1 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright EVALUATING THE STRATEGIES OF DIVERSIFIED COMPANIES CHAPTER 10

“Achieving superior performance through diversification is largely based on relatedness. Philippe Very “Quote” © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright “The corporate strategies of most companies have dissipated instead of created shareholder value.” Michael Porter

3 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Building Shareholder Value: Questions to Ask About a Diversified Company 1. How attractive is the group of businesses the company has diversified into? 2. How good is the firm’s overall performance outlook in the years ahead with these businesses? 3. If previous two answers aren’t satisfactory, what should the firm do to realign its business lineup?  Divest unattractive businesses?  Strengthen positions of remaining ones?  Acquire new businesses?

4 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright How to Evaluate a Diversified Company’s Strategy Step 1 Step 1: Identify present corporate strategy Step 2 Step 2: Evaluate long-term attractiveness of each industry firm is in Step 3 Step 3: Rank business units based on historical performance and future prospects Step 4 Step 4: Rank business units in terms of priority for resource allocation and decide on general strategic posture Step 5: Step 5: Craft new strategic moves to improve overall company performance

5 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 1: Identify present Corporate Strategy Step 1a:Determine if the diversification is related, unrelated, or mixed (focus on strategic fits, customers, products and distribution) Step 1b:Determine if diversification is broad or narrow (focus on the number of BUs and % of sales contributed by each BU Step 1c:Determine the scope of the geographic operations Step 1d:Determine any moves to add new businesses, go into new industries or to divestany businesses Step 1e:Determine the resource allocation approach

6 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Money Company  Business Units - Agricultural - Nutrition & Consumer - Pharmaceuticals Step 1: Example

7 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Related or Unrelated Diversification  Opportunities to share value chain activities and achieve “strategic fits”  Purchased Supplies and Inbound Logistics – chemical inputs for all BUs  Manufacturing/Operations – Share facilities, training, personnel across BUs  Distribution & Outbound Logistics – Network of Dealers for Pharmaceutical and Nutrition and Consumer Products  Sales & Marketing – Market research & brand name  Research, Technology, & System Development - R&D in Chemicals and Biotechnology Product development for all Bus  Is the company following related or unrelated diversification? Step 1a: Example with Money Company

8 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Broad vs. Narrow  Number of Business Units – 3  Sales Contribution of the Business Unit (in Millions) Sales Agricultural Products - $ % 47% 55% Nutrition & Consumer - $ % 18% Pharmaceuticals -$ % 33% 45% Corporate & Other - $ % 2% Total Corporate Sales$7514 $7200 $6053 Step 1b: Example with Money Company

9 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Broad vs. Narrow (continue)  Profit contribution of Each BU (in Millions) Agricultural Products $762 60%64% Nutrition and Consumer$304 24%18% Pharmaceuticals$340 27%30% Corp. and Other$ (142) (11%)(12%) Total Profit $ 1264 $ 1211  How would you assess this aspect of the diversification strategy? Step 1b: Example with Money Company

10 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Scope of Geographic Operations  International Sales (in Millions) 2001 % of 2000 % of Growth TotalTotal - U.S. $ % $ % 20% - Europe/Africa $ % $ % 6% - Asia/Pacific $ 655 9% $ 569 9% 15% - Canada $ 285 4% $ 271 4% 5% - Latin America $ % $ 515 8% 49% Total Sales $ 7514 $ 7200  How would you assess this aspect of the diversification strategy? Step 1c: Example with Money Company

11 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Entry into new industries or businesses and divestitures  Acquisition of Corn States Hybrid Service  Acquisition of Agroceres SA  Spinoff of Basic Chemicals  Purchase of Cargill's international seed  Acquisition of GD Searle  Alliance with Pfizer Pharmaceutical  sold the Lawn and Garden Business  How would you assess this aspect of the diversification strategy? Step 1d: Example with Money Company

12 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Resource Allocation Approach  Capital Expenditures for each Business Unit (in Millions) Agricultural Products $ % $ % - Nutrition and Consumer $ % $ 67 10% - Pharmaceuticals$ % $ % - Corp. and Other$ % $ 87 14% Total$ 979 $ 644  How would you assess this aspect of the diversification strategy?  What is your overall assessment of the Corporate Strategy? Step 1e: Example with Money Company

13 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Evaluate Industry Attractiveness Attractiveness of each industry in portfolio Each industry’s attractiveness relative to the others Attractiveness of all industries as a group

14 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Attractiveness Factors  Market size and projected growth  Intensity of competition  Emerging opportunities and threats  Seasonal and cyclical factors  Resource requirements  Cross-industry strategic fits and resource fits with present businesses  Industry profitability  Social, political, regulatory, and environmental factors  Degree of risk and uncertainty

15 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Economic Features Industry Economic Features (1997) Food – Miscellaneous (Artificial Sweeteners) Chemicals- Agricultural (Pesticides, herbicides) Market Size (worldwide) $10 Billion $104 Billion Market Growth (U.S.) 4.2%7% Industry StructureConcentrated - 3 Firms with 90% of sales Concentrated – 6 Firms with 66% of sales Scope of RivalryGlobal Life Cycle StageMatureMature/Cyclical Sales

16 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Economic Features (continue) Industry Economic Features Food – Miscellaneous (Artificial Sweeteners) Chemicals- Agricultural (Pesticides, herbicides) Resource Requirements High – Advertising, R&D costs are substantial High – R&D costs are a major factor Social, political, regulatory, and environmental factors Many regulatory requirements from FDA Many regulatory requirements from EPA Profitability (Profit Margin) (2001) Industry Average– 15% Industry Average – 22%

17 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Five Forces Porter’s Five ForcesFood – Miscellaneous (Artificial Sweeteners) Chemicals- Agricultural (Pesticides, herbicides) Threat of New Entrants Weak - (numerous barriers to entry) SuppliersWeak Competitive RivalryStrong Competition from Substitutes StrongWeak Buyers Weak – Consumers Moderate – Food Processors Weak

18 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Opportunity Comparisons Food – Miscellaneous (Artificial Sweeteners) Chemicals- Agricultural (Pesticides, herbicides) Opportunities  Product Line Extension  Expand into related industries (lawn care, turf, roads, etc.)

19 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2: Industry Threats Comparison Food – Miscellaneous (Artificial Sweeteners) Chemicals- Agricultural (Pesticides, herbicides) Threats  Industry Consolidation  Changing Tastes to natural ingredients  Slow Market Growth in the U.S.  Growing Concern regarding pollutants (pesticides, herbicides)  Increasing costs for R&D

20 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2:Comparison of Industry Attractiveness  Economic Features – Size, Growth, Profitability of Chemical Industry appears to make it more attractive  Five Forces – The Chemical Industry has more forces that are weak.  Opportunities – Both industries have few new opportunities  Threats – Both industries have some significant threats  Proportion of Sales – Chemical BU has higher (although decreasing) proportion (41% vs. 20%)  Proportion of Profit Contribution – Fast Food Industry higher (60% vs. 24%)  Strategic Fits – Both BUs provide fits

21 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 2:Comparison of Industry Attractiveness  We have looked at Industry Economic Features, Five Forces, Opportunities and Threats, Sales and Profit Contribution, and Strategic Fits – what are some other things to look at when assessing each the industry for each business unit?  What is your overall assessment regarding the industry for each of the two business units?

22 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 3: Rank Business Units Based on Financial Performance  Yardsticks for comparing performance of different businesses  Sales growth  Profit growth  Contribution to company earnings  Return on capital employed in business  Cash flow generation  How would you assess the performance of the Chemical BU? Nutrition and Consumer Products?

23 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright  Determine cash flow and investment requirements of the business units  Which are cash hogs and which are cash cows?  What is a cash hog?  What is a cash cow? Step 4: Decide Resource Allocation Priorities and Strategic Direction

24 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 4: Good vs. Poor Financial Fit  Good financial fit exists when a business  Contributes to achievement of corporate objectives  Enhances shareholder value  Poor financial fit exists when a business  Soaks up disproportionate share of financial resources  Is an inconsistent bottom-line contributor  Is too small to make a sizable contribution to total corporate earnings  Experiences a profit downturn that could jeopardize entire company

25 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 4: Decide Resource Allocation Priorities and Strategic Direction  Objective - Get the biggest bang for the buck in allocating corporate resources  Procedure  Rank each business from highest to lowest priority for corporate resource support and new investment  Decide on general strategic direction for each business  What is the ranking for each business unit in Money Company?  Are any of the BUs cash cows? Cash hogs?

26 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Options: General Strategic Direction  Invest and grow  Aggressive expansion  Fortify and defend  Protect current position  Overhaul and reposition  Make major strategy changes  Harvest or divest  Gradual market retreat  Spin off business as independent company  Sell business  What are some of the strategic directions that Money company took for each of its business units? Our direction will be..

27 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 5: Crafting a Corporate Strategy - Key Issues  Are enough businesses in attractive industries?  Is the number of mature or declining businesses so great corporate growth will be sluggish?  Are businesses overly vulnerable to seasonal influences or recession?  Are there too many average-to-weak businesses in the company’s business make-up?  Is there ample strategic fit among the businesses?  Can the performance targets be met with the current portfolio of businesses?

28 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright  Is there ample resource fit among the businesses?  Are there enough cash cows to finance those cash hogs with potential to be star performers?  Do core businesses generate dependable profits and/or cash flow?  Does makeup of business portfolio put firm in good future position? Step 5: Crafting a Corporate Strategy - Key Issues (continued)

29 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Step 5: Options for Addressing a Performance Shortfall  Alter strategic plans for some, or all, of businesses  Add new businesses  Divest weak-performing businesses  Form cooperative alliances  Upgrade firm’s resource base  Lower corporate performance objectives

30 © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright Summary Step 1 Step 1: Identify present corporate strategy Step 2 Step 2: Evaluate long-term attractiveness of each industry firm is in Step 3 Step 3: Rank business units based on historical performance and future prospects Step 4 Step 4: Rank business units in terms of priority for resource allocation and decide on general strategic posture Step 5: Step 5: Craft new strategic moves to improve overall company performance