10 Corporate Strategy: Diversification, Acquisitions, and Internal New Ventures

Copyright © Houghton Mifflin Company. All rights reserved Overview Diversification –The process of adding new businesses to the company that are distinct from its established operations Vehicles for diversification –Internal new venturing Starting a new business from scratch –Acquisitions –Joint ventures Restructuring –Reducing the scope of diversified operations by exiting from business areas

Copyright © Houghton Mifflin Company. All rights reserved Expanding Beyond a Single Industry Advantages of staying in a single industry –Focus resources and capabilities on competing successfully in one area –Focus on what the company knows and does best Disadvantages of being in a single industry –Danger of the industry declining –Missing the opportunity to leverage resources and capabilities to other activities –Resting on laurels and not continually learning

Copyright © Houghton Mifflin Company. All rights reserved A Company as a Portfolio of Distinctive Competencies Reconceptualize the company as a portfolio of distinctive competencies rather than a portfolio of products Consider how those competencies might be leveraged to create opportunities in new industries Existing vs. competencies Existing industries in which a company competes vs. new industries

Copyright © Houghton Mifflin Company. All rights reserved Establishing a Competency Agenda Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright © 1994 by Gary Hamel and C. K. Prahalad. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved The Multibusiness Model Develop a business model for each industry in which the company competes Develop a higher-level multi-business model that justifies entry into different industries in terms of profitability

Copyright © Houghton Mifflin Company. All rights reserved Increasing Profitability Through Diversification Transferring competencies –Taking a distinctive competence developed in one industry and applying it to an existing business in another industry –The competencies transferred must involve activities that are important for establishing competitive advantage

Copyright © Houghton Mifflin Company. All rights reserved Transfer of Competencies at Philip Morris

Copyright © Houghton Mifflin Company. All rights reserved Increasing Profitability Through Diversification (cont’d) Leveraging competencies –Taking a distinctive competency developed by a business in one industry and using it to create a new business in a different industry Sharing resources: economies of scope –Cost reductions associated with sharing resources across businesses

Copyright © Houghton Mifflin Company. All rights reserved Sharing Resources at Proctor & Gamble

Copyright © Houghton Mifflin Company. All rights reserved Increasing Profitability Through Diversification (cont’d) Managing rivalry: multipoint competition –Diversifying into an industry in order to hold a competitor in check that has either entered its industry or has the potential to do so –Multipoint competition: companies competing against each other in different industries

Copyright © Houghton Mifflin Company. All rights reserved Increasing Profitability Through Diversification (cont’d) Exploiting general organizational competencies –Competencies that transcend individual functions or businesses and reside at the corporate level in the multi-business enterprise –Entrepreneurial capabilities –Effective organization structure and controls –Superior strategic capabilities

Copyright © Houghton Mifflin Company. All rights reserved Types of Diversification Related diversification –Entry into a new business activity in a different industry that is related to a company’s existing business activity, or activities, by commonalities between one or more components of each activity’s value chain Unrelated diversification –Entry into industries that have no obvious connection to any of a company’s value chain activities in its present industry or industries

Copyright © Houghton Mifflin Company. All rights reserved The Limits of Diversification Related diversification is only marginally more profitable than unrelated diversification Extensive diversification tends to depress rather than improve profitability

Copyright © Houghton Mifflin Company. All rights reserved Bureaucratic Costs and Diversification Strategy The costs increases that arise in large, complex organizations due to managerial inefficiencies Number of businesses in a company’s portfolio –Information overload Coordination among businesses –Inability to identify the unique profit contribution of a business unit that shares resources with another unit

Copyright © Houghton Mifflin Company. All rights reserved Coordination Among Related Business Units

Copyright © Houghton Mifflin Company. All rights reserved Bureaucratic Costs and Diversification Strategy (cont’d) Limits of diversification –Bureaucratic costs place a limit on the amount of diversification that can profitably be pursued Related or unrelated diversification? –Related diversified companies can create value in more ways than unrelated companies, but they have to bear higher bureaucratic costs

Copyright © Houghton Mifflin Company. All rights reserved Diversification That Dissipates Value Diversifying to pool risks –Stockholders can diversify their own portfolios at lower costs than the company can –Research suggests that corporate diversification is not an effective way to pool risks Diversifying to achieve greater growth –Growth on its own does not create value

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Internal New Ventures—Attractions To execute corporate-level strategies when a company has a set of valuable competencies in its existing businesses that can be leveraged to enter the new business area When entering a newly emerging or embryonic industry

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Internal New Ventures—Pitfalls Scale of entry –Large-scale entry is initially more expensive than small-scale entry, but it brings higher returns in the long run

Copyright © Houghton Mifflin Company. All rights reserved Scale of Entry, Profitability, and Cash Flow

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Internal New Ventures—Pitfalls (cont’d) Commercialization –Technological possibilities should not overshadow market needs and opportunities Poor implementation –Demands on cash flow –Clear strategic objectives are needed –Anticipating time and costs

Copyright © Houghton Mifflin Company. All rights reserved Guidelines for Successful Internal New Venturing Structured approach to managing internal new venturing –Research research aimed at advancing basic science and technology –Development research aimed at finding and refining commercial applications for the technology –Foster close links between R&D and marketing; between R&D and manufacturing –Selection process for choosing ventures –Monitor progress

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Acquisitions— Attractions To achieve horizontal integration To achieve diversification when the company lacks important competencies To move quickly Perceived as less risky than internal new ventures When the new industry is well established and enterprises enjoy protection from barriers to entry

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Acquisitions—Pitfalls Difficulty with post-acquisition integration Overestimating economic benefits The expense of acquisitions Inadequate pre-acquisition screening

Copyright © Houghton Mifflin Company. All rights reserved Guidelines for Successful Acquisition Target identification and pre-acquisition screening Bidding strategy –Hostile vs. friendly takeover Integration Learning from experience

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Joint Ventures— Attractions Helps avoid the risks and costs of building a new operation up from the ground floor Teaming with another company that has complementary skills and assets may increase the probability of success

Copyright © Houghton Mifflin Company. All rights reserved Entry Strategy: Joint Ventures—Pitfalls Requires the sharing of profits if the new business succeeds Venture partners must share control; conflicts on how to run the joint venture can cause failure Runs the risk of giving critical know-how away to joint venture partner

Copyright © Houghton Mifflin Company. All rights reserved Restructuring Reducing the scope of the company by exiting business areas Why restructure? –Diversification discount: investors see highly diversified companies as less attractive Complexity and lack of transparency in financial statements Too much diversification or for the wrong reasons –Response to failed acquisitions –Innovations have diminished the advantages of vertical integration or diversification

Copyright © Houghton Mifflin Company. All rights reserved Restructuring Strategies Exit strategies –Divestment Spinoff Selling to another company Management buyout (MBO) –Harvest –Liquidation