing the attractiveness of the industries the firm has


diversified into, both individually and as a group.
2. Assessing the competitive strength of the firms business units
within their respective industries.
3. Evaluating the extent of cross-business strategic fit along the
value chains of the firms various business units.
4. Checking whether the firms resources fit the requirements of its
present business lineup.
5. Ranking the performance prospects of the businesses from best
to worst and determining a priority for allocating resources.
6. Crafting strategic moves to improve corporate performance.

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FIGURE 8.2
Three Strategy Options for
Pursuing Diversification

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STEP 1: EVALUATING INDUSTRY
ATTRACTIVENESS

How attractive are the


industries in which the firm
has business operations?

1. Does each industry represent a good


market for the firm to be in?

2. Which industries are most attractive,


and which are least attractive?

3. How appealing is the whole group


of industries?

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CALCULATING INDUSTRY-ATTRACTIVENESS
SCORES: KEY MEASURES

Market size and projected growth rate


The intensity of competition among market rivals
Emerging opportunities and threats
The presence of cross-industry strategic fit.
Resource requirements.
Social, political, regulatory, environmental factors
Industry profitability

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CALCULATING INDUSTRY ATTRACTIVENESS
FROM THE MULTIBUSINESS PERSPECTIVE

How well do the industrys value chain and


The Question of Cross- resource requirements match up with the value
Industry Strategic Fit chain activities of other industries in which the
firm has operations?

Do the resource requirements for an industry


The Question of
match those of the parent firm or are they
Resource Requirements otherwise within the companys reach?

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CALCULATING INDUSTRY
ATTRACTIVENESS SCORES

Deciding on appropriate weights for


the industry attractiveness measures.

Evaluating Gaining sufficient knowledge of the


Industry industry to assign accurate and
Attractiveness objective ratings.

Whether to use different weights for


different business units whenever the
importance of strength measures differs
significantly from business to business.

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TABLE 8.1
Calculating
Weighted
Industry
Attractiveness
Scores

Remember:
The more
intensely
competitive
an industry is,
the lower the
attractiveness
rating for that
industry!

[Rating scale: 1 = very unattractive to the firm; 10 = very attractive to the firm.]
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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
Benefits from strategic fit with firms other businesses
Bargaining leverage with key suppliers or customers
Profitability relative to competitors

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STRATEGIC MANAGEMENT PRINCIPLE

Using relative market share to measure


competitive strength is analytically superior to
using straight-percentage market share.
Relative market share is the ratio of a business
units market share to the market share of its
largest industry rival as measured in unit
volumes, not dollars.

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TABLE 8.2
Calculating
Weighted
Competitive-
Strength
Scores for a
Diversified
Companys
Business
Units

[Rating scale: 1 = very weak; 10 = very strong.]

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

Cash
cow

Note: Circle sizes are scaled to


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

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STEP 3: DETERMINING THE COMPETITIVE VALUE
OF STRATEGIC FIT IN DIVERSIFIED COMPANIES

Assessing the degree of strategic fit across its


businesses is central to evaluating a companys
related diversification strategy.
The real test of a diversification strategy is what
degree of competitive value can be generated
from strategic fit.

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
STRATEGIC MANAGEMENT PRINCIPLE

The greater the value of cross-business


strategic fit in enhancing a firms performance
in the marketplace or on the bottom line, the
more competitively powerful is its strategy of
related diversification.

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

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CORE CONCEPT

A company pursuing related


diversification exhibits resource fit when
its businesses have matching specialized
resource requirements along their value
chains
A company pursuing unrelated
diversification has resource fit when the
parent company has adequate corporate
resources (parenting and general
resources) to support its businesses
needs and add value.
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STEP 4: 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

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CORE CONCEPTS

A strong internal capital market allows


a diversified firm to add value by shifting
capital from business units generating
free cash flow to those needing additional
capital to expand and realize their growth
potential.
A portfolio approach to ensuring
financial fit among a firms businesses is
based on the fact that different
businesses have different cash flow and
investment characteristics.
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CORE CONCEPTS

A cash cow business generates cash


flows over and above its internal
requirements, thus providing a corporate
parent with funds for investing in cash
hog businesses, financing new
acquisitions, or paying dividends.
A cash hog business generates cash
flows that are too small to fully fund its
operations and growth and requires cash
infusions to provide additional working
capital and finance new capital
investment.
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STEP 4: CHECKING FOR RESOURCE FIT (cont'd)

Nonfinancial 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?

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STEP 5: RANKING BUSINESS UNITS
AND ASSIGNING A PRIORITY
FOR RESOURCE ALLOCATION
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.
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FIGURE 8.5 The Chief Strategic and Financial Options for Allocating
a Diversified Companys Financial Resources

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STEP 6: CRAFTING NEW STRATEGIC MOVES
TO IMPROVE OVERALL CORPORATE
PERFORMANCE

Strategy Options for a Firm


That Is Already Diversified

Divest and Restructure


Stick with Broaden the
Retrench to through
the Existing Diversification
a Narrower Divestitures
Business Base with New
Diversification and
Lineup Acquisitions
Base Acquisitions

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FIGURE 8.6
A Firms Four Main
Strategic Alternatives
After It Diversifies

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BROADENING A DIVERSIFIED
FIRMS BUSINESS BASE

Factors Motivating the Adding of Businesses:


The transfer of resources and capabilities
to related or complementary businesses.
Rapidly changing technology, legislation,
or new product innovations in core businesses.
Shoring up the market position and competitive
capabilities of the firms present businesses.
Extension of the scope of the firms operations
into additional country markets.

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DIVESTING BUSINESSES AND RETRENCHING
TO A NARROWER DIVERSIFICATION BASE

Factors Motivating Business Divestitures:


Improvement of long-term performance by
concentrating on stronger positions in fewer
core businesses and industries.
Business is now in a once-attractive industry where
market conditions have badly deteriorated.
Business has either failed to perform as expected
and\or is lacking in cultural, strategic or resource fit.
Business has become more valuable if sold to
another firm or as an independent spin-off firm.

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CORE CONCEPT

A spinof is an independent company


created when a corporate parent divests
a business either by selling shares to the
public via an initial public offering or by
distributing shares in the new company
to shareholders of the corporate parent.

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STRATEGIC MANAGEMENT PRINCIPLE

Diversified companies need to divest low-


performing businesses or businesses that do
not fit in order to concentrate on expanding
existing businesses and entering new ones
where opportunities are more promising.

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RESTRUCTURING A DIVERSIFIED COMPANYS
BUSINESS LINEUP

Factors Leading to Corporate Restructuring:


A serious mismatch between the firms resources and
capabilities and the type of diversification that it has pursued.
Too many businesses in slow-growth, declining, low-margin, or
otherwise unattractive industries.
Too many competitively weak businesses.
Ongoing declines in the market shares of major business units
that are falling prey to more market-savvy competitors.
An excessive debt burden with interest costs that eat deeply into
profitability.
Ill-chosen acquisitions that havent lived up to expectations.

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CORE CONCEPT

Companywide restructuring
(corporate restructuring) involves making
major changes in a diversified company
by divesting some businesses and/or
acquiring others, so as to put a whole
new face on the companys business
lineup.

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STRATEGIC MANAGEMENT PRINCIPLE

Diversified companies need to divest low-


performing businesses or businesses that dont
fit in order to concentrate on expanding existing
businesses and entering new ones where
opportunities are more promising.

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ILLUSTRATION Growth through Restructuring
CAPSULE 8.2
at Kraft Foods

How is Kraft Foods corporate restructuring


strategy affecting its operational base?
Which competitive advantages were gained
and which were lost by the splitting Kraft
Foods into two separate entities?
What restructuring actions did Kraft Foods
Group take after the spinoff to strengthen
itself?

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