1. MKT 450 Strategic Management Mishari Alnahedh

2. LECTURE 9: DIVERSIFICATION STRATEGY

3. What are the sources of value creation by diversification?
Learning Objectives
Mishari Alnahedh
Define corporate-level strategy and discuss its importance to the diversified firm.
What are the sources of value creation by diversification?
What are the limits to diversification?
What are potential agency problems?
How should organizational structure fit diversification strategies?

4. Three dimensions of scope
Corporate Strategy
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Corporate Strategy
Corporate strategy is the way a company creates value through the configuration and coordination of its multi-market activities
Quest for competitive advantage when competing in multiple industries
- Example: Jeffrey Immelt’s initiative in clean-tech and health care industries
Three dimensions of scope
Industry value chain
Products and services
Geography
Diversification Decision

5. Diversification decisions involve these same two issues:
The Basic Issues in Diversification Decisions
Mishari Alnahedh
Superior profit derives from two sources:
INDUSTRY
ATTRACTIVENESS
RETURN ON CAPITAL
> COST OF CAPITAL
COMPETITIVE
ADVANTAGE
Diversification decisions involve these same two issues:
How attractive is the industry to be entered?
Can the firm achieve a competitive advantage?
© 2013 Robert M. Grant

6. Growth Motivation for Diversification
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Growth
Transferring Core Competencies (Leveraging)
Developing New Competencies (Stretching)
Brand-name that is exportable (e.g., Haagen-Dazs to chocolate candy)
R&D and new product development
The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco, oil, newspapers)
But, growth satisfies managers not shareholders. Diversification in that achieves seeks growth (esp. by acquisition) tends to destroy shareholder value

7. Risk Reduction/Spreading
Motivation for Diversification
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Risk Reduction/Spreading
Financial Motives
internal capital allocation & restructuring
risk reduction
tax advantages
Diversification reduces the variance of profit flows
But, doesn’t create value for shareholders—they can hold diversified portfolios of securities. (Capital Asset Pricing Model shows that diversification only lowers unsystematic risk not systematic risk)

8. Profitability/Value Creation
Motivation for Diversification
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Profitability/Value Creation
Efficient Management
Economies of Scope (shared activities to reduce costs)
Utilizing excess capacity (e.g., in distribution)
Increase market power
multi-point competition
For diversification to create shareholder value, then bringing and putting different businesses under common ownership must increase their total profitability

9. Motivations that “Devaluate”:
Other Motivations for Diversifications:
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Motivations that “Devaluate”:
Growth maximization
managerial capitalism/agency problem
protect against “unemployment risk”
maximize management compensation
Motivations that are “Value neutral”:
Diversification motivated by poor performance in current businesses.

10. Competitive Advantage from Diversification
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Economies of Scope
Sharing tangible resources (research labs, distribution systems) across multiple businesses
Sharing intangible resources (brands, technology) across multiple businesses
Transferring functional capabilities (marketing, product development) across businesses
Applying common general management capabilities to different businesses
Economies from Internalizing Transactions
Economies of scope not a sufficient basis for diversification—must be supported by transaction costs in markets for resources
Diversified firm can avoid external transactions by operating internal capital and labor markets
Diversified firm has better information on resource characteristics than external markets
© 2013 Robert M. Grant

11. Operational relatedness
Relatedness in Diversification
Mishari Alnahedh
Economies of scope in diversification derive from two types of relatedness:
Operational relatedness
Synergies from sharing resources across businesses (common distribution facilities, brands, joint R&D)
Strategic relatedness
Synergies at the corporate level deriving from the ability to apply common management capabilities to different businesses
Problem of operational relatedness: The benefits in terms of economies of scope may be dwarfed by the administrative costs involved in their exploitation
© 2013 Robert M. Grant

12. Internal development Acquisition Joint venture Licensing
Modes of Diversification
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Internal development
Acquisition
Joint venture
Licensing

13. Diversification Issues
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Issue #1: When there is a reduction in managerial (employment) risk, then there is upside and downside effects for stockholders.
On the upside, managers will be more willing to learn firm-specific skills that will improve the productivity and long-run success of the company (to the benefit of stockholders).
On the downside, top-level managers may have the incentive to diversify to a point that is detrimental to stockholders.

14. Diversification Issues
Mishari Alnahedh
Issue #2: There may be no economic value to stockholders in diversification moves since stockholders are free to diversify by holding a portfolio of stocks. No one has shown that investors pay a premium for diversified firms -- in fact, discounts are common.
A classic example is Kaiser Industries
Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum; and (3) Kaiser Cement.
These were independent companies and the stock of each were publicly traded.
Kaiser Industries was selling at a discount which vanished when Kaiser industries revealed its plan to sell its holdings.
Kaiser Industries was dissolved as a holding company because its diversification apparently subtracted from its value.

15. Diversification and Performance
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16. Diversification and Performance
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Source: Rothaermel, F (2013) Strategic Management, McGraw-Hill

17. Diversification Costs
Diversification and Performance
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Diversification Costs
Coordination cost
A function of number, size, and types of businesses linked to one another
Influence cost
Political maneuvering by managers to influence capital and resource allocation

18. Diversification and Performance
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The majority of diversifying acquisitions have destroyed shareholder wealth:
the acquisition premiums paid have greatly exceeded the value added by the acquired businesses
Conversely, stock market valuations have responded positively to divestments, or even to the anticipation of divestment

19. Managing the Multibusiness Firm

20. Managing the multi-business corporation
Mishari Alnahedh
Can value be derived by operating across the different activities and markets in which they are engaged?
How should the multi-business company be structured and managed to ensure that these sources of value are exploited more efficiently than under any other type of organizational arrangement?

21. Industry attractiveness
Managing the multi-business corporation
Mishari Alnahedh
Strategy analysis
Allocating resources
Formulating business strategy
Analyzing portfolio balance
Cash flow
Growth
Setting performance targets
Industry attractiveness
Market size, market growth, industry profitability, cyclicality, inflation recovery, importance of overseas market
Business unit competitive advantage
Market position, competitive position, return on sales relative to that of leading competitors

22. Portfolio Planning Models: BCG Growth-Share Matrix
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23. Among their weaknesses are:
Portfolio Planning
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Since the 1980s, portfolio planning matrices have lost their popularity as analytic tools.
Among their weaknesses are:
Oversimplification
The positioning of businesses within the matrix is highly susceptible to measurement choices and market definitions
The approach assumes that every business is completely independent

24. Managing Linkages Across Boundaries
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Value from exploiting linkages within the multibusiness firm result mainly from exploiting resource and capability linkages:
At the corporate level – Shared corporate services
At the business level – Sharing resources, transferring capabilities
Michael Porter identifies types of corporate strategy based on the nature and extent of internal linkages:
Portfolio management – Parent creates value by operating an internal capital market
Restructuring - Parent creates value by acquiring and revitalizing inefficiently-managed businesses
Transferring skills - Parent creates value by transferring capabilities between businesses
Sharing activities - Parent creates value by sharing resources between businesses
© 2013 Robert M. Grant

25. Today’s Main Takeaway
Mishari Alnahedh
Recognize the central issues of formulating and implementing corporate strategy
Deploy the concepts and techniques necessary for making judgments about these issues
Evaluate the relationships between the resources and capabilities of the firm, its corporate strategy, and the implementation of the strategy through an appropriate organization structure, management system, and leadership style

26. Case: The Virgin Group in 2012
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Case: The Virgin Group in 2012
This is the last case in this class. No case guideline