1. © Ram Mudambi, Temple University and University of Reading, 2006. Lecture 8 Corporate Strategy: Diversification and New Market Entry BA 950 Policy Formulation and Administration

2. © Ram Mudambi, Temple University and University of Reading, 2006. 8-2 Outline  The single business enterprise  Porter’s three tests  Diversification  Related and unrelated diversification  Entering new markets

3. © Ram Mudambi, Temple University and University of Reading, 2006. 8-3 Stages in transitioning from a single business to a diversified company STAGE 1: Small single-business serving a regional market STAGE 2: Geographic expansion STAGE 3: Vertical integration (optional) STAGE 4: Diversification--usually initiated when growth opportunities dwindle in the company’s present business What next?

4. © Ram Mudambi, Temple University and University of Reading, 2006. 8-4 Competitive strengths of a single business strategy – 1 Less ambiguity about “who we are” Less ambiguity about “who we are” Energies of firm, resources and capabilities can be directed down one business path and keeping strategy responsive to industry change Energies of firm, resources and capabilities can be directed down one business path and keeping strategy responsive to industry change Less chance resources will be stretched thinly over too many competing activities Less chance resources will be stretched thinly over too many competing activities

5. © Ram Mudambi, Temple University and University of Reading, 2006. 8-5 Competitive strengths of a single business strategy – 2 Higher probability innovative ideas and important competencies will emerge Higher probability innovative ideas and important competencies will emerge Top executives can maintain hands-on contact with core business Top executives can maintain hands-on contact with core business Ability to parlay experience and reputation into Ability to parlay experience and reputation into  Sustainable competitive advantage  Prominent leadership position

6. © Ram Mudambi, Temple University and University of Reading, 2006. 8-6 Risks of a single business strategy Putting all the “eggs” in one industry basket  If market becomes unattractive, a firm’s prospects can quickly dim  Unforeseen changes can undermine a single business firm’s prospects  Changing customer needs  Technological innovation  New substitutes

7. © Ram Mudambi, Temple University and University of Reading, 2006. 8-7 When to diversify? When it makes sense to diversify depends on  Growth potential in present business  Attractiveness of opportunities to transfer existing competencies to new businesses  Potential cost-saving opportunities to be realized by entering related businesses  Availability of adequate financial and organizational resources  Managerial expertise to cope with complexity of operating a multi-business enterprise

8. © Ram Mudambi, Temple University and University of Reading, 2006. 8-8 Why diversify?  To build shareholder value  Make 2 + 2 = 5  Diversification can increase shareholder value if it passes Porter’s three tests: 1.Attractiveness test 2. Cost of entry test 4 Must not capitalize all future profits 3. Better-off test 4 Combined unit must be better than the ones it replaces

9. © Ram Mudambi, Temple University and University of Reading, 2006. 8-9 Related diversification  Entry into new business activity based on shared commonalities in the components of the value chains of the firms – good strategic or resource fit  A strategy-driven approach to creating shareholder value

10. © Ram Mudambi, Temple University and University of Reading, 2006. 8-10 Resource fit at Procter & Gamble Sharing resources

11. © Ram Mudambi, Temple University and University of Reading, 2006. 8-11 Strategic fit at Philip Morris Transferring competencies

12. © Ram Mudambi, Temple University and University of Reading, 2006. 8-12 Unrelated diversification  Entry into a new business area that has no obvious relationship with any area of the existing business.  A finance-driven approach to creating shareholder value

13. © Ram Mudambi, Temple University and University of Reading, 2006. 8-13 These capabilities help each business unit perform at a higher level than if it operated as an individual company: These capabilities help each business unit perform at a higher level than if it operated as an individual company: 1. Entrepreneurial capabilities – encourage risk taking while managing & limiting the amount of risk undertaken 2. Organizational design – create structure, culture, and control systems that motivate and coordinate employees 3. Superstrategic capabilities – effectively manage the managers of the business units and helping them think through strategic problems General organizational competencies are skills of a company’s top managers and functional experts that transcend individual functions or business units. These managerial skills are often not present, as they are rare and difficult to develop and put into action. Exploiting general organizational competencies

14. © Ram Mudambi, Temple University and University of Reading, 2006. 8-14 Finance-driven diversification often dissipates value Diversifying to pool risks Diversifying to pool risks  Stockholders can diversify their own portfolios at lower costs than the company can.  This represents an unproductive use of resources as profits can be returned to shareholders as dividends.  Research suggests that corporate diversification is not an effective way to pool risks. Diversifying to achieve greater growth Diversifying to achieve greater growth  Growth on its own does not create value.  Business cycles of different industries are inherently difficult to predict. Based on a large number of academic studies: Extensive diversification tends to reduce, rather than improve, company profitability.

15. © Ram Mudambi, Temple University and University of Reading, 2006. 8-15 Sony’s web of corporate-level diversification strategy

16. © Ram Mudambi, Temple University and University of Reading, 2006. 8-16 Strategies for entering new businesses Acquire existing company Start-up new business internally Joint venture with another company

17. © Ram Mudambi, Temple University and University of Reading, 2006. 8-17 Acquisition  Most popular approach to diversification  Advantages:  Quicker entry into target market  Easier to hurdle certain entry barriers  Technological inexperience  Gaining access to reliable suppliers  Being of a size to match rivals in terms of efficiency and costs  Getting adequate distribution access

18. © Ram Mudambi, Temple University and University of Reading, 2006. 8-18 Internal startup More attractive when  Incumbents slow in responding to new entry  Less expensive than acquiring an existing firm  Company already has most of needed skills  Additional capacity will not adversely impact supply-demand balance in industry  New start-up does not have to go head-to-head against powerful rivals

19. © Ram Mudambi, Temple University and University of Reading, 2006. 8-19 Summary  Single business enterprises – strengths and weaknesses  Diversification – Porter’s three tests  Related diversification and unrelated diversification  Good strategy vs. bad finance  New market entry