Diversification and Vertical Integration

by

Dr. Deepikaa Joshi

Diversification: Meaning and Definition

This word is used to identify the direction of development which take the organization away from its present markets and its present products at the same time

Factors that signals when its time to diversify

When to diversify depends partly upon companys growth opportunities in its present industry and partly on the opportunities to utilize its resources, expertise and capabilities in other market arenas. Diminishing growth prospects in its present business Opportunities to add value for its customer Gain competitive advantage by broadening its present business to include complementary products or technologies. To create shareholders value, to spread the business risk across various industries Cost saving opportunities that can be exploited by diversifying into closely related businesses

the financial and organizational resources to support a diversification efforts.

It happens when firm possesses technological expertise, core competencies, and resource strengths that are uniquely well suited for competing successfully in other industries.
3

Choosing the diversification path

Development into activities which are concerned with the input into the companys current business Development into activities which are concerned with the companys output

Backward integration Related diversification Strategy options for a company looking to diversify Unrelated diversification Forward integration Horizontal integration

Development into activities which are competitive with, or directly complementary to a companys present activities

Exploiting Creation New competency

New market and new product Creation of genuinely new market New competencies are developed for new opportunities
4

Related Diversification options for manufacturers

Raw material manufacture Components manufacturer Machinery manufacture Product/Process research/ design

Raw material Supply

Components Supply Transport

Machinery Supply

Financing

Manufacturer Complementary Products

By-products

Distribution Outlet

Transport

Marketing information

Repair and servicing

Note: Some companies will manufacture components or semi-finished items. In those cases there will be additional integration opportunities into assembly or finished product manufacture.

Forward Integration
5

Horizontal Integration

Components Product

Backward Integration

Related Diversification and its strategies

Businesses are said to be related when there are competitively valuable relationship among the activities comprising their respective value chain. Related diversification strategy involves adding businesses whose value chains possess competitively valuable strategic fit with the value chain of the companys present business. Combining related activities of separate businesses into single operations to achieve low cost. Create competitively valuable resource strengths and capabilities for cross business collaborations. Transfer of competitively valuable expertise or technological know-hows from one business to another. The greater the economies of scope: refers to lowering average cost for a firm in

producing two or more product.

A diversified firm that exploits cross-business value chain matchups and capture the benefits of strategic fit can achieve a consolidated performance greater than the sum of what the businesses can earn pursuing independent strategies.
Strategic fit express the degree to which an organization is matching its resources and capabilities with the opportunities in the external environment. Tangible: Financial (Cash, securities), Physical (Location, plant, machinery) Intangible: Technology (Patents, copyrights) ,Human resources, Reputation (Brands), Culture

Unrelated Diversification and its strategies

Businesses are said to be unrelated when the activities comprising their respective value chains are so dissimilar that no real potential exists to transfer skills or technology from one business to another or to combine similar activities and reduce costs or to otherwise produce competitively valuable benefits from operating under a common corporate umbrella. The basic premise of unrelated diversification is that any company that can be acquired on good financial terms and that has satisfactorily profit prospects presents a good business to diversify. Two types of businesses hold attraction for unrelated diversification: Companies whose assets are undervalued Companies that are financially distressed

Value Chain for Related Businesses

Representative Value Chain Activities

Support Activities
Business A Supply chain Activities R&D and Technology Operations Sales and Marketing Distribution Customer service

Competitively valuable opportunities for technology or skills transfer, cost reduction, common brand name usage, and cross-business collaborations exist at one or more points along the value chains of A and B

Business B

Supply chain Activities

R&D and Technology

Operations

Sales and Marketing

Distribution

Customer service

Support Activities

Value Chain for Unrelated Businesses

Representative Value Chain Activities

Support Activities
Business A Supply chain Activities Technology Operations Sales and Marketing Distribution Customer service

An absence of competitively valuable strategic fits between the value chain for Business A and the value chain for Business B

Business B

Supply chain Activities

Technology

Operations

Sales and Marketing

Distribution

Customer service

Support Activities

Strategic Options for a Company That is already Diversified

Make New Acquisition and/or Enter into Additional Strategic Partnership Build position in new related/unrelated industries. Strengthen the position of business units in industries where the firm already as a stake Divest Some of the Companys Existing Businesses Narrow the companys business base and scope of operations. Eliminate business that has very small sizable contribution to earnings. Eliminate businesses that no longer fits in strategic fit. Restructuring the Companys Portfolio of Businesses and turnaround strategies By selling poorly performing or noncore business units. Shifting to a hopefully better business level strategy. Pursuing cost reduction. Launching new initiatives to boost the businesss revenues. Becomes a Multinational, Multi-industry Enterprise To succeed in global competitive core businesses against international, rivals. To capture strategic fit benefit and win multinational diversification. 10

Strategy options for a Diversified Company

Multinational Diversification Strategies

Six ways to build competitive advantage: Full capture of economies of scale and experience curve effects. Opportunities to capitalize on cross-business economies of scope. Opportunities to transfer competitively valuable resources from one business to another and from one country to another. Ability to leverage use of a well-known and competitively powerful brand name. Ability to capitalize on opportunities for cross-business and cross-country collaboration and strategic coordination. Opportunities to use cross-business or cross country subsidization to outcompete rivals.

11

Strategic fit

Matching of the activities of an organization to the environment in which it operates. This is known as the search for strategic fit. It exists whenever one or more activities comprising the value chains of different businesses are sufficiently similar as to present opportunities for.

Strategic fit can be used actively to evaluate the current strategic situation of a company as well as opportunities as M&A and divestitures of organizational divisions.
Strategic fit is related to the Resource-based view of the firm which suggests that the key to profitability is not only through positioning and industry selection but rather through an internal focus which seeks to utilize the unique characteristics of the companys portfolio of resources and capabilities.

12

The lead edge of strategy: fit or stretch

Aspect of strategy Underlining basis of strategy

Environment-led fit Strategic fit b/w market opportunities and organizational resources Correct positioning, Differentiation directed by market need Find and defend a niche Portfolio of product/businesses Strategies of division or subsidiaries

Resource-led fit Leverage of resources to improve value for money Differentiation based on competences to or creating market need Change the rules of the game Portfolio of competences Core competences

Competitive advantage through How small player survive Risk reduction through. Corporate centre invests in.

Source: Hamel and Prahalad, HBR, 1994

13

Synergy

Synergy is commonly diversification.

cited

reason

for

both

related

and

unrelated

Potentially it occurs where two or more activities or processes complement each other, to the extent that their combined effect is greater than the sum of the parts

The conditions of synergy provides a useful link b/w the logic of synergy and the practical realities of adopting such a strategy (see slide 15. )
Determination, acceptance, and compatibility with the system and culture of the organization is also required.

14

Conditions that need to be satisfied if strategies based on exploiting synergy are need to be successful

Pressure to change

The centre is determined

Sharing is appropriate

SBUs have accepted

Opportunity to improve

Compatibility with decentralization contract

Source: Campbell, Synergy and Decentralization, Unpublished, 1991 (sponsored by McKinsey)

15

Critical questions for diversification

What can our company do better than any of its competitors in its current market? What strategic assets do we need in order to succeed in the new market? Can we catch up to or leapfrog competitors at their own game? Will diversification break up strategic assets that need to be kept together? Will we be simply a player in the new market or will we emerge a winner? What can our company learn by diversifying, and are we sufficiently organized to learn it?

Points to take note of

Before diversifying, managers must think not about what their company does but about what it does better than its competitor. To diversify, a company must have all the necessary strategic assets, not just some of them. Managers need to ask whether their strategic assets are transportable to the industry they have targeted.

THANK YOU