Diversification

Why Diversify?
– Minimize risk of being in a single business; Eg. Seasonal products
– To capitalise on its capabilities to maximise organisational strength
or minimise weakness- make use of surplus cash flow- efficient
allocation of capital- ITC/ GE
– Growth in existing industry is blocked/low due to environmental or
regulatory factors
– Maximising returns by investing in profitable business and selling out
unprofitable ones.
– Take advantage of emerging opportunities afforded by expanding
economies and govt. policies.
– Synergy- economies of scale and scope- auto companies diversifying
across geographies/ L&T from EPC to finance, cement, steel
 Types of diversification
• Vertical integration
– Hindalco; Reliance;
• Horizontal or related diversification
– Strategy of adding related or similar product/service lines to existing core
business, either through acquisition of competitors or through internal
development of new products/services.
– Products synergy; eg. Canon- camera, copier, fax, printer, IBM- Infotech; L&T-
Cement
– Geographies; eg. Tata- chorus-JLR/ mahindra- Ssayong/ Kellog- mistake of
assuming Indian families would accept cold breakfast; McDonalds- focused on
spicy vegetarian and chicken
– Microsoft- OS, application software, enterprise software, webhosting and
management services, videogames, surface tablets
• Conglomerate- Unrelated- Across Business
– ITC- Newsprint/Paperboards/Agribusiness/ Match/ Tobacco/Hospitality/
retailing/ personal care/ branded packaged foods/ expressions
– Wipro- consumer goods, software, electric goods
 Diversification and Performance
• 1960s and 70s diversification believed to be profitable; 1980s and 90s
diversification seen as value destroying.
• Several studies conducted to determine correlation between
diversification and performance
• Michael Porter conducted a study of 33 firms in the Fortune 500 list
who had diversified and tracked their post diversification
performance over twenty years from 50s-70s.
– conclusion was that these firms had on the whole performed poorly after
diversification.
– 70% of these firms retraced their original strategic paths and divested from
the businesses
• Some evidence that high levels of diversification detrimental
to profitability
• Diversifying acquisitions, on average, destroy shareholder
value for acquirers
 Diversification- Three tests

If diversification is to create shareholder value, it must meet three tests:

1. The Attractiveness Test: diversification must be directed towards actual

or potentially-attractive industries.

2. The Cost of Entry Test : the cost of entry must not capitalize all future
profits.

3. The Better-Off Test: either the new unit must gain competitive
advantage from its link with the corporation, or vice-versa. (i.e.
synergy must be present)
 Questions for managers to consider

• What can we do better than any of the competitors in the current

market?
– Strategic Assets- Kingfisher
• What strategic assets do we need in order to succeed in the market?
– Oil Exploration BP-EXXON to Mineral exploration
– Coke-Wine; 90-10
• Can we catch up or leapfrog competitors in their own game? ORAL B
entry into toothpastes
• Will diversifications breakup strategic assets that need to be kept
together? McDonalds- frozen foods (logistics, food retail, supplier
relation) theme park (real estate/family entertainment), photo
processing (consistent quality)
• Will we be simply a player in the new market or will we emerge a
winner?
• What can our company learn by diversifying and are we sufficiently
organized to learn it?
 Why diversification works
• Milton Lauenstein has an interesting explanation for the success of
some diversified companies. Sloan Management Review, 1985.
• The hidden reason why diversification can work and often does, lies
in the operation of the system of governance of independent
corporations
– In well-managed conglomerates, the mediocre performance of unit
managers is not tolerated.
– Have corporate staff who go through the annual budgets and long range
plans of the operating units with a microscope
– In focused firms, the CEO, who is effectively the business manager, is
rarely sacked unless the performance is disastrous
– directors of a focused company often do not spend enough time, going
into details
ITC- INDIA FIRST
RATE THE FOUR CHAIRMAN'S OF ITC?
WHOSE INTEREST SHOULD THE FIRM SERVE
SHAREHOLDERS OR NATIONAL/SOCIETY
• Did ITC serve BAT interests as a tobacco major
well
• Did ITC serve BAT, the shareholders well?
• Did ITC manage its diversification well?
• Could ITC have served BATs interest even
better had it not diversified away from core
business?
• What are the strategic challenges facing ITC?
• Should the companies focus be on longevity or
profitability?
• Should ITC divest its personal care business?
• Should ITC divest socially undesirable cigarette
business?