Strategic Management

Chapter 8

Corporate diversification

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 What is Corporate Diversification?
Diversification is a business development strategy
in which a company develops new products and
services, or enters new markets, beyond its existing
ones.
Diversification strategy can kick-start a struggling
business, or it can further extend the success of
already highly profitable companies
Corporate or product diversification represents a
strategic decision. Specifically, it addresses the
strategic question regarding in which businesses the
firm will compete.
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  For example, if you have a dine-in restaurant
in one town, opening a second restaurant in the
next town is expansion, not diversification.
Offering cooking classes during the mornings,
when you are not open for breakfast, would be
another example of diversification.
When a firm operates in multiple industries
simultaneously, it is said to be implementing a
product diversification strategy.

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 Why is diversification important in business?
There are four key reasons why businesses
adopt a diversification strategy:
The company wants more revenue
The company wants less economic risk
The company’s core business is in decline
The company wants to exploit potential
synergies.

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 Types of Corporate Diversification
Limited Corporate Diversification
firm has implemented a strategy of limited
corporate diversification when all or most of its
business activities fall within a single industry
and geographic market.
Two kinds of firms are included in this
corporate diversification category:
Single-business firms
Dominant-business firms

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 Related Corporate Diversification
As a firm begins to engage in businesses in more than
one product or market, it moves away from being a
single-business or dominant-business firm and begins
to adopt higher levels of corporate diversification.
When less than 70 percent of a firm’s revenue comes
from a single-product market the firm has
implemented a strategy of related corporate
diversification.
An economy of scope exists when the value created
by several businesses operated together is greater than
the value of these businesses operated separately.
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 Unrelated Corporate Diversification
 Firms that pursue a strategy of related corporate
diversification have some type of economy of
scope that benefits the different businesses they
pursue. However, it is possible for firms to pursue
numerous different businesses and for there to be
no such economies of scope .
When less than 70 percent of a firm’s revenues is
generated in a single-product market and when the
businesses in a firm’s portfolio share few, if any,
economies of scope, then that firm is pursuing a
strategy of unrelated corporate diversification.
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 The Value of Corporate Diversification
For corporate diversification to be economically
valuable, two conditions must hold.
First, there must be some valuable economy of
scope among the multiple businesses in which a
firm is operating.
Second, it must be less costly for managers in a
firm to realize these economies of scope than for
outside equity holders on their own.

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 What Are Valuable Economies of Scope?
As suggested earlier, economies of scope exist
when the value created by operating several
businesses simultaneously is greater than the value
of operating these businesses separately.
In this definition, the term scope refers to the range
of businesses in which a diversified firm operates.
Economies of scope are valuable to the extent that
they do, in fact, increase a firm’s revenues or
decrease its costs, compared with what would be
the case if these economies of scope did not exist,
or had the potential to exist but were not exploited.
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 Firm Size and Employee Incentives to Diversify
Employees may have incentives to diversify
that are independent of any benefits from other
sources of economies of scope.
employee incentives reflect the interest of
employees to diversify because of the
relationship between firm size and management
compensation.
By making large acquisitions, a diversified firm
can grow substantially in a short period, leading
senior managers to earn higher incomes.
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 Direct Duplication of Diversification
The extent to which a valuable and rare corporate
diversification strategy is depends on how costly it is
for competing firms to realize this same economy of
scope.
Shared activities, risk reduction, tax advantages, and
employee compensation as bases for corporate
diversification are usually relatively easy to duplicate.
The only duplication issues for shared activities
concern developing the cooperative cross-business
relationships that often facilitate the use of shared
activities.
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 It is difficult-to-duplicate economies of scope
include core competencies, internal capital
allocation efficiencies, multipoint competition,
and exploitation of market power.
The realization of capital allocation economies
of scope requires very substantial information-
processing capabilities.
Multipoint competition requires very close
coordination between the different businesses in
which a firm operates.

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 Substitutes for Diversification
Two obvious substitutes for diversification exist.
First, instead of obtaining cost or revenue
advantages from exploiting economies of scope
across businesses in a diversified firm, a firm may
decide to simply grow and develop each of its
businesses separately.
A second substitute for exploiting economies of
scope in diversification can be found in strategic
alliances. By using a strategic alliance, a firm may
be able to gain the economies of scope it could have
obtained if it had carefully exploited economies of
scope across its businesses.
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