Diversification

Strategy Formulation

Strategies for Growth and Diversification

Identifying Growth Strategies

Define the industry

Analyze options for growth

What Is Our Industry?What Is Our Industry?

Defining the industry in new ways can present new opportunities.

Examples: Disney IBM

Business-Level Strategies For Growth

Market Penetration

Strategy

Product Development

Strategy

Market Development

Strategy

Diversification Strategy

Existing

New

Domain

(i.e., Industry Market

Product/Service

Existing New

Product/Market Expansion: Product/Market Expansion: Scale StrategiesScale Strategies

Market Penetration

Goal: increase market share

Low risk/marginal returns

Every business does this

Market Development

Goal: find new markets

Marketing expertise

Mature products/services

Product/Market Expansion: Scope Product/Market Expansion: Scope StrategiesStrategies

Product Development

Goal: develop & introduce new products/services

Technical expertise

Growth of products/services

(Could Entail Related Diversification)

Diversification

Goal: develop & introduce products/services to new or emerging markets

(Most likely Unrelated Diversification)

When Does Diversification When Does Diversification Make Sense?Make Sense?

Single business strategies have a number of advantages …

…but also a number of risks -- all one’s eggs in one basket

The logic: to spread corporate risk across multiple industries

to enhance shareholder value: SYNERGY (i.e., 2 + 2 = 5)

Diversification -- MotivesDiversification -- Motives

The risks of single business strategies are more severe for management than for shareholders of publicly traded firms.

Diversification may be motivated by management’s desire to reduce risk.

Diversification only makes sense when it enhances shareholder value!

Tests For Judging Tests For Judging DiversificationDiversification

Attractiveness

Better-off

Cost of entry

Attractiveness Test

Is the target industry attractive? (Use 5-forces model to assess industry attractiveness)

Does the diversification move fit with the grand strategy of the firm?

Better-off test

Does the diversification move produce opportunities for synergies? Will the company be better off after the diversification than it was before? How and why?

Cost of Entry Test

Is the cost of the diversification worth it?

Will the diversified firm create enough additional value to justify the cost?

Methods for DiversificationMethods for Diversification

Acquisition of an existing business

Creation of a new business from within, e.g. a start-up

Joint venture with another firm or firms

Acquisition Acquisition

Most popular approach to diversification

Quick market entry

Avoids entry barriers:

Technology

Access to suppliers

Efficiency / economies of scale

Promotion

Distribution channels

Major Acquisition IssueMajor Acquisition Issue

Acquire a successful company at a high price

or

Acquire a struggling company at a bargain price

Start-UpStart-Up

Appropriate when:

You have time to launch

Market moves slowly

Internal entry costs lower than acquisition costs

You already possess necessary skills

Target industry is fragmented

Joint Ventures Joint Ventures

Pooling resources to spread risk

Achieving synergy from respective capabilities

Leveraging one another’s experience

Complicated; potential for conflicts if responsibilities, liabilities, & rewards not clearly delineated

Related Diversification Related Diversification

Businesses are distinct …

…but their value chains possess strategic “fit” in operations, marketing, management, R&D. distribution, labor, etc.

Therefore, they tend to exploit economies of scope

Tend to (historically) outperform unrelated diversifications

Unrelated Diversification Unrelated Diversification

No common linkage or element of strategic fit among SBUs -- i.e., no meaningful value chain interrelationships

Strategic approach: venture opportunistically into attractive industries that have solid potential for financial returns

“Conglomerates”

Dominant logic: spreads businesses risk over multiple industries, stabilizing corporate profitability (in theory)

Attractive Acquisition Targets Attractive Acquisition Targets for Unrelated Diversificationfor Unrelated Diversification

Companies whose assets are undervalued (buy’em & sell’em to realize capital gains)

Companies that are financially distressed (purchase at bargain price & turn’em around through injections of financial resources & managerial expertise)

Companies with bright prospects, but limited capital

Dominant logic: any company that can be acquired on good financial terms & offers good prospects for profitability is a good business for diversification

Drawbacks of Unrelated Drawbacks of Unrelated Diversification Diversification

Places enormous demands on corporate management -- shifting resources & making moves into unknown areas, etc.

Cannot capture synergies -- no strategic fit between SBUs

Few businesses have offsetting up-down cycles, so sales-profit stability is more mythical than real (& when EVERYTHING IS in a downturn, assets spread thin are sometimes consumed …)

Strategic Analysis of Diversified Strategic Analysis of Diversified CompaniesCompanies

“The essence of strategic management is to allocate resources to those areas that possess the greatest potential for future success”

Corporate Strategy for Diversified Firms -- Corporate Strategy for Diversified Firms -- Key Strategic IssuesKey Strategic Issues

(1) How attractive are our current businesses?

(2) With these businesses, what is our performance outlook for “X” years in the future?

(3) If answers to (1) & (2) above aren’t satisfactory, what should we do to get out of some businesses, strengthen those remaining, & get into new businesses to boost our prospects for better performance?

BCG Growth-Share MatrixBCG Growth-Share Matrix

Dimensions:

Industry growth rate

Relative market share position of the businesses

SBUs plotted as circles with area proportional to their contribution to overall corporate sales

BCG Business Portfolio MatrixBCG Business Portfolio Matrix

High Low

High

Low

“Stars”

“Cash Cows”

“Question Marks”

“Dogs”

Industry Growth Rate

Relative Market Share Position

BCG Matrix -- StrengthsBCG Matrix -- Strengths

Encourages strategists to view a diversified firm as a collection of cash flows & cash requirements (** its major strategic implication **)

Explains why priorities for corporate resource allocation differ from SBU to SBU

Demonstrates the progression of an SBU --

from Q-mark ===>Star ===>Cash Cow

BCG Matrix -- WeaknessesBCG Matrix -- Weaknesses

Over-simplifies market growth & market share issues

4 simple categories are neat, but trends are more valuable

Doesn’t directly identify which SBUs offer the best investment opportunities

Considers only 2 variables

G.E. 9-Cell MatrixG.E. 9-Cell Matrix

Dimensions:

Long-term industry attractiveness

Business strength/Competitive position

SBUs plotted as circles with area proportional to the size of the industry, & a sector within each circle representing the SBUs market share in its industry

Strong Average Weak

H

M

L

GE 9-Cell MatrixGE 9-Cell MatrixBusiness Strength/Competitive Position

Long-Term Industry Attractiveness

Strategic Implications of the Strategic Implications of the G.E. 9-Cell MatrixG.E. 9-Cell Matrix

SBUs in 3 upper left cells get top investment priority

SBUs in 3 middle diagonal cells merit steady investment to maintain & protect their industry positions

SBUs in 3 lower right cells are candidates for harvesting or divestiture

Advantages of G.E. 9-Cell Advantages of G.E. 9-Cell MatrixMatrix

Allows for intermediate rankings between high & low and between strong & weak

Incorporates a wider variety of strategically relevant variables than the BCG matrix

Stresses the channeling of corporate resources to SBUs with the greatest potential for competitive advantage & superior

performance

Weaknesses of G.E. 9-Cell Weaknesses of G.E. 9-Cell MatrixMatrix

Provides no guidance on specifics of SBU strategy

Only suggests general strategic posture -- aggressive expansion, fortify-&-defend, or harvest/divest

Doesn’t address the issue of strategic coordination across related SBUs

Tends to obscure SBUs about to “take off” or “crash & burn” -- static, not dynamic

Life-Cycle Portfolio MatrixLife-Cycle Portfolio Matrix

Dimensions:

Industry stage in the life cycle

SBU’s competitive position

Area of each SBU circle is proportional to size of the industry; sectors denote SBU’s market share in its industry

This matrix displays the distribution of the firm’s businesses across the various stages of industry evolution

Strong Average Weak

SBUs Competitive Position

Life-Cycle Portfolio MatrixLife-Cycle Portfolio Matrix

Introduction

Growth

Early Maturity

Late Maturity

Decline

Life-Cycle Stages

Common Problems Associated With Common Problems Associated With Diversified Firms:Diversified Firms:

Overemphasis on ROIUnder-emphasis on future earnings streamsShort-term focus“Growth” more valued than quality & valueOver-decentralized; top managers become isolated & out-of-touchAvoidance of manageable (strategic) risk for the sake of short-run profit

Performance: Effectiveness & Performance: Effectiveness & Efficiency Efficiency

Effectiveness: “external” criteria

Efficiency: “internal” criteria

Not mutually exclusive

Both important

EffectivenessEffectiveness

“Doing the right thing”; goal attainment

Determine by the market

Establishes what price you can command

Measures: sales, market share, etc.

Efficiency Efficiency

“Doing the thing right”

Ratio of output to input

Determines price you must charge

Measures: operating profit, unit cost structure, etc.

Market CriteriaMarket Criteria

Future projection

Reflects anticipated results

Indicates investor confidence

Measures: trend in stock price or cash value

Operational Criteria Operational Criteria

Past & present

Reflects actual results

Indicates managerial competence

Measures: ROE, ROI, ROA, market share, revenue, operating margin (profit), time-to-market, inventory turns, quality, etc.

Performance: Performance: The Bottom LineThe Bottom Line

No simple “bottom line”

No single criterion of performance is inherently most important

Multidimensional

Situational -- different measures are more appropriate at different times

Difficult to be successful on all measures at the same time