Weekly Reflection
COURTMCLARKE777
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LO1 Understand when and how diversifying into multiple businesses can enhance shareholder value.
LO2 Gain an understanding of how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage.
LO3 Become aware of the merits and risks of corporate strategies keyed to unrelated diversification.
LO4 Gain command of the analytical tools for evaluating a company’s diversification strategy.
LO5 Understand a diversified company’s four main corporate strategy options for solidifying its diversification strategy and improving company performance.
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Crafting a Diversified Company’s Overall Corporate Strategy
Picking new industries to enter and deciding on the means of entry
Pursuing opportunities to leverage cross-business value chain relationships into competitive advantage
Establishing investment priorities and steering corporate resources into the most attractive business units
Initiating actions to boost the combined performance of the corporation’s collection of businesses
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Strategic Options for Diversified Corporations
Broadly restructuring the business lineup with multiple divestitures and/or acquisitions
Sticking with the existing business lineup and pursuing opportunities presented by these businesses
Retrenching to a narrower scope of diversification by divesting poorly performing businesses
Broadening the scope of diversification by entering additional industries
Strategic Options
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When Business Diversification Becomes a Consideration
Diversification is called for when:
There are diminishing growth prospects in the present business
An expansion opportunity exists in an industry whose technologies and products complement the present business
Existing competencies and capabilities can be leveraged by expanding into an industry that requires similar resource strengths
Costs can be reduced by diversifying into closely related businesses
A powerful brand name can be transferred to the products of other businesses
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Building Shareholder Value: The Ultimate Justification for Business Diversification
Industry attractiveness test
Better-off test
Tests for building shareholder value through diversification
Cost-of-entry test
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Building Shareholder Value: The Ultimate Justification for Business Diversification
Diversification may result in building shareholder value if it passes three tests:
Industry Attractiveness Test—the target industry presents good long-term profit opportunities.
Cost of Entry Test—the cost to enter the target industry does not erode its long-term profit potential.
Better-Off Test—the firm’s businesses will perform better together than as stand-alone firms, producing a synergistic 1+1=3 effect on shareholder value.
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Approaches to Diversifying the Business Lineup
Diversification by acquisition of an existing business
Using joint ventures to achieve diversification
Options for entering new industries and lines of business
Entering a new line of business through internal development
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Diversification by Acquisition of an Existing Business
Quick and effective way to hurdle target market entry barriers related to:
Acquiring technological know-how
Establishing supplier relationships
Achieving scale economies
Building brand awareness
Securing adequate distribution access
The big dilemma:
Whether to pay a premium price to buy a successful firm or to buy a struggling firm at a bargain price.
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Entering a New Line of Business through Internal Development
Is more attractive when:
The parent firm already has the in-house skills and resources needed to compete effectively.
There is ample time to launch a new business.
Start-up cost is lower than cost of entry via acquisition.
The start-up will not compete against powerful rivals.
Adding capacity will not adversely impact supply-demand balance in industry.
Incumbent firms are likely to be slow or ineffective in responding to an entrant’s efforts to crack the market.
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Using Joint Ventures to Achieve Diversification
Situations call for a joint venture when:
Pursuing the expansion opportunity is too complex, uneconomical, or risky to go it alone.
The opportunities in a new industry require a broader range of competencies and know-how than an expansion-minded firm can marshal.
Drawbacks:
Potential for conflicting objectives
Operational and control disagreements
Culture clashes
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Choosing the Diversification Path: Related Versus Unrelated Businesses
Related Businesses
Have value chains with competitively valuable cross-business relationships that present opportunities for the businesses to perform better operating under the same corporate umbrella than they could as stand-alone entities.
Unrelated Businesses
Have value chains and resource requirements are so dissimilar that no competitively valuable cross-business relationships are present.
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Related businesses possess competitively valuable cross-business value chain and resource matchups; unrelated businesses have dissimilar value chains and resources requirements, with no competitively important cross-business value chain relationships.
CORE CONCEPT
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Strategic Themes of Multibusiness Corporation
FIGURE 8.1
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The Case For Related Diversification
Strategic Fit
Exists whenever one or more activities comprising the value chains of different businesses are sufficiently similar to present opportunities for:
Transferring competitively valuable resources, expertise, technological know-how, or other capabilities from one business to another.
Cost sharing between separate businesses where value chain activities can be combined.
Brand sharing between business units that have common customers or that draw upon common core competencies.
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Strategic fit exists when the value chains of different businesses present opportunities for cross-business skills transfer, cost sharing, or brand sharing.
CORE CONCEPT
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Related Diversification Is Built upon Competitively Valuable Strategic Fit in Value Chain Activities
FIGURE 8.2
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Strategic Fit and Economies of Scope
Scope-related cost savings stemming from the strategic fit of the value chains of related businesses:
Operating businesses under same corporate umbrella.
Taking shared advantage of the inter-relationships anywhere along the value chains of different businesses.
Advantage:
The greater the cross-business economies associated with cost-saving strategic fit, the greater the potential for a related diversification strategy to yield a competitive advantage based on lower costs than rivals.
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Economies of scope are cost reductions stemming from strategic fit along the value chains of related businesses (thereby, a larger scope of operations), whereas economies of scale accrue from a larger operation.
CORE CONCEPT
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The Ability of Related Diversification to Deliver Competitive Advantage and Gains in Shareholder Value
Cross-business strategic fit :
Builds shareholder value in ways that shareholders cannot replicate by simply owning a diversified portfolio of stocks.
Captures benefits that are possible only through related diversification.
Does not automatically result in benefits, it must be pursued by management in order to capture the greater profitability of cross-business benefits
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Diversifying into Unrelated Businesses
Strategic approach:
Growth through acquisition into any industry where potential exists enhancing shareholder value through upward-trending corporate revenues and earnings and/or a stock price that rises yearly.
While industry attractiveness and cost-of-entry tests are important, better-off test is secondary.
Involves diversifying into businesses with:
No strategic fit
No meaningful value chain relationships
No unifying strategic theme
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Types of Acquisition Candidates in Unrelated Diversification Strategies
Struggling firms that can be turned around with parent firm’s financial resources and managerial know-how
Businesses with bright growth prospects but short on investment capital
Undervalued firms that can be acquired at a bargain price
Candidates for Acquisition
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Building Shareholder Value Through Unrelated Diversification
Corporate executives must:
Do a superior job of identifying and acquiring new businesses that can produce consistently good earnings and returns on investment.
Do an excellent job of negotiating favorable acquisition prices.
Do such a good job overseeing and parenting the firm’s businesses that they perform at a higher level than they would otherwise be able to do through their own efforts alone.
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The Pitfalls of Unrelated Diversification
Demanding Managerial Requirements:
Staying abreast of what’s happening in each industry and each subsidiary.
Picking business-unit heads having the requisite combination of managerial skills and know-how to drive gains in performance.
Discerning the difference between strategic proposals that are prudent and those that are risky or unlikely to succeed.
Knowing what to do if a business unit stumbles and its results suddenly head downhill.
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The Pitfalls of Unrelated Diversification
Limited Competitive Advantage Potential:
Unrelated strategy offers limited competitive advantage beyond what each individual business can generate on its own.
Without strategic fit, consolidated performance of an unrelated group of businesses is unlikely to be better than the sum of what the individual business units could achieve independently.
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Misguided Reasons for Pursuing Unrelated Diversification
Risk reduction
Earnings stabilization
Growth
Managerial motives
Misguided Reasons for Diversifying
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Diversifying into Both Related and Unrelated Businesses
Dominant-Business Firms
One major core business accounting for 50–80% of revenues and a collection of small related or unrelated businesses accounts for the remainder
Narrowly-Diversified Firms
Diversification into a few (2–5) related or unrelated businesses
Broadly-Diversified Firms
Diversification includes a wide collection of either related or unrelated businesses or a mixture of both
Multibusiness Enterprises
Diversification into several unrelated groups of related businesses
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Evaluating the Strategy of a Diversified Company
Step 1
Assess the attractiveness of the industries the firm has diversified into.
Step 2
Assess the competitive strength of the firm’s business units.
Step 3
Evaluate the extent of cross-business strategic fit along the value chains of the firm’s various business units.
Step 4
Check whether the firm’s resources fit the requirements of its present business lineup.
Step 5
Rank the performance of the businesses from best to worst and determine a priority for allocating resources.
Step 6
Craft new strategic moves to improve overall corporate performance.
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Step 1: Evaluating Industry Attractiveness
Industry Attractiveness Measures
Resource requirements
Seasonal and cyclical factors
Social, political, regulatory, and environmental factors
Market size and projected growth rate
The intensity of competition
Emerging opportunities and threats
The presence of cross-industry strategic fit
Industry profitability
Industry uncertainty and business risk
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Calculating Weighted Industry Attractiveness Scores
TABLE 8.1
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Step 2: Evaluating Business-Unit Competitive Strength
Competitive Strength Factors
Strategic alliances and collaborative partnerships
Brand image and reputation
Competitively valuable capabilities
Relative market share
Costs relative to competitors’ costs
Products or services that satisfy buyer expectations
Benefit from strategic fit with sibling businesses
Profitability relative to competitors
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Step 2: Evaluating Business-Unit Competitive Strength
Relative market share
Costs relative to competitors’ costs
Products or services that satisfy buyer expectations
Ability to benefit from strategic fits with sibling businesses
Number and caliber of strategic alliances and collaborative partnerships.
Brand image and reputation
Competitively valuable capabilities
Profitability relative to competitors
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Calculating Weighted Competitive Strength Scores for a Diversified Company’s Business Units
TABLE 8.2
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A Nine-Cell Industry Attractiveness–Competitive Strength Matrix
FIGURE 8.3
Note: Circle sizes are scaled to reflect the percentage of companywide revenues generated by the business unit.
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Strategy Implications of the Attractiveness/Strength Matrix
Businesses in the upper left corner
Receive top investment priority.
Strategic prescription: grow and build
Businesses in the three diagonal cells
Are given medium investment priority.
Have brighter or dimmer prospects than others.
Businesses in the lower right corner
Are candidates for divestiture or to be harvested to take cash out of the business.
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Step 3: Determining the Competitive Value of Strategic Fit in Multibusiness Companies
Value chain matchups provide competitive advantage when there are opportunities to:
Combine performance of certain activities, thereby reducing costs and capturing economies of scope.
Transfer skills, technology, or intellectual capital from one business to another.
Share a respected brand name across multiple product and/or service categories.
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Step 4: Evaluating Resource Fit
A diversified firm’s lineup of businesses exhibit good resource fit when:
Each of a firm’s businesses, individually, strengthen the firm’s overall mix of resources and capabilities.
A firm has sufficient resources that add customer value to support its entire group of businesses without spreading itself too thin.
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A diversified company exhibits resource fit when its businesses add to a company’s overall mix of resources and capabilities and when the parent company has sufficient resources to support its entire group of businesses without spreading itself too thin.
CORE CONCEPT
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Determining Financial Resource Fit
Use a portfolio approach to determine the firm’s internal capital market requirements:
Which businesses are cash hogs in need of additional funds to maintain growth and expansion?
Which businesses are cash cows with cash flow surpluses available to fund growth and reinvestment?
Assessing the portfolio’s overall condition:
Which businesses are (or not) capable of contributing to achieving companywide performance targets?
Does the firm have the financial strength to fund all of its businesses and maintain a healthy credit rating?
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A cash hog generates operating cash flows that are too small to fully fund its operations and growth; a cash hog must receive cash infusions from outside sources to cover its working capital and investment requirements
CORE CONCEPT
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A cash cow generates operating cash flows over and above its internal requirements, thereby providing financial resources that may be used to invest in cash hogs, finance new acquisitions, fund share buyback programs, or pay dividends.
CORE CONCEPT
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Assessing Cash Hogs
There’s a decent chance of growing the cash hog into a solid bottom-line contributor.
It has highly valuable strategic fit with other business units
Capital infusions needed from the corporate parent are modest relative to the funds available
Reasons for not divesting a cash hog business
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Examining a Firm’s Nonfinancial Resource Fits
A diversified firm must ensure that it can meet the nonfinancial resource needs of its portfolio of businesses:
Does the firm have or can it develop the specific resources and capabilities needed to be successful in each of its businesses?
Are the firm’s resources being stretched too thinly by the requirements of one or more of its original businesses or a recent acquisition?
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Step 5: Ranking Business Units and Setting a Priority for Resource Allocation
Cash flow generation
Profit growth
Factors to consider in judging business-unit performance
Sales growth
Earnings contribution
Return on investment
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The Chief Strategic and Financial Options for Allocating a Diversified Company’s Financial Resources
FIGURE 8.4
Strategic Options for Allocating Company
Financial Resources
Invest in ways to strengthen or grow existing business
Make acquisitions to establish positions in new industries or to complement existing businesses
Fund long-range R&D ventures aimed at opening market opportunities in new or existing businesses
Financial Options for Allocating Company
Financial Resources
Pay off existing long-term or short-term debt
Increase dividend payments to shareholders
Repurchase shares of the company’s common stock
Build cash reserves; invest in short-term securities
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Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance
Stick closely with existing business lineup and pursue opportunities it presents.
Broaden the firm’s business scope by making acquisitions in new industries.
Divest some businesses and retrench. to a narrower base of business operations.
Restructure the firm’s business lineup to put a new face on its business makeup.
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Sticking Closely with the Existing Business Lineup
Choosing not to expand beyond the current lineup of businesses makes sense when the firm’s present businesses:
Offer attractive growth opportunities, good earnings, and cash flows.
Are in a good position for the future and have good strategic and resource fits.
Have resources that management can steer into areas with the greatest performance and profit potentials.
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Broadening the Diversification Base
Multi-business firms may consider adding to the diversification base when:
There is sluggish revenues and profit growth.
Vulnerable to seasonality or recessionary influences.
There is potential for transfer resources and capabilities to related businesses.
Unfavorable driving forces are facing its core businesses.
Acquisition of related businesses will strengthen the market positions of one or more of its businesses.
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Divesting Businesses and Retrenching to a Narrower Diversification Base
Retrenchment to focus resources on building strength in fewer businesses requires divesting or eliminating:
Once-attractive businesses in deteriorating markets
Businesses that will have a poor strategic or resource fit in the firm’s future portfolio
Cash hog businesses with poor long-term investment returns potential
Weakly-positioned businesses with little prospect for earning a decent return on investment
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Corporate restructuring involves radically altering the business lineup by divesting businesses that lack strategic fit or are poor performers and acquiring new businesses that offer better promise for enhancing shareholder value.
CORE CONCEPT
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Broadly Restructuring the Business Lineup Through a Mix of Divestitures and New Acquisitions
Radical surgery on the business lineup is necessary when:
Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries.
Too many competitively weak businesses.
An excessive debt burden with interest costs that eat deeply into profitability.
Ill-chosen acquisitions that haven’t lived up to expectations.
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KRAFT FOODS’ CORPORATE RESTRUCTURING PLAN TO PURSUE GROWTH AND BOOST SHAREHOLDER VALUE
Concepts & Connections 8.1
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