Intensive Strategies

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Diversification Strategies

Why Firms Diversify?

- To grow

- To more fully utilize existing resources and capabilities.

- To escape from undesirable or unattractive industry environments.

- To make use of surplus cash flows.

Advantage:

- Lessen the risk of being in a single industry.

Disadvantage:

- More difficult to manage.

Diversification decisions involve two basic issues:

- Is the industry to be entered more attractive than the firm’s existing business?

- Can the firm establish a competitive advantage within the industry to be entered? (i.e. what synergies exist between the core business and the new business?)

Aim of diversification should be to create value or wealth in excess of what firms would enjoy without diversification.

Types of Diversification Strategies

- Related Diversification (Horizontal)

Strategy of adding related or similar product/service lines to existing core business, either through acquisition of competitors or through internal development of new products/services.

- When value chains posses competitively valuable cross-business strategic fits.

- A process that takes place when a business expands its activities into product lines that are similar to those it currently offers.

- Either through acquisition of competitors or through internal development of new products/services.

Advantages

- Opportunities to achieve economies of scale and scope.

- Opportunities to expand product offerings or expand into new geographical areas.

Disadvantages

- Complexity and difficulty of coordinating different but related businesses.

- Unrelated Diversification (Conglomerate)

An unrelated diversification strategy favors capitalizing on a portfolio of businesses that are capable of delivering excellent financial performance in their respective industries, rather than striving to capitalize on value chain strategic fits among the business.

A form of diversification when the business adds new or unrelated product lines and penetrates new markets.

Firms pursue this strategy for several reasons:

- Continue to grow after a core business has matured or started to decline.

- To reduce cyclical fluctuations in sales revenues and cash flows.

Problems with conglomerate or unrelated diversification:

- Managers often lack expertise or knowledge about their firms’ businesses.

- Successful diversification strategies result from the ability of managers to develop skill and competency at MANAGING diversification.

Managers must develop two important types of mental models:

- Must have well-developed understandings of their firm’s diversity and relatedness that define their companies.

- Understandings of how their firm’s businesses are related are important for 2 reasons:

- They will influence how managers describe their organizations to important stakeholders.

- Managers’ understandings also describe or suggest how their businesses are related to each other.

- Must also have well-developed beliefs about how diversification should be managed in order to achieve synergies.

- How to coordinate the activities of businesses in order to achieve synergies.

- How to allocate resources to the various businesses in a diversified firm.

- Whether various functional activities such as engineering, finance and accounting, marketing and sales, production, and research and development should be centralized at the corporate HQ or be decentralized and operated by SBU managers.

- How to compensate and reward business unit managers so that their goals and objectives are best aligned with those of the organization.

Size alone does not guarantee firms an advantage.

- Coordination required to exploit economies of scale and scope is not without cost.

- Size creates additional challenges and difficulties, including problems of communication and coordination.

Higher levels of diversification are not incompatible with high performance -- nor do they necessarily imply that firms will suffer lower performance levels.

Critical factor in determining success is the level of management expertise in formulating and implementing corporate strategy.

- More difficult for diversified firms.

- Managers of large diversified firms possess a variety of well-developed mental models that provide them with powerful understandings of how to manage their firms.