CHAPTER 8

Corporate Strategy
Diversification and the
Multibusiness Company

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 Learning Objectives
This Chapter Will Help You Understand:
1. When and how business diversification can enhance
shareholder value.
2. How cross-business strategic fit can contribute to each
business’s competitive advantage.
3. The merits and risks of unrelated diversification
strategies.
4. The analytic tools for evaluating a company’s
diversification strategy.
5. What four main corporate strategy options a diversified
company uses to improve company performance.

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 What Does Crafting a Diversification
Strategy Entail?
STEP DESCRIPTION
Step 1 Picking new industries to enter and
deciding on the means of entry
Step 2 Pursuing opportunities to leverage cross-
business value chain relationships and
strategic fit into competitive advantage
Step 3 Establishing investment priorities and
steering corporate resources into the
most attractive business units

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 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
• Retrenching to a narrower scope of
diversification by divesting poorly performing
businesses
• Broadly restructuring the entire firm by divesting
some businesses and acquiring others to put a
whole new face on the firm’s business lineup
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 When to Consider Diversifying

A firm should consider diversifying when:

1. Growth opportunities are limited as its principal
markets reach their maturity and buyer demand is
either stagnating or set to decline.
2. Changing industry conditions—new technologies,
inroads being made by substitute products, fast-
shifting buyer preferences, or intensifying
competition—are undermining the firm’s competitive
position.

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 How Much Diversification?
Deciding how wide-ranging diversification should be
1. Diversify into closely related businesses or into
totally unrelated businesses?
2. Diversify present revenue and earnings base to a
small or major extent?
3. Move into one or two large new businesses or a
greater number of small ones?
4. Acquire an existing company?
5. Start up a new business from scratch?
6. Form a joint venture with one or more companies to
enter new businesses?

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 Opportunity for Diversifying
Strategic diversification possibilities
1. Expand into businesses whose technologies and
products complement present business(es).
2. Employ current resources and capabilities as
valuable competitive assets in other businesses.
3. Reduce overall internal costs by cross-business
sharing or transfers of resources and capabilities.
4. Extend a strong brand name to the products of other
acquired businesses to help drive up sales and
profits of those businesses.

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 Building Shareholder Value: The Ultimate
Justification for Diversifying

Testing Whether Diversification Will Add

Long-Term Value for Shareholders

The industry attractiveness test

The cost-of-entry test

The better-off test

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 Three Tests for Building Shareholder Value
through Diversification
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
cause 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?

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 Better Performance through Synergy

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 FIGURE 8.2 Three Strategy Options for Pursuing
Diversification

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 Approaches to Diversifying the
Business Lineup

Diversifying into New Business

Existing business acquisition

Internal new venture (start-up)

Joint venture

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 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 a struggling firm
• Underestimating costs for integrating acquired firm
• Overestimating the acquisition’s potential to deliver
added shareholder value

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 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 corporate 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

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 When to Engage in Internal Development

Factors Favoring Internal Development

Low resistance of incumbent firms to market entry

Ample time to develop and launch business

Availability of in-house skills and resources

Added capacity affects supply and demand balance

Cost of acquisition higher than internal entry

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 Using Joint Ventures to
Achieve Diversification
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 or ownership.

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 Risks of Diversification by Joint Venture
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.
• Dissolution of the venture when one of the venture
partners decides to go their own way.

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 Choosing a Mode of Market Entry
The question of The question
The Question of Critical Does the firm have the
Resources and Capabilities resources and capabilities
for internal development?

The Question of Entry Barriers Are there entry barriers to

overcome?
The Question of Speed Is speed crucial to the
firm’s chances for
successful entry?

The Question of Comparative Which is the least costly

Cost mode of entry, given the
firm’s objectives?

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 Choosing the Diversification Path:
Related versus Unrelated Businesses

Which Diversification Path to Pursue?

Related Businesses

Unrelated Businesses

Both Related and Unrelated Businesses

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 Diversification 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
• Sharing costs by combining the related value chain
activities of different businesses 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
• Engaging in cross-business collaboration and
knowledge sharing to create new competitively
valuable resources and capabilities

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 Pursuing Related Diversification
Generalized resources Specialized resources
and capabilities: and capabilities:
• Can be deployed widely • Have very specific
across a broad range of applications which
industry and business restrict their use to a
types. narrow range of industry
• Can be leveraged in and business types.
both unrelated and • Can typically be
related diversification leveraged only in related
situations. diversification situations.

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 FIGURE 8.1 Related Businesses Provide
Opportunities to Benefit from Competitively
Valuable Strategic Fit.

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 Identifying Cross-Business Strategic Fits
along the Value Chain
Potential Cross-Business Fits
• Sales and marketing activities
• R&D technology activities
• Supply chain activities
• Manufacturing-related activities
• Distribution-related activities
• Customer service activities

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 Strategic Fit, Economies of Scope, and
Competitive Advantage
Using economies of scope to convert strategic fit
into competitive advantage can entail:
• Transferring specialized and generalized skills
or knowledge
• Combining related value chain activities to
achieve lower costs
• Leveraging brand names and other
differentiation resources
• Using cross-business collaboration and
knowledge sharing

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 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.

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 From Strategic Fit to Competitive Advantage, Added
Profitability, and Gains in Shareholder Value

Capturing the cross-business strategic-fit benefits

of related diversification
• Builds more shareholder value than owning a
stock portfolio
• Only possible via a strategy of related
diversification
• Yields value in the application of specialized
resource and capabilities
• Requires that management take internal actions
to realize them

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 The Effects of Cross-Business Fit
• Fit builds more value than owning a stock
portfolio of firms in different industries.
• Strategic-fit benefits are possible only via
related diversification.
• The stronger the fit, the greater its effect on the
firm’s competitive advantages.
• Fit fosters the spreading of competitively
valuable resources and capabilities specialized
to certain applications and that have value only
in specific types of industries and businesses.

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 The Kraft-Heinz Merger: Pursuing the
Benefits of Cross-Business Strategic Fit
Why did Kraft choose to seek a merger with Heinz
rather than starting its own food products
subsidiary?

What are the anticipated results of the merger?

To what extent is decentralization required when

seeking cross-business strategic fit?

What should Kraft-Heinz do to ensure the

continued success of its related diversification
strategy?
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 Diversification into Unrelated Businesses

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 Building Shareholder Value via
Unrelated Diversification
Type Details
Astute corporate • Provide leadership, oversight, expertise, and
parenting by guidance
management • Provide generalized or parenting resources that
lower operating costs and increase SBU efficiencies
Cross-business • Serve as an internal capital market
allocation of • Allocate surplus cash flows from businesses to fund
financial the capital requirements of other businesses
resources
Acquiring and • Acquire weakly performing firms at bargain prices
restructuring • Use turnaround capabilities to restructure them to
undervalued increase their performance and profitability
companies

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 The Path to Greater Shareholder Value
through Unrelated Diversification

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 The Drawbacks of Unrelated Diversification

Pursuing an Unrelated Diversification Strategy

Demanding Managerial Limited Competitive

Requirements Advantage Potential

Monitoring and Possible lack of cross-

maintaining the business strategic-fit
parenting advantage benefits

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 Misguided Reasons for Pursuing
Unrelated Diversification
Poor Rationales for Unrelated Diversification
• Seeking a reduction of business
investment risk
• Pursuing rapid or continuous growth for its
own sake
• Seeking stabilization of earnings to avoid
cyclical swings in businesses
• Pursuing personal managerial motives

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 Combination Related-Unrelated
Diversification Strategies
Related-Unrelated business portfolio
combinations may be suitable for

Dominant-business enterprises

Narrowly diversified firms

Broadly diversified firms

Multibusiness enterprises
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 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.

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 Steps in Evaluating the Strategy of a
Diversified Firm
1. Assess the attractiveness of the industries the firm has diversified
into, both individually and as a group.
2. Assess the competitive strength of the firm’s business units within
their respective industries.
3. Evaluate the extent of cross-business strategic fit along the value
chains of the firm’s various business units.
4. Check whether the firm’s resources fit the requirements of its
present business lineup.
5. Rank the performance prospects of the businesses from best to
worst and determine resource allocation priorities.
6. Craft strategic moves to improve corporate performance.

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 Step 1: Evaluating Industry Attractiveness
How attractive are the industries in which the firm
has business operations?

1. Does each industry represent a good market

for the firm to be in?
2. Which industries are most attractive, and which
are least attractive?
3. How appealing is the whole group of
industries?

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 Calculating Industry-Attractiveness Scores:
Key Measures
• Market size and projected growth rate
• The intensity of competition among market
rivals
• Emerging opportunities and threats
• The presence of cross-industry strategic fit
• Resource requirements
• Social, political, regulatory, environmental
factors
• Industry profitability
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 Calculating Industry Attractiveness from the
Multibusiness Perspective
The question of cross- The question of
industry strategic fit resource requirements
How well do the Do the resource
industry’s value chain requirements for an
and resource industry match those of
requirements match up the parent firm or are
with the value chain they otherwise within
activities of other the company’s reach?
industries in which the
firm has operations?

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 Calculating Industry-Attractiveness Scores

• Deciding on appropriate
weights for industry
attractiveness measures

• Gaining sufficient knowledge

of the industry to assign
Evaluating Industry accurate and objective ratings
Attractiveness
• Whether to use different
weights for different business
units whenever the importance
of strength measures differs
significantly from business to
business

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 TABLE 8.1 Calculating Weighted Industry-Attractiveness Scores
Aspects Importance Business Business A in Business B in Business B in Business C in Business C in
weight A in Industry A Industry B Industry B Industry C Industry C
Industry A

Competitive-Strength Measures Importance Business A Business A in Business B in Business B in Business C in Business C in

weight in Industry Industry A Industry B Industry B Industry C Industry C
A Strength Weighted Score Strength Weighted Strength Weighted
Rating Rating Score Rating Score

Relative market share 0.15 10 1.50 2 0.30 6 0.90

Costs relative to competitor’s costs 0.20 7 1.40 4 0.80 5 1.00

Ability to march or beat rivals on 0.05 9 0.45 5 0.25 8 0.40

key product attributes

Ability to benefit from strategic fit 0.20 8 1.60 4 0.80 8 0.80

with other portfolio businesses

Bargaining leverage with 0.05 9 0.45 2 0.10 6 0.30

suppliers/customers

Brand image and reputation 0.10 9 0.90 4 0.40 7 0.70

Competitively valuable capabilities 0.15 7 1.05 2 0.30 5 0.75

Profitability relative to competitors 0.10 5 0.50 2 0.20 4 0.40

Sum of importance weights 1.00 0 0 0 0 0 0

Weighted overall competitive NA NA Business A in NA Business B in NA Business C in

strength scores Industry A Industry B Industry C
weighted score weighted score weighted score
7.85 3.15 5.25

Rating scale: 1 equals very weak; 10 equals very strong.

Remember: The more intensely competitive an industry is, the lower the attractiveness rating for that industry!
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 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
• Benefits from strategic fit with firm’s other businesses
• Bargaining leverage with key suppliers or customers
• Profitability relative to competitors

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 TABLE 8.2 Calculating Weighted Competitive-Strength Scores
for a Diversified Company’s Business Units
NA NA COMPETITIVE- COMPETITIVE- COMPETITIVE- COMPETITIVE- COMPETITIVE- COMPETITIVE-
STRENGTH STRENGTH STRENGTH STRENGTH STRENGTH STRENGTH
ASSESSMENTS ASSESSMENT ASSESSMENTS ASSESSMENTS ASSESSMENTS ASSESSMENTS
S

NA NA Business A in Business A in Business B in Business B in Business C in Business C in

Industry A Industry A Industry B Industry B Industry C Industry C

Competitive-Strength Importance Strength Rating* Weighted Score Strength Rating* Weighted Score Strength Rating* Weighted Score
Measures Weight

Relative market share 0.15 10 1.50 2 0.30 6 0.90

Costs relative to competitors’ 0.20 7 1.40 4 0.80 5 1.00

costs

Ability to match or beat rivals 0.05 9 0.45 5 0.25 8 0.40

on key product attributes

Ability to benefit from strategic 0.20 8 1.60 4 0.80 8 0.80

fit with sister businesses

Bargaining leverage with 0.05 9 0.45 2 0.10 6 0.30

suppliers/customers

Brand image and reputation 0.10 9 0.90 4 0.40 7 0.70

Other valuable 0.15 7 1.05 2 0.30 5 0.75

resources/capabilities

Profitability relative to 0.10 5 0.50 2 0.20 4 0.40

competitors

Sum of importance weights 1.00 NA NA NA NA NA NA

Weighted overall competitive NA NA 7.85 NA 3.15 NA 5.25

strength scores

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

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 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.

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

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 Step 4: Checking for Good Resource Fit
Financial resource fit Nonfinancial resource fit
• State of the internal • Does the firm have (or can
capital market it develop) the specific
• Using the portfolio resources and capabilities
approach: needed to be successful in
• Cash hogs need cash to each of its businesses?
develop. • Are the firm’s resources
• Cash cows generate excess being stretched too thin by
cash. the resource requirements
• Star businesses are self- of one or more of its
supporting. businesses?
Success sequence:
• Cash hog to Star to Cash cow

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 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.

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 The Chief Strategic and Financial Options for Allocating
a Diversified Company’s Financial Resources

Strategic options Financial options

• Invest in ways to strengthen • Pay off existing long-term or
or grow existing business. short-term debt.
• Make acquisitions to establish • Increase dividend payments
positions in new industries or to shareholders.
to complement existing • Repurchase shares of the
businesses. company’s common stock.
• Fund long-range R&D • Build cash reserves; invest in
ventures aimed at opening short-term securities.
market opportunities in new or
existing businesses.

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 Step 6: Crafting New Strategic Moves to
Improve Overall Corporate Performance
1. Stick with the present
business lineup.
2. Broaden the
diversification with
Strategy Options for a new acquisitions.
Firm That Is Already
3. Divest and retrench to
Diversified
a narrower
diversification base.
4. Restructure through
divestitures and
acquisitions.
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 FIGURE 8.6 A Company’s Four Main Strategic Alternatives after
It Diversifies

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 Broadening a Diversified
Firm’s Business Base
Factors motivating the addition of more 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

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 Divesting Businesses and Retrenching to a
Narrower Diversification Base
Factors motivating business divestitures
• Long-term performance can be improved by
concentrating on stronger positions in fewer core
businesses and industries.
• The business is in a once-attractive industry where
market conditions have badly deteriorated
• The business has either failed to perform as expected
or is lacking in cultural, strategic, or resource fit.
• The business will become more valuable if sold to
another firm or as an independent spin-off firm.

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 Restructuring a Diversified Company’s
Business Lineup
Factors that drive corporate restructuring
• A serious mismatch between the firm’s resources and capabilities
and the type of diversification 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

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 Restructuring for Better Performance
at Hewlett-Packard (HP)
What are the expected benefits of splitting HP into
two separate and independent companies?

Why did HP take so long to recognize changes in

the industry and the necessity for changing itself?

How can internal growth create a lack of strategic

fit where none existed before?

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