3Slides_Diversification

Managerial reasons for diversification
Diversification

Acquiring new activities either unrelated to its existing activities.

related
to
or
New products or services.
Product markets Product Existing New Existing 1 3 New 2 4 Geographical markets Existing 5 7 New 6 8
move from box 1 to boxes 2, 3 or 4 move from box 5 to boxes 6, 7 or 8.
EC3203 Economics of Corporate Strategy
Diversification, Mergers & Acquisitions
Diversification

Why do firms diversify?

Efficiency-based reasons for diversification
Economic Arguments for Diversification

Push factors

Poor performance and unhappy shareholders. Limited size of the existing market. Existence of underutilized resources/assets. Surplus investment resources that could be used to finance new activities. Greater profit and growth in new sectors. Greater expected profit the greater the pull. Higher degree of uncertainty in new products and new markets. Commitment of financial and managerial resources for uncertain returns.

Will the new unit gain competitive advantage from the link with the existing business?
Studies

Rumelt (1974) found:


Highly diversified firms performed less well than that more focused or less diversified enterprises, but that diversified firms grew faster than single-product firms. Related activities were more profitable than firms engaged in unrelated diversification.


To identify economies of scale in multi business firms, the “relatedness” concept was developed by Richard Rumelt. Two businesses are related if they share technological characteristics, production characteristics and/or distribution channels.



Classification by Relatedness
Type Proportion of Revenue from Primary Activity >95% Example
Single
Dominant
பைடு நூலகம்
70 – 95%
Related
<70%
Conglomerate
<70%
Firm’s Portfolio of Activities

Selling existing products in new geographically distinct markets. Diversify in terms of new products or new markets as illustrated in Table 1.

Directions of diversification – Table 1

SWOT Analysis SWOT = strengths, weaknesses, opportunities and threats. Existing products – product characteristics. Existing markets – demand growth rate, price and income elasticities of demand. Existing markets – supply structure. The competitive strengths of competitors.

Pandya and Rao (1998) found:

Diversified firms better performance in terms dispersion. Undiversified better returns. Diversification discount applied by stock market.
Classification by Relatedness

A single business firm derives more than 95 percent of its revenues from a single activity.
A dominant business firm derives 70 to 95 percent of its revenues from its principal activity. A related business firm derives less than 70 of its revenue from its primary activity, but its other lines of business are related to the primary one. An unrelated business firm or a conglomerate derives less than 70 percent of its revenue from its primary area and has few activities related to the primary area.
1. The attractiveness吸引力 test

Is the industry structurally attractive?
2. The cost-of-entry test

Must not capitalise all future profits
3. The better-off test 经济情况好的，利益好的
Assess position in each market relative to rival. Record results in matrix – Table 2.

Table 2: Categorizing a firm's portfolio of activities or products
of
Diversification and Long-Term Performance


Long term performance of diversified firms appear to be poor. One third to one half of all acquisitions and over half of all new business acquisitions are eventually divested. Corporate refocusing of the 1980s could be viewed as a correction to the conglomerate merger wave of the 1960s. Another view is that both the conglomerate diversification of the 60s and the refocusing of the 80s could be value creating. Conditions in the 60s could have favored unrelated diversification and these conditions could since have changed. Example: Anti-trust climate
Table 2: Strategies

Box 9: high-growth and strongly competitive.

Commit resources.

Boxes 3 and 6: high-growth sectors.

Box 3: weakly competitive – exit. Box 6: averagely competitive – exit or commit.