WHAT DOES CRAFTING A

DIVERSIFICATION STRATEGY ENTAIL?

Picking new industries to enter and deciding on the means of

Step 1 entry.

Pursuing opportunities to leverage cross-business value chain

Step 2 relationships and strategic fit into competitive advantage.

Establishing investment priorities and steering corporate

Step 3 resources into the most attractive business units.

Initiating actions to boost the combined performance

Step 4 of the cooperation’s collection of businesses.

8–1
STRATEGIC DIVERSIFICATION OPTIONS

 Sticking closely with the existing business lineup and

pursuing opportunities presented by these businesses.
 Broadening the current scope of diversification by
entering additional industries.
 Divesting some businesses and retrenching to a
narrower collection of diversified businesses with better
overall performance prospects.
 Restructuring the entire firm by divesting some
businesses and acquiring others to put a whole new
face on the firm’s business lineup.

8–2
WHEN BUSINESS DIVERSIFICATION
BECOMES A CONSIDERATION
 A firm should consider diversifying when:
1. It can expand into businesses whose technologies
and products complement its present business.
2. Its resources and capabilities can be used as
valuable competitive assets in other businesses.
3. Costs can be reduced by cross-business sharing
or transfer of resources and capabilities.
4. Transferring a strong brand name to the products
of other businesses helps drive up sales and
profits of those businesses.

8–3
BUILDING SHAREHOLDER VALUE:
THE ULTIMATE JUSTIFICATION
FOR DIVERSIFYING

Testing Whether Diversification

Will Add Long-Term
Value for Shareholders

The industry
The cost-of-entry The better-off
attractiveness
test test
test

8–4
TESTING WHETHER DIVERSIFICATION
ADDS VALUE FOR SHAREHOLDERS

 The Attractiveness Test:

● Are the industry’s profits and return on investment
as good or better than present business(es)?
 The Cost of Entry Test:
● Is the cost of overcoming entry barriers so great as
to long delay or reduce the potential for profitability?
 The Better-Off Test:
● How much synergy (stronger overall performance)
will be gained by diversifying into the industry?

8–5
CORE CONCEPT

♦ Creating added value for shareholders via

diversification requires building a multibusiness
company where the whole is greater than the
sum of its parts—an outcome known as synergy.

8–6
 BETTER PERFORMANCE
THROUGH SYNERGY

Firm A purchases Firm B in

another industry. A and B’s No
profits are no greater than Synergy
what each firm could have (1+1=2)
Evaluating the earned on its own.
Potential for
Synergy
through
Firm A purchases Firm C in
Diversification
another industry. A and C’s
Synergy
profits are greater than what
each firm could have earned (1+1=3)
on its own.

8–7
APPROACHES TO DIVERSIFYING
THE BUSINESS LINEUP

Diversifying into
New Businesses

Acquisition of an Internal new Joint

existing business venture (start-up) venture

8–8
 DIVERSIFICATION BY ACQUISITION
OF AN EXISTING BUSINESS

 Advantages:
● Quick entry into an industry
● Barriers to entry avoided
● Access to complementary resources and capabilities
 Disadvantages:
● Cost of acquisition—whether to pay a premium for a
successful firm or seek a bargain in struggling firm
● Underestimating costs for integrating acquired firm
● Overestimating the acquisition’s potential to deliver
added shareholder value

8–9
CORE CONCEPT

♦ An acquisition premium is the amount by

which the price offered exceeds the
preacquisition market value of the target firm.

8–10
ENTERING A NEW LINE OF BUSINESS
THROUGH INTERNAL DEVELOPMENT

 Advantages of New Venture Development:

● Avoids pitfalls and uncertain costs of acquisition.
● Allows entry into a new or emerging industry where
there are no available acquisition candidates.
 Disadvantages of Intrapreneurship:
● Must overcome industry entry barriers.
● Requires extensive investments in developing
production capacities and competitive capabilities.
● May fail due to internal organizational resistance to
change and innovation.
8–11
CORE CONCEPT

♦ Corporate venturing (or new venture

development) is the process of developing
new businesses as an outgrowth of a firm’s
established business operations. It is also
referred to as corporate entrepreneurship
or intrapreneurship since it requires
entrepreneurial-like qualities within a larger
enterprise.

8–12
 WHEN TO ENGAGE IN
INTERNAL DEVELOPMENT
Ample time to
develop and
launch business
Availability of Cost of acquisition
in-house skills is higher than
and resources internal entry

Factors Favoring
Internal Development

No head-to-head Added capacity

competition in will not affect
targeted industry supply and
Low resistance of demand balance
incumbent firms
to market entry

8–13
 WHEN TO ENGAGE IN
A JOINT VENTURE

Is the opportunity too complex, uneconomical,

or risky for one firm to pursue alone?

Evaluating
Does the opportunity require a broader range
the Potential
of competencies and know-how than the firm
for a Joint now possesses?
Venture

Will the opportunity involve operations in a

country that requires foreign firms to have a
local minority or majority ownership partner?

8–14
 DIVERSIFICATION BY
JOINT VENTURE

 Joint ventures are advantageous when

diversification opportunities:
● Are too large, complex, uneconomical, or risky for
one firm to pursue alone.
● Require a broader range of competencies and know-
how than a firm possesses or can develop quickly.
● Are located in a foreign country that requires local
partner participation and/or ownership.

8–15
 DIVERSIFICATION BY
JOINT VENTURE (cont’d)

 Joint ventures have the potential for developing

serious drawbacks due to:
● Conflicting objectives and expectations of venture
partners.
● Disagreements among or between venture partners
over how best to operate the venture.
● Cultural clashes among and between the partners.
● The venture dissolving when one of the venture
partners decides to go their own way.

8–16
 CHOOSING A MODE OF
MARKET ENTRY

The Question of Critical Does the firm have the resources and
Resources and Capabilities capabilities for internal development?

The Question of
Are there entry barriers to overcome?
Entry Barriers

The Question of Is speed of the essence in the firm’s

Speed chances for successful entry?

The Question of Which is the least costly mode of entry,

Comparative Cost given the firm’s objectives?

8–17
CORE CONCEPT

♦ Transaction costs are the costs of completing

a business agreement or deal of some sort,
over and above the price of the deal. They can
include the costs of searching for an attractive
target, the costs of evaluating its worth,
bargaining costs, and the costs of completing
the transaction.

8–18
CHOOSING THE DIVERSIFICATION PATH:
RELATED VERSUS UNRELATED
BUSINESSES

Which Diversification
Path to Pursue?

Both Related
Related Unrelated
and Unrelated
Businesses Businesses
Businesses

8–19
CORE CONCEPT

♦ Related businesses possess competitively

valuable cross-business value chain and
resource matchups.
♦ Unrelated businesses have dissimilar value
chains and resource requirements, with no
competitively important cross-business
relationships at the value chain level.

8–20
CHOOSING THE DIVERSIFICATION PATH:
RELATED VERSUS UNRELATED
BUSINESSES

 Related Businesses
● Have competitively valuable cross-business
value chain and resource matchups.
 Unrelated Businesses
● Have dissimilar value chains and resource
requirements, with no competitively important
cross-business relationships at the value chain
level.

8–21
CORE CONCEPT

♦ Strategic fit exists whenever one or more

activities constituting the value chains of
different businesses are sufficiently similar as
to present opportunities for cross-business
sharing or transferring of the resources and
capabilities that enable these activities.

8–22
 DIVERSIFYING INTO RELATED
BUSINESSES

 Strategic Fit Opportunities:

● Transferring specialized expertise, technological
know-how, or other resources and capabilities from
one business’s value chain to another’s.
● Cost sharing between businesses by combining their
related value chain activities into a single operation.
● Exploiting common use of a well-known brand name.
● Sharing other resources (besides brands) that
support corresponding value chain activities across
businesses.

8–23
Pursuing Related Diversification

 Related diversification involves sharing or

transferring specialized resources and
capabilities.
● Specialized Resources and Capabilities
 Have very specific applications and their use
is limited to a restricted range of industry and
business types.

8–24
CORE CONCEPTS
♦ Specialized Versus Generalized Resources
and Capabilities
● Specialized resources and capabilities have very
specific applications and their use is limited to a
restricted range of industry and business types.
 Leveraged in related diversification
● Generalized resources and capabilities can be
widely applied and can be deployed across a broad
range of industry and business types.
 Leveraged in unrelated and
related diversification

8–25
FIGURE 8.1 Related Businesses Provide Opportunities to
Benefit from Competitively Valuable Strategic Fit

8–26
 IDENTIFYING CROSS-BUSINESS
STRATEGIC FITS ALONG
THE VALUE CHAIN
Supply
Chain
Activities
R&D and Manufacturing-
Technology Related
Activities Activities

Potential
Cross-Business Fits

Sales and Distribution-

Marketing Related
Activities Activities
Customer
Service
Activities

8–27
STRATEGIC FIT, ECONOMIES OF SCOPE,
AND COMPETITIVE ADVANTAGE

Using Economies of Scope to Convert

Strategic Fit into Competitive Advantage

Transferring Combining Leveraging Using cross-

specialized and related value brand names business
generalized chain activities and other collaboration
skills and\or to achieve differentiation and knowledge
knowledge lower costs resources sharing

8–28
CORE CONCEPTS

♦ Economies of scope are cost reductions

that flow from operating in multiple
businesses (a larger scope of operation).
♦ Economies of scale accrue from a larger-
size operation.

8–29
 ECONOMIES OF SCOPE DIFFER
FROM ECONOMIES OF SCALE

 Economies of Scope
● Are cost reductions that flow from cross-business
resource sharing in the activities of the multiple
businesses of a firm.
 Economies of Scale
● Accrue when unit costs are reduced due to the
increased output of larger-size operations of a firm.

8–30
 FROM STRATEGIC FIT TO
COMPETITIVE ADVANTAGE,
ADDED PROFITABILITY AND
GAINS IN SHAREHOLDER VALUE

Capturing the Cross-Business Benefits

of Related Diversification

Builds more Is only possible Yields value in Requires that

shareholder via a strategy the application management
value than of related of specialized take internal
owning a stock diversification resources and actions to
portfolio capabilities realize them

8–31
 DIVERSIFICATION INTO
UNRELATED BUSINESSES

Can it meet corporate targets

for profitability and return on
investment?
Evaluating the
acquisition of a
Is it is in an industry with
new business or
attractive profit and growth
the divestiture of
potentials?
an existing
business
Is it is big enough to contribute
significantly to the parent firm’s
bottom line?

8–32
BUILDING SHAREHOLDER VALUE
VIA UNRELATED DIVERSIFICATION

Using an Unrelated Diversification

Strategy to Pursue Value

Cross-Business Acquiring and

Astute Corporate
Allocation of Restructuring
Parenting by
Financial Undervalued
Management
Resources Companies

8–33
CORE CONCEPT

♦ Restructuring refers to overhauling and

streamlining the activities of a business—
combining plants with excess capacity, selling
off underutilized assets, reducing unnecessary
expenses, and otherwise improving the
productivity and profitability of the firm.

8–34
THE PATH TO GREATER SHAREHOLDER
VALUE THROUGH UNRELATED
DIVERSIFICATION

The attractiveness test Diversify into businesses that can

produce consistently good earnings
and returns on investment

Actions taken by upper

management to create The cost-of-entry test Negotiate favorable
value and gain a acquisition prices
parenting advantage

Provide managerial oversight and

The better-off test resource sharing, financial resource
allocation and portfolio management,
and restructure underperforming
businesses

8–35
 THE DUAL DRAWBACKS OF
UNRELATED DIVERSIFICATION

Pursuing an Limited
Demanding
Unrelated Competitive
Managerial
Diversification Advantage
Requirements
Strategy Potential

Monitoring and Potential lack of

maintaining cross-business
the parenting strategic-fit
advantage benefits

8–36
 MISGUIDED REASONS FOR
PURSUING UNRELATED
DIVERSIFICATION

Poor Rationales for

Unrelated Diversification

Seeking
Seeking a Pursuing rapid Pursuing
stabilization to
reduction of or continuous personal
avoid cyclical
business growth for its managerial
swings in
investment risk own sake motives
businesses

8–37
STRATEGIC MANAGEMENT PRINCIPLE

♦ Only profitable growth—the kind that comes

from creating added value for shareholders—
can justify a strategy of unrelated
diversification.

8–38
 COMBINATIONS OF RELATED-
UNRELATED DIVERSIFICATION
STRATEGIES

Related-Unrelated Business
Portfolio Combinations

Dominant- Narrowly Broadly

Multibusiness
Business Diversified Diversified
Enterprises
Enterprises Firms Firms

8–39
STRUCTURES OF COMBINATION RELATED-
UNRELATED DIVERSIFIED FIRMS

 Dominant-Business Enterprises
● Have a major “core” firm that accounts for 50 to 80% of total
revenues and a collection of small related or unrelated firms
that accounts for the remainder.
 Narrowly Diversified Firms
● Are comprised of a few related or unrelated businesses.
 Broadly Diversified Firms
● Have a wide-ranging collection of related businesses,
unrelated businesses, or a mixture of both.
 Multibusiness Enterprises
● Have a business portfolio consisting of several unrelated
groups of related businesses.
8–40
EVALUATING THE STRATEGY
OF A DIVERSIFIED COMPANY

Attractiveness Strength of Cross-business

of industries Business Units strategic fit

Diversified
Strategy

Fit of firm’s Allocation of New Strategic

resources resources Moves

8–41
 EVALUATING THE STRATEGY
OF A DIVERSIFIED FIRM
1. Assessing the attractiveness of the industries the firm has
diversified into, both individually and as a group.
2. Assessing the competitive strength of the firm’s business units
within their respective industries.
3. Evaluating the extent of cross-business strategic fit along the
value chains of the firm’s various business units.
4. Checking whether the firm’s resources fit the requirements of its
present business lineup.
5. Ranking the performance prospects of the businesses from best
to worst and determining a priority for allocating resources.
6. Crafting strategic moves to improve corporate performance.

8–42
FIGURE 8.2
Three Strategy Alternatives
for Pursuing Diversification

8–43
STEP 1: EVALUATING INDUSTRY
ATTRACTIVENESS

How attractive are the

industries in which the firm
has business operations?

Does each industry represent a good

market for the firm to be in?

Which industries are most attractive,

and which are least attractive?

How appealing is the whole group of

industries?

8–44
 KEY INDICATORS OF INDUSTRY
ATTRACTIVENESS

 Social, political, regulatory, environmental factors

 Seasonal and cyclical factors
 Industry uncertainty and business risk
 Market size and projected growth rate
 Industry profitability
 The intensity of competition among market rivals
 Emerging opportunities and threats

8–45
 CALCULATING INDUSTRY
ATTRACTIVENESS FROM THE
MULTIBUSINESS PERSPECTIVE
How well do the industry’s value chain and
The Question of Cross- resource requirements match up with the value
Industry Strategic Fit chain activities of other industries in which the
firm has operations?

Do the resource requirements for an industry

The Question of
match those of the parent firm or are they
Resource Requirements otherwise within the company’s reach?

8–46
 CALCULATING INDUSTRY
ATTRACTIVENESS SCORES

Deciding on appropriate weights for

the industry attractiveness measures.

Evaluating Gaining sufficient knowledge of the

Industry industry to assign accurate and
Attractiveness objective ratings.

Whether to use different weights for

different business units whenever the
importance of strength measures differs
significantly from business to business.

8–47
TABLE 8.1
Calculating
Weighted
Industry
Attractivenes
s Scores

Remember:
The more
intensely
competitive
an industry is,
the lower the
attractiveness
rating for that
industry!

[Rating scale: 1 = very unattractive to the firm; 10 = very attractive to the firm.]

8–48
STEP 2: EVALUATING BUSINESS-UNIT
COMPETITIVE STRENGTH

 Relative market share

 Costs relative to competitors’ costs
 Ability to match or beat rivals on key product attributes
 Brand image and reputation
 Other competitively valuable resources and capabilities
and partnerships and alliances with other firms
 Benefit from strategic fit with firm’s other businesses
 Bargaining leverage with key suppliers or customers
 Profitability relative to competitors

8–49
STRATEGIC MANAGEMENT PRINCIPLE

♦ Using relative market share to measure

competitive strength is analytically superior to
using straight-percentage market share.
♦ Relative market share is the ratio of a business
unit’s market share to the market share of its
largest industry rival as measured in unit
volumes, not dollars.

8–50
TABLE 8.2
Calculating
Weighted
Competitive
Strength
Scores for a
Diversified
Company’s
Business
Units

[Rating scale: 1 = very weak; 10 = very strong.]

8–51
FIGURE 8.3
A Nine-Cell Industry Star
Attractiveness–
Competitive
Strength Matrix

Cash
cow

Note: Circle sizes are scaled to

reflect the percentage of
companywide revenues
generated by the business unit.

8–52
 STEP 3: DETERMINING THE
COMPETITIVE VALUE OF STRATEGIC
FIT IN DIVERSIFIED COMPANIES

 Assessing the degree of strategic fit across its

businesses is central to evaluating a company’s
related diversification strategy.
 The real test of a diversification strategy is what
degree of competitive value can be generated
from strategic fit.

8–53
STRATEGIC MANAGEMENT PRINCIPLE

♦ The greater the value of cross-business

strategic fit in enhancing a firm’s performance
in the marketplace or on the bottom line, the
more competitively powerful is its strategy of
related diversification.

8–54
FIGURE 8.4 Identifying the Competitive Advantage
Potential of Cross-Business Strategic Fit

8–55
CORE CONCEPT

♦ A diversified firm exhibits resource fit when its

businesses add to a firm’s overall resource
strengths and have matching resource
requirements and/or when the parent firm has
adequate corporate resources to support its
businesses’ needs and add value.

8–56
STEP 4: CHECKING FOR RESOURCE FIT

 Financial Resource Fit

● State of the internal capital market
● Using the portfolio approach:
 Cash hogs need cash to develop.
 Cash cows generate excess cash.
 Star businesses are self-supporting.
 Success sequence:
● Cash hog  Star  Cash cow

8–57
CORE CONCEPT

♦ A cash cow business generates cash flows

over and above its internal requirements, thus
providing a corporate parent with funds for
investing in cash hog businesses, financing
new acquisitions, or paying dividends.

8–58
CORE CONCEPT

♦ A cash hog business generates cash flows

that are too small to fully fund its operations
and growth and requires cash infusions to
provide additional working capital and finance
new capital investment.

8–59
CORE CONCEPT

♦ A strong internal capital market allows a

diversified firm to add value by shifting capital
from business units generating free cash flow
to those needing additional capital to expand
and realize their growth potential.

8–60
STEP 4: CHECKING FOR RESOURCE FIT

 Nonfinancial Resource Fit

● Does the firm have (or can it develop)
the specific resources and capabilities
needed to be successful in each of its
businesses?
● Are the firm’s resources being stretched
too thinly by the resource requirements
of one or more of its businesses?

8–61
CORE CONCEPT

♦ A portfolio approach to ensuring financial fit

among a firm’s businesses is based on the fact
that different businesses have different cash
flow and investment characteristics.

8–62
STEP 5: RANKING BUSINESS UNITS
AND ASSIGNING A PRIORITY FOR
RESOURCE ALLOCATION
 Ranking Factors:
● Sales growth
● Profit growth
● Contribution to company earnings
● Return on capital invested in the business
● Cash flow
 Steer resources to business units with the
brightest profit and growth prospects and
solid strategic and resource fit.
8–63
FIGURE 8.5 The Chief Strategic and Financial Options for Allocating
a Diversified Company’s Financial Resources

8–64
STEP 6: CRAFTING NEW STRATEGIC
MOVES TO IMPROVE OVERALL
CORPORATE PERFORMANCE

Strategy Options for a Firm

That Is Already Diversified

Divest and Restructure

Stick with Broaden the
Retrench to through
the Existing Diversification
a Narrower Divestitures
Business Base with New
Diversification and
Lineup Acquisitions
Base Acquisitions

8–65
FIGURE 8.6
A Firm’s Four Main
Strategic Alternatives
After It Diversifies

8–66
 BROADENING A DIVERSIFIED
FIRM’S BUSINESS BASE

 Factors Motivating the Adding of Businesses:

● The transfer of resources and capabilities
to related or complementary businesses.
● Rapidly changing technology, legislation,
or new product innovations in core businesses.
● Shoring up the market position and competitive
capabilities of the firm’s present businesses.
● Extension of the scope of the firm’s operations
into additional country markets.

8–67
 DIVESTING BUSINESSES AND
RETRENCHING TO A NARROWER
DIVERSIFICATION BASE

 Factors Motivating Business Divestitures:

● Improvement of long-term performance by
concentrating on stronger positions in fewer
core businesses and industries.
● Business is now in a once-attractive industry where
market conditions have badly deteriorated.
● Business has either failed to perform as expected
and\or is lacking in cultural, strategic or resource fit.
● Business has become more valuable if sold to
another firm or as an independent spin-off firm.
8–68
CORE CONCEPT

♦ A spinoff is an independent company created

when a corporate parent divests a business by
distributing to its stockholders new shares in
this business.

8–69
 ILLUSTRATION CAPSULE 8.1
Managing Diversification at Johnson & Johnson:
The Benefits of Cross-Business Strategic Fit

♦ What does the growth in both revenues and

profits reveal about the success of J&J’s
diversification through acquisition strategy?
♦ To what extent is decentralization required
when seeking cross-business strategic fit?
♦ What should J&J do to ensure the continued
success of its diversification strategy?

8–70
STRATEGIC MANAGEMENT PRINCIPLE

♦ Diversified companies need to divest low-

performing businesses or businesses that do
not fit in order to concentrate on expanding
existing businesses and entering new ones
where opportunities are more promising.

8–71
 RESTRUCTURING A DIVERSIFIED
COMPANY’S BUSINESS LINEUP

 Factors Leading to Corporate Restructuring:

● A serious mismatch between the firm’s resources and
capabilities and the type of diversification that it has pursued.
● Too many businesses in slow-growth, declining, low-margin,
or otherwise unattractive industries.
● Too many competitively weak businesses.
● Ongoing declines in the market shares of major business
units that are falling prey to more market-savvy competitors.
● An excessive debt burden with interest costs that eat deeply
into profitability.
● Ill-chosen acquisitions that haven’t lived up to expectations.

8–72
CORE CONCEPT

♦ Companywide restructuring (corporate

restructuring) involves making major changes
in a diversified company by divesting some
businesses and/or acquiring others, so as to
put a whole new face on the company’s
business lineup.

8–73