Chapter 12 Flashcards
What is Diversification Strategy?
Diversification is a corporate strategy that involves expanding a company’s product or service offerings into new markets or industries. This can be achieved through various means, such as acquisitions, mergers, or internal development.
Why does companies Diversify?
Companies diversify for various reasons, including:
Growth: to increase revenue and expand into new markets
Risk Reduction: to reduce dependence on a single industry or market
Increasing Shareholder Value: to create value for shareholders by expanding into new areas
What is a conglomerate?
A conglomerate is a company that has diversified into multiple, unrelated industries. This type of company was popular in the 1960s and 1970s, but has since fallen out of favor due to the conglomerate discount, where the stock market values diversified companies at less than the sum of their parts.
What is the relationship between Diversification and Performance?
he relationship between diversification and performance is complex, and research has shown that:
Related diversification (expanding into related industries) can create value for shareholders
Unrelated diversification (expanding into unrelated industries) can destroy value for shareholders
Corporate parenting (the ability of the parent company to add value to its subsidiaries) is critical to the success of diversification
However:
Diversification can lead to an inverted-U relationship between diversification and profitability, where diversification enhances profitability up to a point, after which further diversification reduces profitability due to increasing costs of complexity.
Can Diversification reduce risk?
No.
The idea that diversification can reduce risk is a common misconception. In reality, systematic risk (the risk that is correlated with overall market returns) cannot be reduced through diversification.
How can Diversification create value?
Diversification can create value for shareholders through:
Economies of scope: reducing costs and increasing efficiency by sharing resources and expertise across different businesses
Internalizing transactions: reducing transaction costs by bringing different businesses under common ownership
Corporate parenting: adding value to subsidiaries through the parent company’s expertise and resources
What are some types of diversification?
There are several types of diversification, including:
Related diversification: expanding into related industries
Unrelated diversification: expanding into unrelated industries
Horizontal diversification: expanding into new markets or industries at the same level of the value chain
Vertical diversification: expanding into new markets or industries at different levels of the value chain
What are three essential tests for value creation from diversification, according to Michael Porter?
The attractiveness test: The industries chosen for diversification must be structurally attractive or capable of being made attractive.
The cost-of-entry test: The cost of entry must not capitalize all the future profits.
The better-off test: Either the new unit must gain competitive advantage from its link with the corporation or vice versa.
What are some Synergies that come from Diversification?
Economies of scope: The ability to share resources and capabilities across different businesses
Tangible resources: Such as distribution networks, IT systems, sales forces, and research laboratories
Intangible resources: Such as brands, corporate reputation, and technology
Organizational capabilities: Such as design, market analysis, advertising and promotion, retail management, and craftsmanship
What is Demand-Side Economies of Scope?
Demand-side economies of scope arise when customers benefit from buying multiple products from the same company. This can include:
Convenience of one-stop shopping
Ease and time-saving of funneling online purchases through a single website
What’s the meaning of Economies from Internalizing Transactions?
Economies from internalizing transactions can be achieved by exploiting economies of scope in resources and capabilities. However, this does not necessarily require a company to own the businesses that share these resources and capabilities. Instead, companies can:
exploit economies of scope in resources and capabilities simply by selling or licensing the use of the resource or capability to another company
What is the Parenting Advantage
?
The parenting advantage refers to the value-adding role of the corporate center in a diversified company. For a company to successfully diversify, it must be able to add more value to a business than any other potential parent. This requires:
Applying the management capabilities of the parent company to the business
Having the necessary resources and capabilities to support the business
What is good with Internal Capital Markets?
Internal capital markets can be more efficient than external capital markets in certain situations. For example:
Diversified firms can maintain a balanced portfolio of cash-generating and cash-using businesses, avoiding the transaction costs of external capital markets
Private equity firms can operate efficient internal capital markets by managing multiple funds and avoiding the transaction costs of external capital markets
What are the benefits with Internal Labor Markets?
Internal labor markets can also provide advantages such as:
Transferring employees between businesses and avoiding some of the costs of hiring and firing
Attracting a higher caliber of employee due to the broader set of career opportunities available
Building detailed information on the competencies and characteristics of employees
What are the Advantages of Diversification?
Diversification can provide several advantages, including:
Reduced risk through portfolio diversification
Increased opportunities for growth and expansion
Improved economies of scope through shared resources and capabilities
Enhanced competitive advantage through increased market presence and brand recognition
