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Corporate Strategy - Diversification and the Multibusiness Company
Transcript of Corporate Strategy - Diversification and the Multibusiness Company
Images from Shutterstock.com Chapter 8: Corporate Strategy - Diversification and the Multibusiness Company Renée Higgins
COMM6006 - Business Policy: Strategy Formulation
MBA Presentation A business that creates characters, movies, videos and theatrical productions. In this Strategy course so far, we
have focused on business strategy
for single-business enterprises. Today we will learn about strategy in multi-business enterprises, which are called diversified enterprises. Tylenol operates in one industry (nonprescription drugs). Band-Aid operates in one industry (first-aid products). Johnson's Baby operates in one industry (baby products). Tylenol, Band-Aid and Johnson's Baby are all businesses which are owned by: Johnson & Johnson is a diversified company. Instead of developing a business strategy for one industry, they need to develop business strategies for each different industry that they operate in. This is often entrusted to the heads of each individual business. Outline:
Introduction: How does strategy for a diversified enterprise compare to strategy for a single-business enterprise?
Part 1. When, why and how can a company become diversified?
Part 2. Should a company diversify into related or unrelated businesses?
Part 3. How can we evaluate the strategy of a diversified company?
Conclusion: Questions? On top of strategies for each of its individual businesses, J&J also needs to develop a corporate strategy for the overall collection of its businesses. This is the task of its top-level executives.
What is the strategy that brings together the collection of Tylenol, Band-Aid and Johnson's Baby businesses? Diversified Company Strategy 1. Picking new industries 2. Picking businesses with value-chain matchups 3. Establishing
investment priorities 4. Enhancing performance
of the corporation Which industries should the company enter? What should the mode of entry be? They can start the new business themselves, acquire
an existing business or form an alliance/joint venture. Value-chain matchups create competitive
advantage because the company can leverage
existing resources and capabilities: Example: J & J acquired McNeil Laboratories and their Tylenol product in order to enter the nonprescription drugs industry. Sharing of skills/technology across businesses reduces time & cost Sharing of facilities and resources reduces cost Using existing brands and distribution networks increases sales Collaboration and knowledge-sharing across businesses improves them all J & J has
both Tylenol and
in the nonprescription
drugs industry Value chain relationships create competitive advantage 1. Priorities need to be determined so
that resources can be put into the company's most attractive businesses. 2. Resources should be used where earning potentials are highest. 3. Businesses performing poorly should be divested to free up resources for better performing or new businesses. Options: 1. Pursue opportunities in existing businesses 2. Enter new industries 3. Divest existing businesses for better overall company 4. New face by divesting & acquiring businesses No urgency to diversify if all is
good with current industry. Reasons to diversify: Mature or declining market - profitable growth difficult Too much competition in industry diminishes opportunity Demand for product diminishes due to alternative technologies, substitute products or evolving needs When resources or capabilities can be better employed in another business. Diversification should especially be considered when: 1. Technologies and products in another business complement existing business 2. Resources and capabilities can be used in another business to get competitive advantage 3. Opportunities exist to reduce costs across businesses 4. Brand name can be transferred to other products to drive sales in business WHEN? WHY? Add shareholder value 1. Business must have
attractive potential returns 2. Cost to enter must not erode good profitability 3. Synergy. The sum of its parts must be greater than the whole.
The businesses need to perform better together than they would separately. Their combined profits must be higher after diversification. 1+1 = 3! Must pass
three tests: HOW? Acquisition Internal Start-up Joint Ventures - quicker than starting new - overcomes entry barriers (technology, supplier relationships, slow growth, brand building, distribution) - access existing resources and capabilities - focus on being the best rather than starting up - expensive to buy good company (need to pay 30-40% premium over actual value in order to convince owners to sell) - struggling companies are cheaper but require more work and time - high integration costs - must be able to integrate into buyer's existing culture - new business from scratch - time consuming and uncertain but may be most profitable option - enter new industry with no acquisition possibilities - needs to overcome entry barriers - need to take time and money growing new business - high risk - culture could impede innovation - good if resources are available, time is not an issue, less cost than acquisition, no large rivals, extra capacity in industry won't affect demand balance, competition slow to react - new business owned by more than one company 1. share risk, cost, complexity 2. combine all resources and competencies for best result 3. entry into foreign country easier with local partner - potential conflicts from differing objectives, culture clashes, disagreements and also have less control of business Resources and Capabilities - does firm have what it needs to develop a new business internally? Entry Barriers Speed Cost - Can entry barriers be overcome on company's own? - how soon does the new business need to be ready? - Which mode is more cost effective? Should the company expand into related businesses,
unrelated businesses, or a mix of both? Related - Strategic fit with existing businesses
Key value chain/resource matchups
Transfer specialized skills/technology
Achieve economies of scope
Leverage brand name
Cross-business collaboration/sharing to drive innovation of all businesses
eg: J&J prescription and nonprescription drugs
Competitive advantages come from lower costs and differentiation Unrelated - Enter really different businesses
No value chain/resource matchups
Can't use existing specific skills/technology, only general ones
Less economies of scope
Not similar enough to leverage brand
eg. specialty foods, candles and matting products
Competitive advantages come from pursuing new opportunities Related Businesses can share generalized resources (legal, human resources, IT, accounting, budgeting, finance) but the main competitive advantage comes from the ability to share specialized resources and capabilities across the related businesses.
Examples: Economies of scope result from sharing of the value chain: Unrelated Diversification
No cross-business strategic fit, focus on increasing company earnings
Expand to any industry with good profit and/or growth potential with ability to contribute significantly to company's total profits
Usually acquisitions instead of startups and joint ventures
Must still pass the 1+1=3 test to provide value to shareholders Related vs Unrelated Diversification Related Diversification Drawbacks of Unrelated Diversification: Mixing Related and Unrelated Diversification
Dominant-business companies have 50-80% related and 20-50% unrelated
Narrowly diversified companies have businesses in only a few industries
Broadly diversified businesses have businesses in many industries
Could also have several unrelated groups of related businesses (eg. GE has many home appliance businesses, also many different financial services businesses) 1. Assess attractiveness of current industries Steps to Evaluate the Strategy of a Diversified Company 2. Assess competitive strength of businesses 3. Check potential for strategic fit 4. Check whether resources meet requirements 5. Rank prospects to determine resource priorities 6. Strategize to improve overall performance The attractiveness of current industries indicates long-term company performance potential Calculate quantitative industry attractiveness scores to: - determine individual industry attractiveness - rank industries to prioritize resources - determine attractiveness of group of industries >5 = attractive The strength of each business in its industry reveals chance of success Calculate quantitative competitive strength to: - Determine position of business in industry - Rank strength of businesses - Determine competitive strength of all businesses as a group >6.7 = strong <3.3 = weak Can be skipped for unrelated diversification Important to identify strategic fit for related diversification and determine how a competitive advantage can be obtained from it Related diversification: - businesses have matching critical resource requirements in value chain Unrelated diversification: - corporate parent has general resources, capabilities and support that can be transferred to its businesses Financial resource fit
When company has cash flows to cover
capital requirements of businesses, pay dividends, meet debt obligations and be financially healthy Internal capital market: shift free cash flow from businesses to those needing additional capital (less debt) Cash hogs: businesses that can't generate enough internal cash flow to fund their own expansion (esp. in rapidly-growing industries) Cash cows: businesses that generate cash surpluses over what is needed to fund expansion (esp. in mature industries) Good financial resource fit exists when the surpluses from the mature cash cows can be used to fund the promising cash hogs Cash hogs may eventually become market leaders and self-supporting star businesses (future cash cows) Aside from cash flows, good financial fit exists when interest and debt payments don't cause companies to cut back on capital investments (healthy credit rating) and also when all of the individual businesses are adequately contributing to performance targets Nonfinancial resource fit
When company has enough administrative, managerial and competitive capabilities to support all of its businesses Does the company have the resources and capabilities required for its businesses to be successful (do competitive assets match KSFs?) Are the company's resources being stretched thin? This can be caused by too many acquisitions or problems transferring skills across very differentiated businesses Determine priority businesses for resource allocation and capital investment based on: - sales growth - profit growth - contribution to total company earnings - return on capital invested in the business - sometimes, cash flow - take into account the analysis from the other steps Options for resource allocation: - invest to strengthen or grow existing businesses - acquisitions into new industries or complimentary businesses - long-term R&D opportunities in new/existing businesses Strategic Financial - pay off debt - increase dividend payments - repurchase shares of company - build cash reserves Once a company has diversified, they have four strategic options: 1. Stick closely with existing business lineup - if there are attractive growth opportunities and value for shareholders - if company is in good position for the future, with good strategic and resource fit, then no need to make major changes - focus on getting the best performance from each business Next three options are good if change is required 2. Increase diversification: enter new industries with related or unrelated businesses - transfer resources and capabilities to related/complimentary businesses - adapt to changing buyer preferences or resource requirements - compliment or strengthen the competitiveness & market position of present businesses - reach new geographic markets to achieve economies of scale 3. Decrease diversification: divest weak or unattractive businesses - might be worth more to another company, concentrate on own strong businesses in a smaller number of industries - if market conditions have deteriorated, prospects are dim or business doesn't have strategic/resource fit 4. Increase and decrease diversification - companywide restructuring - divest businesses that are weak, are in unattractive industries, have low competitiveness or have bad fit - use cash from divestures and unused debt to acquire businesses in better, more promising industries Vision: "Trusted to enrich the health and wellness of every Canadian, every day" (Source: jnjcanada.com). 1. Supply Chain: easier procurement and logistics, manage less suppliers, volume discounts (eg. Dell) 2. Technology: R&D cheaper, quicker to market, share technological advances (Apple iPhone/iPod) 3. Operations: share expertise, share assembly lines (cars) 4. Sales & Marketing: one sales force, one website, shared ads, after-sales service combined, transfer marketing skills 5. Distribution: same warehouses, distributors or retailers (eg. L'Oreal sells different products to same drug stores) 6. Customer Service: same infrastructure, share knowledge Yamaha first offered motorcycles then entered the boat business (leveraged Yamaha brand to reduce advertising costs) Apple iPod brand excellence/specialty leveraged to the iPhone L'Oréal human hair/skin labs used for hair products, skin care, cosmetics Returns from the entire company exceed what each individual business could achieve on its own (1+1=3) Use cash flows from one business for another, lowers cost of debt
Acquire low-cost weak companies, restructure them to perform better
Corporate parenting through management, business development skills, incentive systems, financial resources, guidance.
Sharing of general resources and capabilities (accounting, human resources, IT, finance, legal, existing systems, etc) to lower total company costs due to less duplication
Sharing of brand through "umbrella branding" (eg. GE lightbulbs, GE Capital) to build customer trust in new brands 1. Demanding managerial requirements:
Many different industries and competitive environments
Get involved in problems they don't know much about
Easy to underestimate forces, misjudge potential, be overly optimistic
Could be 1+1 = 2 or less 2. Limited competitive advantage potential:
Hard to generate competitive advantage larger than the individual businesses would have on their own (1+1=3)
Don't have benefit of more effective/efficient value chains To benefit shareholders, don't diversify just to lower risk (can do that on their own) or to gain stability during economic downturns (all businesses could be affected). Instead, aim to grow 1+1=3 not 1+1=2 and ensure management is motivated for the right reasons (not just to increase number of businesses). Walt Disney: "It all started with a mouse".