chapter
8
CORPORATE STRATEGY:
DIVERSIFICATION AND
THE MULTIBUSINESS
COMPANY
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
LO1 Understand when and how diversifying into
multiple businesses can enhance shareholder
value.
LO2 Gain an understanding of how related
diversification strategies can produce crossbusiness strategic fit capable of delivering
competitive advantage.
LO3 Become aware of the merits and risks of
corporate strategies keyed to unrelated
diversification.
8-2
(cont’d)
LO4 Gain command of the analytical tools for
evaluating a company’s diversification strategy.
LO5 Understand a diversified company’s four main
corporate strategy options for solidifying its
diversification strategy and improving company
performance.
8-3
The Four Main Tasks in
Crafting Corporate Strategy
1. Picking new industries to enter and deciding
on the means of entry
2. Pursuing opportunities to leverage crossbusiness value chain relationships into
competitive advantage
3. Establishing investment priorities and steering
corporate resources into the most attractive
business units
4. Initiating actions to boost the combined
performance of the corporation’s collection
of businesses
8-4
Strategic Options for
Diversified Corporations
Sticking with the existing business
lineup and pursuing opportunities
presented by these businesses
Broadening the scope of diversification
by entering additional industries
Strategic
Options
Retrenching to a narrower scope of
diversification by divesting poorly
performing businesses
Broadly restructuring the business
lineup with multiple divestitures
and/or acquisitions
8-5
Corporate Strategy Alternatives
Vertical
Integration
Diversify into
Related
Businesses
PostDiversification
Strategic
Alternatives
l
Single Business
Concentration
Diversify into
Unrelated
Businesses
Diversify into
Related &
Unrelated
Businesses
l
l
Make new
acquisitions
Divest weak
units
Restructure
portfolio
l
Retrench
l
Liquidate
Corporate Strategy Alternatives
Vertical
Integration
Diversify into
Related
Businesses
PostDiversification
Strategic
Alternatives
Make new
acquisitions
l
Single Business
Concentration
Diversify into
Unrelated
Businesses
Diversify into
Related &
Unrelated
Businesses
Divest weak
units
l
Restructure
portfolio
l
l
Retrench
l
Liquidate
9-7
Competitive Strengths of a
Single-Business Strategy
 Less
ambiguity about “Who we are,” “What we
do,” “Where we are headed”
 Energies of firm can be directed down one
business path and keeping strategy responsive
to industry change.
 Less chance resources will be stretched too
thinly.
 Top Executives can maintain hands-on contact
with core business.
8-8
Risks of a Single Business Strategy
 Putting
all the “eggs” in one industry basket
 If
market becomes unattractive, a
firm’s prospects can quickly dim
 Unforeseen
changes can undermine
a single business firm’s prospects
 Changing customer needs
 Technological innovation
 New substitutes
8-9
When Business Diversification
Becomes a Consideration

Diversification is called for when:
 There are diminishing growth prospects in the present business
 An expansion opportunity exists in an industry whose
technologies and products complement the present business
 Existing competencies and capabilities can be leveraged by
expanding into an industry that requires similar resource
strengths
 Costs can be reduced by diversifying into closely related
businesses
 A powerful brand name can be transferred to the products of
other businesses
8-10
Building Shareholder Value:
The Ultimate Justification for
Business Diversification
Tests for building
shareholder value
through diversification
Industry
attractiveness test
Cost of entry
test
Better-off
test
8-11
Building Shareholder Value:
The Ultimate Justification for
Business Diversification
 Diversification
may result in building
shareholder value if it passes three tests:
 Industry Attractiveness Test—the target industry
presents good long-term profit opportunities
 Cost of Entry Test—the costs of entering the target
industry do not erode its long-term profit potential
 Better-Off Test—the firm’s businesses will perform
better together than as stand-alone firms, producing
a synergistic 1+1=3 effect on shareholder value
8-12
Approaches to Diversifying
the Business Lineup
Options for entering
new industries and
lines of business
Diversification by
acquisition of an
existing business
Entering a new line
of business through
internal development
Using joint ventures to
achieve diversification
8-13
Diversification by Acquisition
of an Existing Business
 Most
popular approach to diversification
 Advantages:
 Quicker entry into target market
 Easier to hurdle certain entry barriers:
Acquiring technological know-how
 Establishing supplier relationships
 Securing adequate distribution access

 The
big dilemma is whether to pay a
premium price to buy a successful firm or to
buy a struggling firm at a bargain price
8-14
Entering a New Line of Business
through Internal Development
 Is
more attractive when:
 The parent firm already possesses the resources
needed to compete effectively.
 There is ample time to launch a new business.
 Internal entry will cost less than entry via acquisition.
 The start-up does not have to compete head-to-head
against powerful rivals.
 Adding capacity will not adversely impact supplydemand balance in industry.
 Incumbent firms are likely to be slow or ineffective in
responding to an entrant’s efforts to crack the market.
8-15
Using Joint Ventures to Achieve
Diversification
A
good way to diversify when:
 The expansion opportunity is too complex,
uneconomical, or risky to go it alone.
 The opportunity in a new industry requires a
broader range of competencies and know-how than
an expansion-minded firm can marshal.
 Drawbacks:
 Potential for conflicting objectives
 Operational and control disagreements
 Culture clashes
8-16
Choosing the Diversification Path:
Related Versus Unrelated Businesses
 Related
Businesses
 Have value chains with competitively valuable
cross-business relationships that present
opportunities for the businesses to perform better
operating under the same corporate umbrella
than they could as stand-alone entities.
 Unrelated
Businesses
 Have value chains and resource requirements
that are so dissimilar that no competitively
valuable cross-business relationships are present.
8-17
 Core Concept 
Related businesses possess competitively
valuable cross-business value chain and
resource matchups; unrelated businesses
have dissimilar value chains and resources
requirements, with no competitively important
cross-business value chain relationships.
8-18
FIGURE 8.1
Strategic Themes
of Multibusiness
Corporations
8-19
The Case For Related Diversification
 Strategic
Fit
 Exists whenever one or more activities comprising
the value chains of different businesses are
sufficiently similar to present opportunities for:

Transferring competitively valuable resources, expertise,
technological know-how, or other capabilities from one
business to another.

Cost sharing between separate businesses where value
chain activities can be combined.

Brand sharing between business units that have common
customers or that draw upon common core competencies.
8-20
 Core Concept 
Strategic fit exists when the value chains of
different businesses present opportunities for
cross-business skills transfer, cost sharing, or
brand sharing.
8-21
FIGURE 8.2
Related Diversification Is Built upon Competitively
Valuable Strategic Fit in Value Chain Activities
8-22
Strategic Fit and Economies of Scope

Stem directly from strategic fit along the value
chains of related businesses when costs can be
cut by:
 Operating businesses under same corporate umbrella
 Taking advantage of the interrelationships anywhere
along the value chains of different businesses

Advantage:
 The greater the cross-business economies associated with
cost-saving strategic fit, the greater the potential for a related
diversification strategy to yield a competitive advantage based
on lower costs than rivals.
8-23
 Core Concept 
Economies of scope are cost reductions
stemming from strategic fit along the value
chains of related businesses (thereby, a
larger scope of operations), whereas
economies of scale accrue from a larger
operation.
8-24
Diversifying into Unrelated Businesses
 Involves
diversifying into businesses with:
 No strategic fit
 No meaningful value chain relationships
 No unifying strategic theme
 Strategic
approach:
 Diversify through acquisition into any industry where
potential exists for enhancing shareholder value
through upward-trending corporate revenues and
earnings and/or a stock price that rises yearly.
 While industry attractiveness and cost-of-entry tests
are important, better-off test is secondary.
8-25
Criteria for Acquisition Candidates in
Unrelated Diversification Strategies

Can the business meet corporate targets for
profitability and ROI?

Is the business in an industry with growth potential?

Is the business big enough to contribute to the
parent firm’s bottom line?

Does the business have burdensome capital
requirements?

Is the industry vulnerable to inflation, tough
government regulations, or other negative factors?
8-26
Criteria for Acquisition Candidates in
Unrelated Diversification Strategies
Businesses with bright
growth prospects but short
on investment capital
Candidates
for
Acquisition
Undervalued firms that can be
acquired at a bargain price
Struggling firms that can be turned
around with parent firm’s financial
resources and managerial know-how
8-27
Building Shareholder Value Through
Unrelated Diversification
 Corporate
managers must:
 Do a superior job of identifying and acquiring new
businesses that can produce consistently good
earnings and returns on investment.
 Do an excellent job of negotiating favorable
acquisition prices.
 Do such a good job overseeing and parenting the
firm’s businesses that they perform at a higher level
than they would otherwise be able to do through their
own efforts alone.
8-28
The Pitfalls of Unrelated Diversification
 Demanding
Managerial Requirements:
1. Staying abreast of what’s happening in each
industry and each subsidiary.
2. Picking business-unit heads with the requisite
combination of managerial skills and know-how to
drive gains in performance.
3. Discerning the difference between strategic
proposals that are prudent and those that are risky
or unlikely to succeed.
4. Knowing what to do if a business unit stumbles and
its results suddenly head downhill.
8-29
The Pitfalls of Unrelated Diversification
 Limited
Competitive Advantage Potential:
 Unrelated strategy offers limited competitive
advantage beyond what each individual business can
generate on its own.
 Without strategic fit, consolidated performance of an
unrelated group of businesses is unlikely to be better
than the sum of what the individual business units
could achieve independently.
8-30
Misguided Reasons for Pursuing
Unrelated Diversification
Risk
reduction
Growth
Misguided
Reasons for
Diversifying
Earnings
stabilization
Managerial
motives
8-31
Corporate Strategies Combining Related
and Unrelated Diversification

Dominant-Business Firms
 One major core business accounting for 50–80% of revenues
and a collection of small related or unrelated businesses account
for the remainder

Narrowly Diversified Firms
 Diversification into a few (2–5) related or unrelated businesses

Broadly Diversified Firms
 Diversification includes a wide collection of either related or
unrelated businesses or a mixture

Multibusiness Enterprises
 Diversification into several unrelated groups of related
businesses
8-32
Evaluating the Strategy of
a Diversified Company
Step 1
Assess the attractiveness of the industries the firm has
diversified into.
Step 2
Assess the competitive strength of the firm’s business
units.
Step 3
Evaluate the extent of cross-business strategic fit along
the value chains of the firm’s various business units.
Step 4
Check whether the firm’s resources fit the requirements
of its present business lineup.
Step 5
Rank the performance of the businesses from best to
worst and determine a priority for allocating resources.
Step 6
Craft new strategic moves to improve overall corporate
performance.
8-33
Evaluating the Strategy of
a Diversified Company
Step 1: Assess the attractiveness of the industries the firm has
diversified into.
Step 2: Assess the competitive strength of the firm’s business
units.
Step 3: Evaluate the extent of cross-business strategic fit along
the value chains of the firm’s various business units.
Step 4: Check whether the firm’s resources fit the requirements
of its present business lineup.
Step 5: Rank the performance prospects of the businesses from
best to worst and determine a priority for allocating
resources.
Step 6: Craft new strategic moves to improve overall corporate
performance.
8-34
Step 1: Evaluating Industry
Attractiveness
Market size and
projected growth rate
The intensity
of competition
Resource
requirements
Industry
Attractiveness
Measures
Seasonal and
cyclical factors
Emerging opportunities
and threats
Social, political, regulatory,
and environmental factors
The presence of crossindustry strategic fit
Industry
profitability
Industry uncertainty
and business risk
8-35
Step 1: Evaluating Industry
Attractiveness

Market size and
projected growth rate

Seasonal and cyclical
factors

Intensity of competition


Emerging opportunities
and threats
Social, political,
regulatory, and
environmental factors

Presence of crossindustry strategic fit

Industry profitability

Degree of uncertainty
and business

Resource requirements
risk
8-36
TABLE 8.1
Calculating Weighted Industry Attractiveness Scores
8-37
Step 2: Evaluating Business-Unit
Competitive Strength
Relative market
share
Costs relative to
competitors’ costs
Strategic alliances and
collaborative partnerships
Competitive
Strength
Factors
Brand image
and reputation
Products or services that
satisfy buyer expectations
Competitively valuable
capabilities
Benefit from strategic fit
with sibling businesses
Profitability relative
to competitors
8-38
Step 2: Evaluating Business-Unit
Competitive Strength

Relative market share

Costs relative to competitors’ costs

Products or services that satisfy buyer expectations

Ability to benefit from strategic fits with sibling
businesses

Number and caliber of strategic alliances and
collaborative partnerships

Brand image and reputation

Competitively valuable capabilities

Profitability relative to competitors
8-39
TABLE 8.2
Calculating Weighted Competitive Strength Scores
for a Diversified Company’s Business Units
8-40
FIGURE 8.3
A Nine-Cell Industry
Attractiveness–
Competitive
Strength Matrix
Note: Circle sizes are scaled
to reflect the percentage of
companywide revenues
generated by the business unit.
8-41
Strategy Implications of the
Attractiveness/Strength Matrix
 Businesses
in the upper left corner
 Receive top investment priority
 Strategic prescription: grow and build
 Businesses
in the three diagonal cells
 Are given medium investment priority
 Some businesses have brighter or dimmer
prospects than others.
 Businesses
in the lower right corner
 Are candidates for divestiture or to be harvested to
take cash out of the business
8-42
Step 3: Determining the Competitive
Value of Strategic Fit in
Multibusiness Companies
 Value
chain matchups offer competitive
value/advantage when there are:
 Opportunities to combine the performance of
certain activities, thereby reducing costs and
capturing economies of scope.
 Opportunities to transfer skills, technology, or
intellectual capital from one business to another.
 Opportunities to share a respected brand name
across multiple product and/or service categories.
8-43
Identifying Cross-Business Strategic Fits
8-44
Step 4: Evaluating Resource Fit
A
diversified firm’s lineup of businesses
exhibits good resource fit when:
1. Each of a firm’s businesses, individually, strengthen
the firm’s overall mix of resources and capabilities
2. A firm has sufficient resources to support its entire
group of businesses without spreading itself too thin
8-45
 Core Concept 
A diversified company exhibits resource fit
when its businesses add to a company’s
overall mix of resources and capabilities and
when the parent company has sufficient
resources to support its entire group of
businesses without spreading itself too thin.
8-46
 Core Concept 
A strong internal capital market allows a
diversified company to add value by shifting
capital from business units generating free
cash flow to those needing additional capital
to expand and realize their growth potential.
8-47
Determining Financial Resource Fit
 Use
a portfolio approach to determine the
firm’s internal capital market requirements:
 Which business units are cash hogs in need of capital
funds to maintain growth and expansion?
 Which business units are cash cows with capital
surpluses available to fund growth and reinvestment?
 Assessing
the portfolio’s overall condition:
 Which businesses are (or are not) capable of
contributing to achieving companywide performance
targets?
 Does the firm have the financial strength to fund all of
its businesses and maintain a healthy credit rating?
8-48
 Core Concept 
A cash hog generates operating cash flows
that are too small to fully fund its operations
and growth; a cash hog must receive cash
infusions from outside sources to cover its
working capital and investment requirements.
8-49
 Core Concept 
A cash cow generates operating cash flows
over and above its internal requirements,
thereby providing financial resources that
may be used to invest in cash hogs, finance
new acquisitions, fund share buyback
programs, or pay dividends.
8-50
Examining a Firm’s
Nonfinancial Resource Fits

A diversified firm must ensure that it can meet the
nonfinancial resource needs of its portfolio of
businesses:
 Does the firm presently have or can it develop the specific
resources and capabilities (e.g., managerial talent, technology
and information systems, and marketing support) needed to be
successful in each of its businesses?
 Are the firm’s resources being stretched too thinly by the
requirements of one or more of its present businesses?
 Have recent acquisitions strengthened the firm’s collection of
resources or are they overtaxing management’s ability to
assimilate and oversee the expanded firm’s businesses?
8-51
Step 5: Ranking Business Units and
Setting a Priority for Resource Allocation
Factors to consider in judging
business-unit performance
Sales growth
Profit growth
Earnings contribution
Cash flow generation
Return on investment
8-52
Step 5: Ranking Business Units and
Setting a Priority for Resource Allocation
 Factors
to consider in judging business-unit
performance:
 Sales growth
 Profit growth
 Contribution to company earnings
 Cash flow generation
 Return on capital employed in business
8-53
FIGURE 8.4 The Chief Strategic and Financial Options for Allocating
a Diversified Company’s Financial Resources
Strategic Options for
Allocating Company
Financial Resources
Financial Options for
Allocating Company
Financial Resources
Invest in ways to strengthen
or grow existing business
Pay off existing long-term
or short-term debt
Make acquisitions to establish
positions in new industries or to
complement existing businesses
Increase dividend payments
to shareholders
Repurchase shares of the
company’s common stock
Fund long-range R&D ventures
aimed at opening market
opportunities in new or
existing businesses
Build cash reserves;
invest in short-term securities
8-54
Step 6: Crafting New Strategic Moves to
Improve Overall Corporate Performance
1. Stick with existing business lineup
and pursue opportunities it presents
2. Broaden the firm’s business scope by
making acquisitions in new industries
3. Divest some businesses and retrench
to a narrower base of business operations
4. Restructure the firm’s business lineup to
put a new face on its business makeup
8-55
Sticking Closely with
the Existing Business Lineup
 Choosing
not to expand beyond the
current lineup of businesses makes sense
when the firm’s present businesses:
 Offer attractive growth opportunities, good
earnings, and cash flows
 Are well-positioned for the future and have good
strategic and resource fits
 Have sufficient resources that management can
allocate into areas with the greatest performance
and profit potentials
8-56
Broadening the Diversification Base
 Multibusiness
firms may consider adding to
the diversification base when:
 There is sluggish revenues and profit growth
 There is potential for transfer resources and
capabilities to related businesses
 Driving forces are hurting its core businesses
 The acquisition of related businesses strengthens the
market positions of one or more of its business units
8-57
Divesting Businesses and Retrenching
to a Narrower Diversification Base
 Retrenchment
to focus resources on
building strength in fewer businesses
requires divesting or eliminating:
 Once-attractive businesses in deteriorating markets
 Businesses that will have a poor strategic or resource
fit in the firm’s future portfolio
 Cash hog businesses with poor long-term investment
returns potential
 Weakly competitively positioned businesses with little
prospect for earning a decent return on investment
8-58
 Core Concept 
Corporate restructuring involves radically
altering the business lineup by divesting
businesses that lack strategic fit or are poor
performers and acquiring new businesses
that offer better promise for enhancing
shareholder value.
8-59
Broadly Restructuring
the Business Lineup
 Radical
surgery on the business lineup
is necessary when portfolio performance
is hampered by:
 Too many businesses in slow-growth, declining,
low-margin, or otherwise unattractive industries.
 Too many competitively weak businesses.
 An excessive debt burden with interest costs that
eat deeply into profitability.
 Ill-chosen acquisitions that haven’t lived up to
expectations.
8-60
Concepts and Connections 8.1
VF’s Corporate Restructuring Strategy That
Made It the Star of the Apparel Industry
VF Corporation’s corporate restructuring that included
a mix of divestitures and acquisitions has provided its
shareholders with returns that are more than five times
greater than shareholder returns provided by
competing apparel manufacturers. In fact, VF delivered
a total shareholder return of 21 percent between 2000
and 2010, and its 2010 revenues of $7.7 billion made it
number 310 on Fortune ’s list of the 500 largest U.S.
companies. The company’s corporate restructuring
began in 2000 when it divested its slow-growing
businesses including its namesake Vanity Fair brand of
lingerie and sleepwear. The company’s $136 million
acquisition of North Face in 2000 was the first in a
series of many acquisitions of “lifestyle brands” that
connected with the way people lived, worked, and
played. Since the acquisition and turnaround of North
Face, VF has spent nearly $5 billion to acquire 19
additional businesses, including about $2 billion in
2011 to acquire Timberland. New apparel brands
acquired by VF Corporation include Timberland, Vans
skateboard shoes, Nautica, John Varvatos, and 7 For
All Mankind sportswear, Reef surf wear, and Lucy
athletic wear. The company also acquired a variety of
apparel companies specializing in apparel segments
such as uniforms for professional baseball and football
teams and law enforcement.
VF Corporation’s acquisitions came after years of
researching each company and developing a
relationship with an acquisition candidate’s chief
managers before closing the deal. The company made a
practice of leaving management of acquired companies
in place, while bringing in new managers only when
necessary talent and skills were lacking. In addition,
companies acquired by VF were allowed to keep longstanding traditions that shaped culture and spurred
creativity. For example, the Vans headquarters in
Cypress, California, retained its half-pipe and concrete
floor so that its employees could skateboard to and
from meetings.
In 2010, VF Corporation was among the most profitable
apparel firms in the industry with net earnings of $571
million. The company expected new acquisitions that
would push the company’s revenues to $8.5 billion in
2011.
Sources: Suzanne Kapner, “How a 100-Year-Old Apparel
Firm Changed Course,” Fortune, April 9, 2008, online
edition; and www.vf.com, accessed July 26, 2011.
8-61