CHAPTER 2
LITERATURE REVIEW
2.1. Diversification Strategy
Market Alternatives
Product/Service
Alternatives
Reduce Market
Existing Market
Expanded
Market
Market
diversification
Reduced
Product/Services
Existing
Product/Services
Modified
Product/Services
New Market
Product
diversification
Market and
Product
diversification
New
Product/Services
Figure 1: Competitive Position Growth Alternatives ( Woodcock & Beamish, 13: 2003 )
Diversification is a part of corporate-strategy (Hill & Jones: 2001; Pearce II & Robinson:
2003; Hit et al: 2007). Diversification inside corporate strategy level means this option
may bring the future direction of the company.
2.2. Reasons for diversification
Every strategy always has reasons because strategy would be used by the company to
fulfill its goals. Reasoning is a basic-concept for effective-strategy. Hit et al (173: 2007)
explained some reasons why a company uses diversification-strategy
2.2.1. Value Creating Diversification
•
Economies of scope (related diversification)
o Sharing activities
o Transferring core competencies
•
Market Power (related diversification)
o Blocking competitors through multipoint competition
o Vertical integration
•
Financial economies (unrelated diversification)
o Efficient internal capital allocation
o Business restructuring
2.2.2. Value Neutral Diversification
•
Antitrust regulation
•
Tax laws
•
Low performance
•
Uncertain future cash flows
•
Risk reduction for firm
•
Tangible resources
•
Intangible resources
2.2.3. Value Reducing Diversification
•
Diversifying managerial employment risk
•
Increasing managerial compensation
Operational relatedness:
Sharing
Activities
Between
Business
High
Low
Related
Constrained
diversification
Both operational
Corporate
relatedness
Unrelated
diversification
Related linked
diversification
Low
High
Corporate relatedness:
transforming core competencies into business
Figure 2: Value Creating Diversification Strategies: Operational and Corporate
Relatedness
2.3. Operational and Corporate Relatedness
When a company decided to do diversification, it was important to pay attention in
relation between core-competencies and operational of the company. Operational
relatedness and corporate relatedness are the ways to diversify for creating value for the
company. Study about relation of these two things showed how important resources and
key-competencies are when company needed to diversify.
2.4. Levels of Diversification (Hill et al, 170: 2007)
•
Single Business: 95% or more of revenue comes from a single business.
•
Dominant Business: between 70% and 95% of revenue comes from a single
business
•
Moderate to High Level of Diversification
o Related Constrained: less than 70% of revenue comes from the dominant
business, and all business share product, technological, and distribution
linkages.
o Related linked (mixed related and unrelated): less than 70% of revenue
comes from the dominant business and there are only limited links
between businesses.
•
Very High Levels of Diversification
o Unrelated: less than 70% of revenue comes from the dominant business
and there are no common links between businesses.
2.5. Types of Diversification
•
Related Diversification
Diversification into a new business activity is linked to a company’s existing
business activity or activities, by commonality between one or more components
of each activity’s value chain. Normally, these linkages are based on
manufacturing, marketing or technological commonalities. Example: Philip
Morris did diversification by acquiring Miller Brewing because there is closed
relation between beer and smokers.
• Unrelated Diversification
Diversification into a new business area has no obvious connecting with any of
the company’s existing areas.
2.6. Diversification for Grand Strategy
As explained before, diversification may become a variant of corporate-strategy.
Diversification together with other variant of strategies might be used by a company to
reach its goals. There are two matrixes which connected with diversification. First, was
Grand Strategy Selection Matrix and second was Model of Grand Strategy Clusters. In
Grand Strategy Matrix we can see that diversification would be chosen by the company
with strong external pressure/inducements. In Strategy Cluster Matrix, diversification
would be used in slow market-growth. The target of this strategy was to create new-value
for the company outside the existing market at this moment.
Overcome Weakness
Turnaround or
retrenchment Divesture
Liquidation
Internal
(redirected
resources
within the firm)
Vertical Integration
Conglomerate
diversification
I
II
IV
III
Concentrated growth
Market development
Product development
Innovation
Horizontal Integration
Concentric diversification
Joint venture
External
(acquisition or
merger
for
resource
capability)
Maximize Strengths
Figure 3: Grand Strategy Selection Matrix (Pierce II & Robinson Jr, 208: 2003)
Rapid Market Growth
•
•
•
I
Strong
Competitive
Forces
IV
•
•
•
•
Concentrated Growth
Vertical Integration
Concentric
diversification
Concentric
diversification
Conglomerate
diversification
Joint ventures
•
•
•
Reformulation
of
concentrated growth
Horizontal integration
Divestiture
Liquidation
II
Weak
Competitive
Forces
III
•
•
•
•
•
Turnaround
retrenchment
Concentric
diversification
Conglomerate
diversification
Divestiture
Liquidation
or
Slow Market Growth
Figure 4: Model of Grand Strategy Clusters (Pearce II & Robinson Jr, 210: 2003)
2.7. Growth Strategy: Diversification
Definition
A strategy based on investing in companies and sectors which are growing faster than
their peers.
WIKA has already decided to grow as named the roadmap to 2010. In the end of the
roadmap, the company hopes to be the excellent company in Southeast Asia with Sales
Growth of 36%. Core business is still in construction but it focuses in EPC, Investment
and International Construction. From 2002 to 2010 WIKA has gradually changed its
business-lines but never leave the construction as a core business.
2.7.1. Ansoff Matrix
Igor Ansoff presented a matrix that focused on the firm's present and potential products
and markets (customers). By considering ways to grow via existing products and new
products, and in existing markets and new markets, there are four possible productmarket combinations. Ansoff's matrix is shown below:
Existing
Markets
New
Markets
Existing Products
New Products
Market
Penetration
Product Development
Market
Development
Diversification
Figure 5: Anzoff Matrix
2.7.2. What is the product – Market-Grid - Description
The Product/ Market Grid of Ansoff is a model that has proven to be very useful in
business unit strategy processes to determine business growth opportunities.The Product/
Market Grid has two dimensions: products and markets.Over these 2 dimensions, four
growth strategies can be formed.
Four growth strategies in the product/market grid:
1. Market Penetration. Sell more of the same products or service in current
markets. These strategies normally try to change incidental clients to regular
clients, and regular client into heavy clients. Typical systems are volume
discounts, bonus cards and Customer Relationship Management. Strategy is often
to achieve economies of scale through more efficient manufacturing, more
efficient distribution, more purchasing power, overhead sharing.
2. Market Development. Sell more of the same products or services in new
markets. These strategies often try to lure clients away from competitors or
introduce existing products in foreign markets or introduce new brand names in a
market. New markets can be geographic of functional, such as when we sell the
same product for another purpose. Small modifications may be necessary. Beware
of cultural differences.
3. Product Development. Sell new products or services in current markets. These
strategies often try to sell other products to (regular) clients. These can be
accessories, add-ons, or completely new products. Cross-selling. Often, existing
communication channels are used.
4. Diversification. Sell new products or service in new markets. These strategies are
the most risky type of strategies. Often there is a credibility focus in the
communication to explain why the company enters new markets with new
products. On the other hand diversification strategies also can decrease risk,
because a large corporation can spread certain risks if it operates on more than
one market.
Diversification can be done in four ways:
-
Horizontal diversification. This occurs when the company acquires or
develops new products that could appeal to its current customer groups
even though those new products may be technologically unrelated to the
existing product lines.(new products, current market)
-
Vertical diversification. The company moves into the business of its
suppliers or into the business of its customers. (move into firms supplier's
or customer's business)
-
Concentric diversification. This results in new product lines or services
that have technological and/or marketing synergies with existing product
lines, even though the products may appeal to a new customer group. (new
product closely related to current product in new market)
-
Conglomerate diversification. This occurs when there is neither
technological nor marketing synergy and this requires reaching new
customer groups. Sometimes used by large companies seeking ways to
balance a cyclical portfolio with a non-cyclical one.(new product in new
market)
There are two types of diversification:
-
related
-
unrelated diversification.
Related diversification means that the firm remains in a particular industry, but diversify into another type of
product
to
be
sold
to
new
markets.
Unrelated diversification refers to a situation where the firm completely ventures into a new business area to
serve new markets with its new product development. New capital investments are also needed. In this
scenario, it would mean that the firm is entering into an industry that it has little experience with limited or no
knowledge of the industry.
2.7.3. Selecting a Product-Market Growth Strategy
The market penetration strategy is the least risky since it leverages many of the firm's
existing resources and capabilities. In a growing market, simply maintaining market share
will result in growth, and there may exist opportunities to increase market share if
competitors reach capacity limits. However, market penetration has limits, and once the
market approaches saturation another strategy must be pursued if the firm is to continue
to grow.
Market development options include the pursuit of additional market segments or
geographical regions. The development of new markets for the product may be a good
strategy if the firm's core competencies are related more to the specific product than to its
experience with a specific market segment. Because the firm is expanding into a new
market, a market development strategy typically has more risk than a market penetration
strategy.
A product development strategy may be appropriate if the firm's strengths are related to
its specific customers rather than to the specific product itself. In this situation, it can
leverage its strengths by developing a new product targeted to its existing customers.
Similar to the case of new market development, new product development carries more
risk than simply attempting to increase market share.
Diversification is the most risky of the four growth strategies since it requires both
product and market development and may be outside the core competencies of the firm.
In fact, this quadrant of the matrix has been referred to by some as the "suicide cell".
However, diversification may be a reasonable choice if the high risk is compensated by
the chance of a high rate of return. Other advantages of diversification include the
potential to gain a foothold in an attractive industry and the reduction of overall business
portfolio risk.
The product/market grid of Ansoff is a model that has proven to be very useful in
business unit strategy processes to determine business growth opportunities. The
product/market grid has two dimensions: products and markets.
2.8. What kind of decision will be the best in diversification?
What is the basis?
2.8.1. Diversity to unrelated industry
Example: Conglomerate PT Astra International Tbk.
In 1957, Astra was established as a trading company. Over the course of its development,
Astra has formed a number of strategic alliances with leading global players in various
industries.
Since 1990, the Company had been a go public company, listed on both the Jakarta and
Surabaya Stock Exchanges, now known as the Indonesia Stock Exchange with the
Company’s market capitalization as of 31 December 2007 stood at Rp 110.5 trillion.
Astra now has six core businesses: Automotive, Financial Services, Heavy Equipment,
Agribusiness, Information Technology and Infrastructure. At year-end 2007, Astra Group
had a workforce of 116,867 people, spread across 130 subsidiaries and affiliates.
Table 1: Financial Performance
(Rpbn)
Automotive
Financial services
Agribusiness
Information technology
Heavy equipment and mining
Others
Total
Less elimination
Total consolidated
Contribution (%)
Automotive
Financial services
Agribusiness
Information technology
Heavy equipment and mining
Others
Total
2006
30,259.0
7,567.8
3,758.0
619.0
13,719.6
28.9
55,952.2
(243.0)
55,709.2
54.1
13.5
6.7
1.1
24.5
0.1
100.0
Net revenue
2007
38,318.4
7,310.5
5,961.0
725.6
18,165.6
28.3
70,509.3
(326.4)
70,183.0
54.3
10.4
8.5
1.0
25.8
0.0
100.0
Source: Bahana Securities
2.8.2. Diversity to related-industry
Growth (%)
26.6
(3.4)
58.6
17.2
32.4
(2.0)
26.0
34.3
26.0
2006
859.1
727.0
1,198.6
76.7
1,340.1
(10.4)
4,191.2
52.0
4,243.2
20.5
17.3
28.6
1.8
32.0
(0.2)
100.0
Operating profit
2007
Growth (%)
1,717.9
99.9
1,355.6
86.5
2,907.1
142.5
95.1
23.9
2,393.3
78.6
(8.9)
(14.4)
8,460.0
101.9
41.5
(20.3)
8,501.5
100.4
20.3
16.0
34.4
1.1
28.3
(0.1)
100.0
Figure 6: Strategies of Related Diversification
Timing: The first question to assess is the competitive strength of the firm that is looking
to expand. Is the motive to expand an offensive one-- triggered by healthy margins in the
core business, and strengths that can be leveraged elsewhere? Or, is it primarily
defensive, where a firm is looking to “escape” its declining core? Unfortunately, scope
expansions are in most cases not effective in solving the latter predicament; in addition,
they are unlikely to leverage any existing strengths of the firm in such a setting. Thus,
Bausch and Lomb, the market leader in soft contact lenses, decided to expand away from
its core business when growth slowed and competitors attacked with new technologies
such as cast molding. The company invested in electric toothbrushes, dental aids, skin
ointments, and hearing aids. After several years, and having seen its market share in its
core business decline from 40% to 16% (while Johnson and Johnson introduced the idea
of disposable lenses), Bausch and Lomb exited many of these noncore businesses and
looked to focus on the core again. Companies in similar situations often do well not by
looking outward but inward: invariably, a more effective solution is to identify ways to
solve the problems in, and “profit from the core”1, as companies like Harley-Davidson
have done.
Industry attractiveness: Structurally, how attractive is the new business arena being
considered for expansion? Do incumbents enjoy healthy margins or are competition
likely to be fierce and profits meager? The familiar “five forces” analysis is useful not
only in predicting industry profitability but, more importantly, in identifying the various
sources of competition that the company is likely to face. Specifically, it is useful to
examine whether and how the firm’s intended entry strategy can effectively combat the
likely competitive forces. For example, consider the furniture industry. An entrant that
seeks to exploit scale economies by automating manufacturing processes is likely to be
more vulnerable to the industry’s cyclical dynamics since automation would increase the
fraction of its costs that are fixed. On the other hand, the “infinite variety” in designs that
characterizes the industry also makes it difficult for manufacturers to develop brands with
consistent identities and carve out a high-end position.
Scope economies with existing business: The viability of an entry strategy leaves
unanswered the question of which firm is in the best position to pull off such a strategy.
Specifically, what are the scope economies or synergies with the firm’s existing
businesses: might expansion into the new businesses either leverage particular strengths
from the existing ones, or benefit them in turn? Exhibit 1 illustrates the different sources
of such synergies. These might arise from cost-sharing: for example, the centralization of
procurement, combination of staff functions, economies in distribution and logistics, or
common production platforms. Or, they might enhance revenues of the combined
businesses by mechanisms such as cross-selling, bundling, and one-stop shopping. While
cost synergies are often the driving force in scope expansions and mergers, the search for
revenue synergies has become more common as well. For example, several mergers
between high-end and low-end machine tool manufacturers in the last decade were driven
by the desire to combine breadth of product offerings in “one-stop shopping” for
industrial customers. Health care delivery has seen the emergence of multi-business firms
like Covenant Health Systems, whose outpatient ambulatory care centers have led to
more referrals for more profitable inpatient care. And, cross-selling motivations have
resulted in financial services companies like Charles Schwab expanding to offer products
ranging from money market funds to investment advisory services.
Each of the synergies described above stems from the sharing of activities by different
businesses. Activity analysis is a useful, and concrete, approach to evaluating scope
economies. At the same time, it is useful to keep in mind that tangible activity
coordination is not the only source of synergies. Often, synergies can arise from the
sharing of resources or intangible skills. These might include a common brand,
reputation, specific knowledge and expertise, managerial talent, systems and processes,
values, or even a common culture.
As these examples illustrate, resource sharing, while intangible, can be no less important.
More importantly, it suggests a different way to evaluate the question of “relatedness”
between any two businesses: rather than simply ask whether the products being sold by
the businesses are related, one ought to also examine whether there are common
competencies required to succeed in these businesses. This can often lead to
counterintuitive, but no less powerful, expansion decisions. For example, Honda
expanded into cars, motorcycles, lawn mowers, and generators, leveraging its
competence in engines and power trains. Canon expanded into copiers, laser printers, and
cameras, exploiting its competencies in optics, imaging, and processor controls. And,
Minebea expanded from ball bearings to semiconductors, leveraging its competence in
miniaturized manufacturing.
Each of these examples suggests a useful principle to keep in mind when evaluating
resource sharing benefits: these benefits are most compelling when the competencies in
question are not only
(i) important drivers of performance in that business, but they are also (ii) distinctive or
unique to the firm.
Organizational mechanisms for coordination: Having examined the potential sources
of synergies, one ought to scrutinize how exactly they will be realized. Specifically, what
organizational mechanisms need to be put in place to ensure this? Firms often deem this
question to fall under the domain of “implementation”. However, failing to think through
the organizational choices and changes that accompany any scope expansion is a
common reason why mergers fail. Consider, for example, Saatchi and Saatchi’s foray
into the consulting businesses in the 1980s. Regardless of whether one viewed the
potential synergies between advertising and consulting services to be large or small, the
firm’s approach to organizational integration proved to be the decisive factor in its failed
expansion. Specifically, its approach of “front-end separation, back-end integration”—
while successful in integrating its earlier advertising acquisitions—was flawed here, in
light of the differences between the “push based” budgeting systems common in
consulting and the “pull based” approach intrinsic to advertising.
The nature of organizational coordination will of course be informed by the types of
synergies identified above. For example, the incentives to cross-sell two products will be
greater when there is a common sales-force for both products than with different ones for
each. Or, the ability to leverage company-wide competencies is often easier with a
functional organizational structure than with a divisional one. And, in addition to the role
of the formal organizational structure in facilitating (or impeding) coordination, informal
mechanisms can often be quite powerful in “boundary-spanning” as well: company-wide
norms, values, and cultures. Recognizing, and acting on, these organizational changes can
be critical to realizing the benefits of scope in practice.
Ownership: Extracting the rents from expansion into a new arena does not require that
companies fully own the new business as well. The choice of ownership (i.e., where the
boundaries of the firm should be drawn) is relevant for most horizontal expansion
decisions, but is particularly central to firms’ decisions on whether to expand into
adjacent parts of the value chain—the vertical integration question. Therefore, although
the key insights behind the logic of ownership are quite general, they are discussed, in
what follows, largely in the context of the choice to vertically integrate.
Source: Adopted from Bharat N. Anand, Strategies of Related Diversification (2005)
Example: Engineering and Construction: PT Wijaya Karya (Persero) Tbk.
Table 2: Growth of order
Source: company
Table 3: Financial Performance
Year to 31 Dec
Revenue (IDRb)
EBITDA (IDRb)
Net Profit (IDRb)
EPS (IDR)
Growth (%)
P/E (x)
BVPS (IDR)
P/BV (x)221
EV/EBITDA (x)
ROA (%)
ROE (%)
Dividend (IDR)
Dividend Yield (%)
2006
3.049
135
94
16
37.3
36.7
69
8.6
25.6
3.5
23.3
13
2.2
Source: company, Bahana Estimates
Table 4: Construction Company Margin
2007
4.285
242
129
22
37.5
14.5
221
1.4
3.4
3.1
10.0
4.8
1.5
2008F
6.450
281
152
26
17.8
12.3
240
1.3
4.7
2.7
10.8
6.6
2.1
WIKA : fully diversified; ADHI : partly diversified; TOTL : focus
TOTL net margin was higher than the others when the construction growth was high in
2007. On the other hand when oil prices increased significantly since the beginning of
2008, the cost of construction company raised and could possibly ruin its profit as shown
at above figure. As escalation clause on cost of construction only applicable for multi
year projects and mostly for companies with exposures to government projects, the
benefited companies would be WIKA and ADHI.
WIKA would be the most benefited because of it diversified business model to reduce the
volatility in margin as a result of the uncertain raw material cost and global financeturmoil.
2.8.3. Do not diversify
From the figure below, there are many other industries which have interesting growth in
its own business. It means even focusing in one line of business; it will still have
opportunity to grow in its industries.
Table 5: The growth of industry in Indonesia
Indonesia
Banking
Mining & Energy
Telecom
Consumer & Retail
Automotive
Cement**
Plantations
Heavy Equipments
Property
Oil & Gas services
Construction
Toll Road
Poultry
Mkt Cap
US$mn
115,367
30,836
29,616
19,487
9,892
7,931
5,296
3,944
3,545
2,358
651
270
280
79
Source: Bahana Securities
05A
2.7
-19.5
16.2
15.9
-10.4
0.9
44.7
-6.1
-4.4
-0.1
N/A
7.1
22.8
N/A
EPS Growth (%)
06A
07A
43.1
50.9
68.4
52.0
26.5
96.4
-32.0
-16.4
36.8
-10.9
-8.1
N/A
35.6
50.3
480.5
23.0
107.6
26.1
10.3
58.7
45.3
112.2
59.5
3.6
3.1
19.8
-29.5
-14.7
08F
27.1
05A
20.6
21.9
18.7
33.8
23.8
19.0
27.4
8.3
4.4
27.7
26.7
47.0
13.0
55.3
25.6
31.8
25.6
11.0
10.3
57.6 N/A
55.4
20.7
59.0
13.2
-18.2
11.0
ROE (%)
06A
07A
22.5
27.2
18.3
30.7
32.0
6.2
16.6
15.3
23.7
20.4
8.5
15.5
22.6
16.8
39.9
18.7
45.3
31.9
6.0
22.2
18.5
35.9
26.0
6.4
14.4
12.8
5.8
26.7
08F
26.3
19.5
40.1
30.6
6.4
23.7
20.7
39.7
27.7
6.7
20.2
16.9
8.1
18.0