4. Diversification Flashcards
1
Q
Measurements for Successful Diversification
A
- Objective look at its existing businesses/ value added by the corporation
- Understanding should guide future diversification/ development of skills & activities with which to select further new businesses
2
Q
Motives for Diversification
A
- Diversification should be in the interest of shareholders not of managers (E.g. for Managerial arrogance/ Empire)
- Growth -> But! cost of entry into different product market
- Risk Spreading -> But! Limited value creation
- Value Creation -> By sharing resources and capabilities across multiple businesses/ EOScale = Decrease average cost of production through different products/ EOScope = Increase in volume of a single product
- Value Creation -> Economies from Internalizing Transactions (Internal capital & labor market transfer)
3
Q
Porters Three Essential Test:
A
- Attractiveness Test = Attractive industry?
- Cost of Entry Test = Cost of entry must not exhaust all future profits
- Better-Off Test = Potential to generate a competitive advantage (synergy)
- Requires a dynamic view because these tests are interconnected
4
Q
Diversification and Shareholder Value comparison
A
- Diversified firms not always outperform non-diversified firms
- No significant causality between diversification and profitability
- But! evidence of an inverted-U relationship
- Performance outcomes depend not only on costs/ benefits of diversification but also on its implementation
5
Q
Relatedness and Unrelatedness
A
- Related diversification outperforms unrelated diversification
- Unrelatedness = No clear opportunity to transfer skills or share important activities (Philip Morris & 7UP)
- Relatedness = Potential for sharing and transferring resources and capabilities between businesses
6
Q
Types of Relatedness
A
- Operational Relatedness = Synergies from sharing resources across businesses (Brands, Joint R&D)
- Strategic Relatedness = Synergies at corporate level/ Ability to apply common management capabilities & systems & resource allocation processes/ In different businesses
7
Q
Evolution of diversification strategies
A
- Past two decades strong trend towards firm specialization rather than diversification
- But some Outliers: Chae bol, Keiretsu, Latam Group, Major Business House in India
8
Q
Video Advantages Financial Reasons to diversify
A
- Reinvest profits into other growth opportunities
- Capitalize on opportunities in related markets
- Reduce volatility by diversifying assets (E.g. unsuccessful movies)
- Reduce overall risk by diversifying assets (E.g. reducing employment)
9
Q
Video Disadvantages Financial Reasons to diversify
A
- Shareholders can diversify for themselves -> Retained profit must be shared with dividends and they decide where to reinvest
- Internal capital market not necessarily more efficient than public capital markets
- Combining units can compound risks across units by raising costs of volatility and risk of bankruptcy
10
Q
Video Advantages Operational Reasons to diversify
A
- Exploiting Economies of Scale and Scope
- Transfer/ Leverage assets (Know-how/ Technology between businesses
- Improve coordination among businesses
11
Q
Video Disadvantages Operational Reasons to diversify
A
- Synergies are hard to realize in practice -> Carefully check feasibility before a merger
- Often synergies can be better achieved through market mechanisms (E.g. outsourcing, alliances, contracts)
12
Q
Video Advantages Strategic Reasons to diversify
A
- Raise rivals costs
- Multipoint competition = Competitors are in similar markets -> Reduces incentives to fight
- Eliminating competition by encouraging price war among internal BU -> Competitors might have limited access to capital
- Minimizing transaction costs -> Contracts are costly and might be incomplete
13
Q
Video Disadvantages Strategical Reasons to diversify
A
- May be antitrust violation
- Monopoly position must be maintained in the upstream or downstream activities
- Complexity makes such tacit collusion difficult and when price wars break out they tend to be severe
- Assumes that trust is difficult to achieve in market due to opportunistic behavior of players