1. Corporate-Level Strategy: Related and Unrelated Diversification 10 Chapter Prepared by C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University Prepared by C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Student Version Theory of Strategic Management 10th ed. GARETH R. JONES /CHARLES W. L. HILL

2. Learning Objective:After reading this chapter, you should be able to differentiate between multibusiness models based on related and unrelated diversification. Learning Objective: After reading this chapter, you should be able to differentiate between multibusiness models based on related and unrelated diversification. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. INCREASING PROFITABILITY THROUGH DIVERSIFICATION  Diversification is the process of entering new industries, distinct from a company’s core or original industry, to make new kinds of products that can be sold profitable.  A diversified company is one that makes and sells in two or more distinct industries.

3. 10-3 INCREASING PROFITABILITY THROUGH DIVERSIFICATION  The managers of most companies often consider diversification when they are generating free cash flow, that is, cash in excess of that required: to fund new investments in the company’s current business and to meet debt commitments.  In theory, any free cash flow belongs to the shareholders; thus, a diversification strategy is not consistent with maximizing returns to shareholders. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. 10-4 Learning Objective:After reading this chapter, you should be able to explain the five primary ways in which diversification can increase company profitability. Learning Objective: After reading this chapter, you should be able to explain the five primary ways in which diversification can increase company profitability. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Transferring competencies involves taking a distinctive competency developed by a new business unit in one industry and implanting it in a business unit operating in another industry.  Companies that base their diversification strategy on transferring competencies tend to acquire new business related to their existing business activities. TRANSFERRING COMPETENCIES

5. 10-5  A commonality is some kind of skill or attribute, which, when it is shared or used by two or more business units: allows both businesses to operate more effectively and efficiently, and create more value for customers. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  To increase profitability, the competencies transferred must involve value-chain activities that gives the business unit competitive advantage in the future. TRANSFERRING COMPETENCIES-

6. 10-6  Leveraging competencies involves taking a distinctive competency developed by a business unit in one industry and using it to create a new business unit or division of a different industry.  The difference between leveraging competencies and transferring competencies is that leveraging competencies means a new business is being created.  Transferring competencies involves the sharing of competencies between two existing businesses. LEVERAGING COMPETENCIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. 10-7  Economies of scope arise when one or more of a diversified company’s business units are able to realize cost-saving or differentiation synergies.  Companies can more effectively pool, share, and utilize expensive resources or capabilities.  Sharing resources or capabilities across business units lowers a company’s cost structure compared to companies that operate in only one industry. SHARING RESOURCES AND CAPABILITIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

8. 10-8  In search of new ways to differentiate products, more and more companies are entering into industries that provide customers with new products connected or related to existing products.  This product bundling allows a company to expand the range of products it produces to provide customers a complete package of related products.  The goal is to bundle products to offer customers lower prices and/or a superior product or service. USING PRODUCT BUNDLING © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. 10-9  General organizational competencies are the result of the skills of a company’s top managers and functional experts. UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Entrepreneurial Capabilities x  To promote entrepreneurship, a company must: 1)Encourage managers to take risks. 2)Give them the time and resources to pursue novel ideas. 3)Not punish managers when a new idea fails. 4)Not pursue too many risky new ventures that have a low probability of generating a profit.

10. 10-10 UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capabilities of Organizational Design  Organizational design skills are a result of a manager’s ability to create a structure, culture, and control systems.  Effective organizational structure and controls create incentives that encourage business unit managers to maximize efficiency and effectiveness of their units.  Good organizational design helps prevent missing out on profitable new opportunities.

11. 10-11 UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Superior Strategic Management Capabilities x  For diversification to increase profitability, a company’s top managers must have superior capabilities in strategic management.  They must possess the intangible skills that are required to manage different business units in a way that enables these units to perform better than they would if they were independent companies.  These skills are a rare and valuable capability.

12. 10-12 UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES UTILIZING GENERAL ORGANI- ZATIONAL COMPETENCIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Superior Strategic Management Capabilities x  There are several ways to improve the performance of an acquired company: 1)Replace top managers of the acquired company with a more aggressive top management team. 2)Sell off expensive assets and terminates managers and employees to reduce the cost structure. 3)The new management team works to devise new strategies to improve performance of the operations of the acquired company. 4)Offer bonuses to motivate managers and employees. 5)Set challenging goals at all levels (stretch goals).

13. Learning Objective:After reading this chapter, you should be able to discuss the conditions that lead managers to pursue related diversification versus unrelated diversification and explain why some companies pursue both strategies. Learning Objective: After reading this chapter, you should be able to discuss the conditions that lead managers to pursue related diversification versus unrelated diversification and explain why some companies pursue both strategies. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. RELATED DIVERSIFICATION  Related diversification is a corporate-level strategy that is based on the goal of establishing a business unit in a new industry that is related to a company’s existing business units by: some form of commonality or linkage between value- chain functions of the existing and new business units.

14. 10-14  The greater the number of linkages that can be formed among business units, the greater the potential to realize the profit-enhancing benefits of diversifying.  Diversification allows a company to use any general organizational competency it possesses to increase the overall performance of all its different industry divisions.  Strategic managers may strive to create a structure and culture that encourages entrepreneurship across divisions. RELATED DIVERSIFICATION © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. 10-15 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Unrelated diversification is a corporate-level strategy based on a multibusiness model with a goal to increase profitability through: the use of general organizational competencies, and increase the performance of all the company’s business units. UNRELATED DIVERSIFICATION  Companies pursuing this strategy are often called conglomerates; that is, business organizations that operate in many diverse industries.

16. 10-16 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  When the managers who possess hard-to-define skills leave, they often take their visions with them.  A company’s new leader may lack the competency or commitment necessary to pursue diversification successfully over time.  The environment often changes rapidly and unpredictably over time.  The future success of any business is hard to predict when using diversification. THE LIMITS AND DISADVANTAGES OF DIVERSIFICATION Changes in the Industry or Company

17. 10-17 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Although they know they should divest unprofitable businesses, managers “make up” reasons why they should keep their businesses together.  In the past, one widely used (and false) justification for diversification was that the strategy would allow a company to obtain the benefits of risk pooling.  When a company’s core business is in trouble, some think diversification will rescue it and lead to long-term growth and profitability. THE LIMITS AND DISADVANTAGES OF DIVERSIFICATION Diversification for the Wrong Reasons

18. 10-18 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Bureaucratic costs are the costs associated with solving the transaction difficulties that arise between a company’s business unit and between the business unit and corporate headquarters, as the company attempts to obtain the benefits from transferring, sharing, and leveraging competencies.  The greater the number of business units, the more difficult it is for corporate managers to remain informed about each business. THE LIMITS AND DISADVANTAGES OF DIVERSIFICATION The Bureaucratic Costs of Diversification

19. 10-19 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Related diversification is preferred when (1) the company’s competencies can be applied across a greater number of industries, and (2) the company has superior strategic capabilities that allow it to keep bureaucratic costs under control.  Unrelated diversification is preferred when (1) top managers are skilled at raising the profitability of a poorly run business, and (2) superior management is able to keep costs under control. THE LIMITS AND DISADVANTAGES OF DIVERSIFICATION Choosing a Strategy

20. 10-20 Learning Objective:After reading this chapter, you should be able to describe the three methods companies use to enter new industries: internal new venturing, acquisitions, and joint ventures. Then be able to discuss the advantages and disadvantages associated with each of these methods. Learning Objective: After reading this chapter, you should be able to describe the three methods companies use to enter new industries: internal new venturing, acquisitions, and joint ventures. Then be able to discuss the advantages and disadvantages associated with each of these methods. ENTERING NEW INDUSTRIES: INTERNAL NEW VENTURING © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Internal new venturing is the process of transferring resources to and creating a new business unit or division in a new industry.  A company may use internal venturing to enter a newly emerging or embryonic industry.

21. 10-21 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Reasons given to explain the high failure rate (33% to 60%) of internal new ventures include: 1)Market entry on too small a scale. 2)Poor commercialization of the new-venture product. 3)Poor corporate management of the new venture division.  Steps taken to ensure good science ends with good, commercially viable products. 1)Put research in the hands of skilled managers. 2)Encourage managers to work with R&D scientists. 3)Foster a close link between R&D and marketing. ENTERING NEW INDUSTRIES: INTERNAL NEW VENTURING

22. 10-22 ENTERING NEW INDUSTRIES: ACQUISITIONS © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  A company is particularly likely to use acquisitions when it needs to move fast to establish a presence in an industry.  Entering a new industry through internal venturing is a relatively slow process. Acquisition is a much quicker way for a company to establish a significant market presence.  Acquisitions are often perceived as being less risky than internal new ventures because they involve less commercial uncertainty.  It is an attractive way to enter an industry that is protected by high barriers to entry.

23. 10-23 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Acquisitions may fail to raise the performance of the acquiring companies for the following reasons: 1)Management problems 2)Overestimating the potential economic benefits 3)Acquisitions tend to be expensive (no profit increases) 4)Poor screening results in not seeing major problems  Guidelines for successful acquisition: 1)Target identification and preacquisition screening 2)Bidding strategy 3)Integration 4)Learning from experience ENTERING NEW INDUSTRIES: ACQUISITIONS

24. 10-24 ENTERING NEW INDUSTRIES: JOINT VENTURES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Joint ventures involve two or more companies agreeing to pool their resources to create new businesses.  It frequently becomes the most appropriate method to enter a new industry because it allows a company to share the risks and costs associated with establishing a business unit in the new industry with another company.  The joint ventures approach is most appropriate when the companies share complementary skills or distinctive companies because this increases the probability of a joint venture’s success.

25. 10-25 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Disadvantages of entering a joint venture: 1)While it allows companies to share the risks and costs of developing a new business, it also requires that they share in the profits if they succeed. 2)If one partner’s skills are more important than the other partner’s skills, the partner with more valuable skills will have to “give away” profits to the other party because of the 50/50 agreement. 3)Problems can arise if the partners’ business models conflict. 4)A company runs the risk of giving away important company-specific knowledge to its partner. ENTERING NEW INDUSTRIES: JOINT VENTURES