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

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diversification strategy
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
slide2

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?
diversifi cation among the us fortune 500 1949 74
Diversification among the US Fortune 500, 1949-74

70.2 63.5 53.7 53.9 39.9 37.0

29.8 36.5 46.3 46.1 60.1 63.0

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

1949 1954 1959 1964 1969 1974

diversification the evolution of strategy and management thinking
Diversification: The Evolution of Strategy and Management Thinking

MANAGEMENT

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

1960 1970 1980 1990 2000 2006

motives for diversification
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 forshareholders—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.

diversification and shareholder value porter s three essential tests
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

competitive advantage from diversification
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

relatedness in diversification
Relatedness inDiversification

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.

diversification performance
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
managing the multibusiness corporation
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
the multidivisional structure theory of the m form
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.
the divisionalized firm in practice
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
the functions of corporate management
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

the development of strategic planning techniques general electric in the 1970 s
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
portfolio planning models their uses in strategy formulation
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.
portfolio planning models the bcg growth share matrix
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

slide18

Applying the BCG Matrix to Time Warner Inc.

Cable TV

Networks

Film

production

Cable

-8 -404 8 12

Magazine

Publishing

Annual real rate of market growth (%)

Bakery division

Music

AOL

Relative market share

Position in 2003 Position in 2000. (Area of circle proportional to $ sales)

portfolio planning models the ge mckinsey matrix
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

do portfolio planning models help or hinder corporate strategy formulation
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
corporate restructuring to create value the mckinsey pentagon
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

Potential value

with external

improvements

Disposal/acquisition

opportunities

exxon s strategic planning process
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

corporate control over the business es
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,

includingoperating budgets

and HR appraisals

goold campbell s corporate management styles financial and strategic control
Goold & Campbell’s Corporate Management Styles: Financial and Strategic Control

High

Centralized

Strategic

planning

CORPORATEINFLUENCE

Strategic

control

Financial

control

Holding

company

Low

Flexible strategic

Tight strategic

Tight financial

CONTROL INFLUENCE

corporate management application s of pims analysis
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 theimpact of changing strategic
    • variables.
  • Allocating investment funds between businesses
    • — PIMS Strategic Attractiveness Scan comparison different
    • business units’strategic attractiveness and their cash flow
    • characteristics
managing linkages between businesses
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 createsvalue by transferringcapabilities
  • between businesses
  • Sharing activities—Parent createsvalue by sharing resources between
  • businesses

ROLE OF DOMINANT LOGIC—importance of corporate managers’ perception of linkages

what corporate management activities are implied by porter s concepts of corporate strategy
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).

rethinking the management of multibusiness corporations lessons from g eneral e lectric
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”).
rethinking the management of multibusiness corporations lessons from abb
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 2002-03, deteriorating profitability and complexity of

matrix structure caused ABB to dismantle its matrix and adopt simpler line of business structure

slide30
Rethinking the Management of Multibusiness Corporations: Bartlett & Ghoshal’s Analysis of Key Management Processes

RENEWAL PROCESS

Managing the tension between short-term ambition

Managing operational interdependencies and personal networks

Creating and pursuing opportunities

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

case virgin
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?
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