Diversification strategy lessson

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Diversification Strategy Diversification Strategy • Introduction: The Basic Issues • The Trend over Time • Motives for Diversification - Growth and risk spreading - Diversification and Shareholder Value: Porter’s Three Essential Tests. • Competitive Advantage from Diversification • Diversification and Performance: Empirical Evidence • Relatedness in Diversification OUTLINE Objectives • Define corporate strategy, describe some of the reasons why firms diversify, identify and describe different types of corporate diversification, and assess the advantages and disadvantages associated with each. • Identify sources of synergy in diversified firms while also describing why synergies are so difficult to achieve. Objectives (cont.) • Explore the complex relationship between diversification and firm performance. • In particular, explore the influence of managers and managerial thinking on the relationship between diversification and performance. Introduction • Definition of Corporate Strategy – Address the question: “What is the appropriate scale and scope of the enterprise?” • Influences how large and how diversified firms will be. • Successful corporate strategies are not only the product of successful definition – Also the result of organizational capabilities or competencies that allow firms to exploit potential economies/synergies that large size or diversity can offer. Introduction (cont.) • Why Firms Diversify – To grow – To more fully utilize existing resources and capabilities. – To escape from undesirable or unattractive industry environments. – To make use of surplus cash flows. Introduction (cont.) • Horizontal or related diversification – Strategy of adding related or similar product/service lines to existing core business, either through acquisition of competitors or through internal development of new products/services. Introduction (cont.) • Horizontal or related diversification – Advantages • Opportunities to achieve economies of scale and scope. • Opportunities to expand product offerings or expand into new geographical areas. Disadvantages of related diversification • Complexity and difficulty of coordinating different but related businesses. Introduction (cont.) Conglomerate or unrelated diversification – Firms pursue this strategy for several reasons: • Continue to grow after a core business has matured or started to decline. • To reduce cyclical fluctuations in sales revenues and cash flows. – Problems with conglomerate or unrelated diversification: • Managers often lack expertise or knowledge about their firms’ businesses. Introduction: The Basic Issues Introduction: The Basic Issues Diversification decisions involve two basic issues: • Is the industry to be entered more attractive than the firm’s existing business? • Can the firm establish a competitive advantage within the industry to be entered? (i.e. what synergies exist between the core business and the new business?) Aim of Corporate Strategy: Synergy • Aim of diversification should be to create value or wealth in excess of what firms would enjoy without diversification. • Synergy: the value of the combined firm after acquisition should be greater than the value of the two firms prior to acquisition. – Obtained in three ways: • Exploiting economies of scale. – Unit costs decline with increases in production. [...]... business) BUT Since late 1970’s, diversification has declined Diversification and Performance: The Score • What is relationship between diversification and firm performance? – Academics, consultants,and financial community have dim view of diversification – Some studies suggest that diversification beyond a core business leads to lower performance Diversification and Performance: Diversification and Performance:... net assets (%) • Diversification trends have been driven by beliefs rather than evidence:- 1960s and 70s diversification believed to be profitable; 1980s and 90s diversification seen as value destroying • Empirical evidence inconclusive no consistent findings on impact of diversification on profitability, or on related vs unrelated diversification • Some evidence that high levels of diversification. .. returns Diversification and Performance: The Score (cont.) – Exhibit summarizes findings of study that sought to determine how much various factors, including industry attractiveness, business strategy, and corporate strategy contribute to performance • Findings suggest that industry attractiveness and business strategy together explain more than 99% of variation of business unit performance – Corporate strategy. .. For diversification to create shareholder value, the act of bringing different businesses under common ownership must somehow increase their profitability Diversification and Shareholder Value: Diversification and Shareholder Value: Porter’s Three Essential Tests Porter’s Three Essential Tests If diversification is to create shareholder value, it must meet three tests: 1 The Attractiveness Test: diversification. .. performance! Diversification and Performance: The Score (cont.) – Additional studies conclude that corporate strategy rarely makes significant contribution to shareholder value – Recent study is shown in Exhibit below: Low­ High­ Performing Firms Less Diversified Performing Firms 47 46 46 47 Diversification and Performance: The Score (cont.) – Exhibit suggests: • Categorization of firms into the 4 diversificationperformance... more or less diversified firms Diversification and Performance: The Score (cont.) • Summary – Though diversification has been disastrous for many firms, diversified firms can also be successful – Studies have found no obvious differences between high- and low-performing diversified firms along several important strategic dimensions Motives for Motives for Diversification Diversification GROWTH RISK SPREADING...Aim of Corporate Strategy: Synergy (cont.) • Exploiting economies of scope – Using the same resource to do different things • Efficient allocation of capital – Many assets in acquired firms are undervalued -managers seek to exploit these opportunities and improve their operations and add value to their businesses Relatedness in Relatedness in Diversification Diversification Synergy in diversification. .. present) Introduction: The Tasks of Corporate Introduction: The Tasks of Corporate Strategy In the Multibusiness Corporation Strategy In the Multibusiness Corporation • Determining the company’s business portfolio -diversification, acquisition, divestment • Allocating resources between the different businesses • Formulating strategy for the different businesses • Controlling business performance • Coordinating... powerful motives for diversification (tobacco, oil, defense) But, growth satisfies management not shareholder goals Growth strategies (esp by acquisition), tend to destroy shareholder value Diversification reduces variance of profit flows But, does not normally create value for shareholders, since shareholders can hold diversified portfolios Capital Asset Pricing Model shows that diversification lowers... matrix structures where functional and/or geographical structure is imposed on top of a product/market structure Crucial Role of Managers • Successful diversification strategies result from the ability of managers to develop skill and competency at MANAGING diversification • Managers must develop two important types of mental models: – Must have well-developed understandings of their firm’s diversity and . Diversification Strategy Diversification Strategy • Introduction: The Basic Issues • The Trend over Time • Motives for Diversification - Growth and risk spreading - Diversification. Tests. • Competitive Advantage from Diversification • Diversification and Performance: Empirical Evidence • Relatedness in Diversification OUTLINE Objectives • Define corporate strategy, describe some. related diversification • Complexity and difficulty of coordinating different but related businesses. Introduction (cont.) Conglomerate or unrelated diversification – Firms pursue this strategy