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CHAPTER 8
Corporate Strategy:
Diversification and
the Multi business
Company

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 LEARNING OBJECTIVES

1. Understand when and how business diversification can

enhance shareholder value.
2. Explain how related diversification strategies can produce
cross-business strategic fit capable of delivering competitive
advantage.
3. Recognize the merits and risks of corporate strategies keyed
to unrelated diversification.
4. Evaluate a company’s diversification strategy.
5. Identify a diversified company’s four main corporate strategy
options for solidifying its diversification strategy and
improving company performance.

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 When Business Diversification Becomes a Consideration

Diversification is called for when:

• There are diminishing growth prospects in the present
business.
• An expansion opportunity exists in an industry whose
technologies and products complement the present business.
• Existing competencies and capabilities can be leveraged by
expanding into an industry requires similar resource strengths.
• Costs can be reduced by diversifying into closely related
businesses.
• A powerful brand name can be transferred to the products of
other businesses.

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 Building Shareholder Value: The Ultimate Justification
for Business Diversification

Diversification may result in added shareholder

value if it passes three tests.
1. Industry-Attractiveness Test. The target industry offers
equal or better profit and return on potential
investment opportunities.
2. Cost of Entry Test. The cost to enter the target industry
does not erode its long-term profit potential.
3. Better-Off Test. The firm’s businesses will perform better
together than as standalone firms, producing a
synergistic 1 + 1 = 3 effect on shareholder value.

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 Approaches to Diversifying the Business Lineup

Options for entering new industries and

lines of business:
• Diversification by acquisition of an existing
business.
• Entering a new line of business through
internal development.
• Using joint ventures to achieve
diversification.

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 Strategic Options for Diversified Corporations

Stick with the existing business lineup and pursuing

opportunities presented by these businesses.
Broaden the scope of diversification by entering
additional industries.
Retrench to a narrower scope of diversification by
divesting poorly performing businesses.
Broadly restructure the business lineup with multiple
divestitures and/or acquisitions.

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 Crafting a Diversified Firm’s Overall Corporate Strategy

1. Pick new industries to enter and deciding on the means

of entry.
2. Pursue opportunities to leverage cross-business value
chain relationships into competitive advantage.
3. Establish investment priorities and steering corporate
resources into the most attractive business units.
4. Initiate actions to boost the combined performance of
the corporation’s collection of businesses.

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 Diversification by Acquisition of an Existing Business

Quick and effective way to hurdle target market entry

barriers related to:
• Acquiring technological know-how.
• Establishing supplier relationships.
• Achieving scale economies.
• Building brand awareness.
• Securing adequate distribution access.
The big dilemma is whether to pay a premium price
to buy a successful firm or to buy a struggling firm at
a bargain price.

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 Entering a New Line of Business Through
Internal Development

Is more attractive when:

• The parent firm already has the in-house skills and
resources needed to compete effectively.
• There is ample time to launch a new business.
• Startup cost is lower than cost of entry via acquisition.
• The startup will not compete against powerful rivals.
• Adding capacity will not adversely impact supply–demand
balance in industry.
• Incumbent firms are likely to be slow or ineffective in
responding to an entrant’s efforts to crack the market.

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 Using Joint Ventures to Achieve Diversification

Situations call for a joint venture when:

• Pursuing the expansion opportunity is too
complex, uneconomical, or risky to go it alone.
• The opportunities in a new industry require a
broader range of competencies and know-how
than an expansion-minded firm can marshal.
Drawbacks:
• Potential for conflicting objectives.
• Operational and control disagreements.
• Culture clashes.

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 Choosing the Diversification Path:
Related Versus Unrelated Businesses

Related businesses:
• Have value chains with competitively valuable cross-business
relationships that present opportunities for the businesses to
perform better operating under the same corporate umbrella
than they could as standalone entities.
Unrelated businesses:
• Have value chains and resource requirements that are so
dissimilar no competitively valuable cross-business relationships
are present.

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 CORE CONCEPTS: Related and Unrelated Businesses

Related businesses possess competitively valuable cross-

business value chain and resource matchups; unrelated
businesses have dissimilar value chains and resources
requirements, with no competitively important cross-
business value chain relationships.

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 Figure 8.1 Strategic Themes of Multi business Corporation

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 Diversifying into Related Businesses

Strategic Fit:
Exists whenever one or more activities comprising the value
chains of different businesses are sufficiently similar to present
opportunities for:
• Transferring competitively valuable resources, expertise,
technological know-how, or other capabilities from one
business to another.
• Cost sharing between separate businesses where value chain
activities can be combined.
• Brand sharing between business units that have common
customers or that draw upon common core competencies.

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 CORE CONCEPT: Strategic Fit

Strategic fit exists when the value chains of different

businesses present opportunities for cross-business skills
transfer, cost sharing, or brand sharing.

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Figure 8.2 Related Diversification Is Built upon Competitively
Valuable Strategic Fit in Value Chain Activities

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 Strategic Fit and Economies of Scope

Scope-related cost savings stemming from the strategic

fit of the value chains of related businesses:
• Operating businesses under same corporate umbrella.
• Taking shared advantage of the interrelationships anywhere
along the value chains of different businesses.
Advantage:
• The greater the cross-business economies associated with
cost-saving strategic fit, the greater the potential for a related
diversification strategy to yield a competitive advantage based
on lower costs than rivals.

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 CORE CONCEPT: Economies of Scope and
Economies of Scale

Economies of scope are cost reductions stemming from

strategic fit along the value chains of related businesses
(thereby, a larger scope of operations), whereas
economies of scale accrue from a larger operation.

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The Ability of Related Diversification to Deliver Competitive
Advantage and Gains in Shareholder Value

Cross-business strategic fit:

• Builds shareholder value in ways that shareholders cannot
replicate by simply owning a diversified portfolio of stocks.
• Captures benefits that are possible only through related
diversification.
• Does not automatically result in benefits; must be pursued
by management in order to capture the greater profitability
of cross-business benefits.

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 Concepts and Connections 8.1 The Kraft-Heinz Merger:
Managerial Missteps in Capturing Cross-Business Strategic
Fit and Building Shareholder Value
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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 Diversifying into Unrelated Businesses

Strategic approach:
• Growth through acquisition into any industry where potential
exists for enhancing shareholder value through upward-
trending corporate revenues and earnings and/or a stock price
that rises yearly.
• While industry attractiveness and cost-of-entry tests important,
better-off test secondary.
Involves diversifying into businesses with:
• No strategic fit.
• No meaningful value chain relationships.
• No unifying strategic theme.
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 Types of Acquisition Candidates in
Unrelated Diversification Strategies

Candidates for acquisition:

• Firms with bright growth prospects but short on investment
capital.
• Undervalued firms that can be acquired at a bargain price.
• Struggling firms that can be turned around with parent firm’s
financial resources and managerial know-how.

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 Building Shareholder Value Through
Unrelated Diversification

Corporate executives must:

• Do a superior job of identifying and acquiring new businesses
that can produce consistently good earnings and returns on
investment.
• Do an excellent job of negotiating favorable acquisition prices.
• Do such a good job of overseeing and parenting the firm’s
businesses that they perform at a higher level than they would
otherwise be able to do through their own efforts alone.

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 The Pitfalls of Unrelated Diversification (1 of 2)

Demanding managerial requirements:

1. Staying abreast of what is happening in each industry
and each subsidiary.
2. Picking business unit heads having the requisite
combination of managerial skills and know-how to drive
gains in performance.
3. Telling the difference between those strategic proposals
of business unit managers that are prudent and those
that are risky or unlikely to succeed.
4. Knowing what to do if a business unit stumbles and its
results suddenly head downhill.

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 The Pitfalls of Unrelated Diversification (2 of 2)

Limited competitive advantage potential:

• Unrelated strategy offers limited competitive advantage beyond
what each individual business can generate on its own.
• Without strategic fit, consolidated performance of an unrelated
group of businesses is unlikely to be better than the sum of what
the individual business units could achieve independently.

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 Misguided Reasons for Pursuing Unrelated Diversification

Misguided reasons for diversifying:

• Risk reduction.
• Growth.
• Earnings stabilization.
• Managerial motives.

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 Diversifying into Both Related and Unrelated Businesses

Dominant-business enterprises:
• One major core business accounting for 50 to 80 percent of total
revenues and a collection of small related or unrelated businesses
accounts for the remainder.
Narrowly diversified firms:
• Diversification into a few (two to five) related or unrelated businesses.

Broadly diversified firms:

• Diversification includes a wide collection of either related or unrelated
businesses or a mixture of both.
Multi business enterprises:
• Diversification into several unrelated groups of related businesses.

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 Evaluating the Strategy of a Diversified Company

Step 1: Assess the attractiveness of the industries the company

has diversified into.
Step 2: Assess the competitive strength of the company’s business
units.
Step 3: Evaluate the extent of cross-business strategic fit along the
value chains of the company’s various business units.
Step 4: Check whether the company’s resources fit the
requirements of its present business lineup.
Step 5: Rank the performance of the businesses from best to
worst and determine a priority for allocating resources.
Step 6: Craft new strategic moves to improve overall corporate
performance.

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 Step 1: Evaluating Industry Attractiveness

Industry-attractiveness measures:
• Market size and projected growth rate.
• Intensity of competition.
• Emerging opportunities and threats.
• Presence of cross-industry strategic fit.
• Resource requirements.
• Seasonal and cyclical factors.
• Social, political, regulatory, and environmental factors.
• Industry profitability.
• Industry uncertainty and business risk.

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Table 8.1 Calculating Weighted Industry-Attractiveness Scores

Industry-Attractiveness Importance/ Industry A Industry B Industry C Industry D

Measure Weight Rating/Score Rating/Score Rating/Score Rating/Score

A table divided into0.106 columns8/0.80

Market size and projected
growth rate lists the ratings for 4 industries
5/0.50 2/0.20 3/0.30

with
Intensity of industry-attractiveness
competition 0.25 measures.
8/2.00 Columns
7/1.75 3 through 6 for
3/0.75 2/0.50
Emerging the industries
opportunities and have0.10
no values in the second last data row for sum
threats 2/0.20 9/0.90 4/0.40 5/0.50
of the assigned weights. Column 2 labeled importance or weight
has no value in the0.20
Cross-industry strategic fit
last data cell.
8/1.60 4/0.80 8/1.60 2/0.40

Resource requirements 0.10 9/0.90 7/0.70 5/0.50 5/0.50

Seasonal and cyclical influences 0.05 9/0.45 8/0.40 10/0.50 5/0.25

Societal, political, regulatory,
and environmental factors 0.05 10/0.50 7/0.35 7/0.35 3/0.15

Industry profitability 0.10 5/0.50 10/1.00 3/0.30 3/0.30

Industry uncertainty and
business risk Underlined 0.05 Underlined 5/0.25 Underlined 7/0.35 Underlined 10/0.50 Underlined 1/0.05

Sum of the assigned weights 1.00

Overall weighted industry- 7.20 6.75 5.10 2.95
attractiveness scores. Rating
scale: 1 = very unattractive to
the company, 10 = very
attractive to the company

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 Step 2: Evaluating Business Unit Competitive Strength

Competitive strength factors:

• Relative market share.
• Costs relative to competitors’ costs.
• Products or services that satisfy buyer expectations.
• Ability to benefit from its strategic fit with sibling businesses.
• Number and caliber of strategic alliances and collaborative
partnerships.
• Brand image and reputation.
• Competitively valuable capabilities.
• Profitability relative to competitors.

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Table 8.2 Calculating Weighted Competitive Strength Scores
for a Diversified Company’s Business Units
Business A in Business B in Business C in Business D in
Importance Industry A Industry B Industry C Industry D
Competitive Strength Measure Weight Rating/Score Rating/Score Rating/Score Rating/Score
Relative market share 0.15 10/1.50 1/0.15 6/0.90 2/0.30

Costs relative to competitors’ costs 0.20 7/1.40 2/0.40 5/1.00 3/0.60

A table divided into 6 columns lists the ratings for 4 business units with
Ability to match or beat rivals on key
competitive
product attributes strength measures. Columns 3 through 6 for the business units
0.05 9/0.45 4/0.20 8/0.40 4/0.20
have no values in the second last data row for sum of assigned weights.
Ability to benefit from strategic fit with
Column
sister businesses2 labeled importance weight has no value in the last data cell.
0.20 8/1.60 4/0.80 4/0.80 2/0.60

Bargaining leverage with

0.05 9/0.45 3/0.15 6/0.30 2/0.10
suppliers/buyers; caliber of alliances
Brand image and reputation 0.10 9/0.90 2/0.20 7/0.70 5/0.50
Competitively valuable capabilities 0.15 7/1.05 2/0.30 5/0.75 3/0.45

Profitability relative to competitors 0.10 5/0.50 1/0.10 4/0.40 4/0.40

Sum of assigned weights 1.00

Overall weighted competitive strength scores Rating 7.85 2.30 5.25 3.15
scale: 1 = very weak; 10 = very strong

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

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Strategy Implications of the Attractiveness/Strength Matrix

Businesses in the upper-left corner:

• Receive top investment priority.
• Strategic prescription: grow and build.
Businesses in the three diagonal cells:
• Given medium investment priority.
• Brighter or dimmer prospects than others.
Businesses in the lower-right corner:
• Candidates for divestiture or to be harvested
to take cash out of the business.

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 Step 3: Determining the Competitive Value
of Strategic Fit in Multi business Companies

Value chain matchups provide competitive

advantage when there are opportunities to:
1. Combine performance of certain activities, thereby
reducing costs and capturing economies of scope.
2. Transfer skills, technology, or intellectual capital
from one business to another.
3. Share a respected brand name across multiple
product and/or service categories.

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 Step 4: Evaluating Resource Fit

A diversified firm’s lineup of businesses exhibit

good resource fit when:
• Each of its businesses, individually, strengthen the
firm’s overall mix of resources and capabilities.
• The firm has sufficient resources that add customer
value to support its entire group of businesses without
spreading itself too thin.

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 CORE CONCEPT: Resource Fit

A diversified company exhibits resource fit when its

businesses add to a company's overall mix of resources
and capabilities and when the parent company has
sufficient resources to support its entire group of
businesses without spreading itself too thin.

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 CORE CONCEPT: Internal Capital Market

A strong internal capital market allows a diversified

company to add value by shifting capital from business
units generating free cash flow to those needing
additional capital to expand and realize their growth
potential.

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 Determining Financial Resource Fit

Use a portfolio approach to determine the firm’s internal capital

market requirements.
• Which businesses are cash hogs in need of additional funds to
maintain growth and expansion?
• Which businesses are cash cows with cash flow surpluses
available to fund growth and reinvestment?
Assess the portfolio’s overall condition.
• Which businesses are (or not) capable of contributing to
achieving companywide performance targets?
• Does the firm have the financial strength to fund all of its
businesses and maintain a healthy credit rating?

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 CORE CONCEPTS: Cash Hog and Cash Cow

A cash hog generates operating cash flows that are too

small to fully fund its operations and growth; a cash hog
must receive cash infusions from outside sources to
cover its working capital and investment requirements.
A cash cow generates operating cash flows over and
above its internal requirements, thereby providing
financial resources that may be used to invest in cash
hogs, finance new acquisitions, fund share buyback
programs, or pay dividends.

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 Assessing Cash Hogs

Reasons for not divesting a cash hog business:

• It has highly valuable strategic fit with other
business units.
• Capital infusions needed from the corporate parent
are modest relative to the funds available.
• There’s a decent chance of growing the cash hog
into a solid bottom-line contributor.

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 Examining a Diversified Company’s
Nonfinancial Resource Fit

A diversified firm must ensure that it can meet the

nonfinancial resource needs of its portfolio of
businesses.
• Does the firm have or can it develop the specific resources and
capabilities needed to be successful in each of its businesses?
• Are the firm’s resources being stretched too thinly by the
requirements of one or more of its original businesses or a
recent acquisition?

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 Step 5: Ranking Business Units and
Setting a Priority for Resource Allocation

Factors to consider in judging

business unit performance:
• Sales growth.
• Profit growth.
• Earnings contribution.
• Return on investment.
• Cash flow generation.

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 Figure 8.4 The Chief Strategic and Financial Options for
Allocating a Diversified Company’s Financial Resources

Strategic Options for Allocating Financial Options for Allocating

Company Financial Resources: Company Financial Resources:
• Invest in ways to strengthen • Pay off existing long-term or
or grow existing business. short-term debt.
• Make acquisitions to • Increase dividend payments
establish positions in new to shareholders.
industries or to complement • Repurchase shares of the
existing 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
the Overall Corporate Performance

1. Sticking closely with existing business lineup and

pursue opportunities it presents.
2. Broadening the firm’s business scope by making
acquisitions in new industries.
3. Divesting some businesses and retrench to a
narrower base of business operations.
4. Restructuring the firm’s business lineup to put a new
face on its business makeup.

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 Sticking Closely with the Existing Business Lineup

Choosing not to expand beyond the current

lineup of businesses makes sense when the
firm’s present businesses:
• Offer attractive growth opportunities, good
earnings, and cash flows.
• Are in a good position for the future and have
good strategic and resource fits.
• Have resources that management can steer into
areas of the greatest potential and profitability.

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 Broadening the Diversification Base

Multi business firms may consider adding to

the diversification base when:
• There are sluggish revenues and profit growth.
• They are vulnerable to seasonality or recessionary
influences.
• There is potential for transfer resources and
capabilities to related businesses.
• Unfavorable driving forces are facing its core
businesses.
• Acquisition of related businesses will strengthen
the market positions of one or more of its
businesses.
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 Divesting Businesses and Retrenching
to a Narrower Diversification Base

Retrenchment to focus resources on building strength in fewer

businesses requires divesting or eliminating the following:
• Once-attractive businesses in deteriorating markets.
• Businesses that will have a poor strategic or resource fit in the firm’s future
portfolio.
• Cash hog businesses with poor long-term investment returns potential.
• Weakly positioned businesses with little prospect for earning a decent
return on investment.

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 CORE CONCEPTS: Corporate Restructuring and Spin-offs

Corporate restructuring involves radically altering the business

lineup by divesting businesses that lack strategic fit or are poor
performers and acquiring new businesses that offer better promise
for enhancing shareholder value.
A spin-off is an independent company created when a corporate
parent divests a business either by selling shares to the public via
an initial public offering or by distributing shares in the new
company to shareholders of the corporate parent.

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 Broadly Restructuring the Business Lineup Through
a Mix of Divestitures and New Acquisitions

Radical surgery on the business lineup is necessary when:

• There is a serious mismatch between the firm’s resources and capabilities
and the type of diversification that it has pursued.
• Too many businesses are in slow-growth, declining, low-margin, or
otherwise unattractive industries.
• There are too many competitively weak businesses.
• New technologies threaten the survival of important businesses.
• There are ongoing declines in the market shares of one or more major
business units that are falling prey to more market-savvy competitors.
• An excessive debt burden with interest costs eats deeply into profitability.
• Ill-chosen acquisitions have not lived up to expectations.

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