Diversification Strategy
OUTLINE
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Introduction: The Basic Issues
The Trend over Time
Motives for Diversification
- Growth and risk spreading
- Diversification and Shareholder Value: Porter’s
Three Essential Tests.
Competitive Advantage from Diversification
Diversification and Performance: Empirical Evidence
Relatedness in Diversification

Objectives
• Define corporate strategy, describe some of the reasons why firms diversify, identify and describe different types of corporate diversification, and assess the advantages and disadvantages associated with each.
• Identify sources of synergy in diversified firms while also describing why synergies are so difficult to achieve.

Objectives (cont.)
• Explore the complex relationship between diversification and firm performance.
• In particular, explore the influence of managers and managerial thinking on the relationship between diversification and performance. Introduction
• Definition of Corporate Strategy
– Address the question: “What is the appropriate scale and scope of the enterprise?”
• Influences how large and how diversified firms will be.
• Successful corporate strategies are not only the product of successful definition
– Also the result of organizational capabilities or competencies that allow firms to exploit potential economies/synergies that large size or diversity can offer.

Introduction (cont.)
• Why Firms Diversify
– To grow
– To more fully utilize existing resources and capabilities. – To escape from undesirable or unattractive industry environments.
– To make use of surplus cash flows.

Introduction (cont.)
• Horizontal or related diversification
– Strategy of adding related or similar product/service lines to existing core business, either through acquisition of competitors or through internal development of new products/services.

Introduction (cont.)
• Horizontal or related diversification
– Advantages
• Opportunities to achieve economies of scale and scope. • Opportunities to expand product offerings or expand into new geographical areas.

Disadvantages of related diversification
• Complexity and difficulty of coordinating different but related businesses.

Introduction (cont.)
Conglomerate or unrelated diversification
– Firms pursue this strategy for several reasons:
• Continue to grow after a core business has matured or started to decline.
• To reduce cyclical fluctuations in sales revenues and cash flows.

– Problems with conglomerate or unrelated diversification: • Managers often lack expertise or knowledge about their firms’ businesses.

Introduction: The Basic
Issues
Diversification decisions involve two basic issues:
• Is the industry to be entered more attractive than the firm’s existing business?
• Can the firm establish a competitive advantage within the industry to be entered? (i.e. what synergies exist between the core business and the new business?)

Aim of Corporate Strategy:
Synergy
• Aim of diversification should be to create value or wealth in excess of what firms would enjoy without diversification.
• Synergy: the value of the combined firm after acquisition should be greater than the value of the two firms prior to acquisition.
– Obtained in three ways:
• Exploiting economies of scale.
– Unit costs decline with increases in production.

Aim of Corporate Strategy:
Synergy (cont.)
• Exploiting economies of scope.
– Using the same resource to do different things.

• Efficient allocation of capital.
– Many assets in acquired firms are undervalued -managers seek to exploit these opportunities and improve their operations and add value to their businesses.

Relatedness in
Diversification

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Synergy in diversification derives from two main types of relatedness: Operational Relatedness-- synergies from sharing resources across businesses (common distribution facilities, brands, joint R&D)