CHAPTER 8

CORPORATE STRATEGY
Diversification and
the Multibusiness Company

2013 by McGraw-Hill Education. All rights reserved.

81

WHEN BUSINESS DIVERSIFICATION

BECOMES A CONSIDERATION

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.

2013 by McGraw-Hill Education. All rights reserved.

85

APPROACHES TO DIVERSIFYING
THE BUSINESS LINEUP
Diversifying into
New Businesses

Acquisition of an
existing business

2013 by McGraw-Hill Education. All rights reserved.

Internal new
venture (start-up)

Joint
venture

810

CHOOSING A MODE OF
MARKET ENTRY
The Question of Critical
Resources and Capabilities

Does the firm have the resources and

capabilities for internal development?

The Question of
Entry Barriers

Are there entry barriers to overcome?

The Question of
Speed

Is speed of the essence in the firms

chances for successful entry?

The Question of
Comparative Cost

2013 by McGraw-Hill Education. All rights reserved.

Which is the least costly mode of entry,

given the firms objectives?

819

CHOOSING THE DIVERSIFICATION PATH:

RELATED VERSUS UNRELATED
BUSINESSES
Which Diversification
Path to Pursue?

Related
Businesses

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Unrelated
Businesses

Both Related
and Unrelated
Businesses

821

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.

2013 by McGraw-Hill Education. All rights reserved.

824

FIGURE 8.1

Related Businesses Provide Opportunities to

Benefit from Competitively Valuable Strategic Fit

2013 by McGraw-Hill Education. All rights reserved.

828

STRATEGIC FIT, ECONOMIES OF SCOPE,

AND COMPETITIVE ADVANTAGE
Using Economies of Scope to Convert
Strategic Fit into Competitive Advantage

Transferring
specialized and
generalized skills
and\or knowledge

Combining
related value
chain activities
to achieve
lower costs

2013 by McGraw-Hill Education. All rights reserved.

Leveraging
brand names
and other
differentiation
resources

Using crossbusiness
collaboration
and knowledge
sharing

830

CORE CONCEPTS
Economies of scope are cost reductions
that flow from operating in multiple
businesses (a larger scope of operation).
Economies of scale accrue from a largersize operation.

2013 by McGraw-Hill Education. All rights reserved.

831

DIVERSIFICATION INTO
UNRELATED BUSINESSES
Can it meet corporate targets
for profitability and return on
investment?
Evaluating the
acquisition of a
new business or
the divestiture of
an existing
business

Is it is in an industry with
attractive profit and growth
potentials?
Is it is big enough to contribute
significantly to the parent firms
bottom line?

2013 by McGraw-Hill Education. All rights reserved.

835

BUILDING SHAREHOLDER VALUE

VIA UNRELATED DIVERSIFICATION
Astute Corporate
Parenting by
Management
Cross-Business
Allocation of
Financial
Resources
Acquiring and
Restructuring
Undervalued
Companies

Provide leadership, oversight, expertise, and guidance.

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

Serve as an internal capital market.

Allocate surplus cash flows from businesses to fund
the capital requirements of other businesses.

Acquire weakly performing firms at bargain prices.

Use turnaround capabilities to restructure them to
increase their performance and profitability.

2013 by McGraw-Hill Education. All rights reserved.

837

THE PATH TO GREATER SHAREHOLDER

VALUE THROUGH UNRELATED
DIVERSIFICATION
The attractiveness test

Actions taken by upper

management to create
value and gain a
parenting advantage

The cost-of-entry test

The better-off test

2013 by McGraw-Hill Education. All rights reserved.

Diversify into businesses that can

produce consistently good earnings
and returns on investment

Negotiate favorable
acquisition prices

Provide managerial oversight and

resource sharing, financial resource
allocation and portfolio management,
and restructure underperforming
businesses
842

THE DRAWBACK OF UNRELATED

DIVERSIFICATION
Demanding
Managerial
Requirements

Pursuing an
Unrelated
Diversification
Strategy

Monitoring and
maintaining
the parenting
advantage

2013 by McGraw-Hill Education. All rights reserved.

843

MISGUIDED REASONS FOR

PURSUING UNRELATED
DIVERSIFICATION
Poor Rationales for
Unrelated Diversification

Seeking a
reduction of
business
investment risk

Pursuing rapid
or continuous
growth for its
own sake

2013 by McGraw-Hill Education. All rights reserved.

Seeking
stabilization to
avoid cyclical
swings in
businesses

Pursuing
personal
managerial
motives

844

COMBINATIONS OF RELATEDUNRELATED DIVERSIFICATION

STRATEGIES
Related-Unrelated Business
Portfolio Combinations

DominantBusiness
Enterprises

Narrowly
Diversified
Firms

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Broadly
Diversified
Firms

Multibusiness
Enterprises

846

EVALUATING THE STRATEGY

OF A DIVERSIFIED COMPANY
Attractiveness
of industries

Strength of
Business Units

Cross-business
strategic fit

Diversified
Strategy

Fit of firms
resources

2013 by McGraw-Hill Education. All rights reserved.

Allocation of
resources

New Strategic
Moves

848

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.

2013 by McGraw-Hill Education. All rights reserved.

849

STEP 1: EVALUATING INDUSTRY

ATTRACTIVENESS
How attractive are the
industries in which the firm
has business operations?

Does each industry represent a good

market for the firm to be in?
Which industries are most attractive,
and which are least attractive?
How appealing is the whole group of
industries?
2013 by McGraw-Hill Education. All rights reserved.

851

CALCULATING INDUSTRY
ATTRACTIVENESS SCORES
Deciding on appropriate weights for
the industry attractiveness measures.
Evaluating
Industry
Attractiveness

Gaining sufficient knowledge of the

industry to assign accurate and
objective ratings.
Whether to use different weights for
different business units whenever the
importance of strength measures differs
significantly from business to business.

2013 by McGraw-Hill Education. All rights reserved.

854

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.]
2013 by McGraw-Hill Education. All rights reserved.

855

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

and partnerships and alliances with other firms

Benefit from strategic fit with firms other businesses

Bargaining leverage with key suppliers or customers

Profitability relative to competitors

2013 by McGraw-Hill Education. All rights reserved.

856

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

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

2013 by McGraw-Hill Education. All rights reserved.

858

FIGURE 8.3
A Nine-Cell Industry
Attractiveness
Competitive
Strength Matrix

Star

Cash
cow

Note: Circle sizes are scaled to

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

2013 by McGraw-Hill Education. All rights reserved.

859

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.

2013 by McGraw-Hill Education. All rights reserved.

860

FIGURE 8.4 Identifying the Competitive Advantage

Potential of Cross-Business Strategic Fit

2013 by McGraw-Hill Education. All rights reserved.

862

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

2013 by McGraw-Hill Education. All rights reserved.

864

STEP 4: CHECKING FOR RESOURCE FIT

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?

2013 by McGraw-Hill Education. All rights reserved.

868

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.

2013 by McGraw-Hill Education. All rights reserved.

870

STEP 6: CRAFTING NEW STRATEGIC

MOVES TO IMPROVE OVERALL
CORPORATE PERFORMANCE
Strategy Options for a Firm
That Is Already Diversified

Stick with
the Existing
Business
Lineup

Broaden the
Diversification
Base with New
Acquisitions

2013 by McGraw-Hill Education. All rights reserved.

Divest and
Retrench to
a Narrower
Diversification
Base

Restructure
through
Divestitures
and
Acquisitions

872

FIGURE 8.6

A Firms Four Main

Strategic Alternatives
After It Diversifies

2013 by McGraw-Hill Education. All rights reserved.

873