1. Diversification Strategy
OUTLINE
Introduction: The Basic Issues
The Trend over Time
Motives for Diversification
- Growth and Risk Reduction
- Shareholder Value: Porter’s Essential Tests
Competitive Advantage from Diversification
Diversification and Performance: Empirical Evidence
Relatedness in Diversification 27

2. The Basic Issues in Diversification Decisions
Superior profit derives from two sources:
INDUSTRY
ATTRACTIVENESS
RATE OF PROFIT
> COST OF CAPITAL
COMPETITIVE
ADVANTAGE
Diversification decisions involve these same two issues:
How attractive is the sector to be entered?
Can the firm achieve a competitive advantage?

3. Diversification among the US Fortune 500, 1949-74
Percentage of Specialized Companies (single-business,
vertically-integrated and dominant-business)
Percentage of Diversified Companies (related-business
and unrelated business)
Note: During the 1980s and 1990s the trend reversed as large
companies refocused upon their core businesses 29

4. Diversification among Large UK Corporations, 1950-93

5. Diversification: The Evolution of Strategy and Management Thinking
PRIORITIES
Quest for Growth
Addressing under-performance of widely-diversified firms
Creating shareholder value
Competitive advantage through speed & flexibility
Creating opportunities for future growth
Emergence of conglomerates
Diversification by established companies into related sectors
Emphasis on
“related’ &
“concentric” diversification
Refocusing on core businesses
Divesting diversified businesses
Joint ventures and alliances
Creating growth options
through focused
diversification
DEVELOPMENTS
IN CORPORATE
STRATEGY
STRATEGY TOOLS
& CONCEPTS
Financial analysis
Diffusion of M form structures
Creation of corporate planning depts.
Economies of scope & synergy”
Portfolio planning models
Capital asset pricing model
Maximization of shareholder wealth
Core competences
Dominant logic
Dynamic capabilities
Transaction cost analysis
Real options 1

6. Motives for Diversification
GROWTH --The desire to escape stagnant or declining industries a powerful motives for diversification (e.g. tobacco,
oil, newspapers).
--But, growth satisfies managers not shareholders.
--Growth strategies (esp. by acquisition), tend to
destroy shareholder value
RISK Diversification reduces variance of profit flows
SPREADING --But, doesn’t create value for shareholders—they can
hold diversified portfolios of securities.
--Capital Asset Pricing Model shows that diversification
lowers unsystematic risk not systematic risk.
PROFIT For diversification to create shareholder value, then
bringing together of different businesses under
common ownership & must somehow increase
their profitability. 31

7. Diversification and Shareholder Value: Porter’s Three Essential Tests
If diversification is to create shareholder value, it must meet three tests:
1. The Attractiveness Test: diversification must be directed towards attractive industries (or have the potential to become attractive).
2. The Cost of Entry Test : the cost of entry must not capitalize all future profits.
3. The Better-Off Test: either the new unit must gain competitive advantage from its link with the company, or vice-versa. (i.e. some form of “synergy” must be present)
Additional source of value from diversification: Option value 32

8. Competitive Advantage from Diversification
Predatory pricing/tie-in sales Evidence
Reciprocal buying of these
Mutual forbearance is sparse
MARKET
POWER
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 general management capabilities to multiple businesses
ECONOMIES OF
SCOPE
Economies of scope not a sufficient basis for diversification ----must be supported by transaction costs
Diversification firm can avoid transaction costs by operating internal capital and labor markets
Key advantage of diversified firm over external markets--- superior access to information
ECONOMIES
FROM
INTERNALIZING
TRANSACTIONS

9. Relatedness in Diversification
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. 35

10. Diversification & Performance
No consistent systematic relationships between performance and degree of diversification
Perhaps an Inverse U shape – why?
Stock market returns to acquiring firms negative on average
Related vs. unrelated diversification
Conglomerate discount & “ stick to the knitting”
But GE, LVMH, Virgin Group are anomalies

11. Managing the Multibusiness Corporation
OUTLINE
Structure of the Multidivisional Company
Theory of the M-form
The divisionalized firm in practice
The Role of Corporate Management
Managing the Corporate Portfolio
Portfolio planning techniques
Value-creation through corporate restructuring
Managing Individual Businesses
Managing Internal Linkages
Recent Trends 37

12. The Multidivisional Structure: Theory of the M-Form
Efficiency advantages of the multidivisional firm:
Recognizes bounded rationality—top management has limited decision-making capacity
Divides decision-making according to frequency:
—high-frequency operating decisions at divisional level
—low-frequency strategic decisions at corporate level
Reduces costs of communication and coordination: business level decisions confined to divisional level (reduces decision making at the top)
Global, rather than local optimization:- functional organizations encourage functional goals. M-form structure encourages focus on profitability.
Efficient allocation of resources through internal capital and labor markets
Resolves agency problem-- corporate management an interface between shareholders and business-level managers. 40

13. The Divisionalized Firm in Practice
Constraints upon decentralization.
Difficult to achieve clear division of decision making between corporate and divisional levels.
On-going dialogue and conflict between corporate and divisional managers over both strategic and operational issues.
Standardization of divisional management
Despite potential for divisions to develop distinctive strategies and structures—corporate systems may impose uniformity.
Managing divisional inter-relationships
Requires more complex structures, e.g. matrix structures where functional and/or geographical structure is imposed on top of a product/market structure.
Added complexity undermines the efficiency advantages of the M-form 41

14. The Functions of Corporate Management
—Decisions over diversification, acquisition,
divestment
—Resource allocation between businesses.
Managing the
Corporate
Portfolio
— Business strategy formulation
—Monitoring and controlling business
performance
Managing the
individual
businesses
—Sharing and transferring resources and
capabilities
Managing
linkages
between
businesses 42

15. The Development of Strategic Planning Techniques: General Electric in the 1970’s
Late 1960’s: GE encounters problems of direction, coordination, control, and profitability
Corporate planning responses:
Portfolio Planning Models —matrix-based frameworks for evaluating business unit performance, formulating business strategies, and allocating resources
Strategic Business Units —GE reorganized around SBUs (business comprising a strategically-distinct group of closely-related products
PIMS —a database which quantifies the impact of strategy on performance. Used to appraise SBU performance and guide business strategy formulation 43

16. Portfolio Planning Models: Their Uses in Strategy Formulation
Allocating resources-- the analysis indicates both the investment requirements of different businesses and their likely returns
Formulating business-unit strategy-- the analysis yields simple strategy recommendations (e.g..: “build”, “hold”, or “harvest”)
Setting performance targets-- the analysis indicates likely performance outcomes in terms of cash flow and ROI
Portfolios balance-- the analysis can assist in corporate goals such as a balanced cash flow and balance of growing and declining businesses. 46

17. Portfolio Planning Models: The BCG Growth-Share Matrix
Earnings: low, unstable, growing
Cash flow: negative
Strategy: analyze to determine whether business can be grown into a star, or will degenerate into a dog
Earnings: high stable, growing
Cash flow: neutral
Strategy: invest for growth ?
HIGH
Annual real rate of market growth (%)
Earnings: high stable
Cash flow: high stable
Strategy: milk
Earnings: low, unstable
Cash flow: neutral or negative
Strategy: divest
LOW
LOW
HIGH
Relative market share 44

18. Annual real rate of market growth (%)
Applying the BCG Matrix to Time Warner Inc.
Cable TV
Networks
Film
production
Cable
Magazine
Publishing
Annual real rate of market growth (%)
Bakery division
Music
AOL
Relative market share
Position in Position in (Area of circle proportional to $ sales) 47

19. Portfolio Planning Models: The GE/ McKinsey Matrix
High
B U I L D
Industry Attractiveness
H O L D
Medium
H A R V E S T
Low
Low
Medium
High
Business Unit Position
Industry Attractiveness Criteria Business Unit Position
- Market size Market share (domestic,
- Market growth global, and relative)
- Industry profitability Competitive position
- Inflation recovery Relative profitability
- Overseas sales ratio 45

20. Do Portfolio Planning Models Help or Hinder Corporate Strategy Formulation?
ADVANTAGES
Simplicity: Can be quickly
prepaired
Big picture: Permits one page
representation of the corporate
portfolio & the strategic
positioning of each business
Analytically versatile:
Applicable to businesses,
products, countries,
distribution channels.
Can be augmented: A useful
point of departure for more
sophisticated analysis
DISADVANTAGES
Simplicity: Oversimplifies the
factors determining industry
attractiveness and competitive
advantage
Ambiguous:The positioning
of a business depends
critically upon how a market is
defined
Ignores synergy: the analysis
takes no account of any
interdependencies between
businesses 48

21. Corporate Restructuring to Create Value: The McKinsey Pentagon
Current
market
value 1
Current perceptions
gap
Maximum raider
opportunity
Optimal
restructured
value
Company
value as is 2 5
RESTRUCTURING
FRAMEWORK
Strategic and
operating
opportunities
Total company
opportunities 3 4
Potential value
with internal
improvements
Disposal/acquisition
opportunities
Potential value
with external
improvements 50

22. Exxon’s Strategic Planning Process
Economic Review
Energy Review
Discuss- -ion with contact director
Approval by Mgmt. Committee
Business Plans
Stewardship Review
Stewardship Basis
Financial Forecast
Corporate Plan
Investment Reappraisals
Annual Budget 18

23. Corporate Control over the Businesses
2 basic approaches
Input
control
Output (or performance)
control
Monitoring & approving
business level decisions
Setting & monitoring
the achievement of
performance targets
Primarily through strategic
planning system & capital
expenditure approval
system
Primarily through performance
management system,
including operating budgets
and HR appraisals

24. Goold & Campbell’s Corporate Management Styles: Financial and Strategic Control
High
Centralized
Strategic
planning
CORPORATE INFLUENCE
Strategic
control
Financial
control
Holding
company
Low
Flexible strategic
Tight strategic
Tight financial
CONTROL INFLUENCE 52

25. Corporate Management Applications of PIMS Analysis
Setting performance targets
—feeding business unit strategic and industry data into the PIMS
regression model gives performance norms for the business
(PAR ROI).
Formulating business unit strategy
— PIMS model can simulate the impact of changing strategic
variables.
Allocating investment funds between businesses
— PIMS Strategic Attractiveness Scan comparison different
business units’ strategic attractiveness and their cash flow
characteristics 49

26. Managing Linkages between Businesses
KEY ISSUE—How does the corporate center add value to the business?
BASIS OF BUSINESS LINKAGES—Sharing of resources and capabilities.
SHARING OCCURS AT TWO LEVELS:
Corporate level—common corporate services
Business level—sharing resources, transferring capabilities
PORTER’S ANALYSIS OF BUSINESS LINKAGES AND CORPORATE
STRATEGY TYPES
Portfolio management— Parent creates value by operating an internal
capital market
Restructuring—Parent create value by acquiring and restructuring
Inefficiently-managed businesses
Transferring skills—Parent creates value by transferring capabilities
between businesses
Sharing activities—Parent creates value by sharing resources between
businesses
ROLE OF DOMINANT LOGIC—importance of corporate managers’ perception of linkages

27. What Corporate Management Activities are Implied by Porter’s “Concepts of Corporate Strategy”
(1) Portfolio Management
Using superior information and analysis to acquire attractive companies at
favorable prices (e.g. Berkshire Hathaway).
Minimizing cost of capital (e.g. GE)
Create efficientt internal system for capital allocation (e.g. Exxon-Mobil)
Efficient monitoring of business unit performance (e.g BP-Amoco).
(2) Restructuring: Intervening to cut costs and divest under performing assets (e.g.
Hanson during 1980s & early 1990s)
(3) Transferring skills:
—Transferring best practices (e.g. Hewlett-Packard)
—Transferring innovations (e.g. Sharp)
—Transferring key personnel between businesses (e.g. Sony)
(4) Sharing activities:
—Common corporate services (e.g. 3M)
—Sharing operational resources and functions (e.g. sales and distribution,
manufacturing facilities). 51

28. Rethinking the Management of Multibusiness Corporations: Lessons from General Electric
Jack Welch’s transformation of GE’s structure and management systems:
Delayering --- from 9 or 10 layers of hierarchy to 4 or 5
Decentralizing decisions.
Reformulating strategic planning—from formal, document-intensive analysis to direct face-to-face discussion of key issues.
Redefining the role of HQ—from checker, inquisitor, and authority to facilitator, helper, and supporter.
Coordinating role of HQ— corporate HQ to lead in creating the “boundaryless corporation” where innovations and ideas flow and where horizontal coordination occurs to respond to new opportunities.
HQ as change agent— corporate HQ driving force for continual organizational change (e.g. “workout”, “six-sigma”). 53

29. Rethinking the Management of Multibusiness Corporations: Lessons from ABB
Key features of ABB’s corporate management system:
Matrix organization—both product and country / regional coordination; flexible reporting requirements
Radical decentralization—ABB’s corporate HQ was tiny (<100 staff). Decision making authority lay with individual national subsidiaries (mostly small or medium-sized businesses).
Bottom-up management. Each business had its own balance sheet and could retain 1/3 of net income.
Informal collaboration and integration.
Yet, for all of ABB’s apparent success at reconciling coordination with
decentralization, by , deteriorating profitability and complexity of
matrix structure caused ABB to dismantle its matrix and adopt simpler line of business structure 54

30. Rethinking the Management of Multibusiness Corporations: Bartlett & Ghoshal’s Analysis of Key Management Processes
Managing the tension between short-term ambition
Managing operational interdependencies and personal networks
Creating and pursuing opportunities
RENEWAL PROCESS
Shaping and embedding corporate purpose
Developing and nurturing organizational values
Establishing
strategic mission &
performance standards
Creating and maintaining organizational trust
Linking skills, knowledge, and resources
Reviewing, developing, and supporting initiatives
INTEGRATION PROCESS
ENTREPRENEURIAL PROCESS
Front-line Management Middle Management Top Management 55

31. Case: Virgin
What common resources and capabilities link the separate Virgin companies?
Which businesses, if any, should Branson consider divesting?
What criteria should Branson apply in deciding what new diversification to pursue?
What is the Virgin business model?
What changes in the financial structure, organizational structure, and management systems of the Virgin groupwould you recommend?