copyright © 2014 by the mcgraw-hill education all rights reserved. 19e global edition thompson |...

Copyright © 2014 by The McGraw-Hill Education All rights reserved.

19e Global EditionTHOMPSON | PETERAF | GAMBLE | STRICKLAND

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

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1. Understand when and how business diversification can enhance shareholder value.

2. Gain an understanding of how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage.

3. Become aware of the merits and risks of corporate strategies keyed to unrelated diversification.

4. Gain command of the analytical tools for evaluating a firm’s diversification strategy.

5. Understand a diversified firm’s four main corporate strategy options for solidifying its diversification strategy and improving company performance.

WHAT DOES CRAFTING A WHAT DOES CRAFTING A DIVERSIFICATION STRATEGY ENTAIL?DIVERSIFICATION STRATEGY ENTAIL?

Step 1 Picking new industries to enter and deciding on the means of entry.

Step 2 Pursuing opportunities to leverage cross-business value chain relationships and strategic fit into competitive advantage.

Step 3 Establishing investment priorities and steering corporate resources into the most attractive business units.

Step 4 Initiating actions to boost the combined performanceof the cooperation’s collection of businesses.

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STRATEGIC DIVERSIFICATION OPTIONSSTRATEGIC DIVERSIFICATION OPTIONS

Sticking closely with the existing business lineup and Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses.pursuing opportunities presented by these businesses.

Broadening the current scope of diversification by Broadening the current scope of diversification by entering additional industries.entering additional industries.

Divesting some businesses and retrenching to a Divesting some businesses and retrenching to a narrower collection of diversified businesses with better narrower collection of diversified businesses with better overall performance prospects.overall performance prospects.

Restructuring the entire firm by divesting some Restructuring the entire firm by divesting some businesses and acquiring others to put a whole new businesses and acquiring others to put a whole new face on the firm’s business lineup.face on the firm’s business lineup.

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WHEN BUSINESS DIVERSIFICATION WHEN BUSINESS DIVERSIFICATION BECOMES A CONSIDERATIONBECOMES A CONSIDERATION

A firm should consider diversifying when:A firm should consider diversifying when:1.1. It can expand into businesses whose technologies It can expand into businesses whose technologies

and products complement its present business.and products complement its present business.

2.2. Its resources and capabilities can be used as Its resources and capabilities can be used as valuable competitive assets in other businesses.valuable competitive assets in other businesses.

3.3. Costs can be reduced by cross-business sharing Costs can be reduced by cross-business sharing or transfer of resources and capabilities. or transfer of resources and capabilities.

4.4. Transferring a strong brand name to the products Transferring a strong brand name to the products of other businesses helps drive up sales and of other businesses helps drive up sales and profits of those businesses.profits of those businesses.

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BUILDING SHAREHOLDER VALUE: BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION THE ULTIMATE JUSTIFICATION

FOR DIVERSIFYINGFOR DIVERSIFYING

The industry The industry attractiveness attractiveness

testtest

The cost-of-entry test

The better-off test

Testing Whether Diversification Will Add Long-Term

Value for Shareholders

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TESTING WHETHER DIVERSIFICATION TESTING WHETHER DIVERSIFICATION ADDS VALUE FOR SHAREHOLDERSADDS VALUE FOR SHAREHOLDERS

The Attractiveness Test:The Attractiveness Test:● Are the industry’s profits and return on investment Are the industry’s profits and return on investment

as good or better than present business(es)?as good or better than present business(es)? The Cost of Entry Test:The Cost of Entry Test:

● Is the cost of overcoming entry barriers so great as Is the cost of overcoming entry barriers so great as to long delay or reduce the potential for profitability?to long delay or reduce the potential for profitability?

The Better-Off Test:The Better-Off Test:● How much synergy (stronger overall performance) How much synergy (stronger overall performance)

will be gained by diversifying into the industry?will be gained by diversifying into the industry?

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CORE CONCEPTCORE CONCEPT

♦ Creating added value for shareholders via Creating added value for shareholders via diversification requires building a multibusiness diversification requires building a multibusiness company where the whole is greater than the company where the whole is greater than the sum of its parts—an outcome known as sum of its parts—an outcome known as synergysynergy..

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BETTER PERFORMANCE BETTER PERFORMANCE THROUGH SYNERGYTHROUGH SYNERGY

Evaluating the Evaluating the Potential for Potential for

Synergy Synergy through through

DiversificationDiversification

Firm A purchases Firm B in Firm A purchases Firm B in another industry. A and B’s another industry. A and B’s profits are no greater than profits are no greater than what each firm could have what each firm could have earned on its own.earned on its own.

Firm A purchases Firm C in Firm A purchases Firm C in another industry. A and C’s another industry. A and C’s profits are greater than what profits are greater than what each firm could have earned each firm could have earned on its own.on its own.

No No SynergySynergy(1+1=2)(1+1=2)

SynergySynergy(1+1=3)(1+1=3)

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APPROACHES TO DIVERSIFYING APPROACHES TO DIVERSIFYING THE BUSINESS LINEUPTHE BUSINESS LINEUP

Acquisition of an Acquisition of an existing businessexisting business

Internal new venture (start-up)

Joint venture

Diversifying into New Businesses

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DIVERSIFICATION BY ACQUISITION DIVERSIFICATION BY ACQUISITION OF AN EXISTING BUSINESSOF AN EXISTING BUSINESS

Advantages:Advantages:● Quick entry into an industryQuick entry into an industry● Barriers to entry avoidedBarriers to entry avoided● Access to complementary resources and capabilitiesAccess to complementary resources and capabilities

Disadvantages:Disadvantages:● Cost of acquisition—whether to pay a Cost of acquisition—whether to pay a premiumpremium for a for a

successful firm or seek a bargain in struggling firmsuccessful firm or seek a bargain in struggling firm● Underestimating costs for integrating acquired firmUnderestimating costs for integrating acquired firm● Overestimating the acquisition’s potential to deliver Overestimating the acquisition’s potential to deliver

added shareholder valueadded shareholder value

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♦ An An acquisition premiumacquisition premium is the amount by is the amount by which the price offered exceeds the which the price offered exceeds the preacquisition market value of the target firm.preacquisition market value of the target firm.

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ENTERING A NEW LINE OF BUSINESS ENTERING A NEW LINE OF BUSINESS THROUGH INTERNAL DEVELOPMENTTHROUGH INTERNAL DEVELOPMENT

Advantages of New Venture Development:Advantages of New Venture Development:● Avoids pitfalls and uncertain costs of acquisition.Avoids pitfalls and uncertain costs of acquisition.● Allows entry into a new or emerging industry where Allows entry into a new or emerging industry where

there are no available acquisition candidates.there are no available acquisition candidates. Disadvantages of Intrapreneurship:Disadvantages of Intrapreneurship:

● Must overcome industry entry barriers.Must overcome industry entry barriers.● Requires extensive investments in developing Requires extensive investments in developing

production capacities and competitive capabilities.production capacities and competitive capabilities.● May fail due to internal organizational resistance to May fail due to internal organizational resistance to

change and innovation.change and innovation.

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♦ Corporate venturing Corporate venturing (or new venture (or new venture development) is the process of developing development) is the process of developing new businesses as an outgrowth of a firm’s new businesses as an outgrowth of a firm’s established business operations. It is also established business operations. It is also referred to as referred to as corporate entrepreneurship corporate entrepreneurship or or intrapreneurshipintrapreneurship since it requires since it requires entrepreneurial-like qualities within a larger entrepreneurial-like qualities within a larger enterprise.enterprise.

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WHEN TO ENGAGE IN WHEN TO ENGAGE IN INTERNAL DEVELOPMENTINTERNAL DEVELOPMENT

Availability of in-house skills and resources

Ample time to develop and

launch business Cost of acquisition Cost of acquisition is higher than is higher than internal entryinternal entry

Added capacity will not affect supply and

demand balanceLow resistance of incumbent firms to market entry

No head-to-head competition in

targeted industry

Factors Favoring Internal Development

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WHEN TO ENGAGE IN WHEN TO ENGAGE IN A JOINT VENTUREA JOINT VENTURE

Evaluating Evaluating the Potential the Potential

for a Joint for a Joint VentureVenture

Is the opportunity too complex, uneconomical, Is the opportunity too complex, uneconomical, or risky for one firm to pursue alone?or risky for one firm to pursue alone?

Does the opportunity require a broader range of competencies and know-how than the firm now possesses?

Will the opportunity involve operations in a Will the opportunity involve operations in a country that requires foreign firms to have a country that requires foreign firms to have a local minority or majority ownership partner?local minority or majority ownership partner?

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DIVERSIFICATION BY DIVERSIFICATION BY JOINT VENTUREJOINT VENTURE

Joint ventures are advantageous when Joint ventures are advantageous when diversification opportunities:diversification opportunities:● Are too large, complex, uneconomical, or risky for Are too large, complex, uneconomical, or risky for

one firm to pursue alone.one firm to pursue alone.● Require a broader range of competencies and know-Require a broader range of competencies and know-

how than a firm possesses or can develop quickly.how than a firm possesses or can develop quickly.● Are located in a foreign country that requires local Are located in a foreign country that requires local

partner participation and/or ownership.partner participation and/or ownership.

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DIVERSIFICATION BY DIVERSIFICATION BY JOINT VENTURE (cont’d)JOINT VENTURE (cont’d)

Joint ventures have the potential for developing Joint ventures have the potential for developing serious drawbacks due to:serious drawbacks due to:● Conflicting objectives and expectations of venture Conflicting objectives and expectations of venture

partners.partners.● Disagreements among or between venture partners Disagreements among or between venture partners

over how best to operate the venture.over how best to operate the venture.● Cultural clashes among and between the partners.Cultural clashes among and between the partners.● The venture dissolving when one of the venture The venture dissolving when one of the venture

partners decides to go their own way.partners decides to go their own way.

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CHOOSING A MODE OF CHOOSING A MODE OF MARKET ENTRYMARKET ENTRY

The Question of Critical Resources and Capabilities

Does the firm have the resources and capabilities for internal development?

The Question of Entry Barriers Are there entry barriers to overcome?

The Question of Speed

Is speed of the essence in the firm’s chances for successful entry?

The Question of Comparative Cost

Which is the least costly mode of entry, given the firm’s objectives?

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♦ Transaction costs Transaction costs are the costs of completing are the costs of completing a business agreement or deal of some sort, a business agreement or deal of some sort, over and above the price of the deal. They can over and above the price of the deal. They can include the costs of searching for an attractive include the costs of searching for an attractive target, the costs of evaluating its worth, target, the costs of evaluating its worth, bargaining costs, and the costs of completing bargaining costs, and the costs of completing the transaction.the transaction.

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CHOOSING THE DIVERSIFICATION PATH: CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED RELATED VERSUS UNRELATED

BUSINESSESBUSINESSES

Related Related BusinessesBusinesses

Unrelated Businesses

Both Related and Unrelated

Businesses

Which Diversification Path to Pursue?

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♦ Related businesses Related businesses possess competitively possess competitively valuable cross-business value chain and valuable cross-business value chain and resource matchups.resource matchups.

♦ Unrelated businesses Unrelated businesses have dissimilar value have dissimilar value chains and resource requirements, with no chains and resource requirements, with no competitively important cross-business competitively important cross-business relationships at the value chain level.relationships at the value chain level.

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CHOOSING THE DIVERSIFICATION PATH: CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED RELATED VERSUS UNRELATED

BUSINESSESBUSINESSES

Related BusinessesRelated Businesses● Have competitively valuable cross-business Have competitively valuable cross-business

value chain and resource matchups.value chain and resource matchups. Unrelated BusinessesUnrelated Businesses

● Have dissimilar value chains and resource Have dissimilar value chains and resource requirements, with no competitively important requirements, with no competitively important cross-business relationships at the value chain cross-business relationships at the value chain level.level.

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♦ Strategic fit Strategic fit exists whenever one or more exists whenever one or more activities constituting the value chains of activities constituting the value chains of different businesses are sufficiently similar as different businesses are sufficiently similar as to present opportunities for cross-business to present opportunities for cross-business sharing or transferring of the resources and sharing or transferring of the resources and capabilities that enable these activities.capabilities that enable these activities.

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DIVERSIFYING INTO RELATED DIVERSIFYING INTO RELATED BUSINESSESBUSINESSES

Strategic Fit Opportunities:Strategic Fit Opportunities:● Transferring specialized expertise, technological Transferring specialized expertise, technological

know-how, or other resources and capabilities from know-how, or other resources and capabilities from one business’s value chain to another’s.one business’s value chain to another’s.

● Cost sharing between businesses by combining their Cost sharing between businesses by combining their related value chain activities into a single operation.related value chain activities into a single operation.

● Exploiting common use of a well-known brand name.Exploiting common use of a well-known brand name.● Sharing other resources (besides brands) that Sharing other resources (besides brands) that

support corresponding value chain activities across support corresponding value chain activities across businesses.businesses.

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Pursuing Related DiversificationPursuing Related Diversification

Related diversification involves sharing or Related diversification involves sharing or transferring transferring specializedspecialized resources and resources and capabilities.capabilities.● Specialized Resources and CapabilitiesSpecialized Resources and Capabilities

Have very specific applications and their use Have very specific applications and their use is limited to a restricted range of industry and is limited to a restricted range of industry and business types.business types.

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CORE CONCEPTSCORE CONCEPTS

♦ Specialized Versus Generalized Resources Specialized Versus Generalized Resources and Capabilities and Capabilities ● Specialized resources and capabilities Specialized resources and capabilities have very have very

specific applications and their use is limited to a specific applications and their use is limited to a restricted range of industry and business types.restricted range of industry and business types.

Leveraged in related diversificationLeveraged in related diversification● Generalized resources and capabilities Generalized resources and capabilities can be can be

widely applied and can be deployed across a broad widely applied and can be deployed across a broad range of industry and business types.range of industry and business types.

Leveraged in unrelated and Leveraged in unrelated and related diversificationrelated diversification

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Related Businesses Provide Opportunities to Benefit from Competitively Valuable Strategic Fit

FIGURE 8.1

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IDENTIFYING CROSS-BUSINESS IDENTIFYING CROSS-BUSINESS STRATEGIC FITS ALONG STRATEGIC FITS ALONG

THE VALUE CHAINTHE VALUE CHAIN

R&D and R&D and Technology Technology

ActivitiesActivities

Supply Supply Chain Chain

ActivitiesActivitiesManufacturing-Manufacturing-

Related Related ActivitiesActivities

Distribution-Distribution-Related Related

ActivitiesActivitiesCustomer Customer Service Service

ActivitiesActivities

Sales and Sales and Marketing Marketing ActivitiesActivities

Potential Potential Cross-Business FitsCross-Business Fits

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STRATEGIC FIT, ECONOMIES OF SCOPE, STRATEGIC FIT, ECONOMIES OF SCOPE, AND COMPETITIVE ADVANTAGEAND COMPETITIVE ADVANTAGE

Transferring specialized and

generalized skills and\or knowledge

Combining related value

chain activities to achieve lower costs

Leveraging brand names

and other differentiation

resources

Using cross-business

collaboration and knowledge

sharing

Using Economies of Scope to Convert Strategic Fit into Competitive Advantage

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CORE CONCEPTSCORE CONCEPTS

♦ Economies of scope Economies of scope are cost reductions are cost reductions that flow from operating in multiple that flow from operating in multiple businesses (a larger scope of operation).businesses (a larger scope of operation).

♦ Economies of scale Economies of scale accrue from a accrue from a larger-larger-sizesize operation. operation.

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ECONOMIES OF SCOPE DIFFER ECONOMIES OF SCOPE DIFFER FROM ECONOMIES OF SCALEFROM ECONOMIES OF SCALE

Economies of ScopeEconomies of Scope● Are cost reductions that flow from cross-business Are cost reductions that flow from cross-business

resource sharing in the activities of the multiple resource sharing in the activities of the multiple businesses of a firm.businesses of a firm.

Economies of ScaleEconomies of Scale● Accrue when unit costs are reduced due to the Accrue when unit costs are reduced due to the

increased output of larger-size operations of a firm.increased output of larger-size operations of a firm.

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FROM STRATEGIC FIT TO FROM STRATEGIC FIT TO COMPETITIVE ADVANTAGE, COMPETITIVE ADVANTAGE, ADDED PROFITABILITY AND ADDED PROFITABILITY AND

GAINS IN SHAREHOLDER VALUEGAINS IN SHAREHOLDER VALUE

Builds more Builds more shareholder value shareholder value

than owning a than owning a stock portfoliostock portfolio

Is only possible via a strategy

of related diversification

Yields value in the application of specialized resources and

capabilities

Requires that management take internal actions to

realize them

Capturing the Cross-Business Benefits of Related Diversification

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STRATEGIC MANAGEMENT PRINCIPLESTRATEGIC MANAGEMENT PRINCIPLE

♦ Diversifying into related businesses where Diversifying into related businesses where competitively valuable strategic-fit benefits can competitively valuable strategic-fit benefits can be captured puts a company’s businesses in be captured puts a company’s businesses in position to perform better financially as part of position to perform better financially as part of the company than they could have performed the company than they could have performed as independent enterprises, thus providing a as independent enterprises, thus providing a clear avenue for boosting shareholder value clear avenue for boosting shareholder value and satisfying and satisfying the better-off testthe better-off test..

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DIVERSIFICATION INTO DIVERSIFICATION INTO UNRELATED BUSINESSESUNRELATED BUSINESSES

Evaluating the Evaluating the acquisition of a acquisition of a new business or new business or the divestiture of the divestiture of

an existing an existing businessbusiness

Can it meet corporate targets Can it meet corporate targets for profitability and return on for profitability and return on

investment?investment?

Is it is in an industry with attractive profit and growth

potentials?

Is it is big enough to contribute Is it is big enough to contribute significantly to the parent firm’s significantly to the parent firm’s

bottom line?bottom line?

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BUILDING SHAREHOLDER VALUE BUILDING SHAREHOLDER VALUE VIA UNRELATED DIVERSIFICATIONVIA UNRELATED DIVERSIFICATION

Astute Corporate Parenting by Management

Cross-Business Allocation of

Financial Resources

Acquiring and Restructuring Undervalued Companies

Using an Unrelated Diversification Strategy to Pursue Value

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BUILDING SHAREHOLDER VALUE BUILDING SHAREHOLDER VALUE VIA UNRELATED DIVERSIFICATIONVIA UNRELATED DIVERSIFICATION

Astute Corporate Astute Corporate Parenting by Parenting by ManagementManagement

• Provide leadership, oversight, expertise, and guidance.• Provide generalized or parenting resources that lower

operating costs and increase SBU efficiencies.

Cross-Business Cross-Business Allocation of Allocation of

Financial Financial ResourcesResources

• Serve as an internal capital market.• Allocate surplus cash flows from businesses to fund

the capital requirements of other businesses.

Acquiring and Acquiring and Restructuring Restructuring Undervalued Undervalued CompaniesCompanies

• Acquire weakly performing firms at bargain prices.• Use turnaround capabilities to restructure them to

increase their performance and profitability.

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♦ Corporate parenting Corporate parenting refers to the role that a refers to the role that a diversified corporation plays in nurturing its diversified corporation plays in nurturing its component businesses through the provision of component businesses through the provision of top management expertise, disciplined control, top management expertise, disciplined control, financial resources, and other types of financial resources, and other types of generalized resources and capabilities such as generalized resources and capabilities such as long-term planning systems, business long-term planning systems, business development skills, management development development skills, management development processes, and incentive systems.processes, and incentive systems.

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♦ A diversified firm has a A diversified firm has a parenting advantage parenting advantage when it is more able than other firms to boost when it is more able than other firms to boost the combined performance of its individual the combined performance of its individual businesses through high-level guidance, businesses through high-level guidance, general oversight, and other corporate-level general oversight, and other corporate-level contributions.contributions.

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♦ An umbrella brand is a corporate brand name An umbrella brand is a corporate brand name that can be applied to a wide assortment of that can be applied to a wide assortment of business types. As such, it is a generalized business types. As such, it is a generalized resource that can be leveraged in unrelated resource that can be leveraged in unrelated diversification.diversification.

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♦ RestructuringRestructuring refers to overhauling and refers to overhauling and streamlining the activities of a business—streamlining the activities of a business—combining plants with excess capacity, selling combining plants with excess capacity, selling off underutilized assets, reducing unnecessary off underutilized assets, reducing unnecessary expenses, and otherwise improving the expenses, and otherwise improving the productivity and profitability of the firm.productivity and profitability of the firm.

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THE PATH TO GREATER SHAREHOLDER THE PATH TO GREATER SHAREHOLDER VALUE THROUGH UNRELATED VALUE THROUGH UNRELATED

DIVERSIFICATIONDIVERSIFICATION

Diversify into businesses that can Diversify into businesses that can produce consistently good earnings produce consistently good earnings

and returns on investmentand returns on investment

Negotiate favorable acquisition prices

Provide managerial oversight and Provide managerial oversight and resource sharing, financial resource resource sharing, financial resource

allocation and portfolio management, allocation and portfolio management, and restructure underperforming and restructure underperforming

businessesbusinesses

The attractiveness test

The cost-of-entry testActions taken by upper Actions taken by upper management to create management to create

value and gain a value and gain a parenting advantageparenting advantage

The better-off test

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THE DUAL DRAWBACKS OF THE DUAL DRAWBACKS OF UNRELATED DIVERSIFICATIONUNRELATED DIVERSIFICATION

Pursuing an Pursuing an Unrelated Unrelated

Diversification Diversification StrategyStrategy

Limited Limited Competitive Competitive Advantage Advantage PotentialPotential

Demanding Managerial

Requirements

Monitoring and maintaining

the parenting advantage

Potential lack of cross-business

strategic-fit benefits

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MISGUIDED REASONS FOR MISGUIDED REASONS FOR PURSUING UNRELATED PURSUING UNRELATED

DIVERSIFICATIONDIVERSIFICATION

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

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♦ Only profitable growth—the kind that comes Only profitable growth—the kind that comes from creating added value for shareholders—from creating added value for shareholders—can justify a strategy of unrelated can justify a strategy of unrelated diversification.diversification.

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COMBINATIONS OF RELATED-COMBINATIONS OF RELATED-UNRELATED DIVERSIFICATION UNRELATED DIVERSIFICATION

STRATEGIESSTRATEGIES

Dominant-Dominant-Business Business

EnterprisesEnterprises

Narrowly Diversified

Firms

Broadly Diversified

Firms

Multibusiness Enterprises

Related-Unrelated Business Portfolio Combinations

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STRUCTURES OF COMBINATION RELATED-STRUCTURES OF COMBINATION RELATED-UNRELATED DIVERSIFIED FIRMSUNRELATED DIVERSIFIED FIRMS

Dominant-Business EnterprisesDominant-Business Enterprises● Have a major “core” firm that accounts for 50 to 80% of total Have a major “core” firm that accounts for 50 to 80% of total

revenues and a collection of small related or unrelated firms revenues and a collection of small related or unrelated firms that accounts for the remainder.that accounts for the remainder.

Narrowly Diversified FirmsNarrowly Diversified Firms● Are comprised of a few related or unrelated businesses.Are comprised of a few related or unrelated businesses.

Broadly Diversified FirmsBroadly Diversified Firms● Have a wide-ranging collection of related businesses, Have a wide-ranging collection of related businesses,

unrelated businesses, or a mixture of both.unrelated businesses, or a mixture of both. Multibusiness EnterprisesMultibusiness Enterprises

● Have a business portfolio consisting of several unrelated Have a business portfolio consisting of several unrelated groups of related businesses.groups of related businesses.

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EVALUATING THE STRATEGY EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANYOF A DIVERSIFIED COMPANY

Diversified Diversified StrategyStrategy

Attractiveness of industries

Strength of Business Units

Cross-business strategic fit

Fit of firm’s resources

Allocation of resources

New Strategic Moves

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EVALUATING THE STRATEGY EVALUATING THE STRATEGY OF A DIVERSIFIED FIRMOF A DIVERSIFIED FIRM

1.1. Assessing the attractiveness of the industries the firm has Assessing the attractiveness of the industries the firm has diversified into, both individually and as a group.diversified into, both individually and as a group.

2.2. Assessing the competitive strength of the firm’s business units Assessing the competitive strength of the firm’s business units within their respective industries.within their respective industries.

3.3. Evaluating the extent of cross-business strategic fit along the Evaluating the extent of cross-business strategic fit along the value chains of the firm’s various business units.value chains of the firm’s various business units.

4.4. Checking whether the firm’s resources fit the requirements of its Checking whether the firm’s resources fit the requirements of its present business lineup.present business lineup.

5.5. Ranking the performance prospects of the businesses from best Ranking the performance prospects of the businesses from best to worst and determining a priority for allocating resources.to worst and determining a priority for allocating resources.

6.6. Crafting strategic moves to improve corporate performance.Crafting strategic moves to improve corporate performance.

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Three Strategy Alternatives for Pursuing Diversification

FIGURE 8.2

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STEP 1: EVALUATING INDUSTRY STEP 1: EVALUATING INDUSTRY ATTRACTIVENESS ATTRACTIVENESS

Does each industry represent a good Does each industry represent a good market for the firm to be in?market for the firm to be in?

Which industries are most attractive, and which are least attractive?

How appealing is the whole group of How appealing is the whole group of industries?industries?

How attractive are the industries in which the firm has business operations?

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KEY INDICATORS OF INDUSTRY KEY INDICATORS OF INDUSTRY ATTRACTIVENESSATTRACTIVENESS

Social, political, regulatory, environmental factorsSocial, political, regulatory, environmental factors Seasonal and cyclical factorsSeasonal and cyclical factors Industry uncertainty and business riskIndustry uncertainty and business risk Market size and projected growth rateMarket size and projected growth rate Industry profitabilityIndustry profitability The intensity of competition among market rivalsThe intensity of competition among market rivals Emerging opportunities and threatsEmerging opportunities and threats

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CALCULATING INDUSTRY CALCULATING INDUSTRY ATTRACTIVENESS FROM THE ATTRACTIVENESS FROM THE

MULTIBUSINESS PERSPECTIVEMULTIBUSINESS PERSPECTIVE

The Question of Cross-The Question of Cross-Industry Strategic FitIndustry Strategic Fit

How well do the industry’s value chain and resource requirements match up with the value chain activities of other industries in which the firm has operations?

The Question of The Question of Resource RequirementsResource Requirements

Do the resource requirements for an industry match those of the parent firm or are they otherwise within the company’s reach?

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CALCULATING INDUSTRY CALCULATING INDUSTRY ATTRACTIVENESS SCORESATTRACTIVENESS SCORES

Evaluating Evaluating Industry Industry

AttractivenessAttractiveness

Deciding on appropriate weights for Deciding on appropriate weights for the industry attractiveness measures.the industry attractiveness measures.

Gaining sufficient knowledge of the Gaining sufficient knowledge of the industry to assign accurate and industry to assign accurate and

objective ratings.objective ratings.

Whether to use different weights for different business units whenever the

importance of strength measures differs significantly from business to business.

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Calculating Weighted Industry Attractiveness Scores

Remember: The more intensely competitive an industry is, the lower the attractiveness rating for that industry!

TABLE 8.1

[Rating scale: 1 = very unattractive to the firm; 10 = very attractive to the firm.]

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STEP 2: EVALUATING BUSINESS-UNIT STEP 2: EVALUATING BUSINESS-UNIT COMPETITIVE STRENGTHCOMPETITIVE STRENGTH

Relative market shareRelative market share Costs relative to competitors’ costsCosts relative to competitors’ costs Ability to match or beat rivals on key product attributesAbility to match or beat rivals on key product attributes Brand image and reputationBrand image and reputation Other competitively valuable resources and capabilities Other competitively valuable resources and capabilities

and partnerships and alliances with other firmsand partnerships and alliances with other firms Benefit from strategic fit with firm’s other businessesBenefit from strategic fit with firm’s other businesses Bargaining leverage with key suppliers or customersBargaining leverage with key suppliers or customers Profitability relative to competitorsProfitability relative to competitors

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♦ Using relative market share to measure Using relative market share to measure competitive strength is analytically superior to competitive strength is analytically superior to using straight-percentage market share.using straight-percentage market share.

♦ Relative market share is the ratio of a business Relative market share is the ratio of a business unit’s market share to the market share of its unit’s market share to the market share of its largest industry rival as measured in unit largest industry rival as measured in unit volumes, not dollars.volumes, not dollars.

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Calculating Weighted Competitive Strength Scores for a Diversified Company’s Business Units

TABLE 8.2

[Rating scale: 1 = very weak; 10 = very strong.]

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A Nine-Cell Industry Attractiveness–Competitive Strength Matrix

Note: Circle sizes are scaled to reflect the percentage of companywide revenues generated by the business unit.

Star

Cashcow

FIGURE 8.3

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STEP 3: DETERMINING THE STEP 3: DETERMINING THE COMPETITIVE VALUE OF STRATEGIC COMPETITIVE VALUE OF STRATEGIC

FIT IN DIVERSIFIED COMPANIESFIT IN DIVERSIFIED COMPANIES

Assessing the degree of strategic fit across its Assessing the degree of strategic fit across its businesses is central to evaluating a company’s businesses is central to evaluating a company’s related diversification strategy.related diversification strategy.

The real test of a diversification strategy is what The real test of a diversification strategy is what degree of competitive value can be generated degree of competitive value can be generated from strategic fit.from strategic fit.

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♦ The greater the value of cross-business The greater the value of cross-business strategic fit in enhancing a firm’s performance strategic fit in enhancing a firm’s performance in the marketplace or on the bottom line, the in the marketplace or on the bottom line, the more competitively powerful is its strategy of more competitively powerful is its strategy of related diversification.related diversification.

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Identifying the Competitive Advantage Potential of Cross-Business Strategic Fit

FIGURE 8.4

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♦ A diversified firm exhibits resource fit when its A diversified firm exhibits resource fit when its businesses add to a firm’s overall resource businesses add to a firm’s overall resource strengths and have matching resource strengths and have matching resource requirements and/or when the parent firm has requirements and/or when the parent firm has adequate corporate resources to support its adequate corporate resources to support its businesses’ needs and add value.businesses’ needs and add value.

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STEP 4: CHECKING FOR RESOURCE FITSTEP 4: CHECKING FOR RESOURCE FIT

Financial Resource FitFinancial Resource Fit● State of the internal capital marketState of the internal capital market● Using the portfolio approach:Using the portfolio approach:

Cash hogs need cash to develop.Cash hogs need cash to develop. Cash cows generate excess cash.Cash cows generate excess cash. Star businesses are self-supporting.Star businesses are self-supporting.

Success sequence:Success sequence:● Cash hog Cash hog Star Star Cash cow Cash cow

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♦ A A cash cow business cash cow business generates cash flows generates cash flows over and above its internal requirements, thus over and above its internal requirements, thus providing a corporate parent with funds for providing a corporate parent with funds for investing in cash hog businesses, financing investing in cash hog businesses, financing new acquisitions, or paying dividends.new acquisitions, or paying dividends.

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♦ A A cash hog business cash hog business generates cash flows generates cash flows that are too small to fully fund its operations that are too small to fully fund its operations and growth and requires cash infusions to and growth and requires cash infusions to provide additional working capital and finance provide additional working capital and finance new capital investment.new capital investment.

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♦ A strong A strong internal capital market internal capital market allows a allows a diversified firm to add value by shifting capital diversified firm to add value by shifting capital from business units generating free cash flow from business units generating free cash flow to those needing additional capital to expand to those needing additional capital to expand and realize their growth potential.and realize their growth potential.

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STEP 4: CHECKING FOR RESOURCE FITSTEP 4: CHECKING FOR RESOURCE FIT

Nonfinancial Resource FitNonfinancial Resource Fit● Does the firm have (or can it develop) Does the firm have (or can it develop)

the specific resources and capabilities the specific resources and capabilities needed to be successful in each of its needed to be successful in each of its businesses?businesses?

● Are the firm’s resources being stretched Are the firm’s resources being stretched too thinly by the resource requirements too thinly by the resource requirements of one or more of its businesses?of one or more of its businesses?

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♦ A A portfolio approach portfolio approach to ensuring financial fit to ensuring financial fit among a firm’s businesses is based on the fact among a firm’s businesses is based on the fact that different businesses have different cash that different businesses have different cash flow and investment characteristics.flow and investment characteristics.

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STEP 5: RANKING BUSINESS UNITS STEP 5: RANKING BUSINESS UNITS AND ASSIGNING A PRIORITY FOR AND ASSIGNING A PRIORITY FOR

RESOURCE ALLOCATION RESOURCE ALLOCATION Ranking Factors:Ranking Factors:

● Sales growthSales growth● Profit growthProfit growth● Contribution to company earningsContribution to company earnings● Return on capital invested in the businessReturn on capital invested in the business● Cash flowCash flow

Steer resources to business units with the Steer resources to business units with the brightest profit and growth prospects and brightest profit and growth prospects and solid strategic and resource fit.solid strategic and resource fit.

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The Chief Strategic and Financial Options for Allocating a Diversified Company’s Financial Resources

FIGURE 8.5

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STEP 6: CRAFTING NEW STRATEGIC STEP 6: CRAFTING NEW STRATEGIC MOVES TO IMPROVE OVERALL MOVES TO IMPROVE OVERALL CORPORATE PERFORMANCECORPORATE PERFORMANCE

Stick with Stick with the Existing the Existing Business Business

LineupLineup

Broaden the Diversification Base with New Acquisitions

Divest and Retrench to a Narrower

Diversification Base

Restructure through

Divestitures and

Acquisitions

Strategy Options for a Firm That Is Already Diversified

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A Firm’s Four Main Strategic Alternatives After It Diversifies

FIGURE 8.6

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BROADENING A DIVERSIFIED BROADENING A DIVERSIFIED FIRM’S BUSINESS BASEFIRM’S BUSINESS BASE

Factors Motivating the Adding of Businesses:Factors Motivating the Adding of Businesses:● The transfer of resources and capabilities The transfer of resources and capabilities

to related or complementary businesses.to related or complementary businesses.● Rapidly changing technology, legislation, Rapidly changing technology, legislation,

or new product innovations in core businesses.or new product innovations in core businesses.● Shoring up the market position and competitive Shoring up the market position and competitive

capabilities of the firm’s present businesses.capabilities of the firm’s present businesses.● Extension of the scope of the firm’s operations Extension of the scope of the firm’s operations

into additional country markets.into additional country markets.

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DIVESTING BUSINESSES AND DIVESTING BUSINESSES AND RETRENCHING TO A NARROWER RETRENCHING TO A NARROWER

DIVERSIFICATION BASEDIVERSIFICATION BASE

Factors Motivating Business Divestitures:Factors Motivating Business Divestitures:● Improvement of long-term performance by Improvement of long-term performance by

concentrating on stronger positions in fewer concentrating on stronger positions in fewer core businesses and industries.core businesses and industries.

● Business is now in a once-attractive industry where Business is now in a once-attractive industry where market conditions have badly deteriorated.market conditions have badly deteriorated.

● Business has either failed to perform as expected Business has either failed to perform as expected and\or is lacking in cultural, strategic or resource fit.and\or is lacking in cultural, strategic or resource fit.

● Business has become more valuable if sold to Business has become more valuable if sold to another firm or as an independent spin-off firm.another firm or as an independent spin-off firm.

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♦ A A spinoffspinoff is an independent company created is an independent company created when a corporate parent divests a business by when a corporate parent divests a business by distributing to its stockholders new shares in distributing to its stockholders new shares in this business.this business.

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♦ What do the problems which developed from What do the problems which developed from the M&A strategy reveal?the M&A strategy reveal?

♦ To what extent is centralization of core To what extent is centralization of core processes required?processes required?

♦ What other measures could Posco undertake What other measures could Posco undertake to capitalize on its past M&A strategy? to capitalize on its past M&A strategy?

ILLUSTRATION CAPSULE 8.1ILLUSTRATION CAPSULE 8.1Posco’s Strategic Moves to Resolve Challenges Posco’s Strategic Moves to Resolve Challenges from Aggressive Mergers and Acquisitionsfrom Aggressive Mergers and Acquisitions

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♦ Diversified companies need to divest low-Diversified companies need to divest low-performing businesses or businesses that do performing businesses or businesses that do not fit in order to concentrate on expanding not fit in order to concentrate on expanding existing businesses and entering new ones existing businesses and entering new ones where opportunities are more promising.where opportunities are more promising.

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RESTRUCTURING A DIVERSIFIED RESTRUCTURING A DIVERSIFIED COMPANY’S BUSINESS LINEUPCOMPANY’S BUSINESS LINEUP

Factors Leading to Corporate Restructuring:Factors Leading to Corporate Restructuring:● A serious mismatch between the firm’s resources and A serious mismatch between the firm’s resources and

capabilities and the type of diversification that it has pursued.capabilities and the type of diversification that it has pursued.

● Too many businesses in slow-growth, declining, low-margin, Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries.or otherwise unattractive industries.

● Too many competitively weak businesses.Too many competitively weak businesses.

● Ongoing declines in the market shares of major business Ongoing declines in the market shares of major business units that are falling prey to more market-savvy competitors.units that are falling prey to more market-savvy competitors.

● An excessive debt burden with interest costs that eat deeply An excessive debt burden with interest costs that eat deeply into profitability.into profitability.

● Ill-chosen acquisitions that haven’t lived up to expectations.Ill-chosen acquisitions that haven’t lived up to expectations.

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♦ Companywide restructuring Companywide restructuring (corporate (corporate restructuring) involves making major changes restructuring) involves making major changes in a diversified company by divesting some in a diversified company by divesting some businesses and/or acquiring others, so as to businesses and/or acquiring others, so as to put a whole new face on the company’s put a whole new face on the company’s business lineup.business lineup.

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♦ Is Kraft Food’s corporate restructuring strategy Is Kraft Food’s corporate restructuring strategy narrowing or broadening its diversification base?narrowing or broadening its diversification base?

♦ How will restructuring help ensure that Kraft How will restructuring help ensure that Kraft Foods will be better prepared to adapt to Foods will be better prepared to adapt to changing market conditions than its competitors?changing market conditions than its competitors?

♦ What actions did Kraft Foods take after making What actions did Kraft Foods take after making acquisitions to ensure the success of those acquisitions to ensure the success of those acquisitions?acquisitions?

ILLUSTRATION CAPSULE 8.2ILLUSTRATION CAPSULE 8.2Growth through Restructuring at Kraft Growth through Restructuring at Kraft FoodsFoods

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