CHAPTER 8

CORPORATE STRATEGY:
Diversification and the Multibusiness Company

Student Version
Copyright 2012 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin

Diversification and Corporate Strategy

A company is diversified when it is in two

or more lines of business that operate in

diverse market environments
Strategy-making in a diversified

company is a bigger picture

exercise than crafting a strategy
for a single line-of-business
A diversified company needs a
multi-industry, multi-business strategy
A strategic action plan must be developed
for several different businesses competing
in diverse industry environments
8-2

BUILDING SHAREHOLDER VALUE:

THE ULTIMATE JUSTIFICATION FOR
DIVERSIFYING
Testing Whether a Diversification
Move Will Add Long-Term
Value for Shareholders

The industry
attractiveness
test

The cost-of-entry
test

The better-off
test

83

Better Performance through Synergy

Evaluating the
Potential for
Synergy
through
Diversification

Firm A purchases Firm B in

another industry. A and Bs
profits are no greater than
what each firm could have
earned on its own.

No
Synergy
(1+1=2)

Firm A purchases Firm C in

another industry. A and Cs
profits are greater than what
each firm could have earned
on its own.

Synergy
(1+1=3)

84

CHOOSING THE DIVERSIFICATION

PATH: RELATED VERSUS UNRELATED
BUSINESSES

Which Diversification
Path to Pursue?

Related
Businesses

Unrelated
Businesses

Both Related
and Unrelated
Businesses

85

8.1

Related Businesses Provide Opportunities to Benefit

from Competitively Valuable Strategic Fit

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

86

Identifying Cross-Business Strategic Fit

along the Value Chain
Supply Chain
Activities
R&D and
Technology
Activities

ManufacturingRelated Activities

Potential
Cross-Business Fits
Sales and
Marketing
Activities

DistributionRelated Activities
Customer
Service Activities

87

Strategic Fit, Economies of Scope,

and Competitive Advantage
Using Economies of Scope to Convert
Strategic Fit into 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 crossbusiness
collaboration
and knowledge
sharing

88

What Is Unrelated Diversification?

Involves diversifying into businesses with

No strategic fit
No meaningful value chain
relationships
No unifying strategic theme
Basic approach Diversify into

any industry where potential exists

to realize good financial results
While industry attractiveness and cost-of-

entry tests are important, better-off test is

secondary
8-9

Attractive Acquisition Targets

Companies with undervalued assets

Capital gains may be realized

Companies in financial distress

May be purchased at bargain

prices and turned around
Companies with bright growth prospects

but short on investment capital

Cash-poor, opportunity-rich companies are
coveted acquisition candidates
8-10

Building Shareholder Value via

Unrelated Diversification

Using an Unrelated Diversification

Strategy to Pursue Value

Astute Corporate
Parenting by
Management

Cross-Business
Allocation of
Financial
Resources

Acquiring and
Restructuring
Undervalued
Companies

811

Building Shareholder Value via

Unrelated Diversification
Astute Corporate
Parenting by
Management
Cross-Business
Allocation of
Financial
Resources
Acquiring and
Restructuring
Undervalued
Companies

Provide leadership, oversight, expertise, and guidance.

Provide generalized or parenting resources that lower
operating costs and increase SBU efficiencies.

Serve as an internal capital market.

Allocate surplus cash flows from businesses to fund
the capital requirements of other businesses.

Acquire weakly performing firms at bargain prices.

Use turnaround capabilities to restructure them to
increase their performance and profitability.

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

812

The Path to Greater Shareholder Value

through Unrelated Diversification
Do a superior job of diversifying into
businesses that produce good
earnings and returns on investment.
Actions taken by
upper management
to create value and
gain a parenting
advantage

Do an excellent job of negotiating

favorable acquisition prices.
Provide managerial oversight and
resource sharing, financial resource
allocation and portfolio management,
and restructure underperforming
businesses.

813

The Drawbacks of Unrelated Diversification

Demanding
Managerial
Requirements

Monitoring and
maintaining
the parenting
advantage

Pursuing an
Unrelated
Diversification
Strategy

Limited
Competitive
Advantage
Potential

Potential lack of
cross-business
strategic-fit
benefits

814

Diversification and Shareholder Value

Related Diversification
A strategy-driven approach to creating
shareholder value
Unrelated Diversification
A finance-driven approach to creating
shareholder value
8-15

EVALUATING THE STRATEGY

OF A DIVERSIFIED COMPANY
Attractiveness
of industries

Strength of
Business Units

Cross-business
strategic fit

Diversified
Strategy

Fit of firms
resources

Allocation of
resources

New Strategic
Moves

816

Step 1: Evaluating Industry Attractiveness

How attractive are the
industries in which the firm
has business operations?
Does each industry represent a good
market for the firm to be in?
Which industries are most attractive,
and which are least attractive?
How appealing is the whole group of
industries?

817

Step 2: Evaluate Each BusinessUnits Competitive Strength

Objectives

Appraise how well each business is positioned

in its industry relative to rivals
Evaluate whether it is or can be competitively
strong enough to contend for market leadership

8-18

Step 2: Evaluating BusinessUnit Competitive Strength

Relative market share
Costs relative to competitors costs.
Ability to match or beat rivals on key product attributes.
Brand image and reputation.
Other competitively valuable resources and capabilities.
Strategic fit with the firms other businesses.
Bargaining leverage with key suppliers or customers.
Alliances and partnerships with suppliers and/or buyers.
Profitability relative to competitors
819

Figure 8.5: A Nine-Cell Industry Attractiveness-Competitive Strength Matrix

8-20

Strategy Implications of
Attractiveness/Strength Matrix
Businesses in upper left corner
Accorded top investment priority
Strategic prescription grow and build

Businesses in three diagonal cells

Given medium investment priority
Invest to maintain position

Businesses in lower right corner

Candidates for harvesting or divestiture
May, based on potential for good earnings and
ROI, be candidates for an overhaul and
reposition strategy
8-21

Appeal of Attractiveness/Strength Matrix

Incorporates a wide variety of

strategically relevant variables

Strategy implications
Concentrate corporate resources
in businesses that enjoy high degree of industry
attractiveness and high degree of competitive
strength
Make selective investments in businesses with
intermediate positions on grid
Withdraw resources from businesses low in
attractiveness and strength unless they offer
exceptional potential
8-22

Crafting New Strategic Moves to Improve

Overall Corporate Performance
Strategy Options for a Firm
That Is Already Diversified

Stick with
the Existing
Business
Lineup

Broaden the
Diversification
Base with New
Acquisitions

Divest and
Retrench to
a Narrower
Diversification
Base

Restructure
through
Divestitures
and
Acquisitions

823

Retrenchment Strategies
Objective
Reduce scope of diversification to smaller
number of core businesses

Strategic options involve divesting

businesses that
Are losing money
Have little growth potential
Have little strategic fit
with core businesses
Are too small to contribute
meaningfully to earnings
8-24

Options for Accomplishing Divestiture

Sell it
Involves finding a company which views the
business as a good deal and good fit

Spin it off as independent company

Involves deciding whether or not to retain partial
ownership

Liquidation
Involves closing down operations
and selling remaining assets
A last resort because no buyer
can be found
8-25