Corporate Strategy and Diversification
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CONTEMPORARY STRATEGY ANALYSIS
tenth edition
Robert M. Grant
John Wiley & Sons Ltd., 2019
Chapter 12
Diversification
Strategy
- Introduction: The Basic Issues
- Motives for Diversification
- Competitive Advantage from Diversification
- Diversification and Performance
- The Meaning of Relatedness in Diversification
Diversification Strategy
Copyright © 2019 John Wiley & Sons, Inc.
OUTLINE
27
INDUSTRY
ATTRACTIVENESS
COMPETITIVE
ADVANTAGE
Superior profit derives from two sources:
Diversification decisions involve these same two issues:
- How attractive is the industry to be entered?
- Can the firm achieve a competitive advantage?
Core Issues in Diversification Decisions
Copyright © 2019 John Wiley & Sons, Inc.
RETURN ON CAPITAL
> COST OF CAPITAL
INTRODUCTION: THE BASIC ISSUES
United States
United Kingdom
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Diversification Strategies of US and UK Corporations during the 20th Century
Copyright © 2019 John Wiley & Sons, Inc.
INTRODUCTION: THE BASIC ISSUES
IMPLICATIONS
FOR
DIVERSIFICATION
STRATEGY
MANAGEMENT
GOALS
STRATEGY
TOOLS AND
CONCEPTS
Growth
Making diversification profitable
Creating shareholder value
1960 1970 1980 1990 2000 2018
- Diversification by established firms
- Emergence of conglomerates
- Boom in M&A
- Core business focus
- Divestments, and spin-offs
- Leveraged buyouts
- Financial
analysis
- M-form
structures
- Corporate
planning
- Economies of
scope
- Portfolio
planning models
- Modern
financial theory
- Shareholder
value
- Transaction cost
analysis
- Core competence
- Dominant logic
Corporate advantage
- Product bundling and customer solutions
- Alliances
- Growth options
- Parenting advantage
- Real options
- Demand-side economies of scope
- Tech platforms
- Emphasis on
related
diversification
- Quest for
synergy
The Evolution of Diversification Strategies, 1960-2018
INTRODUCTION: THE BASIC ISSUES
Copyright © 2019 John Wiley & Sons, Inc.
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- The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco, oil, newspapers).
- But, growth in the interests of managers not shareholders
- Growth-seeking diversification (esp. by acquisition) tends to destroy shareholder value
- Diversification reduces the variance of profit flows
- But, doesn’t create value for shareholders—they can
hold diversified portfolios of securities. [Capital Asset
Pricing Model shows that diversification only lowers
unsystematic risk not systematic risk]
- For diversification to create shareholder value, then
bringing putting different businesses under common
ownership must increase their total profitability
Motives for Diversification
Copyright © 2019 John Wiley & Sons, Inc.
GROWTH
RISK SPREADING
VALUE CREATION
MOTIVES FOR DIVERSIFICATION
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For diversification to create shareholder value, it must meet three tests:
1. The Attractiveness Test: diversification must be directed towards attractive industries (or those with e 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 Test: either the new unit must gain competitive advantage from its link with the company, or vice-versa. (i.e. some form of “synergy” must be present)
Diversification and Shareholder Value: Porter’s Three Essential Tests
Copyright © 2019 John Wiley & Sons, Inc.
MOTIVES FOR DIVERSIFICATION
32
Sources of Competitive
Advantage from Diversification
Copyright © 2019 John Wiley & Sons, Inc.
`COMPETITIVE ADVANTAGE FROM DIVERSIFICATION
| ECONOMIES OF SCOPE | Sharing tangible resources (e.g. research labs, distribution systems) across multiple businesses |
| Sharing intangible resources (e.g. brands, technology) across multiple businesses | |
| Transferring functional capabilities (e.g. marketing, product development) across businesses | |
| Applying common general management capabilities to different businesses |
| ECONOMIES FROM INTERNALIZING TRANSACTIONS | Economies of scope not a sufficient basis for diversification—must be supported by transaction costs in markets for resources |
| Diversified firm can avoid external transactions by operating internal capital and labor markets | |
| Diversified firm has better information on resource characteristics than external markets |
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The Findings of Empirical Research
Copyright © 2019 John Wiley & Sons, Inc.
DIVERSIFICATION AND PERFORMANCE
| Do diversified firms outperform specialized firms? | No consistent relationship Evidence of a ∩-shaped relationship: dn. first increases profitability, then further dn. reduces profitability (increased complexity?) McKinsey & Co. identify benefits from moderate dn.—especially for firms that have run out of growth opportunities Question of direction of causation: does dn. drive profitability, or vice-versa? |
| What type of diversification is most profitable? ---Related dn. vs. unrelated dn. | Most studies show related dn. outperforms unrelated dn. Related dn. offers greater synergies—but also imposes higher management costs But what is “related dn.”? Businesses can be related in many different ways (e.g. LMVH, GE, Virgin group) |
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 businesses.
Types of Relatedness between Businesses
Copyright © 2019 John Wiley & Sons, Inc.
Problem of operational relatedness:
The benefits from economies of scope may be dwarfed by the administrative costs involved in their exploitation.
RELATEDNESS IN DIVERSIFICATION
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The Sources of Strategic Relatedness
Between Businesses
Copyright © 2019 John Wiley & Sons, Inc.
RELATEDNESS IN DIVERSIFICATION
| Corporate Manage-ment Tasks | Determinants of Strategic Similarity |
| Resource allocation | Similar sizes of capital investment projects Similar time spans of investment projects Similar sources of risk Similar general management skills required for business unit managers |
| Strategy formulation | Similar key success factors Similar stages of the industry life cycle Similar competitive positions occupied by each business within its industry |
| Performance management and control | Targets defined in terms of similar performance variables Similar time horizons for performance targets |
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30
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70
1949
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1950
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1993
Single business
Dominant business
Related business
Unrelated business