quiz 4 Flashcards
When does diversification occur?
Occurs when a firm develops a new, autonomous unit, as opposed to an extension of a current product line
Each unit within the firm
Competes in a unique product market
Can control the resources and capabilities required to compete effectively
Can develop an effective strategic plan for the unit
Including a unique mission for the business within the firm
Motivations for diversification
To reduce earnings volatility (shareholders can do this themselves at much lower cost)
To acquire a new source of revenues and earnings
To reposition current businesses
To employ current resources and capabilities in new markets
Cost Driver - Scale/Volume Economy
Average cost declines as volume increases based on high recurring fixed costs or sunk costs
Cost Driver - Scope Economy
Cost of producing two products together is lower than the cost of producing them separately
Cost Driver - Learning Curve
Cost declines with cumulative volume as learning takes place and practices improve
Attractive Industries
Large ultimate size of new market
A high growth rate in demand
A future industry structure in which the startup will have a favorable position
All inputs of the parent to its new businesses can be seen as alternatives to inputs from an external market
Every diversification event is an entry event
New Venture Governance
Multiple perspectives on business unit valuation across the firm
Separate resource allocation mechanisms for existing and startup business units
Different management incentive schemes for existing and startup businesses
Alternative mechanisms for inter-unit coordination and control
Diversification Through Acquisition
About 40% of all acquisitions occur in a merger wave
Four major waves with peaks in 1900, 1927, 1970 and 2000
Three minor waves with peaks in 1919, 1948 and 1986
Why do they occur?
Shifts in the rules of competition in some industries
Stock market booms which make acquirers feel rich
Top management optimism
Empirics on Acquisition Performance
Target firm shareholders typically benefit from being acquired
Acquiring firm shareholders are likely to benefit when:
Deals are made with cash
Targets are private
Multi Business Structure
Organizing functional activities under a product division manager lowers coordination costs within the product line
Resource allocation across product lines is improved by establishing a general office at the corporate level
Tasks of Corporate Management
Allocate resources across business units
Manage the portfolio of businesses
Organize and manage relationships among businesses
Centralize activities across businesses
Develop top-down initiatives
Develop corporate infrastructure
Resource Allocation
In efficient financial markets, diversified firms with unrelated businesses typically incur a diversification discount:
The firm’s market value is lower than the aggregate value of its businesses calculated as if they were independent
Explaining Diversification Discount
The multibusiness firm performs poorly and cannot improve by adding more businesses
The firm buys good businesses and degrades their performance through poor integration and post integration management
The firm is out-performed by focused firms in each of the industries it competes in
All of these may be true, but only one is necessary
Unrelated Diversification
The businesses were managed to support short-term corporate financial goals
The complexity of the business portfolio exceeded corporate management’s capability
There was no enduring economic rationale at the level of operations for the business units to be in the same corporation
Transfer Pricing - Mandated Market Price
More appropriate when internal buyer competes on value
