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
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2
Q

Motives for Diversification

A
  • Diversification should be in the interest of shareholders not of managers (E.g. for Managerial arrogance/ Empire)
    1. Growth -> But! cost of entry into different product market
    1. Risk Spreading -> But! Limited value creation
    1. 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
    1. Value Creation -> Economies from Internalizing Transactions (Internal capital & labor market transfer)
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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
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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
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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
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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
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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
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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)
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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
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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
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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)
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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
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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
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