Diversification Corporate Strategy PDF

Topic 3. Diversification Corporate Strategy Pág. 1 Agenda 3.1 3.2 3.3 3.4 What is Types of Advantages and risks Diversification y Diversification? Diversificati...

Topic 3. Diversification Corporate Strategy Pág. 1 Agenda 3.1 3.2 3.3 3.4 What is Types of Advantages and risks Diversification y Diversification? Diversification of Diversification resultados Bibliography: Grant, R. (2022): Chapter Navas y Guerras (2022). Chapter 10 Rothaermel (2024): Chapter 8 Topic 3. Diversification Pág. 2 3.1 What is Diversification? Pág. 3 3.1 What is Diversification? What is Diversification? The diversification strategy seeks to answer the question of what products or services the company should offer and in which geographic markets? Product diversification: the number of products or services Geographic diversification: number of geographic markets (Topic 5) A diversified company offers: A set of products or services in a market or one product or service in multiple geographic markets at the same time, or a double diversification Topic 3. Diversification Pág. 4 3.2 Types of Diversification Pág. 5 3.2 Types of Diversification Types of Diversification To understand the types of corporate diversification, Rumelt developed a classification that identifies diversification types based on two key variables: (1) the percentage of revenue from the dominant or main business (2) the relationship established between the core skills of different business units * Note: this classification refers only to product diversification. The percentage of revenue allows us to identify the first two types of diversification: (1) single business and (2) dominant business The relationship between core competencies allows us to identify: (3) related diversification and (4) unrelated diversification Topic 3. Diversification Pág. 6 3.2 Types of Diversification Types of Diversification Single business Low level of diversification, where 95% or more of the revenue comes from a single business unit. Example: Netflix Dominant business The dominant business unit generates between 70% and 95% of the revenue but pursues at least one other business activity that generates the remaining revenue. The dominant business shares products, services, technology, and distribution with the rest of the units. Example: Harley-Davidson (motorcycles, merchandising, and accessories) Topic 3. Diversification Pág. 7 3.2 Types of Diversification Types of Diversification Related Diversification (RD) Its most important business does not generate more than 70% of its revenue. This diversification leverages economies of scale and scope, as different business units share resources and core skills. Two types: (1) Limited RD, (2) Linked RD Limited Related Diversification The main business generates less than 70% of the revenue, with the remaining revenue coming from business units related to the main one. Executives only enter new business units when that new business truly leverages the company's resources and skills. Entry into new businesses is limited by these characteristics. Linked Related Diversification Executives in the company believe that these resources or skills should not limit diversification (these links may exist, but not necessarily). Example: Amazon Topic 3. Diversification Pág. 8 3.2 Types of Diversification Types of Diversification Limited Related Diversification Linked Related Diversification Topic 3. Diversification Pág. 9 3.2 Types of Diversification Types of Diversification Unrelated Diversification or Conglomerate The main business does not generate more than 70% of the revenue, and there are very few links between the company's business units. Few resources or skills are shared between units. This type of diversification is very common in emerging countries (to overcome structural deficiencies in those economies). Examples: Berkshire Hathaway, Yamaha, or the Tata Group in India. Topic 3. Diversification Pág. 10 3.2 Types of Diversification Leveraging core skills to diversify A company's core skills are its unique strengths that allow it to increase perceived benefits for customers or reduce costs. In short, the skills that allow it to create value. Examples of core skills: Walmart, Google, Inditex, Ikea, Coca-Cola. To survive and thrive, companies need to grow Especially relevant for publicly traded companies because the value they generate for shareholders needs to continuously grow. Strategic leaders respond to this imperative by making the most of their core skills to find future growth opportunities The first thing executives need to do is identify their company's core skills to understand their current market position (next slide) Topic 3. Diversification Pág. 11 3.2 Types of Diversification Leveraging core skills to diversify Markets Existing New Build new core skills to Build new core skills to New protect and extend the create and compete in current market position. future markets. Core Skills Leverage core skills to Redeploy and recombine Existing improve the current market existing core skills to position. compete in future markets Source: Rothaermel (2024) Topic 3. Diversification Pág. 12 3.2 Types of Diversification Leveraging core competencies to diversify Markets Bank of America Founded in 1904 (Bank of Italy in San Existing Francisco) Renamed to Bank of America and Italy in 1922. Leverage core skills to Core Skills Existing improve the current market Acquired in 1997 by NationsBank, a bank position whose core skills was identifying, valuing, and acquiring other banks. Specifically, during the 1970s and 1980s, it gradually bought small banks to grow organically, and between 1989 and 1992, it purchased over 200 regional banks to improve Source: Rothaermel (2024) its market position. This example illustrates how NationsBank (rebranded as Bank of America since 1998) perfected and developed its core competency of acquiring and integrating other commercial banks to drastically grow in size and geographic reach, emerging as one of Topic 3. Diversification the leading banks in the United States. Pág. 13 3.2 Types of Diversification Leveraging core competencies to diversify Markets Bank of America Existing During the 2008 crisis, Bank of America purchased the investment bank Merrill Lynch Redeploying and for $50 billion. recombining existing core Currently, that bank is the investment banking Core Skills Existing skills to compete in future markets and wealth management division of Bank of America. Source: Rothaermel (2024) It is an example of how their core skills of acquiring and integrating banks enters a new market (investment and wealth management). The challenge now is to be able to leverage economies of scope to manage both units. Topic 3. Diversification Pág. 14 3.2 Types of Diversification Leveraging core competencies to diversify Markets Gatorade In the early 1990s, Gatorade dominated the sports drink Existing market, a segment in which it had been the original innovator. About 25 years earlier, medical research had created energy drinks that improved athletes' performance. PepsiCo acquired Build new core skills to Gatorade in 2001 to incorporate it into its beverage line. In Core Skills Existing protect and extend the contrast, Coca-Cola had the core skills of bottling, selling, and current market position distributing soft drinks, but had never ventured into competing in the sports drink market. After 10 years of R&D investment, Powerade was launched in 1990. This is an example of leveraging your core skills in a new market. Source: Rothaermel (2024) Topic 3. Diversification Pág. 15 3.2 Types of Diversification Leveraging core competencies to diversify Markets Gatorade In the early 1990s, Gatorade dominated the sports drink Existing market, a segment in which it had been the original innovator. About 25 years earlier, medical research had created energy drinks that improved athletes' performance. PepsiCo acquired Build new core Gatorade in 2001 to incorporate it into its beverage line. In Core Skills New competencies to create and contrast, Coca-Cola had the core skills of bottling, selling, and compete in future markets distributing soft drinks, but had never ventured into competing in the sports drink market. After 10 years of R&D investment, Powerade was launched in 1990. This is an example of leveraging your core skills in a new market. Source: Rothaermel (2024) Topic 3. Diversification Pág. 16 3.3 Advantages and Risks of Diversification Pág. 17 3.4 Diversification y results Pág. 18 3.4 Diversification y resultados Diversification and results Executives follow a diversification strategy with the aim of achieving a competitive advantage and maintaining it over time But does diversification really lead to superior performance? The key question is to determine in which situations it is worthwhile to increase the level of diversification and in which it is not. Topic 3. Diversification Pág. 19 Source: Adaptado de Palich, Cardinal y Miller (2001) 3.4 Diversification y resultados Diversification and results Inverted U-shaped relationship: Very low and very high levels of diversification are associated with poorer performance, while moderate levels of diversification are associated with superior performance. Single-business models: They could increase their performance if they are able to apply their core competencies to adjacent businesses. Unrelated diversification: They often suffer the negative consequences of excessive diversification. They experience what is called a diversification discount. Example: General Electric. Despite this, it may make sense in less developed institutional contexts (Africa, India, etc.). Topic 3. Diversification Pág. 20 3.4 Diversification y resultados Diversification and results Inverted U-shaped relationship: Conversely, companies that pursue related diversification often enjoy a diversification premium, leading to superior performance. For diversification to improve the company's performance, it must achieve at least one of the following situations: Provide economies of scale, which reduces costs Exploit economies of scope, which increases perceived benefits Reduce costs and increase perceived benefits The next slide details the sources of value creation and costs for different corporate strategies, including vertical integration as well as related and unrelated diversification. Topic 3. Diversification Pág. 21 3.4 Diversification y resultados Diversification and results Topic 3. Diversification Pág. 22 3.4 Diversification y resultados Diversification and results Financial economies: (1) Restructuring (2) Internal capital markets The restructuring process describes the situation of reorganizing and divesting business units to refocus the company to better leverage its core competencies Executives can restructure the company's portfolio in the same way shareholders manage their stock portfolio Boston Consulting Group Matrix: Market share (horizontal axis) Market growth rate (vertical axis) Topic 3. Diversification Pág. 23 3.4 Diversification y resultados Topic 3. Diversification Pág. 24 3.4 Diversification y resultados Diversification and results Dog products: Businesses with poor performance and low expectations. They have a small market share and little growth potential. Small and unstable profits combined with neutral or negative cash flows. The company should abandon these units. Cash cow products: Businesses with low growth rates but significant market share. High and stable revenues and cash flows. Invest in them to maintain that market position and avoid them becoming dogs. Star products: High growth expectations and market share. The recommendation is to invest to maintain or even improve that competitive position. Try to avoid it becoming a cash cow. Question mark products: It is unclear whether they will become dogs or stars in the future. Current revenues are low and unstable but may grow in the short term. Invest in them to see if they can become stars. Topic 3. Diversification Pág. 25 3.4 Diversification y resultados Diversification and results Internal capital markets can be a source of value creation. The corporation allocates capital more efficiently than the market itself. The corporation's executives are in a better position than the market to know which of their business units will provide the best performance. For example, if a company unit has difficulty obtaining financing because the market lacks information about its actual performance, the company's executives may know that it will be more profitable than it appears, leading them to divert the company's investments towards that unit. Topic 3. Diversification Pág. 26 3.4 Diversification y resultados Diversification and results In summary, regarding the diversification strategy: A related diversification strategy has more chances of increasing performance than a single- business, dominant-business, or unrelated diversification strategy. However, to create additional value, the benefits of diversification must outweigh the costs generated. Main costs of related diversification: coordination costs and influence costs. Topic 3. Diversification Pág. 27 Topic 3. Diversification Corporate Strategy Pág. 28