Lecture 6: Diversification Strategy

Question 1

Business level strategy vs. Corporate level strategy

Answer 1

*Business level strategy- determined at individual business level, competitiveness is driven excellent resource and industry positioning.

*Corporate level strategy- determined by balance of individual business mix. Focus on product, partners, geographic sphere.

Question 2

Product scope: 2 types

Answer 2

1. FOCUSED COMPANIES
   managers/business decides to focus on few business line selection. Usually focus on single industry.
   ex. Tesla, Zara etc.
2. DIVERSIFIED COMPANIES
   Do not focus on one thing but work in a very broad line of businesses, span their activities across multiple industries.
   ! Can experience pressure to keep all the business units together !
   ex. Tata group, Siemens, Johnson & Johnson

Question 3

Diversification discount

Answer 3

Diversification discount:
It is common for market to assign lower values to conglomerates that engage in different activities rather than focused on single/few activities.

Example: Many investors prefer to invest in focused firms (working in specific industry). Investors are suspicious of conglomerate multi-business. The risk is uncertain because of the complex structure.

Question 4

Related diversification

Answer 4

Growth strategy to expand business into new markets/products which are in synergy closely related to their current business operations.

Chosen expansion market share similarities (distribution channels, customer segment, technology). Allows to further expand its existing strengths.

!!!Note: this strategy provides bigger value to the “parent” company than to the “offspring” –> PARENTING ADVANTAGE. But still has net positive effects.

Question 5

History of diversification key points.

Answer 5

1. Second industrial revolution
   Diversification start with rise of mass production techniques.
2. New structures
   diversification innovation–> adapt M-form structure.
   multi-divisional; decentralised decision making.
3. Diversification era
   Many conglomerate firms created by multiple unrelated acquisitions.
   Senior management does not need to have industry specific knowledge, but specialise activities.
4. Refocusing
   Firms sell their “unprofitable” “un-core” businesses. Focus on core competencies, cut bureaucracy costs.
5. Diversification comeback (until now)
   Investors willing to invest in diversified companies if parenting effect is obvious.

Question 6

Parenting effect and how can it be obvious?

Answer 6

strategy provides bigger value to the “parent” company than to the “offspring” –> PARENTING ADVANTAGE.

*firms use related diversification only
*product scope must be limited
*skills, capabilities, technologies must be transferable from parent to subsidiaries
*long-term vision of parent clearly articulated
*shared values
*must be visible in organisation form

Question 7

Diversified company- reasons

Answer 7

1. Economies of scope
   cost savings and efficiency that business can achieve by selling multiple products/services. Arise when joint production companies share resources, capabilities etc.
2. Growth
   low-growth but cash-flow rich industry with little diversification–> diversification to grow.
3. Risk reduction
   reduce variance by combining cash-flows. Reduce financial risk exposure.
4. Strategic control
   moving into business that will offer valuable inputs. “cut out the middleman” and prevent control issues.
5. Parenting advantage
   Management skills and resources of parent company.
   Parent with established reputation can help subsidiary to gain trust in market.

Question 8

Agency problem

Answer 8

*Principal- owner of company
*Agent- manager running company

Agency problem 1:
small shareholders fear “lazy, incompetent or over-ambitious managers”.
difficult to monitor managers in multidivisional companies–>
too much independence of managers, because they think that shareholders will not notice.

ex. Destroy old plants and build new–> overall productivity and profitability decrease.

Agency problem 2:
small shareholders fear “large and controlling owners” because they can pursue their own interest at the expense of small owners with less power.

Tunnelling

Question 9

Tunnelling (Agency problem 2)

Answer 9

Unethical and illegal practices where most shareholders direct assets or future business to themselves for personal gain.