Diversification Flashcards
Why Diversify (be in many different businesses)?
- Economies of Scale And Scope
- Market Power
- Superior internal Financial Structures
- Risk Reduction
Economies of Scale and Scope from diversification
due to shared activities and competencies, it creates synergies by eliminating duplicate resources and shares information
Example of Economies of Scale and Scope
Disney: the businesses rely on product extensions, synergies in the brand, and synergies in management and leadership
Why should an animation company own an amusement park?
This levels out the revenue streams - movies don’t always work out but then can create rides off of them and keep the brand alive and have a retail branch
Market Power from diversification
This strengthens bargaining power, leverages strengths, and reduces rivalry
risk reduction from diversification
(Kay, 1997)
unrelatedness of a conglomerate is an advantage in dealing with unforeseeable risks and can reduce risks for employees and managers .. but this does nothing for value creation for investors - they diversify by investing
example of risk reduction through diversification
diversification can stabilize cashflows and avoid cyclical fluctuations as was the case with Rossignol: as a ski brand, Rossignol bought Time a french bike brand in 2016 and Felt Bike, a US Firm in 2017 for seasonal balance off piste as climate change brought challenges to their 2014/15 ski seasons
Issues
Bureaucracy, managerial Influence, cross-subsidization
Issue Bureacracy
size requires standardization, but may neutralize synergies (Porter 1985) which can be a central advantage
issue of managerial influence
management might be spending time on politics rather than management
and skills are not always perfectly transferable
cross-subsidization issue
loss making areas can drain from profit-making areas which is the opposite of the point of diversification, which is to capitalize on synergies and complementary resources
Potential consequence: trading at a discount
(Berger& Ofek, 1995) diversified firms trade at a discount compared to undiversified firms at an estimated amount of 13-15% probably due to cross-subsidization and overinvestment
Issues with studying it
Endogeneity (whether a firm diversifies is not independent of past performance)
under sampling of failure & causality
Dominant Logic Approach
Prahalad & Beltis 1986
Pick a diversification strategy that fits with the firm’s dominant strategy
(strategically similar businesses need a single dominant logic, while diversification with strategic variety requires multiple dominant logic)
Related v unrelated diversification
related is better (Rumelt) because it is harder to maximize value without synergies or market power
