Block 6

Question 1

Strategy making in a diversified enterprise. Who starts the process?

Answer 1

Top-level corporate executives have the task of crafting a diversified company’s overall corporate strategy.

Question 2

WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL? (3 distinct facets)

Answer 2

Step 1: Picking new industries to enter and deciding on the means of entry (How? by starting a new business from the ground up, by acquiring a company already in the target industry, or by forming a joint venture)

Step 2: Pursuing opportunities to leverage cross-business value chain relationships, where there is strategic fit into competitive advantage
(Determine: do opportunities exist to strengthen diversified company’s business- transfer of competitively valuable resources and capabilities, combining related value chain activities, sharing knowledge and a powerful brand name)

Step 3: Initiating actions to boost combined performance of corporation’s collection of businesses

Question 3

Strategic options for improving the corporation’s overall performance include? (4)

Answer 3

• Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses
• Broadening the current scope of diversification by
  entering additional industries
• Retrenching to a narrower scope of diversification by divesting poorly performing businesses
• Broadly restructuring the entire firm by divesting
  some businesses and acquiring others to put a whole new face on the firm’s business lineup

Question 4

A firm should consider diversifying when: (2)

Answer 4

1. Growth opportunities are limited as its principal markets reach their maturity and buyer demand is either stagnating or set to decline.
2. Changing industry conditions-(new technologies, inroads being made by substitute products, fastshifting buyer preferences, or intensifying competition)-are undermining the firm’s competitive position.

Question 5

How wide-ranging diversification should be? (6) 6 questions

Answer 5

1. Diversify into closely related businesses or into
   totally unrelated businesses?
2. Diversify present revenue and earnings base to a
   small or major extent?
3. Move into one or two large new businesses or a
   greater number of small ones?
4. Acquire an existing company?
5. Start up a new business from scratch?
6. Form a joint venture with one or more companies to
   enter new businesses?

Question 6

What are the tests of Corporate Advantage?

Answer 6

1. The industry attractiveness test

• Are the industry’s profits and return on investment as good or better than present business(es)?
• Industry resource requirements match companies resources& capabilities
• The industry is structurally attractive based on the 5 forces
• The industry has good potential for growth and profitability

2. The cost-of-entry test

• Is the cost of overcoming entry barriers so great as to long delay or reduce the potential for profitability?
• Catch 22 -> the greater the attractiveness of the industry the higher the cost of entry

3. The better-off test

• How much synergy (stronger overall performance)
  will be gained by diversifying into the industry? 1+1=3 Scenario

To add shareholder value, diversification into a new business must pass the three tests of corporate advantage

Question 7

3 ways of Diversifying into
New Businesses

Answer 7

• Existing business acquisition
• Internal new venture (start-up)
• Joint venture

Question 8

Advantages of Aquisition?(3)

Answer 8

• Quick entry into an industry
• Barriers to entry avoided (acquiring technology, establishing supplier relationships, building brand awareness and securing adequate distribution)
• Access to complementary resources and capabilities that are complementary to those of the acquiring firm and that cannot be developed readily internally.

Question 9

Disadvantages of Aquisition? (3)

Answer 9

• Cost of acquisition—whether to pay a premium for a successful firm or seek a bargain in a struggling firm
• Underestimating costs for integrating acquired firm
• Overestimating the acquisition’s potential to deliver added shareholder value

Question 10

What is Internal Development ? (also referred to as corporate venturing or intrapreneurship)

Answer 10

Involves starting a new business subsidiary from scratch and is often referred to as corporate venturing or new venture development.

Question 11

Advantages of Internal development (2)

Answer 11

• Avoids pitfalls and uncertain costs of acquisition associated with entry via acquisition
• Allows entry into a new or emerging industry where there are no available acquisition candidates

Question 12

Disadvantages of Internal Development (3)

Answer 12

• Must overcome industry entry barriers (production capacities and competitive capabilities, sources of supply, hire and train employees, build channels of distribution)
• Requires extensive investments in developing production capacities and competitive capabilities, hire and train employees, build channels of distribution
• May fail due to internal organizational resistance to change and innovation (the culture, structures and organisational systems of some companies may impede innovation and make it difficult for corporate intrapreneurship to flourish)

Question 13

Factors Favoring
Internal Development (5)

Answer 13

• The parent company already has in-house most or all of the skills and resources it needs to piece together a new business and compete effectively
• There is ample time to launch the business
• Internal cost of entry is lower than the cost of entry via acquisition
• Adding new production capacity will not adversely impact the supply-demand balance in the industry
• Established firms are likely to be slow or ineffective in responding to a new entrant’s efforts to crack the market

Question 14

Define Joint Venture?

Answer 14

is a cooperative arrangement between two or more business entities, often for the purpose of starting a new business activity.

Question 15

Evaluating
the Potential
for a Joint
Venture (3)

Answer 15

• Is the opportunity too complex, uneconomical,
  or risky for one firm to pursue alone?
• Does the opportunity require a broader range
  of competencies and know-how than the firm
  now possesses?
• Will the opportunity involve operations in a
  country that requires foreign firms to have a
  local minority or majority ownership partner?

If the answer is yes to each of these questions, then
engaging in a joint venture makes strategic sense.

Question 16

In which three types of situations can a strategic partnership or joint venture be useful?

Answer 16

• To pursue an opportunity that is too complex, uneconomical, or risky for a single organization to pursue alone
• When the opportunities in a new industry require a broader range of competencies and know-how than any one organization can marshal
• To diversify into a new industry when the diversification move entails having operations in a foreign country.

Question 17

Joint Venture drawbacks (4)

Answer 17

• Conflicting objectives and expectations of venture partners (when partners have different priorities, strategies, or timelines for the venture)
• Disagreements among or between venture partners over how best to operate the venture (when partners have divergent opinions on crucial aspects of the business)
• Cultural clashes among and between the partners (cultural differences can lead to misunderstandings, communication barriers, and clashes in management styles)
• Dissolution of the venture when one of the venture partners decides to go their own way (due to strategic shifts, changes in priorities, or disagreements between partners)

Question 18

Name and explain each of the 4 important questions to choosing a mode of market entry (8)

Answer 18

1. The Question of Critical Resources and Capabilities
   Does the firm have the resources and capabilities
   for internal development or is it lacking some critical resources?
2. The Question of Entry Barriers
   Are there entry barriers to overcome?
3. The Question of Speed
   Is speed of the essence in the firm’s chances for successful entry?
4. The Question of Comparative Cost
   Which is the least costly mode of entry, given the firm’s objectives?

Question 19

Explain the options of market entry from the Question of Critical Resources and Capabilities (2)

Answer 19

• If a firm has all the resources it needs to start up
  a new business or will be able to easily purchase
  or lease any missing resources, it may choose to
  enter the business via internal development.
• If missing critical resources cannot be easily
  purchased or leased, a firm wishing to enter a new
  business must obtain these missing resources
  through either acquisition or joint venture.

Question 20

Explain the options of market entry from the Question of Entry Barriers(2)

Answer 20

• If entry barriers are low and the industry is
  populated by small firms, internal development
  may be the preferred mode of entry.
• If entry barriers are high, the company may still
  be able to enter with ease if it has the requisite
  resources and capabilities for overcoming high
  barriers. Firms should then opt for joint venture
  or acquisition as a mode of entry

Question 21

Explain the options of market entry from the Question of Speed (2)

Answer 21

• Acquisition is a favored mode of entry when
  speed is of the essence, as is the case in rapidly
  changing industries where fast movers can
  secure long-term positioning advantages.
• In other cases it can be better to enter a market
  after the uncertainties about technology or
  consumer preferences through joint venture or
  internal development.

Question 22

Explain the options of market entry from the Question of Comparative cost (3)

Answer 22

• Acquisition can be a high-cost mode of entry due
  to the need to pay a premium over the share
  price of the target company.
• Whether it is worth it to pay that high a price will
  depend on how much extra value will be created
  by the new combination of companies in the form
  of synergies.
• Joint ventures may provide a way to conserve
  on such entry costs.

Question 23

Define Transaciton Costs

Answer 23

are the costs of completing a business agreement or deal, over and above the price of the deal. They can include the costs of searching for an attractive target, the costs of evaluating its worth, bargaining costs, and the costs of completing the transaction.

Question 24

What are related and unrelated businesses ?

Answer 24

Related businesses are businesses that possess competitively valuable cross-business value chain and resource matchups. There is a close correspondence between the businesses in terms of how they perform key value chain activities and the resources and capabilities each needs to perform those activities.

Unrelated businesses are businesses that possess dissimilar value chains and resource requirements, with no competitively important cross-business commonalities at the value chain level.

Question 25

Explain strategic fit

Answer 25

Strategic fit exists whenever one or more activities constituting the value chains of different businesses are sufficiently similar and present opportunities for cross-business sharing or transferring of the resources and capabilities that enable these activities.

Question 26

What are the 5 strategic fit possibilities?

Answer 26

- Transferring specialized expertise, technological know-how, or other resources and capabilities from one business’s value chain to another’s- Google, transfer software developers. - Sharing costs by combining related value chain activities into a single operation- Using same warehouse for shipping and distribution - Exploiting common use of a well-known brand name- use brand loyalty and to give credibility- Starbucks (Going into food) - Sharing other resources (besides brands) that support corresponding value chain activities across businesses relationships with suppliers - Engaging in cross-business collaboration and knowledge sharing to create new competitively valuable resources and capabilities

Question 27

Name and distinguish between the 2 types of resources

Answer 27

**Generalized resourcesand capabilities:** * Can be deployed widely across a broad range of industry and business types * Can be leveraged in both unrelated and related diversification situations **Specialized resources and capabilities:** * Have very specific applications which restrict their use to a narrow range of industry and business types * Can typically be leveraged only in related diversification situations

Question 28

Potential Cross-Business Fits (6)

Answer 28

- R&D and technology activities - Supply chain activities - Manufacturing related activities - Distribution related activities - Customer service activities - Sales and marketing activities

Question 29

Differentiate between economies of scope and economies of scale

Answer 29

**Economies of scope** are cost reductions as a result of larger-sized operations. **Economies of scale** are cost reductions that flow from operating in multiple businesses and from cross-business resource sharing in the activities of the multiple businesses of a firm.

Question 30

5 ways of using Using Economies of Scope to Convert Strategic Fit into Competitive Advantage

Answer 30

1. Transferring specialized and generalized skills or knowledge 2. Combining related value chain activities to achieve lower costs 3. Leveraging brand names and other differentiation resources 4. Sharing other valueable resources 5. Using cross business collaboration and knowledge sharing

Question 31

Explain the 4 effects of cross business fit and explain the underlying test it proves.

Answer 31

* Strategic Fit builds more value than owning a stock portfolio of firms in different industries * Strategic Fit benefits are possible only via related diversification * The stronger the strategic fit, the greater its effect on the firm’s competitive advantages * Strategic Fit fosters the spreading of competitively valuable resources and capabilities specialized to certain applications and that have value only in specific types of industries and businesses Better off test: Diversifying into related businesses where competitively valuable strategic-fit benefits can be captured puts a firm’s businesses in position to perform better financially as part of the firm than they could have performed as independent enterprises, thus providing a clear avenue for boosting shareholder value and satisfying the better-off test.

Question 32

Explain the three considerations in evaluating the acquisition of a new business or the divestiture of an existing business (unrelated businesses)

Answer 32

* Can it meet corporate targets for profitability and return on investment? * Is it in an industry with attractive profit and growth potentials? * Is it is big enough to contribute significantly to the parent firm’s bottom line?

Question 33

Name and explain the 3 ways an Unrelated Diversification Strategy can pursue / create Value (6)

Answer 33

**Astute corporate parenting by management:** * Provide leadership, oversight, expertise, and guidance * Provide generalized or parenting resources that lower operating costs and increase SBU efficiencies **Cross-business allocation of financial resources:** * Serve as an internal capital market * Allocate surplus cash flows from some businesses to fund the capital requirements of other businesses **Acquiring and restructuring undervalued companies**: * Acquire weakly performing firms at bargain prices * Use turnaround capabilities to restructure them to increase their performance and profitability

Question 34

Explain corporate parenting (4)

Answer 34

Corporate parenting is the role that a diversified corporation plays in nurturing its component businesses through the provision of: * Top management expertise * Disciplined control * Financial resources * Other types of generalized resources and capabilities such as long-term planning systems, business development skills, management development processes, and incentive systems

Question 35

How can Corporate Parents Add Value to their unrelated Businesses

Answer 35

* by offering high-level oversight and guidance * by providing businesses with other types of general resources that lower the operating costs of the individual businesses or that enhance their operating effectiveness * by allocating surplus cash flows from some businesses to fund the capital requirements of other business (having the company serve as an internal capital market) * by acquiring weakly performing companies at a bargain price and then restructuring their operations in ways that produce dramatic increases in profitability

Question 36

Define Parenting Advantage

Answer 36

is when a diversified company is more able than other companies to boost the combined performance of its individual businesses through high-level guidance, general oversight, and other corporate-level contributions.

Question 37

Define Umbrella Brand

Answer 37

is a corporate brand name that can be applied to a wide assortment of business types. It is a type of general resource that can be leveraged in unrelated diversification.

Question 38

Define restructuring

Answer 38

Restructuring refers to overhauling and streamlining the activities of a business: combining plants with excess capacity, selling off underutilized assets, reducing unnecessary expenses, and otherwise improving the productivity and profitability of the firm.

Question 39

The competitive advantage test through unrelated diversification. Name each test and explain how it is achieved in unrelated diversification.

Answer 39

**The industry attractiveness Test:** Diversify into businesses that can produce consistently good earnings and returns on investment **The cost of entry test:** Negotiate favorable acquisition prices **The better off test:** Provide managerial oversight and resource sharing, financial resource allocation and portfolio management, and restructure underperforming businesses

Question 40

What are the 2 drawbacks of unrelated diversification and explain

Answer 40

**Very demanding managerial requirements** due to the monitoring and maintaining of a parenting advantage **Limited competitive advantage potential** due to the potential lack of cross-business strategic-fit benefits

Question 41

What are misguided reasons for pursuing unrelated diversification ? (4)

Answer 41

* **risk reduction** – spreading the company’s investments over a set of diverse industries to spread risk cannot create long-term shareholder value since the company’s shareholders can more flexibly reduce their exposure to risk by investing in a diversified portfolio of stocks and bonds * **growth** – only profitable growth (the kind that comes from creating added value for shareholders) can justify a strategy of unrelated diversification * **stabilisation** – there is no evidence to support the thought that consolidated profits of firms with unrelated diversification strategies are more stable or less subject to reversal in periods of recession and economic stress than the profits of firms with related diversification strategies * **managerial motives** – unrelated diversification can provide benefits to managers such as higher compensation and reduced unemployment risk but pursuing diversification for these reasons will likely reduce shareholder value and violate managers’ fiduciary responsibilities

Question 42

What are the 3 diversification strategy options ?

Answer 42

related unrelated both

Question 43

Related-Unrelated Business Portfolio Combinations (4) and define each

Answer 43

**Dominant-business enterprises:** Have a major “core” firm that accounts for 50% to 80% of total revenues and a collection of small related or unrelated firms that accounts for the remainder **Narrowly diversified firms:** Some diversified companies are narrowly diversified around a few (two to five) related or unrelated businesses **Broadly diversified firms:** Have a wide-ranging collection of related businesses, unrelated businesses, or a mixture of both **Multi-business enterprises:** Have a business portfolio consisting of several unrelated groups of related businesses (A number of multi business enterprises have diversified into unrelated areas but have a collection of related businesses within each area, thus giving them a business portfolio consisting of several unrelated groups of related businesses)

Question 44

Steps in evaluating the strategy of a diversified firm (6)

Answer 44

1. Assess the attractiveness of the industries the firm has diversified into, both individually and as a group 2. Assess the competitive strength of the firm’s business units within their respective industries 3. Evaluate the extent of cross-business strategic fit along the value chains of the firm’s various business units 4. Check whether the firm’s resources fit the requirements of its present business lineup 5. Rank the performance prospects of the businesses from best to worst and determine resource allocation priorities 6. Craft strategic moves to improve corporate performance

Question 45

Step 1: Evaluating Industry Attractiveness for diversified multi business companies. How attractive are the industries in which the firm has business operations? (3)

Answer 45

1. Does each industry represent a good market for the firm to be in? 2. Which industries are most attractive, and which are least attractive? 3. How appealing is the whole group of industries?

Question 46

Step 4: EVALUATING INDUSTRY ATTRACTIVENESS for diversified multi business companies Checking for resource fit : Name and explain both types (6)

Answer 46

- **Financial resource fit** ● State of the internal capital market ● Using the portfolio approach  Cash hogs need cash to develop.  Cash cows generate excess cash.  Star businesses are self supporting. ♦ Success sequence: ● Cash hog ➔ Star ➔ Cash cow - **Nonfinancial resource fit** ● Does the firm have (or can it develop) the specific resources and capabilities needed to be successful in each of its businesses? ● Are the firm’s resources being stretched too thin by the resource requirements of one or more of its businesses?

Question 47

Craft strategic moves to improve corporate performance: Name and explain all 4 options (8)

Answer 47

- **Maintain existing business lineup** ► Makes sense when the current business lineup offers attractive growth opportunities and can generate added economic value for shareholders - **Broaden diversification base** ► Acquire more businesses and build positions in new related or unrelated industries ► Add businesses that will complement and strengthen the market position and competitive capabilities of businesses in industries where the firm already has a stake - **Narrow diversification base** ► Get out of businesses that are competitively weak or in unattractive industries, or lack adequate strategic and resource fit - **Restructure a diversified company's business line-up** ► Restructure the firm’s business lineup through a mix of divestitures and new acquisitions ► Use debt capacity and cash from divesting businesses that are in unattractive industries, or that lack strategic or resource fit and are non-core businesses to make acquisitions in more promising industries

Question 48

Define Financial Resource Fit

Answer 48

is concerned with whether a diversified company can generate the internal cash flows sufficient to fund the capital requirements of its businesses, pay its dividends, meet its debt obligations, and remain financially healthy.

Question 49

How to determine whether a diversified company’s businesses exhibit good financial resource fit?

Answer 49

1. do any of the company’s individual businesses present financial challenges with respect to contributing adequately to achieving companywide performance targets? 2. does the corporation have adequate financial strength to fund its different businesses and maintain a healthy credit rating? 3. cash flow considerations

Question 50

Define Internal Capital Market

Answer 50

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 realise their growth potential.

Question 51

Define Portfolio Approach

Answer 51

is based on the fact that different businesses have different cash flow and investment characteristics.

Question 52

Define Cash Hog

Answer 52

business generates cash flows that are too small to fully fund its growth. It thereby requires cash infusions to provide additional working capital and finance new capital investment.

Question 53

Define Cash Cow

Answer 53

business generates cash flows over and above its internal requirements, thus providing a corporate parent with funds for investing in cash hog businesses, financing new acquisitions, or paying dividends.

Question 54

How to determine whether a diversified company’s businesses exhibit good nonfinancial resource fit?

Answer 54

1. does the parent company have or can it develop the specific resources and capabilities needed to be successful in each of its businesses? 2. are the parent company’s resources being stretched too thinly by the resource requirements of one or more of its businesses?

Question 55

What are Strategic option s for allocating company Financial Resources?

Answer 55

* Invest in ways to strengthen or grow existing business * Make acquisitions to establish positions in new industries or to complement existing businesses * Fund long-range R&D ventures aimed at opening market opportunities in new or existing businesses

Question 56

What are Financial options for allocating company Financial Resources?

Answer 56

* Pay off existing long-term or short-term debt * Increase dividend payments to shareholders * Repurchase shares of the company’s common stock * Build cash reserves; invest in short-term securities

Question 57

Factors motivating the addition of businesses (4)

Answer 57

* The transfer of resources and capabilities to related or complementary businesses * Rapidly changing technology, legislation, or new product innovations in core businesses * Boosting the market position and competitive capabilities of the firm’s present businesses * Extension of the scope of the firm’s operations into additional country markets

Question 58

Factors motivating business divestitures (4)

Answer 58

* Long-term performance can be improved by concentrating on stronger positions in fewer core businesses and industries. * Business is in a once-attractive industry where market conditions have badly deteriorated * Business has either failed to perform as expected or is lacking in cultural, strategic, or resource fit. * Business has become more valuable if sold to another firm or as an independent spin-off firm.

Question 59

What is Companywide restructuring/corporate restructuring?

Answer 59

involves making major changes in a diversified company by divesting some businesses and/or acquiring other, so as to put a whole new face on the company’s business line-up.

Question 60

Factors leading to corporate restructuring: (6)

Answer 60

* A serious mismatch between the firm’s resources and capabilities and the type of diversification that it has pursued * Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries * Too many competitively weak businesses * Ongoing declines in the market shares of major business units that are falling prey to more market-savvy competitors * An excessive debt burden with interest costs that eat deeply into profitability * Ill-chosen acquisitions that haven’t lived up to expectations

Question 61

Define a spin off ?

Answer 61

A spinoff is an independent company created when a corporate parent divests a business either by selling shares to the public via an initial public offering or by distributing shares in the new company to shareholders of the corporate parent.