CORPORATE STRATEGY: DIVERSIFICATION AND THE MULTIBUSINESS COMPANY CHAPTER 8 CORPORATE STRATEGY: DIVERSIFICATION AND THE MULTIBUSINESS COMPANY

Understand when and how business diversification can enhance shareholder value. Gain an understanding of how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage. Become aware of the merits and risks of corporate strategies keyed to unrelated diversification. Gain command of the analytical tools for evaluating a firm’s diversification strategy. Understand a diversified firm’s four main corporate strategy options for solidifying its diversification strategy and improving company performance.

STRATEGIC DIVERSIFICATION OPTIONS Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses. Broadening the current scope of diversification by entering additional industries. Divesting some businesses and retrenching to a narrower collection of diversified businesses with better overall performance prospects. Restructuring the entire firm by divesting some businesses and acquiring others to put a whole new face on the firm’s business lineup. 8–3

APPROACHES TO DIVERSIFYING THE BUSINESS LINEUP Diversifying into New Businesses Acquisition of an existing business Internal new venture (start-up) Joint venture 8–4

DIVERSIFICATION BY ACQUISITION OF AN EXISTING BUSINESS Advantages: Quick entry into an industry Barriers to entry avoided Access to complementary resources and capabilities Disadvantages: Cost of acquisition—whether to pay a premium for a successful firm or seek a bargain in struggling firm Underestimating costs for integrating acquired firm Overestimating the acquisition’s potential to deliver added shareholder value 8–5

ENTERING A NEW LINE OF BUSINESS THROUGH INTERNAL DEVELOPMENT Advantages of New Venture Development: Avoids pitfalls and uncertain costs of acquisition. Allows entry into a new or emerging industry where there are no available acquisition candidates. Disadvantages of Intrapreneurship: Must overcome industry entry barriers. Requires extensive investments in developing production capacities and competitive capabilities. May fail due to internal organizational resistance to change and innovation. 8–6

WHEN TO ENGAGE IN INTERNAL DEVELOPMENT Availability of in-house skills and resources Ample time to develop and launch business Cost of acquisition is higher than internal entry Added capacity will not affect supply and demand balance Low resistance of incumbent firms to market entry No head-to-head competition in targeted industry Factors Favoring Internal Development 8–7

WHEN TO ENGAGE IN A JOINT VENTURE Is the opportunity too complex, uneconomical, or risky for one firm to pursue alone? Evaluating the Potential for a Joint Venture Does the opportunity require a broader range of competencies and know-how than the firm now possesses? Will the opportunity involve operations in a country that requires foreign firms to have a local minority or majority ownership partner? 8–8

CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES Which Diversification Path to Pursue? Related Businesses Unrelated Businesses Both Related and Unrelated Businesses 8–9

Related businesses possess competitively valuable cross-business value chain and resource matchups. Unrelated businesses have dissimilar value chains and resource requirements, with no competitively important cross-business relationships at the value chain level. 8–10

CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES Have competitively valuable cross- business value chain and resource matchups. Unrelated Businesses Have dissimilar value chains and resource requirements, with no competitively important cross- business relationships at the value chain level. 8–11

DIVERSIFYING INTO RELATED BUSINESSES Strategic Fit Opportunities: Transferring specialized expertise, technological know-how, or other resources and capabilities from one business’s value chain to another’s. Cost sharing between businesses by combining their related value chain activities into a single operation. Exploiting common use of a well-known brand name. Sharing other resources (besides brands) that support corresponding value chain activities across businesses. 8–12

IDENTIFYING CROSS-BUSINESS STRATEGIC FITS ALONG THE VALUE CHAIN R&D and Technology Activities Supply Chain Activities Manufacturing-Related Activities Distribution-Related Activities Customer Service Activities Sales and Marketing Activities Potential Cross-Business Fits 8–13

DIVERSIFICATION INTO UNRELATED BUSINESSES Can it meet corporate targets for profitability and return on investment? Evaluating the acquisition of a new business or the divestiture of an existing business Is it is in an industry with attractive profit and growth potentials? Is it is big enough to contribute significantly to the parent firm’s bottom line? 8–14

BUILDING SHAREHOLDER VALUE VIA UNRELATED DIVERSIFICATION Using an Unrelated Diversification Strategy to Pursue Value Astute Corporate Parenting by Management Cross-Business Allocation of Financial Resources Acquiring and Restructuring Undervalued Companies 8–15

MISGUIDED REASONS FOR PURSUING UNRELATED DIVERSIFICATION Seeking a reduction of business investment risk Pursuing rapid or continuous growth for its own sake Seeking stabilization to avoid cyclical swings in businesses Pursuing personal managerial motives Poor Rationales for Unrelated Diversification 8–16

COMBINATIONS OF RELATED-UNRELATED DIVERSIFICATION STRATEGIES Related-Unrelated Business Portfolio Combinations Dominant-Business Enterprises Narrowly Diversified Firms Broadly Diversified Firms Multibusiness Enterprises 8–17

STRUCTURES OF COMBINATION RELATED-UNRELATED DIVERSIFIED FIRMS Dominant-Business Enterprises Have a major “core” firm that accounts for 50 to 80% of total revenues and a collection of small related or unrelated firms that accounts for the remainder. Narrowly Diversified Firms Are comprised of a few related or unrelated businesses. Broadly Diversified Firms Have a wide-ranging collection of related businesses, unrelated businesses, or a mixture of both. Multibusiness Enterprises Have a business portfolio consisting of several unrelated groups of related businesses. 8–18

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY Diversified Strategy Attractiveness of industries Strength of Business Units Cross-business strategic fit Fit of firm’s resources Allocation of resources New Strategic Moves 8–19

Three Strategy Alternatives for Pursuing Diversification FIGURE 8.2 Three Strategy Alternatives for Pursuing Diversification 8–20

STEP 1: EVALUATING INDUSTRY ATTRACTIVENESS How attractive are the industries in which the firm has business operations? Does each industry represent a good market for the firm to be in? Which industries are most attractive, and which are least attractive? How appealing is the whole group of industries? 8–21

Key Indicators of Industry Attractiveness Social, political, regulatory, environmental factors Seasonal and cyclical factors Industry uncertainty and business risk Market size and projected growth rate Industry profitability The intensity of competition among market rivals Emerging opportunities and threats

http://www. theatlantic http://www.theatlantic.com/business/archive/2012/03/newspapers-are-americas-fastest-shrinking-industry/254307/

CALCULATING INDUSTRY ATTRACTIVENESS SCORES Deciding on appropriate weights for the industry attractiveness measures. Evaluating Industry Attractiveness Gaining sufficient knowledge of the industry to assign accurate and objective ratings. Whether to use different weights for different business units whenever the importance of strength measures differs significantly from business to business. 8–24

TABLE 8.1 Calculating Weighted Industry Attractiveness Scores Remember: The more intensely competitive an industry is, the lower the attractiveness rating for that industry! [Rating scale: 1 = very unattractive to the firm; 10 = very attractive to the firm.] 8–25

STEP 2: EVALUATING BUSINESS-UNIT COMPETITIVE STRENGTH Relative market share Costs relative to competitors’ costs Ability to match or beat rivals on key product attributes Brand image and reputation Other competitively valuable resources and capabilities and partnerships and alliances with other firms Benefit from strategic fit with firm’s other businesses Bargaining leverage with key suppliers or customers Profitability relative to competitors 8–26

TABLE 8.2 Calculating Weighted Competitive Strength Scores for a Diversified Company’s Business Units [Rating scale: 1 = very weak; 10 = very strong.] 8–27

FIGURE 8.3 A Nine-Cell Industry Attractiveness–Competitive Strength Matrix Star Cash cow Note: Circle sizes are scaled to reflect the percentage of companywide revenues generated by the business unit. 8–28

STEP 3: DETERMINING THE COMPETITIVE VALUE OF STRATEGIC FIT IN DIVERSIFIED COMPANIES Assessing the degree of strategic fit across its businesses is central to evaluating a company’s related diversification strategy. The real test of a diversification strategy is what degree of competitive value can be generated from strategic fit. 8–29

STEP 4: CHECKING FOR RESOURCE FIT Financial Resource Fit State of the internal capital market Using the portfolio approach: Cash hogs need cash to develop. Cash cows generate excess cash. Star businesses are self-supporting. Success sequence: Cash hog  Star  Cash cow 8–30

STEP 5: RANKING BUSINESS UNITS AND ASSIGNING A PRIORITY FOR RESOURCE ALLOCATION Ranking Factors: Sales growth Profit growth Contribution to company earnings Return on capital invested in the business Cash flow Steer resources to business units with the brightest profit and growth prospects and solid strategic and resource fit. 8–31

STEP 6: CRAFTING NEW STRATEGIC MOVES TO IMPROVE OVERALL CORPORATE PERFORMANCE Strategy Options for a Firm That Is Already Diversified Stick with the Existing Business Lineup Broaden the Diversification Base with New Acquisitions Divest and Retrench to a Narrower Diversification Base Restructure through Divestitures and Acquisitions 8–32

FIGURE 8.6 A Firm’s Four Main Strategic Alternatives After It Diversifies 8–33

DIVESTING BUSINESSES AND RETRENCHING TO A NARROWER DIVERSIFICATION BASE Factors Motivating Business Divestitures: Improvement of long-term performance by concentrating on stronger positions in fewer core businesses and industries. Business is now in a once-attractive industry where market conditions have badly deteriorated. Business has either failed to perform as expected and\or is lacking in cultural, strategic or resource fit. Business has become more valuable if sold to another firm or as an independent spin-off firm. 8–34

Using Divestitures and Acquisitions to Restructure the Business Lineup Factors Leading to Corporate Restructuring: Too many businesses in unattractive industries Too many competitively weak businesses Ongoing declines in the market shares of business units due to more market-savvy competitors Debt and interest costs that sap profitability Acquisitions that haven’t lived up to expectations Reallocation of assets to strengthen the lineup Businesses with poor resource or strategic fit

ILLUSTRATION CAPSULE 8.1 Managing Diversification at Johnson & Johnson: The Benefits of Cross-Business Strategic Fit What does the growth in both revenues and profits reveal about the success of J&J’s diversification through acquisition strategy? To what extent is decentralization required when seeking cross-business strategic fit? What should J&J do to ensure the continued success of its diversification strategy? 8–36

RESTRUCTURING A DIVERSIFIED COMPANY’S BUSINESS LINEUP Factors Leading to Corporate Restructuring: A serious mismatch between the firm’s resources and capabilities and the type of diversification that it has pursued. Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries. Too many competitively weak businesses. Ongoing declines in the market shares of major business units that are falling prey to more market-savvy competitors. An excessive debt burden with interest costs that eat deeply into profitability. Ill-chosen acquisitions that haven’t lived up to expectations. 8–37

ILLUSTRATION CAPSULE 8.2 Growth through Restructuring at Kraft Foods Is Kraft Food’s corporate restructuring strategy narrowing or broadening its diversification base? How will restructuring help ensure that Kraft Foods will be better prepared to adapt to changing market conditions than its competitors? What actions did Kraft Foods take after making acquisitions to ensure the success of those acquisitions? 8–38