DIVERSIFICATION AND SHAREHOLDER VALUE

RELATED DIVERSIFICATION

A strategy-drivenapproach to creating shareholder value

UNRELATED DIVERSIFICATION

A finance-drivenapproach to creating shareholder value

What Is Related Diversification?

Involves diversifying into businesses whose value chains possess competitively valuable “strategic fits” with the value chain(s) of the present business(es)

Capturing the “strategic fits” makes related diversification a 2 + 2 = 5 phenomenon

CONCEPT: STRATEGIC FIT

Exists when different businesses have sufficiently related value chains that permit:

Transferring skills & expertise from one business to another

Combining performance of related activities so as to reduce costs

Presence of strategic fit in a diversified firm's portfolio, along with corporate management's skill in capturing benefits of the interrelationships

Makes related diversification capable of being a 2 + 2 = 5 phenomenon

1 – MARKET-RELATED FIT

1.Common sales force to call on customers
2.Advertising related products together
3.Use of same brand names
4.Joint delivery & shipping
5.Joint after-sale service & repair work
6.Joint order processing & billing
7.Joint promotional tie-ins

2 – OPERATING FIT

Arise when different businesses present opportunities for cost-sharing or skills transfer

Procurement of purchased inputs

R&D/technology

Manufacture & assembly

Administrative support functions

Marketing & distribution

3 – MANAGEMENT FIT

Emerge when different business units have comparable types of:

Entrepreneurial

Administrative or Operating problems

Allow accumulated managerial know-how in one business to be useful in managing another business

Attractiveness of Related Diversification

What makes related diversification attractive is the opportunity to turn strategic fit into competitive advantage!

Related Diversification
and Competitive Advantage

Competitive advantage can result from related diversification if opportunities exist to:

  • Transfer expertise/capabilities/technology
  • Combine related activities into a single operation and reduce costs
  • Leverage use of firm’s brand name reputation
  • Conduct related value chain activities in a collaborative fashion to create valuable competitive capabilities

Benefits of Related Diversification

  1. Preserves unity in its business activities
  2. Reap competitive advantage benefits of
  3. Skills transfer
  4. Lower costs
  • Common brand name usage
  • Spread investor risks over a broader base (Rubbish!)
  • Achieve consolidated performance greater than the sum of what individual businesses can earn operating independently

Concept: Economies of Scope

  • Arise from ability to eliminate costs by operating two or more businesses under same corporate umbrella
  • Exist when it is less costly for two or more businesses to operate under centralized management than to function independently
  • Cost saving opportunities can stem from interrelationships anywhere along businesses’ value chains

What Is Unrelated Diversification?

Involves diversifying into businesses with:

  • No strategic fit
  • No meaningful value chain relationships
  • No unifying strategic theme
  • Approach is to venture into “any business in which we think we can make a profit”

Firms pursuing unrelated diversification are often referred to as conglomerates

Can Work if:

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 prospects but limited capital
  • However, these only works if you buy, fix, and then sell!

Drawbacks of Unrelated Diversification

  • Difficulties of competently managing many diverse businesses
  • There are no strategic fits which can be leveraged into competitive advantage
  • Consolidated performance of unrelated businesses tends to be no better than sum of individual businesses on their own (and it may be worse)
  • Promise of greater sales-profit stability over business cycles seldom realized

Competitive Advantage Avenues for a DMNC via Related Diversification

  • Transfer of expertise in a core technology to other businesses
  • Collaborative and strategically coordinated R&D benefiting all the related businesses
  • Ability to use same distributors and retail dealers on a worldwide basis
  • Ability to leverage an established brand name
  • Use financial and organizational resources to cross-subsidize a competitive assault against rivals

Remember that there are only two rules for making capital investment:

1. Will it expand market share?

2. Will it strengthen the core competence?

If yes, then invest. Any manager that needs a formula or calculator to answer the questions is an idiot!