What are the 3 tests for judging whether a particular diversification move can create value for shareholders?

are cost-saving efficiencies that stem directly from strategic fits along the value chains of related businesses.

2

Checking a diversified company's business portfolio for the competitive advantage potential of cross-business strategic fits does not involve determining whether sister business units have value chain match-ups that offer opportunities to

Employ the same basic competitive approach and pursue the same type of competitive advantage.

3

The top-level executive task of crafting a diversified company's overall or corporate strategy does not include which one of the following?

Choosing the appropriate value chain for each business the company has entered

4

The three tests for judging whether a particular diversification move can create added long-term value for shareholders are

The industry attractiveness test, the cost-of-entry test, and the better-off test.

5

Retrenching to a narrower diversification base

has the advantage of enabling a company to strive for better long-term performance by concentrating on building strong positions in a small number of core businesses and industries and avoiding the mistake of diversifying so broadly that resources and management attention are stretched thinly across many businesses.

6

The difference between a "cash-cow" business and a "cash hog" business is that

A cash cow business produces large internal cash flows over and above what is needed to build and maintain the business whereas the internal cash flows of a cash hog business are too small to fully fund its operating needs and capital requirements.

7

Diversifying into related businesses where competitively valuable strategic fit benefits can be captured and turned into a competitive advantage over business rivals whose operations do not offer comparable strategic-fit benefits

is what fuels 1+1=3 gains in shareholder value--the necessary outcome for satisfying the better-off test and proving the business merit of a company's diversification effort.

8

Using relative market share to assess a business's competitive strength is analytically superior to straight percentage measures of market share because relative market share

is a better indicator of competitive strength than is a simple percentage measure of market share--for instance, a company with a 20% market share is in a much stronger competitive position if its largest rival has a market share of 10% (which means its relative market share is 2.0) that it is if its largest rival has a 30% market share (in which case the company's relative market share is only 0.67).

9

Which of the following is not part of the procedure for evaluating the pluses and minuses of a diversified company's strategy and deciding what actions to take to improve the company's performance?

Conducting a SWOT analysis of each business the company has diversified into.

10

Which of the following are negatives or disadvantages of pursuing unrelated diversification strategies?

No potential for competitive advantage beyond any benefits of corporate parenting and what each individual business can generate on its own.

11

Which one of the following is not one of the appeals of unrelated diversification?

it is quicker and easier to build a competitive advantage over undiversified or less-diversified companies.

Over the last two articles of the strategy series, I unpacked two interesting topics that included Porter’s Diamond and the resource-based view of strategy. To conclude this short series and the MGrad LinkedIn Agency Influencer competition I thought I’d share several fascinating points on corporate strategy and diversification.

What is corporate strategy?

Corporate strategy is ultimately concerned with how firms create value across different businesses. Corporate strategy addresses two key questions, which are:

1. What business the corporation should be in and,
2. How the corporate office should manage the array of business units regarding how we can combine and link them to create synergies.

With the two questions in mind, it requires the firm to invest in a valuable set of resources, craft portfolios, and design organisational structures to share activities or transfer skills across business units. For that reason, firms should consider diversification. 

Good reasons for diversification:

1.   Seek synergies

Many firms seek diversification to obtain synergies within related businesses due to economies of scale and scope. Synergies enable these businesses to share resources and core competencies, create more value, save time and reduce/share costs.

An example of this is demonstrated by Volkswagen and their diverse automotive and financial service divisions. In their automotive division, they have both broad product and segment mixes, which enables them to capture more profits and achieve time and cost efficiency. They do this by sharing resources and creating an assembly kit strategy that allows them to standardise car parts and create modules in manufacturing.

2.   Create market power

Building market power is another good reason for diversification as it avoids/creates dependencies and blocks competitors at multipoint competition.

Not so good reasons for diversification:

1.   Reduce risk

Firms often diversify to reduce risk as it helps to reduce profit variances and lower unsystematic risk. However, risk reduction is not a strong enough reason for firms to diversify since shareholders can easily perform this process themselves and of course much cheaper. Diversification for risk tends to work well for unrelated companies, although these firms may lack synergies.

2.   Create growth

Diversification is occasionally used for growth to escape stagnant or declining industries. These corporations tend to buy themselves into unrelated industries, which could be quite expensive. It’s often not a good reason to diversify for growth.

3.   Experience low or high performance

Firms that want to diversify due to low or high performance often have excessive cash and make riskier investments in unrelated businesses, where they lack industry knowledge and synergies. Consequently, this leads to the buyer’s curse where they often pay too much for something.

Porter’s three essential tests:

 To ensure that companies are diversifying to create long-term shareholder value, Michael Porter has devised three tests, which need to be fully satisfied.

1.   Attractiveness test

• Aims to ensure that diversification is directed towards an attractive industry.
• Assesses the factors in Porter’s five forces to determine if something is attractive since firms can sometimes pay too much to enter.

2.   Cost of entry test

• Ensures the cost of entry does not capitalise all future profits (i.e. only do it if it can be done cheaply).
• This test tends to act as the main culling factor for diversification.

3.   Better off test

• The new business unit must gain a competitive advantage from its link with the corporation or vice versa.
• If it does not fit into the firm’s portfolio, then a firm should proceed with diversification even if it is cheap. It also needs to have synergies to share resources and capabilities for the long run.

We can now clearly see the strong links between corporate strategy and diversification within related businesses. Ultimately, it’s all about creating synergies that enable firms to transfer resources and share core competencies to achieve a sustained competitive advantage over competitors.

Goold, M.; Campbell, A. Alexander, M. (1998). Corporate strategy and parenting theory. Long Range Planning, 31(2), p. 308-314.

Porter, M. (1996). What is strategy? Harvard Business Review.

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Peter Tran is a Digital Intern at MEC. He is in his final semester at the University of Technology Sydney, majoring in Marketing and Environmental Science.