Date post: | 24-Dec-2015 |
Category: |
Documents |
Upload: | sophie-tucker |
View: | 215 times |
Download: | 1 times |
Session 03 © Furrer 2002-2008 1
Corporate StrategyFall 2007
Session 3 - Lecture 2
Diversification and Performance
Dr. Olivier Furrer
Office: TvA 1-1-11, Phone: 361 30 79e-mail: [email protected]
Office Hours: only by appointment
Session 03 © Furrer 2002-2008 2
Session 03 © Furrer 2002-2008 3
Firms Vary by Degree of Diversification
Single-business > 95% of revenues from a single business unit
Low Levels of Diversification
Dominant-business Between 70% and 95% of revenues from a single business unit
Related-Diversified <70% of revenues from a single business unit
Moderate to High Levels of Diversification
Businesses share product, techno-logical or distribution linkages
Unrelated-Diversified Business units not closely related
High Levels of Diversification
Ref.: Rumelt, 1974
Session 03 © Furrer 2002-2008 4
Firms Vary by Degree of Diversification
Ref.: Rumelt, 1974
Unrelated Business
Related Business
Dominant-Unrelated
Dominant Business
Single Business
1.0 0.95 0.7 0.01.0
0.7
0.0
Specialization Ratio
Rel
ated
Rat
io
Specialization Ratio: Proportion of a firm’s revenues derived from its largest single business.
Related Ratio: Proportion of a firm’s revenues derived from its largest single group of related businesses.
Session 03 © Furrer 2002-2008 5
Types of Diversification Strategies
Ref.: adapted from Rumelt, 1974
Low Levels of Diversification Moderate to High Levels of Diversification
Very High Levels of Diversification
AAAA
BBAA
BB CC
AA
BB CC
AA
BB CC
Single Business Dominant Business Related constrained Related linked
Unrelated
Session 03 © Furrer 2002-2008 6
Reasons for Diversification
Motives to Enhance Strategic Competitiveness
Economies of ScopeMarket Power
Financial Economies
Resources
ManagerialMotives
Incentives
Incentives and Resources with Neutral Effects of
Strategic Competitiveness
Anti-Trust Regulation
Tax Laws
Low Performance
Uncertain Future Cash Flows
Firm Risk Reduction
Tangible Resources
Intangible Resources
Managerial Motives Causing Value Reduction
Diversifying ManagerialEmployment Risk
Increasing Managerial Compensation Ref.: Hoskisson and Hitt, 1990
Session 03 © Furrer 2002-2008 7
Summary Model of the Relationship between Firm Performance and Diversification
Resources
Capital Market Intervention and
Market for Managerial Talent
DiversificationStrategy
FirmPerformance
InternalGovernance
StrategyImplementation
Incentives
ManagerialMotives
Ref.: Hoskisson and Hitt, 1990
Session 03 © Furrer 2002-2008 8
Adding Value by Diversification
By developing economies of scope between business units in the firms which leads to synergistic benefits
By developing market power which lead to greater returns
Diversification most effectively adds value by either of two mechanisms
Session 03 © Furrer 2002-2008 9
Alternative Diversification Strategies
Efficient Internal Capital Market Allocation
Transferring Core Competencies
Sharing Activities
Restructuring
Related Diversification Strategies
Unrelated Diversification Strategies
1
2
3
4
Efficient Internal Capital Market Allocation
Session 03 © Furrer 2002-2008 10
Sharing Activities
Key Characteristics
Sharing Activities often lowers costs or raises differentiation
Sharing Activities can lower costs if it:
Example: Using a common physical distribution system and sales force such as Procter & Gamble’s disposable diaper and paper towel divisions
* Achieves economies of scale
* Boosts efficiency of utilization
* Helps move more rapidly down Learning Curve
Example: General Electric’s costs to advertise, sell and service major appliances are spread over many different products
Session 03 © Furrer 2002-2008 11
Sharing Activities
Key Characteristics
Sharing Activities can enhance potential for or reduce the cost of differentiation
Example: Shared order processing system may allow new features customers value or make more advance remote sensing technology available
Must involve activities that are crucial to competitive advantage
Example: Procter & Gamble’s sharing of sales and physical distribution for disposable diapers and paper towels is effective because these items are so bulky and costly to ship
Session 03 © Furrer 2002-2008 12
Sharing Activities
Assumptions
Strong sense of corporate identity
Clear corporate mission that emphasizes the importance of integrating business units
Incentive system that rewards more than just business unit performance
Session 03 © Furrer 2002-2008 13
Transferring Core Competencies
Key Characteristics
Exploits Interrelationships among divisions
Start with Value Chain analysis
Identify ability to transfer skills or expertise among similar value chains
Exploit ability to share activities
Two firms can share the same sales force, logistics network or distribution channels
Session 03 © Furrer 2002-2008 14
Assumptions
Activities involved in the businesses are similar enough that sharing expertise is meaningful
Transfer of skills involves activities which are important to competitive advantage
The skills transferred represent significant sources of cooperative advantage for the receiving unit
Transferring Core Competencies
Transferring Core Competencies leads to competitive advantage only if the similarities among business units meet the following conditions:
Session 03 © Furrer 2002-2008 15
Key CharacteristicsFirms pursuing this strategy frequently diversify by acquisition:
• Acquire sound, attractive companies
• Acquired units are autonomous
• Acquiring corporation supplies needed capital
• Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs
• Add professional management & control to sub-units
• Sub-unit managers compensation based on unit results
Efficient Internal Capital Market Allocation
Session 03 © Furrer 2002-2008 16
Assumptions
Managers have more detailed knowledge of firm relative to outside investors
Firm need not risk competitive edge by disclosing sensitive competitive information to investors
Firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own
Efficient Internal Capital Market Allocation
Session 03 © Furrer 2002-2008 17
• Portfolio Planning under the Boston Consulting Group (BCG) matrix:
– Identifying the Strategic Business Units (SBUs) by business area or product market
– Assessing each SBU’s prospects (using relative market share and industry growth rate) relative to other SBUs in the portfolio.
– Developing strategic objectives for each SBU.
Portfolio Planning
Session 03 © Furrer 2002-2008 18
The BCG Matrix
Ref: Adapted from The Boston Consulting Group, Inc., Perspectives, No. 66, “The Product Portfolio.” 1970.
Session 03 © Furrer 2002-2008 19
The Strategic Implications of the BCG Matrix
• Stars– Aggressive investments to support continued growth and
consolidate competitive position of firms.
• Question marks– Selective investments; divestiture for weak firms or those
with uncertain prospects and lack of strategic fit.
• Cash cows– Investments sufficient to maintain competitive position.
Cash surpluses used in developing and nurturing stars and selected question mark firms.
• Dogs– Divestiture, harvesting, or liquidation and industry exit.
Session 03 © Furrer 2002-2008 20
Limitations on Portfolio Planning
• Flaws in portfolio planning:
– The BCG model is simplistic; considers only two competitive environment factors– relative market share and industry growth rate.
– High relative market share is no guarantee of a cost savings or competitive advantage.
– Low relative market share is not always an indicator of competitive failure or lack of profitability.
– Multifactor models (e.g., the McKinsey matrix) are better though imperfect.
Session 03 © Furrer 2002-2008 21
The McKinsey Matrix
Session 03 © Furrer 2002-2008 22
Restructuring
Key CharacteristicsSeek out undeveloped, sick or threatened organizations or industries
Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations
Parent company (acquirer) intervenes and frequently:- Changes sub-unit management team
- Shifts strategy
- Infuses firm with new technology
- Divests part of firm
- Makes additional acquisitions to achieve critical mass
- Enhances discipline by changing control systems
Session 03 © Furrer 2002-2008 23
Assumptions
Requires keen management insight in selecting firms with depressed values or unforeseen potential
Must do more than restructure companies
Need to initiate restructuring of industries to create a more attractive environment
Restructuring
Session 03 © Furrer 2002-2008 24
External Incentives
Relaxation of Anti-Trust regulation allows more related acquisitions than in the past
Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions
Incentives to Diversify
After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments
Session 03 © Furrer 2002-2008 25
Diversification and Firm PerformanceP
erfo
rman
ce
Level of Diversification
DominantBusiness
UnrelatedBusiness
RelatedConstrained
Ref.: Palich, Cardinal and Miller, 2000
Session 03 © Furrer 2002-2008 26
Session 03 © Furrer 2002-2008 27
Incentives to Diversify
Poor performance may lead some firms to diversify to attempt to achieve better returns
Firm may diversify into different businesses in order to reduce risk
Internal Incentives
Firms may diversify to balance uncertain future cash flows
Managers often have incentives to diversify in order to increase their compensation and reduce employment risk, although effective governance mechanisms may restrict such abuses
Session 03 © Furrer 2002-2008 28
What Resources, Capabilities and Core Competencies do we possess that would allow us to outperform competitors?
Is it possible to leapfrog competitors?
What Core Competencies must we possess to succeed in a new product or geographic market?
Will diversification break up capabilities and competencies that should be kept together?
Will we only be a player in the new product or geographic market or will we emerge as a winner?
What can the firm learn through its diversification? Is it organized properly to acquire such knowledge?
Issues to Consider Prior to Diversification
Session 03 © Furrer 2002-2008 29
Alternative Diversification Strategies
Efficient Internal Capital Market Allocation
Transferring Core Competencies
Sharing Activities
Restructuring
Related Diversification Strategies
Unrelated Diversification Strategies
1
2
3
4
Efficient Internal Capital Market Allocation
Session 03 © Furrer 2002-2008 30
M&A Wave Era
PortfolioManagement(1960s, 1970s)
Restructuring
(1980s)
Transfer of Skills / Sharing Activities
(1990s)
Corporate Role Passive:
Banker/Investor; Antitrust law
Active:
Surgeon; Asset striping
Active:
Coach & Architect
Focus of Strategy Business Portfolio; Conglomerates
Coordination of businesses; Divestitures
Sharing of knowledge; Relatedness hypothesis
Operational Approach
Lowering costs of capital, increasing financial cash flows; managerial synergies
Higher operating cash flows
Coordination of resources; Economies of scale and scope
Corporate Strategy and Shareholder Value Creation
Source: Business Horizons, January-February 1997, p. 34.
Session 03 © Furrer 2002-2008 31
M&A Wave Era
PortfolioManagement(1960s, 1970s)
Restructuring
(1980s)
Transfer of Skills / Sharing Activities
(1990s)
Results Efficient markets; Conglomerate discounts: the whole less valuable than the sum of its parts
Many distressed businesses result in widespread divesture
Dept financed M&A by raiders beneficial, full-blown M&A less beneficial
Partly beneficial, but “deptism” occurs, limiting ultimate success
Potential for creation of value high, post-M&A management crucial (implementation failures, excess bidding)
The brave new world of corporate synergy?
Corporate Strategy and Shareholder Value Creation
Source: Business Horizons, January-February 1997, p. 34.
Session 03 © Furrer 2002-2008 32
1980 1990 2000
Focused = 95% or more of sales within main industry.Dominant Business = Between 80% and 95% of sales within main industry.Diversified = Between 20% and 40% of sales outside main industry.Highly Diversified = More than 40% of sales outside main industry.
Reference: Franko, 2004
Level of Diversification
Session 03 © Furrer 2002-2008 33
How Parents Create Value
Stand-alone influence Linkage influence
Central functions and services Corporate development
Source: Goold, Campbell and Alexander, 1994
Session 03 © Furrer 2002-2008 34
Summary Model of the Relationship between Firm Performance and Diversification
Resources
Capital Market Intervention and
Market for Managerial Talent
DiversificationStrategy
FirmPerformance
InternalGovernance
StrategyImplementation
Incentives
ManagerialMotives
Ref.: Hoskisson and Hitt, 1990
Session 03 © Furrer 2002-2008 35
• Rumelt’s Strategy, Structure and Economic Performance (1974) represents a landmark in the study of corporate strategy.
• His key finding was the superiority of related over unrelated diversification.
• Empirical studies of the relationship between diversification strategy and performance initially confirmed the superiority of related diversification over unrelated diversification (Bettis, 1981; Christensen and Montgomery, 1981; Rumelt, 1982: Lecraw, 1984).
Summary
Session 03 © Furrer 2002-2008 36
• However, as the volume of empirical work on the relationship between diversification strategy and performance grew, the findings became more inconsistent.
• Some studies found no significant relationship between relatedness in diversification and profitability (Grant et al., 1988)
• While other studies found unrelated diversification to be more profitable than related diversification (Michel and Shaked, 1984; Luffman and Reed, 1984; Lubatkin, 1987).
• Some other studies observed a curvilinear relationship (Grant et al, 1988; Lubatkin and Chatterjee, 1994; Palich et al. 2000).
Summary
Session 03 © Furrer 2002-2008 37
• Recent investigations of the relationship between corporate strategy and performance have featured more refined methodologies.
• These have deployed more sophisticated measures of diversification (Hoskisson et al. 1993; Nayyar, 1992; Robins and Wiersema, 1997) and the use of a wider range of control variables.
• Particular attention has been devoted to the interactions between corporate strategy and industry characteristics (Montgomery and Wernerfelt, 1991; Stimpert and Duhaime, 1997) in addition to the links between resources and diversification (Chatterjee and Wernerfelt, 1991).
Summary
Session 03 © Furrer 2002-2008 38
• In other areas of corporate strategy, the picture is less confusing. Greater consistency found in relation to vertical integration and international diversification.
• In relation to vertical integration, Rumelt’s (1974) fining hat vertically integrated firms underperform both specialized and diversified firms has been supported by subsequent evidence.
• In relation to international diversification, multinationals have tended to outperform nationally focused firms (Grant, 1987; Grant et al., 1988; Hitt et al., 1997)
Summary
Session 03 © Furrer 2002-2008 39
• Recent evidence concerning the relationship between diversification and performance includes the consequences of refocusing initiatives.
• The results of the divestments of diversified businesses by conglomerates suggest that narrowing business scope leads to increased profitability and increased stock market valuation.
• The stock market’s verdict on diversification is unambiguous. The high price-earning ratios attached to conglomerates during the 1960s have been replaced by a ‘conglomerate discount’.
• The result was that diversified companies came under attack from leveraged-buyout specialists seeking to add value by dismembering these companies.
Summary
Session 03 © Furrer 2002-2008 40
• The main conclusion that arises from the empirical literature is that there is no simple and consistent relationship between diversification and firm performance.
• In answering the question: ‘Does diversification enhance firm performance?’ the most we can say is: ‘It all depends’.
Conclusion
Session 03 © Furrer 2002-2008 41
Next Session: Case Study 1
Microsoft’s Diversification Strategy
1. What opportunities and challenges await Microsoft in markets in which it did not have proprietary advantage?
2. What specific strategies did it have to adopt to capitalize on the opportunities and counter the challenges?
3. How best could Microsoft execute its diversification strategy?