Diversification StrategyIntroduction: The Basic IssuesThe Trend over TimeMotives for Diversification - Growth and Risk Reduction - Shareholder Value: Porters Essential TestsCompetitive Advantage from DiversificationDiversification and Performance: Empirical EvidenceRelatedness in Diversification OUTLINE

RATE OF PROFIT > COST OF CAPITALINDUSTRYATTRACTIVENESSCOMPETITIVE ADVANTAGE The Basic Issues in Diversification DecisionsSuperior profit derives from two sources:Diversification decisions involve these same two issues: How attractive is the sector to be entered?Can the firm achieve a competitive advantage?

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 businesses1949 1954 1959 1964 1969 1974 70.2 63.5 53.7 53.9 39.9 37.029.8 36.5 46.3 46.1 60.1 63.0

Diversification among Large UK Corporations, 1950-93

DEVELOPMENTSIN CORPORATESTRATEGYMANAGEMENT PRIORITIES

STRATEGY TOOLS & CONCEPTS

Quest for GrowthAddressing under-performance of widely-diversified firmsCreating shareholder value1960 1970 1980 1990 2000 2006Emergence of conglomerates Diversification by established companies into related sectorsEmphasis on related & concentric diversificationRefocusing on core businesses Divesting diversified businesses Financial analysisDiffusion of M form structures Creation of corporate planning depts. Economies of scope & synergy Portfolio planning models Capital asset pricing modelMaximization of shareholder wealthCore competencesDominant logicDiversification: The Evolution of Strategy and Management Thinking Competitive advantage through speed & flexibilityCreating opportunities for future growthJoint ventures and alliancesCreating growth options through focused diversificationDynamic capabilitiesTransaction cost analysisReal options

Motives for DiversificationGROWTH --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 valueRISK --Diversification reduces variance of profit flowsSPREADING --But, doesnt create value for shareholdersthey 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: Porters Three Essential TestsIf 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 Predatory pricing/tie-in salesEvidence Reciprocal buyingof these Mutual forbearanceis sparseMARKETPOWER 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 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 informationECONOMIES OFSCOPEECONOMIESFROM INTERNALIZINGTRANSACTIONS

Relatedness in DiversificationEconomies 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 & PerformanceNo consistent systematic relationships between performance and degree of diversificationPerhaps an Inverse U shape why?Stock market returns to acquiring firms negative on averageRelated vs. unrelated diversificationConglomerate discount & stick to the knittingBut GE, LVMH, Virgin Group are anomalies

Managing the Multibusiness CorporationStructure of the Multidivisional CompanyTheory of the M-formThe divisionalized firm in practiceThe Role of Corporate ManagementManaging the Corporate PortfolioPortfolio planning techniquesValue-creation through corporate restructuringManaging Individual BusinessesManaging Internal LinkagesRecent TrendsOUTLINE

The Multidivisional Structure: Theory of the M-FormEfficiency advantages of the multidivisional firm:Recognizes bounded rationalitytop management has limited decision-making capacityDivides decision-making according to frequency:high-frequency operating decisions at divisional levellow-frequency strategic decisions at corporate levelReduces 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 marketsResolves agency problem-- corporate management an interface between shareholders and business-level managers.

The Divisionalized Firm in PracticeConstraints 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 managementDespite potential for divisions to develop distinctive strategies and structurescorporate systems may impose uniformity.Managing divisional inter-relationshipsRequires 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 ManagementDecisions over diversification, acquisition, divestment Resource allocation between businesses. Business strategy formulation Monitoring and controlling business performance Sharing and transferring resources and capabilities

Managing linkagesbetween businessesManaging theindividual businessesManaging the Corporate Portfolio

The Development of Strategic Planning Techniques: General Electric in the 1970sLate 1960s: 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 resourcesStrategic 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

Allocating resources-- the analysis indicates both the investment requirements of different businesses and their likely returnsFormulating 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 ROIPortfolios balance-- the analysis can assist in corporate goals such as a balanced cash flow and balance of growing and declining businesses.

HIGH

LOWLOWAnnual real rate of market growth (%)Relative market shareEarnings: high stableCash flow: high stableStrategy: milkEarnings: low, unstableCash flow: neutral or negativeStrategy: divestEarnings: high stable, growingCash flow: neutralStrategy: invest for growthEarnings: low, unstable, growingCash flow: negativeStrategy: analyze to determine whether business can be grown into a star, or will degenerate into a dog

HIGH?Portfolio Planning Models: The BCG Growth-Share Matrix

Annual real rate of market growth (%)Relative market share-8 -4 0 4 8 12Bakery divisionPosition in 2003Position in 2000. (Area of circle proportional to $ sales)Applying the BCG Matrix to Time Warner Inc. AOLFilmproductionCableCable TVNetworksMusicMagazinePublishing

H A R V E S TH O L DB U I L DLowMediumHighLowMediumHighIndustry AttractivenessPortfolio Planning Models: The GE/ McKinsey MatrixIndustry 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 ratioBusiness Unit Position

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 PentagonCurrentmarketvalueMaximum raideropportunityCurrent perceptions gapCompanyvalue as isOptimalrestructuredvalueStrategic andoperatingopportunitiesPotential valuewith internalimprovementsDisposal/acquisitionopportunitiesTotal companyopportunities125RESTRUCTURINGFRAMEWORK34Potential valuewith externalimprovements

Exxons Strategic Planning ProcessEconomic ReviewEnergy ReviewBusiness PlansDiscuss- -ion with contact directorApproval by Mgmt. CommitteeStewardship ReviewStewardship BasisFinancial ForecastCorporate PlanInvestment ReappraisalsAnnual Budget

Corporate Control over the Businesses2 basic approachesInputcontrolMonitoring & approving business level decisionsOutput (or performance) controlSetting & monitoring the achievement ofperformance targetsPrimarily through strategic planning system & capital expenditure approval systemPrimarily through performance management system, including operating budgets and HR appraisals

Goold & Campbells Corporate Management Styles: Financial and Strategic ControlHighLowCONTROL INFLUENCEStrategicplanningCentralizedStrategiccontrolHoldingcompanyFinancialcontrolCORPORATE INFLUENCEFlexible strategicTight strategicTight financial

Corporate Management Applications of PIMS Analysis Setting performance targetsfeeding business unit strategic and industry data into the PIMSregression 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

Managing Linkages between BusinessesKEY ISSUEHow does the corporate center add value to the business? BASIS OF BUSINESS LINKAGESSharing of resources and capabilities.SHARING OCCURS AT TWO LEVELS: Corporate levelcommon corporate services Business levelsharing resources, transferring capabilitiesPORTERS ANALYSIS OF BUSINESS LINKAGES AND CORPORATE STRATEGY TYPES Portfolio management Parent creates value by operating an internal capital market RestructuringParent create value by acquiring and restructuring Inefficiently-managed businesses Transferring skillsParent creates value by transferring capabilities between businesses Sharing activitiesParent creates value by sharing resources between businessesROLE OF DOMINANT LOGICimportance of corporate managers perception of linkages

What Corporate Management Activities are Implied by Porters 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 General Electric Delayering --- from 9 or 10 layers of hierarchy to 4 or 5Decentralizing decisions.Reformulating strategic planningfrom formal, document-intensive analysis to direct face-to-face discussion of key issues.Redefining the role of HQfrom 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).Jack Welchs transformation of GEs structure and management systems:

Rethinking the Management of Multibusiness Corporations: Lessons from ABB Matrix organizationboth product and country / regional coordination; flexible reporting requirementsRadical decentralizationABBs corporate HQ was tiny (

Rethinking the Management of Multibusiness Corporations: Bartlett & Ghoshals Analysis of Key Management ProcessesManaging the tension between short-term ambition

Managing operational interdependencies and personal networks

Creating and pursuing opportunitiesCreating and maintaining organizational trust

Linking skills, knowledge, and resources

Reviewing, developing, and supporting initiativesShaping and embedding corporate purpose

Developing and nurturing organizational values

Establishing strategic mission & performance standardsFront-line Management Middle Management Top ManagementRENEWAL PROCESSINTEGRATION PROCESSENTREPRENEURIAL PROCESS

Case: VirginWhat 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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