Diversification: Strategies for Managing a Group of Businesses

1. Diversification: Strategies for Managing a Group of Businesses Screen graphics created by: Jana F. Kuzmicki, Ph.D. Troy University-Florida Region

2. “To acquire or not to acquire: that is the question.” Robert J. Terry

3. “Make winners out of every business in your company. Don’t carry losers.” Jack Welch Former CEO, General Electric

4. Chapter Roadmap • When to Diversify • Building Shareholder Value: The Ultimate Justification for Diversifying • Strategies for Entering New Businesses • Choosing the Diversification Path: Related versus Unrelated Businesses • The Case for Diversifying into Related Businesses • The Case for Diversifying into Unrelated Businesses • Combination Related-Unrelated Diversification Strategies • Evaluating the Strategy of a Diversified Company • After a Company Diversifies: The Four Main Strategy Alternatives

5. Diversification andCorporate Strategy • A company is diversified when it is in two or more lines of business that operate in diverse market environments • Strategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single line-of-business • A diversified company needs a multi-industry,multi-business strategy • A strategic action plan must be developedfor several different businessescompetingin diverse industry environments

6. Four Main Tasks inCrafting Corporate Strategy • Pick new industries to enteranddecide on means of entry • Initiate actions to boostcombinedperformance of businesses • Pursue opportunities to leverage cross-business value chain relationships and strategic fits into competitive advantage • Establish investment priorities, steering resources into most attractive business units

7. Competitive Strengths of aSingle-Business Strategy • Less ambiguity about • “Who we are” • “What we do” • “Where we are headed” • Resources can be focused on • Improving competitiveness • Expanding into new geographic markets • Responding to changing market conditions • Responding to evolving customer preferences

8. Risks of a Single Business Strategy • Putting all the “eggs” in one industry basket • If market becomes unattractive, a firm’s prospects can quickly dim • Unforeseen changes can undermine a single business firm’s prospects • Technological innovation • New products • Changing customer needs • New substitutes

9. When Should a Firm Diversify? • It is faced with diminishing growth prospects in present business • It has opportunities to expand into industries whose technologies and products complement its present business • It can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factors • It can reduce costs by diversifyinginto closely related businesses • It has a powerful brand name it cantransfer to products of other businesses toincrease sales and profits of these businesses

10. Why Diversify? • To build shareholder value! • Diversification is capable of building shareholder value if it passes three tests • Industry Attractiveness Test — the industry presents good long-term profit opportunities • Cost of EntryTest — the cost of entering is not so high as to spoil the profit opportunities • Better-OffTest — thecompany’s different businesses should perform better together than as stand-alone enterprises, such that company A’s diversification into business B produces a 1 + 1 = 3 effect for shareholders 1 + 1 = 3

11. Acquire existing company Internal start-up Joint ventures/strategic partnerships Strategies for EnteringNew Businesses

12. Acquisition of an Existing Company • Most popular approach to diversification • Advantages • Quicker entry into target market • Easier to hurdle certain entry barriers • Acquiring technological know-how • Establishing supplier relationships • Becoming big enough to match rivals’efficiency and costs • Having to spend large sums onintroductory advertising and promotion • Securing adequate distribution access

13. Internal Startup • More attractive when • Parent firm already has most of needed resources to build a new business • Ample time exists to launch a new business • Internal entry has lower coststhan entry via acquisition • New start-up does not have to gohead-to-head against powerful rivals • Additional capacity will not adversely impactsupply-demand balance in industry • Incumbents are slow in responding to new entry

14. Joint Ventures and Strategic Partnerships • Good way to diversify when • Uneconomical or risky to go it alone • Pooling competencies of two partners provides more competitive strength • Only way to gain entry into a desirable foreign market • Foreign partners are needed to • Surmount tariff barriers and import quotas • Offer local knowledge about • Market conditions • Customs and cultural factors • Customer buying habits • Access to distribution outlets

15. Drawbacks of Joint Ventures • Raises questions • Which partner will do what • Who has effective control • Potential conflicts • Conflicting objectives • Disagreements over how to best operate the venture • Culture clashes

16. Related Diversification Involves diversifying into businesses whose value chains possess competitively valuable “strategic fits” with value chain(s) of firm’s present business(es) Unrelated Diversification Involves diversifying into businesses with no competitively valuable value chain match-ups or strategic fits with firm’s present business(es) Related vs. Unrelated Diversification

17. Fig. 9.1: Strategy Alternatives for a Company Looking to Diversify

18. What Is Related Diversification? • Involves diversifying into businesses whose valuechains possess competitively valuable “strategic fits” with the value chain(s) of the present business(es) • Capturing the “strategic fits” makes related diversification a 1 + 1 = 3 phenomenon

19. Core Concept: Strategic Fit • Exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for • Transferring competitively valuableexpertise or technological know-howfrom one business to another • Combining performance of commonvalue chain activities to achieve lower costs • Exploiting use of a well-known brand name • Cross-business collaboration to create competitively valuable resource strengths and capabilities

20. Fig. 9.2: Related Businesses Possess Related ValueChain Activities and Competitively Valuable Strategic Fits

21. Strategic Appeal of Related Diversification • Reap competitive advantage benefits of • Skills transfer • Lower costs • Common brand name usage • Stronger competitive capabilities • Spread investor risksover a broader base • Preserve strategic unity across businesses • Achieve consolidated performance greater than the sum of what individual businesses can earn operating independently (1 + 1 = 3 outcomes)

22. Types of Strategic Fits • Cross-business strategic fits can exist anywhere along the value chain • R&D and technology activities • Supply chain activities • Manufacturing activities • Sales and marketing activities • Distribution activities • Managerial and administrative support activities

23. R&D and Technology Fits • Offer potential for sharing common technologyor transferring technological know-how • Potential benefits • Cost-savings in technologydevelopment and new product R&D • Shorter times in gettingnew products to market • Interdependence between resultingproducts leads to increased sales

24. Supply Chain Fits • Offer potential opportunities for skills transferand/or lower costs • Procuring materials • Greater bargaining power innegotiating with common suppliers • Benefits of added collaboration withcommon supply chain partners • Added leverage with shippers in securingvolume discounts on incoming parts

25. Manufacturing Fits • Potential source of competitive advantagewhen a diversifier’s expertise can bebeneficially transferred to another business • Quality manufacture • Cost-efficient production methods • Cost-saving opportunities arise from ability to perform manufacturing/assembly activities jointly in same facility, making it feasible to • Consolidate production into fewer plants • Significantly reduce overall manufacturing costs

26. Distribution Fits • Offer potential cost-saving opportunities • Share same distribution facilities • Use many of same wholesaledistributors and retail dealersto access customers

27. Sales and Marketing Fits:Types of Potential Benefits • Reduction in sales costs • Single sales force for related products • Advertising related products together • Combined after-sale service and repair work • Joint delivery, shipping, order processingand billing • Joint promotion tie-ins • Similar sales and marketing approaches provide opportunities to transfer selling, merchandising,and advertising/promotional skills • Transfer of a strong company’sbrand name and reputation

28. Managerial and Administrative Support Fits • Emerge when different business unitsrequire comparable types of • Entrepreneurial know-how • Administrative know-how • Operating know-how • Different businesses often entail same typesof administrative support facilities • Customer data network • Billing and customer accounting systems • Customer service infrastructure

29. Core Concept: Economies of Scope • Stem from cross-business opportunities to reduce costs • Arise when costs can be cutby operating two or more businessesunder same corporate umbrella • Cost saving opportunities can stem from interrelationships anywhere along the value chains of differentbusinesses

30. Related Diversificationand Competitive Advantage • Competitive advantage can result from related diversification when a company captures cross-business opportunities to • Transfer expertise/capabilities/technologyfrom one business to another • Reduce costs by combining related activities of different businesses into a single operation • Transfer use of firm’s brand name reputationfrom one business to another • Create valuablecompetitive capabilities via cross-business collaboration in performing related value chain activities

31. From Competitive Advantage toAdded Gains in Shareholder Value • Capturing cross-business strategic fits • Is possible only via a strategy of related diversification • Builds shareholder value in ways shareholders cannot achieve by owning a portfolio of stocks of companies in unrelated industries • Is not something that happens “automatically” when a company diversifies into related businesses • Strategic fit benefits materialize only after management has successfully pursued internal actions to capture them

32. Test Your Knowledge Which of the following is the best example of related diversification? A. A manufacturer of golf shoes diversifying into the production of fishing rods and fishing lures B. A homebuilder acquiring a building materials retailer C. A steel producer acquiring a manufacturer of farm equipment D. A producer of snow skis and ski boots acquiring a maker of ski apparel and accessories (outerwear, goggles, gloves and mittens, helmets and toboggans) E. A publisher of college textbooks acquiring a publisher of magazines

33. What Is Unrelated Diversification? • Involves diversifying into businesses with • No strategic fit • No meaningful value chainrelationships • No unifying strategic theme • Basic approach – Diversify intoany industry where potential existsto realize good financial results • While industry attractiveness and cost-of-entry tests are important, better-off test is secondary

34. Fig. 9.3: Unrelated Businesses Have Unrelated Value Chains and No Strategic Fits Fig. 9.3: Unrelated Businesses Have UnrelatedValue Chains and No Strategic Fits

35. Acquisition Criteria For Unrelated Diversification Strategies • Can business meet corporate targetsfor profitability and ROI? • Is business in an industry with growth potential? • Is business big enough to contributeto parent firm’s bottom line? • Will business require substantialinfusions of capital? • Is there potential for union difficultiesor adverse government regulations? • Is industry vulnerable to recession, inflation, high interest rates, or shifts in government policy?

36. Attractive Acquisition Targets • Companies with undervalued assets • Capital gains may be realized • Companies in financial distress • May be purchased at bargain prices and turned around • Companies with bright growth prospects but short on investment capital • Cash-poor, opportunity-rich companies are coveted acquisition candidates

37. Appeal of Unrelated Diversification • Business risk scattered over different industries • Financial resources can be directed tothose industries offering best profit prospects • If bargain-priced firms with big profit potential are bought, shareholder wealth can be enhanced • Stability of profits – Hard times in one industrymay be offset by good times in another industry

38. Building Shareholder Valuevia Unrelated Diversification • Corporate managers must • Do a superior job of diversifying into new businesses capable of producing good earnings and returns on investments • Do an excellent job of negotiating favorable acquisition prices • Do a good job overseeing businesses so they perform at a higher level than otherwise possible • Shift corporate financial resources from poorly-performing businesses to those with potential for above-average earnings growth • Discern when it is the “right” time to sell a business at the “right” price

39. Key Drawbacks ofUnrelated Diversification Demanding Managerial Requirements LimitedCompetitive Advantage Potential

40. Unrelated Diversification HasDemanding Managerial Requirements • The greater the number and diversity of businesses, the harder it is for managers to • Discern good acquisitions from bad ones • Select capable managers to managethe diverse requirements of each business • Judge soundness of strategic proposalsof business-unit managers • Know what to do if a business subsidiary stumbles Likely effect is 1 + 1 = 2, rather than 1 + 1 = 3!

41. Unrelated Diversification OffersLimited Competitive Advantage Potential • Lack of cross-business strategic fits means unrelated diversification offers no competitive advantage potential beyond what each business can generate on its own • Consolidated performance of unrelated businessestends to be no better than sum of individualbusinesses on their own (and it may be worse) • Promise of greater sales-profit stability over business cycles is seldom realized

42. Test Your Knowledge Which of the following is the best example of unrelated diversification? A. PepsiCo acquiring Tropicana and Procter & Gamble acquiring Gillette B. Honda diversifying into the production of lawnmowers C. Smuckers acquiring Jif peanut butter and Crisco (from Procter & Gamble) D. Verizon Wireless acquiring Amazon.com E. Harley Davidson acquiring the motorcycle business of Honda

43. Diversification and Shareholder Value • Related Diversification • A strategy-driven approachto creating shareholder value • Unrelated Diversification • A finance-driven approachto creating shareholder value

44. Combination Related-Unrelated Diversification Strategies • Dominant-business firms • One major core business accounting for 50 - 80 percent of revenues, with several small related or unrelated businesses accounting for remainder • Narrowly diversified firms • Diversification includes 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 • Multibusiness firms • Diversification portfolio includes several unrelated groups of related businesses

45. For Discussion: Your Opinion Newell Rubbermaid is in the following businesses: • Cleaning and Organizations Businesses: Rubbermaid storage, organization and cleaning products, Blue Ice ice substitute, Roughneck storage items, Stain Shield and TakeAlongs food storage containers, and Brute commercial-grade storage and cleaning products—25% of annual revenues. • Home and Family Businesses: Calphalon cookware and bakeware, Cookware Europe, Graco strollers, Little Tikes children's toys and furniture, and Goody hair accessories—20% of annual sales. • Home Fashions: Levolor and Kirsch window blinds, shades, and hardware in the U.S.; Swish, Gardinia and Harrison Drape home furnishings in Europe—15% of annual revenues. • Office Products Businesses: Sharpie markers, Sanford highlighters, Eberhard Faber and Berol ballpoint pens, Paper Mate pens and pencils, Waterman and Parker fine writing instruments, and Liquid Paper—25% of annual revenues. Would you say that Newell Rubbermaid’s strategy is one of related diversification, unrelated diversification or a mixture of both? Explain.

46. For Discussion: Your Opinion McGraw-Hill, the publisher of the textbook for this course, is in the following businesses: • Textbook publishing (for grades K-12 and higher education) • Financial and information services (it owns Standard & Poors —a well-known financial ratings agency and provider of financial data, Platts — a provider of energy information, and McGraw-Hill Construction — a provider of construction related information) • Magazine publishing — its flagship publication is Business Week and it is also the publisher of Aviation Week • TV broadcasting — it owns four ABC affiliate stations (in Indianapolis, Denver, San Diego, and Bakersfield) • J.D. Power & Associates — which provides a host of services relating to product quality and consumer satisfaction Would you say that McGraw-Hill’s strategy is one of related diversification, unrelated diversification or a mixture of both? Explain.

47. Fig. 9.4: Identifying a Diversified Company’s Strategy

48. How to Evaluate aDiversified Company’s Strategy Step 1:Assess long-term attractiveness of each industry firm is in Step 2: Assess competitive strength of firm’s business units Step 3: Check competitive advantage potential of cross-business strategic fits among business units Step 4: Check whether firm’s resources fit requirements of present businesses Step 5: Rank performance prospects of businesses and determine priority for resource allocation Step 6: Craft new strategic moves to improve overall company performance

49. Step 1: Evaluate Industry Attractiveness Attractiveness of each industry in portfolio Each industry’s attractivenessrelativeto the others Attractiveness of all industries as a group

50. Industry Attractiveness Factors • Market size and projected growth • Intensity of competition • Emerging opportunities and threats • Presence of cross-industry strategic fits • Resource requirements • Seasonal and cyclical factors • Social, political, regulatory, andenvironmental factors • Industry profitability • Degree of uncertainty and business risk