Diversification Strategy From Contemporary Strategic Analysis by Robert Grant

Before going into that FOUR different types (not mutually exclusive, though) of Strategies to manage an d sustain profitability ! Diversification Strategy ! Integration Strategy ! Intensive Strategy ! Defensi ve Strategy

Before going into that FOUR different types (not mutually exclusive, though) of Strategies to manage an d sustain profitability ! Diversification Strategy ! Integration Strategy --- backward, forward, horizon tal ! Intensive Strategy ! Defensive Strategy

Before going into that FOUR different types (not mutually exclusive, though) of Strategies to manage an d sustain profitability ! Diversification Strategy ! Integration Strategy ! Intensive Strategy --- Marke t penetration, market development, product development ! Defensive Strategy

Before going into that FOUR different types (not mutually exclusive, though) of Strategies to manage an d sustain profitability ! Diversification Strategy ! Integration Strategy ! Intensive Strategy ! Defensi ve Strategy --- divestiture, retrenchment, liquidation

Diversification Strategies Concentric diversification

Conglomerate diversification

Horizontal diversification

Diversification Strategies Concentric Diversification Adding new, but related, products or services

Diversification Strategies Guidelines for Concentric Diversification Competes in no-growth or slow-growth industry Adding new & related products incr eases sales of current products New & related products offered at competitive pr ices Current products are in decline stage of the product life cycle Strong mana gement team

Diversification Strategies Conglomerate Diversification Adding new, unrelated products or services

Diversification Strategies Guidelines for Conglomerate Diversification Declining annual sales and profits Capital and managerial talent to compete succ essfully in a new industry Financial synergy between the acquired and acquiring firms Existing markets for present products are saturated

Diversification Strategies Horizontal Diversification Adding new, unrelated products or services for presen t customers

Diversification Strategies Guidelines for Horizontal Diversification

Revenues from current products/services would increase significantly by adding t he new unrelated products Highly competitive and/or no-growth industry w/ low ma rgins and returns Present distribution channels can be used to market new produc ts to current customers New products have counter cyclical sales patterns compar ed to existing products

Diversification Strategy OUTLINE ! Introduction: The Basic Issues ! tion

The Trend over Time !

Motives for Diversifica

- Growth and Risk Reduction - Shareholder Value: Porters Essential Tests. ! Competitive Advantage from Diversification ! Diversification and Performance: Empirical Evidence ! Relatedness in Diversification

Basic Issues in Diversification Decisions Superior profit derives from two sources: INDUSTRY ATTRACTIVENESS NET OPERATING PROFIT > COST OF CAPITAL COMPETITIVE ADVANTAGE Diversification decisions involve these same two issues: How attractive is the se ctor to be entered? Can the firm achieve a competitive advantage?

Diversification among the US Fortune 500, 1949-74 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 Note: During the 1980s and 1990s the trend reversed as large companies refocused upon their core businesses

Diversification among Large UK Corporations, 1950-93 70 60 50 40 30 20 10 0 1950 1960 1970 1983 1993 Single business Dominant busines s Related business Unrelated business

Diversification: The Evolution of Management Thinking and Management Practice MANAGEMENT GOALS Quest for Growth Financial problems of conglomerates Refocusing on shareholder value Competitive advantage through flexibility, and capability COMPANY DEVELOPMENTS Rise of conglomerates Emphasis onrelated Refocusing on Related diversification cor e businesses & concentric by industrial firms Divestment diversification Joint ventures, Alliance, corporate venturing Financial Analysis Diffusion of M form structures STRATEGY TOOLS & CONCEPTS Analysis of economies of scope & synergy Portfolio planning models Value based Transaction management cost analysis Core competences Dominant logic Dynamic capability Capital asset pricing model Development of corporate planning systems 1950 1960 1970 1980 1990

Motives for Diversification GROWTH ! The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco, newspapers). ! But, growth satisfies managers not shareholders. ! ly by acquisition), tend to destroy shareholder value Growth strategies (especial

Motives for Diversification RISK SPREADING ! Diversification reduces variance of profit flows ! But, does not create value for shareholders ! Capital Asset Pricing Model shows that diversification lowers unsystematic risk not systematic risk.

Motives for Diversification PROFIT ! For diversification to create shareholder value, then bringing together of different businesses under common ownership & must som ehow increase their profitability.

Diversification and Shareholder Value: Porters Three Essential Tests If diversification is to create shareholder value, it must meet three tests:

Diversification and Shareholder Value: Porters Three Essential Tests If diversification is to create shareholder value, it must meet three tests: 1. The Attractiveness Test: diversification must be directed towards attractive industries (or have the potential to become attractive).

Diversification and Shareholder Value: Porters Three Essential Tests If diversification is to create shareholder value, it must meet three tests: 1. The Attractiveness Test: diversification must be directed towards attractive industries (or have the potential to become attractive). 2. The Cost of Entry Test : the cost of entry must not overwhelm all future prof its.

Diversification and Shareholder Value: Porters Three Essential Tests If diversification is to create shareholder value, it must meet three tests: 1. The Attractiveness Test: diversification must be directed towards attractive ind ustries (or have the potential to become attractive). 2. The Cost of Entry Test : the cost of entry must not capitalize all future profits. 3. The Better-Off Te st: either the new unit must gain competitive advantage from its link with the c ompany, or vice-versa. (i.e. some form of synergy must be present)

Diversification and Shareholder Value: Porters Three Essential Tests If diversification is to create shareholder value, it must meet three tests: 1. The Attractiveness Test: diversification must be directed towards attractive ind ustries (or have the potential to become attractive). 2. The Cost of Entry Test : the cost of entry must not overwhelm all future profits. 3. The Better-Off Tes t: either the new unit must gain competitive advantage from its link with the co mpany, or vice-versa. (i.e. some form of synergy must be present) Additional source of value from diversification: Option value

Competitive Advantage from Diversification MARKET POWER 1. Predatory pricing/tie-in sales 2. Reciprocal buying 3. arance Evidence of all three are sparse

Mutual forbe

Competitive Advantage from Diversification ECONOMIES OF SCOPE Sharing tangible resources (research labs, distribution system s) across multiple businesses Sharing intangible resources (brands, technology) a cross multiple businesses

Competitive Advantage from Diversification ECONOMIES OF SCOPE (--- continued) Transferring functional capabilities (marketing, product development) across busi nesses Applying general management capabilities to multiple businesses

Competitive Advantage from Diversification INTERNALIZE TRANSACTION COST Economies of scope not a sufficient basis for divers ificationmust be supported by transaction costs Diversification firm can avoid tra nsaction costs by operating internal capital and labor markets Key advantage of d iversified firm over external markets--- superior access to information

Relatedness in Diversification Economies of scope in diversification derive from two 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 b usinesses.

Relatedness in Diversification Problem of operational relatedness: the benefits in terms of economies of scope may be dwarfed by the administrative costs involved in their exploitation.

Branson & the Virgin Companies: Making strategic sense of apparent entrepreneuri al chaos KEY RESOURCES Virgin brand Branson -charisma/image --PR skills -networking skills -entrepreneurial flair DOMINANT LOGIC Seek competitive advantage by start-up cos. pursuing innovative differentiation in underserved market with sleepy incumbents CHARACTERISTICS OF MARKETSTHAT CONFORM TO THIS LOGIC DESIGNING A CORPORATE STRATEGY & STRUCTURE Whats the business model? (Does Virgin create value by being an entrepreneurial in cubator, a venture capital fund, a diversified corporation, or what?) Which busin esses to divest? Criteria for future diversification What type of structure?Is ther e a need for greater formalization?

consumer dominant incumbent scope for new approaches to customer service high entry b iers to other start-ups Branson/Virgin image appeals to customers