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Corporate diversification

Corporate diversification. A firm implements a corporate diversification strategy when it operates in multiple industries or markets simultaneously. Product diversification. Geographical diversification. Product–market diversification. Limited Diversification.

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Corporate diversification

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  1. Corporate diversification • A firm implements a corporate diversification strategy when it operates in multiple industries or markets simultaneously. • Product diversification • Geographical diversification • Product–market diversification

  2. Limited Diversification > 95% of revenues from a single business unit Single business A Dominant business A Between 70% and 95% of revenues from a single business unit B Related Diversification A < 70% of revenues from dominant business; all businesses share product, technological and distribution linkages Related constrained B C Related linked (mixed) A < 70% of revenues from dominant business, and only limited links exist B C Unrelated Diversification A Business units not closely related B C Levels and Types of Diversification

  3. Acquisitions: A transaction where one firm buys another by making the acquired firm a subsidiary within its portfolio of businesses. • Merger: A transaction where two firms agree to integrate their operations on a relatively coequal basis. • (Hostile) Takeover: An acquisition where the target firm did not solicit the bid of the acquiring firm

  4. The value of M&A/Diversification strategies NPV(A) = net present value of firm/business A as a stand-alone entity NPV(B) = net present value of firm/business B as a stand-alone entity NPV(A+B) = net present value of firms/businesses A and B as a combined entity • Synergies: NPV(A+B)>NPV(A)+NPV(B)

  5. For acquisition: P = NPV(A+B) – NPV(A). Any price for a target (i.e., B) less than P will be a source of an above-normal economic profits for the bidding firm (A). • Acquisition premium: the difference between the current market price of a target firm’s shares and the price that the acquirer offers to pay.

  6. Motives for Diversification • Operational economies of scope • Financial economies of scope • Anti-competitive economies of scope • Employee and stakeholder incentives • Diversifying employees’ human capital investment • Maximizing management compensation

  7. Limits to Related Diversification/acquisition Strategies: Sharing Activities

  8. Limits to Related Diversification Strategies: Transferring core competencies Transferring Core Competencies leads to competitive advantage only if :

  9. Unrelated Diversification Strategies:Efficient Internal Capital Market Allocation Firms pursuing this strategy frequently diversify by acquisition: • Acquire sound, attractive companies • Acquired units are autonomous • Acquiring corporation supplies needed capital • Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs • Add professional management & control to sub-units • Sub-unit managers compensation based on unit results

  10. Limits to unrelated diversification strategies: Efficient Internal Capital Market Allocation Work only if:

  11. Unrelated Diversification Strategies:Restructuring • Seek out undeveloped, sick or threatened organizations or industries • Parent company (acquirer) intervenes and frequently • Changes sub-unit management team • Shifts strategy • Infuses firm with new technology • Enhances discipline by changing control systems • Divests part of firm • Makes additional acquisitions to achieve critical mass • Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations

  12. Limits to Diversification Strategies: Restructuring

  13. Motives for diversification and types of diversification

  14. Dominant Business Related Constrained Unrelated Business Diversification and Firm Performance Performance

  15. Problems with Acquisitions

  16. Empirical findings regarding acquisition performance • The finance literature: acqs increase the avg market value of target firms by 25% • The strategy literature: on average, zero economic profits for bidders

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