University of Cagliari, Faculty of Economics, a.a. 2012-13

1. Business Strategy and Policy A course within the II level degree in Managerial Economics year II, semester I, 6 credits Lecturer: Dr Alberto Asquer aasquer@unica.it Phone: 070 6753399 University of Cagliari, Faculty of Economics, a.a. 2012-13

2. Lecture 6 Diversification Strategy Business Strategy and Policy

3. 1. What is diversification? 2. Why do firms diversify? 3. How do firms enter a new business? 4. Where do firms diversify? - - - - - - - - - - - - - 5. Summary Introduction

4. Diversification consists of expanding the range of business activities carried out by a firm away from the present product line and market structure Diversification involves: Search and selection of new business areas Formulation and implementation of an entry strategy Search and activation of synergies between business areas Definition of priorities for the allocation of resources among business areas 1. What is diversification?

5. Diversification through the development of new products delivered in new markets (Ansoff, 1957) 1. What is diversification? Market development Diversification .... Another new market A2 New market A1 Market penetration Product development Current market A Current product X New product X1 Another new product X2 New product Y ....

6. Diversification may be also directed towards the input market, often through the acquisition of a supplier (upstream vertical integration) 1. What is diversification? Input market Supplier Supplier Supplier Supplier Supplier Firm Upstream integration e.g., oil refinery into oil extraction Output market Current product X

7. Diversification may be also directed towards the output market, often through the acquisition of a supplier (downstream vertical integration) 1. What is diversification? Firm Output market Client Client Client Client Client Downstream integration e.g., movie makers into movie distribution

8. Diversification allows the firm to grow rapidly by expanding operations into new business fields Why is (rapid) growth beneficial? Economies of scale Learning and experience curve effects Lower average unit costs (running at full capacity) More bargaining power with suppliers and customers Exploiting differences between diverse geographical areas 2. Why do firms diversify?

9. Instance: Tiscali (1998-2009) 2. Why do firms diversify? Diversification Telecom in Italy and the UK Product development Market development Fixed phone lines, ADSL Virtual Mobile Network Operator Market entry Acquisitions in the EU Internet (free) access 1998 1999 2003 2009

10. Instance: Tiscali (2009-2011) 2. Why do firms diversify? UK division sold in 2009 Diversification The opposite of diversification: focus strategy Telecom in Italy and the UK Product development Fixed phone lines, ADSL Virtual Mobile Network Operator 2009 2011

11. Instance: Tiscali (2000-2011) (a struggle to protect shareholders' value) 2. Why do firms diversify?

12. Diversification is sometimes regarded as beneficial to shareholders, because it allows to spread risk among various businesses (whose performance presumably are not correlated) Diversification is sometimes considered as detrimental to shareholders, because they would be better off if they diversify risk of their investment portfolio rather than having it done by the company management (Note: but diversifying your investment portfolio among various financial assets is quite different from exploiting synergies between different product and market lines within the same firm!) 2. Why do firms diversify?

13. 3. How do firms enter a new business? Acquisitions of other companies that already operate in another business (a rapid way to acquire assets, employees, know-how, market presence, access to distribution channels, etc.) Internal start-ups by developing own business ideas, allocating capital and other resources, and venturing into a new business (i.e., “corporate venturing”) Joint ventures by partnering with other companies that already operate in another business and sharing assets, employees, know-how, etc. – typically by searching for synergies between respective resources and distinctive capabilities

14. 3. How do firms enter a new business? Acquisition Internal start-up Joint venture

15. Two types of diversification: Related: when the value chains of two businesses that are managed within the same firm (i.e., the same company or company group) share cross-linkages that provide opportunities for superior performance than when they are managed by two independent firms Unrelated: when the value chains of two businesses do not share any linkage, i.e., they are completely different and they do not offer any opportunities for competitive advantage if managed within the same firm (Note: this discussion bears some relatedness to issues about why firms exist, i.e., why higher performance is achieved through hierarchical organisations rather than market exchange; see transaction cost economics; Coase, 1937) 4. Where do firms diversify?

16. Instance of related diversification: Johnson & Johnson 4. Where do firms diversify? Consumers products Baby care Wound care Women's care Medicines Skin and hair care Oral care Nutritionals Vision care

17. When should firms pursue related diversification? When there is 'strategic fit', that is, opportunities for Transfer of skills, knowledge, and other competences across businesses Economies of scope Advantages arising from 'umbrella branding' Developing innovative products and/or processes 4. Where do firms diversify?

18. Instance of unrelated diversification: General Electrics 4. Where do firms diversify? Aviation Healthcare Appliances Financial services Consumer products Energy

19. Instance of unrelated diversification: Virgin 4. Where do firms diversify? Railways Radio Radio Travel agent Megastore Airlines Telecom and media Soft drinks

20. When should firms pursue unrelated diversification? Some scholars (and practitioners) would argue that firms should not pursue unrelated diversification at anytime (Rumelt, 1974; Teece et al., 1997) – except when the firm is clearly facing decline in traditional products and markets When unrelated diversification is pursued, generally firms have robust financial resources and are in search for new investments either the unrelated business presents attractive profitability/risk and growth prospects or the unrelated business presents attractive speculative prospects 4. Where do firms diversify?

21. 5. Summary Main points Diversification consists of expanding the range of business activities carried out by a firm away from the present product line and market structure Diversification can foster rapid growth and provide better shareholder value. Sometimes, however, an opposite focus strategy delivers better results Diversification can be conducted through internal development of new businesses, acquisitions, or joint ventures Diversification may be directed towards related or unrelated business areas. Generally, related diversification delivers better performance