Stanford GSB Sloan Program Strategic Management

1. Stanford GSB Sloan Program Strategic Management 16: Strategic Rationale for Diversification The Walt Disney Company John Roberts

2. Why Diversify? • Acquiring a new business adds a cash flow stream. Since shareholders can do that on their own, diversification must improve the cash flow of the combined business, or reduce its risk beyond what can simply be achieved through shareholder portfolio diversification. John Roberts

3. Why Diversify? • In general, synergy comes from scope economies, the fact that the capabilities and/or position of the combined entity are more valuable than when separate. • The most powerful form of synergy is where the two business lines reinforce one another such that the combined entity effectively creates a new category, and gains a first mover advantage (e.g., Disney and family entertainment) John Roberts

4. Elusiveness of Synergy • But ‘synergy’ is much more easily said than achieved. Reasons why synergy may be elusive: • Presumed complementary simply doesn’t exist. • Difficulty of merging different corporate cultures. • Successive synergistic acquisitions may lead to a less-than synergistic corporation (complexity, influence costs). • Winner’s curse John Roberts

5. History of U.S. Diversification • 200 largest us companies involved in 4.76 lines of business in 1950, 10.89 in 1975 • 45% of these LOB were lines they were in in 1950, 41% entered through merger, 14% through internal development • Novel development was large increase in unrelated diversification. • 1980s-1990s have witnessed significant de-diversification, especially of unrelated businesses John Roberts

6. History of U.S. Diversification • Why Conglomeration? • Regulatory regime • Tax regime • Imperfect capital markets? • Management skills? • Hubris? • Wall Street applauded • Why De-conglomeration? • Poor performance (perceived conglomerate discount) • Shareholder discipline • Shareholder /analyst confusion • Current uncertainties John Roberts

7. Conglomerate Discount(?) • Researchers have identified a “conglomerate discount” • Attribute to inefficient capital allocation, cross-subsidization arising from influence costs • Now widely believed to exist • Very recent research casts some doubt • Investment patterns identified as inefficient existed before • Market rewards both diversifying and focus-increasing moves • Consistent with well-motivated managers John Roberts

8. The Conglomerate Across the Globe • The conglomerate form remains much more prevalent and accepted outside the U.S. Often appears in the form of a family-controlled “business group” (e.g., Tata Sons) • Inefficient markets for capital and labor appear to play a role • Often given governmental legitimacy, support. • Research indicates no evidence of underperformance. • But change may be occurring John Roberts