chapter 8

Corporate
Strategy:
Diversification and the
Multibusiness
Company

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 Learning Objectives
After reading this chapter, you should be able to:
1. Explain when and how business diversification can
enhance shareholder value.
2. Describe how related diversification strategies can
produce cross-business strategic fit capable of delivering
competitive advantage.
3. Identify the merits and risks of unrelated diversification
strategies.
4. Use the analytic tools for evaluating a firm’s diversification
strategy.
5. Understand the four main corporate strategy options a
diversified firm can employ to improve its 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: Initiating actions to boost the combined
performance of the corporation’s collection
of businesses..

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

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 Entering a New Line of Business
through Internal Development
Advantages of new Disadvantages of
venture development: corporate
• Avoids pitfalls and intrapreneurship:
uncertain costs of • Must overcome industry
acquisition. entry barriers.
• Allows entry into a new or • Requires extensive
emerging industry where investments in developing
there are no available production capacities and
acquisition candidates. 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

Cost of acquisition higher than internal entry.

Added capacity affects supply and demand balance.

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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 resources and capabilities for
Capabilities. internal development?
The Question of Entry Are there entry barriers to
Barriers. overcome?
The Question of Speed. Is speed crucial to the firm’s
chances for successful entry?
The Question of Which is the least costly mode
Comparative Cost. 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 restrict
industry and business their use to a narrow range
types. of industry and business
types.
• Can be leveraged in
both unrelated and • Can typically be leveraged
related diversification only in related
situations. diversification situations.

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

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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: Economies of scale:

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

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 ILLUSTRATION CAPSULE 8.1 Examples of Companies Pursuing
a Related Diversification Strategy

Which of the three companies is pursuing a

diversification strategy most focused on growth by
acquisition? on growth by internal growth? on cross-
business fits?
Based on the related diversification strategies of the
three companies, is the successful pursuit of growth
by a single form of related diversification likely to
lead to sustainable competitive advantage?
How is the scale and scope of the strategic fits
present in these companies related to their success
in their markets?
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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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 ILLUSTRATION CAPSULE 8.2 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

Limited
Demanding
Competitive
Managerial
Advantage
Requirements
Potential

Monitoring and Possible lack of

maintaining the cross-business
parenting strategic-fit
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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 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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 ILLUSTRATION CAPSULE 8.4 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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