University of Cagliari, Faculty of Economics, Business Strategy and Policy A course within the II level degree in Managerial Economics year II, semester I, 9 credits Lecturer: Dr Alberto Asquer Phone:

Introduction 1. What is diversification 2. Diversification and shareholder value 3. How to enter a new business 4. Related and unrelated diversification Summary

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

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

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

2. Diversification and shareholder value 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. Diversification and shareholder value Instance: Tiscali ( ) 1998 Internet (free) access 1999 Market entry Market development Product development Diversification Acquisitions in the EU Fixed phone lines, ADSL Virtual Mobile Network Operator Telecom in Italy and the UK

2. Diversification and shareholder value Instance: Tiscali ( ) 2009 Product development Diversification Fixed phone lines, ADSL Virtual Mobile Network Operator Telecom in Italy and the UK The opposite of diversification: focus strategy 2011 UK division sold in 2009

2. Diversification and shareholder value Instance: Tiscali ( ) (a struggle to protect shareholders' value)

2. Diversification and shareholder value 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!)

3. How to enter a new business AcquisitionJoint ventureInternal start-up

4. Related and unrelated diversification 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. Related and unrelated diversification Instance of related diversification: Johnson & Johnson Consumers products Baby care Skin and hair care Wound care Oral care Women's careMedicines Nutritionals Vision care

4. Related and unrelated diversification 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. Related and unrelated diversification Instance of unrelated diversification: General Electrics Appliances Consumer products Energy Financial services Healthcare Aviation

4. Related and unrelated diversification Instance of unrelated diversification: Virgin Radio Travel agent Telecom and media Radio Airlines Railways Megastore Soft drinks

4. Related and unrelated diversification 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 pursues, 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

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