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Diversification Strategy

involves creating value through the configuration and coordination of multi-market activities.

Examples of Diversification

Pepsi: bottled water
Walt Disney: cruise lines
Sony: Sony Pictures
British Petroleum moving "Beyond Petroleum"

Diversification

is a value creating strategy only if the corporate whole adds up to more than sum of its business unit parts

How do you diversify?

Sell your current product in a new distribution channel
Sell a new product in your current distribution channels
Sell a new product in a new distribution channel
It is not necessary to do a M&A to diversify

Low Levels of Diversification: Single business

95% + of revenue come from a single business unit
UPS

Low Levels of Diversification:Dominant-business

70% to 95% of revenue ...
Hershey Foods (chocolate and non-chocolate items, other grocery products like syrups, milk, cocoa mix etc.)

Moderate Levels of Diversification
Related-diversified:

Less than 70% of revenues come from a single business

Many product, technology, and distribution linkages between businesses - Related diversification
Procter & Gamble (soaps, shampoos)

Limited linkages
PepsiCo (drinks and snacks)

High Levels of Diversification

Unrelated-diversification Business units not closely related
Conglomerates

Diversification

Small car maker Saturn enters the SUV market

Vertical Integration

Saturn builds car engines in house (backward vertical integration)
Coca-Cola buys its bottlers (forward vertical integration)

add value by diversification:Transferring Core Competencies

Walt Disney using its capability for family entertainment to enter into the cruise ship industry

add value by diversification:Developing New Competencies

Stretching core competencies
Laidlaw Inc. (school buses, ambulances, emergency rooms)
UPS (messenger business to common carrier business to overnight delivery to logistics services)

add value by diversificationEconomies of Scope

(sharing activities or inputs)
P&G in disposable diaper and paper towel businesses
common distribution system and sales force

Cost (iron + steel) < Cost (iron) + Cost (steel)
thermal economies

Volkswagen's Golf, Skoda, Beetle, and Audi TT share platforms

add value by diversification:Efficient Management

General Electric

Do you object when people use the word conglomerate to describe GE?

"Hate it. I went to business school learning how companies like GE couldn't exist. We run a multi-business company with common cultures, with common management...where the whole is always greater than the sum of its parts. Culture counts." Jeff Immelt

add value by diversification:Using the firm as an internal capital/resource market

Only when external capital market is inefficient
Conglomerates more typical in developing countries
Mexico (Carlos Slim's Groupo Carso)
India (Tata Group)
To keep knowledge and new ideas proprietary
Technology-intensive businesses

add value by diversification:Market power

Multi-point competition
A firm that faces the same rival in two industries will be more cooperative

Value reduction through diversification:Diversification as portfolio management—1960s and 1970s

Risk spreading with unrelated diversification
PepsiCo's acquisition of North American Van Lines in 1968
Shareholders can diversify their investment risk

"Interrelationships between businesses are the essence of corporate-level strategy. Without synergy, a diversified company is a little more than a mutual fund." Michael Porter

Value reduction through diversification:Growth Trap

Neutrogena took its current product into new distribution channels

Maytag sold new products in its current distribution channels

Value reduction through diversification:Growth maximization and diversifying managerial employment risk

Downside Implication
Shareholder value is reduced
With firm size management compensation increases
Diversification that reduces variance of returns is not justified when capital markets function efficiently
Upside Implication
Diversification may encourage managerial commitment by reducing managerial risk

Bottom line

Ultimately, diversity can only be worthwhile if corporate management adds value in some way

To add value, diversification should enable a company,
or one of its business units, to perform one or more of the value creation functions at a lower cost, or in a way which supports a differentiation advantage.

The test of a corporate strategy must be that the businesses in the portfolio are worth more under the management of the company in question than they would be under other ownership.

Issues to Consider Prior to Diversification: What can our company do better than any of its competitors in its current market?

Identify unique competitive strengths
Realistic identification of strategic assets

Blue Circle
British firm, one of the world's leading cement producer
Business of making products related to home building: real estate, bricks, waste management, gas stoves, bath tubs, lawn mowers—logic—you need a lawn mower for your garden, which after all is next to your house.

Prior to Diversification:What can a company learn by diversifying?

What can a company learn by diversifying?

Will the diversification move allow us to learn competencies that can be reapplied in existing businesses?
Canon
Copier business: learned how to develop and manufacture a reliable electrostatic-printing engine
Laser printer business-similar capabilities

Prior to Diversification: Are we sufficiently organized to learn and take advantage of synergies between businesses?

General Electric
Regular meetings to search for cross-business synergies
Senior executives may suggest areas of collaborations and individual business managers have to attend the meetings, but nobody is forced to collaboration

Incentives for division managers and employees
Self-interest (individual) versus mixed incentives (group & individual)

Rotation of managers
"The way we use a business like appliances is, it's a great place to train people. It's a great way for managers to go there and learn what a recession is like... So you learn unbelievable management skills at businesses like that."

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