DIVERSIFICATION Diversified Company A Company is said to be ‘diversified’ when it is in two or more lines of business. Diversification NEED NOT become a strategic priority until the firm gets signals of running out of growth opportunities in its core business. Risk of Single Business All eggs in one basket Changing customer needs, technology innovation, new substitutes affect market Market becomes unattractive Firm’s future prospects dim quickly No ‘fall back’ mechanism available. Benefits of Diversification Extra legs to stand on Cost reduction due to integration with upstream / downstream value chains Variety kills monotony; breeds innovation Gets options ready for future business. When does diversification make sense? Competitive Position Strong Weak Market Rapid Need not Do not diversify now diversify now Growth Slow Top priority: Diversify, Diversify if possible Decision to diversify depends on Growth potential of current business Attractiveness of the opportunity to transfer existing competencies to new business Availability of adequate financial & organizational resources Managerial expertise to cope with complexity of operating multi-business firm Types of Corporate Strategies • Integration Strategies • Intensive Strategies • Diversification Strategies • Defensive Strategies Integration Strategies Forward Amul extended its fresh milk business to production of cheese, ice cream, health drink, paneer etc Integration Backward Arvind Ltd, producer of denim jeans, commenced organic cotton farming in Akola Integration Horizontal Kingfisher Airlines recently acquired Deccan Integration Integration Strategies Forward integration & Backward integration are jointly called Vertical Integration (VI) Horizontal integration is also called Lateral integration. Vertical Integration Strategies Forward integration: towards end-user Backward integration: into source of supply VI extends Firm’s competitive scope in same industry VI makes Firm fully / partially integrated VI appeals only if it strengthens Firm’s competitiveness significantly. Forward Integration Also called ‘downstream integration’ Either go a step ahead to make Value-Added products from current end-product Or decide to distribute current end-product Adopt FI when market for VA goods becomes lucrative or when Current distribution channels are inefficient. Intensive Strategies Market ICICI Bank will open 300 more branches. It has 600 branches now. Penetration Market Development Jet Airways is cultivating new international sectors Product Dabur recently developed sugar-free ‘Chyawan Prakash’ for calorie- Development conscious consumers Diversification Strategies Concentric Microsoft launched personal computers that double as entertainment Diversification centers Conglomerate Godrej sets up fresh food retail stores after success of ‘Real Good’ Diversification chicken & other consumer products Horizontal The Times Group launches FM radio Mirchi and Times Now TV Diversification Defensive Strategies Retrenchment Pfizer retrenched surplus employees after restructuring its operations ICI India divests its entire stake in its wholly owned subsidiary Quest India Divestiture to Givaudan Group Liquidation Svadeshi Mills to be liquidated due to unviable textile operations Diversification is a form of growth marketing strategy for a company. It seeks to increase profitability through greater sales volume obtained from new products and new markets. Diversification can occur either at the business unit or at the corporate level. At the business unit level, it is most likely to expand into a new segment of an industry in which the business is already in. At the corporate level, it is generally and its also very interesting entering a promising business outside of the scope of the existing business unit. Diversification is part of the four main marketing strategies defined by the Product/Market Ansoff matrix: Ansoff pointed out that a diversification strategy stands apart from the other three strategies. The first three strategies are usually pursued with the same technical, financial, and merchandising resources used for the original product line, whereas diversification usually requires a company to acquire new skills, new techniques and new facilities. Therefore, diversification is meant to be the riskiest of the four strategies to pursue for a firm. Note: The notion of diversification depends on the subjective interpretation of “new” market and “new” product, which should reflect the perceptions of customers rather than managers. Indeed, products tend to create or stimulate new markets; new markets promote product innovation. The different types of diversification strategies The strategies of diversification can include internal development of new products or markets, acquisition of a firm, alliance with a complementary company, licensing of new technologies, and distributing or importing a products line manufactured by another firm. Generally, the final strategy involves a combination of these options. This combination is determined in function of available opportunities and consistency with the objectives and the resources of the company. There are three types of diversification: concentric, horizontal and conglomerate: Concentric diversification This means that there is a technological similarity between the industries, which means that the firm is able to leverage its technical know-how to gain some advantage. For example, a company that manufactures industrial adhesives might decide to diversify into adhesives to be sold via retailers. The technology would be the same but the marketing effort would need to change. It also seems to increase its market share to launch a new product which helps the particular company to earn profit. Horizontal diversification The company adds new products or services that are technologically or commercially unrelated (but not always) to current products, but which may appeal to current customers. In a competitive environment, this form of diversification is desirable if the present customers are loyal to the current products and if the new products have a good quality and are well promoted and priced. Moreover, the new products are marketed to the same economic environment as the existing products, which may lead to rigidity and instability. In other words, this strategy tends to increase the firm’s dependence on certain market segments. For example company was making note books earlier now they are also entering into pen market through its new product. Conglomerate diversification (or lateral diversification) The company markets new products or services that have no technological or commercial synergies with current products, but which may appeal to new groups of customers. The conglomerate diversification has very little relationship with the firm’s current business. Therefore, the main reasons of adopting such a strategy are first to improve the profitability and the flexibility of the company, and second to get a better reception in capital markets as the company gets bigger. Even if this strategy is very risky, it could also, if successful, provide increased growth and profitability. Diversification is the riskiest of the four strategies presented in the Ansoff matrix and requires the most careful investigation. Going into an unknown market with an unfamiliar product offering means a lack of experience in the new skills and techniques required. Therefore, the company puts itself in a great uncertainty. Moreover, diversification might necessitate significant expanding of human and financial resources, which may detracts focus, commitment and sustained investments in the core industries. Therefore a firm should choose this option only when the current product or current market orientation does not offer further opportunities for growth. In order to measure the chances of success, different tests can be done: • The attractiveness test: the industry that has been chosen has to be either attractive or capable of being made attractive. • The cost-of-entry test: the cost of entry must not capitalize all future profits. • The better-off test: the new unit must either gain competitive advantage from its link with the corporation or vice versa. Because of the high risks explained above, many attempts of companies to diversify led to failure. However, there are a few good examples of successful diversification: • Virgin Media moved from music producing to travels and mobile phones • Walt Disney moved from producing animated movies to theme parks and vacation properties • Canon diversified from a camera-making company into producing whole new range of office equipment. JOINT VENTURE A joint venture (often abbreviated JV) is an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only, or a continuing business relationship such as the Fuji Xerox joint venture. This is in contrast to a strategic alliance, which involves no equity stake by the participants, and is a much less rigid arrangement. The phrase generally refers to the purpose of the entity and not to a type of entity. Therefore, a joint venture may be a corporation, limited liability company, partnership or other legal structure, depending on a number of considerations such as tax and tort liability. When are joint ventures used? Joint ventures are not uncommon in the oil and gas industry, and are often cooperations between a local and foreign company (about 3/4 are international). A joint venture is often seen as a very viable business alternative in this sector, as the companies can complement their skill sets while it offers the foreign company a geographic presence. Studies show a failure rate of 30-61%, and that 60% failed to start or faded away within 5 years. (Osborn, 2003) It is also known that joint ventures in low-developed countries show a greater instability, and that JVs involving government partners have higher incidence of failure (private firms seem to be better equipped to supply key skills, marketing networks etc.) Furthermore, JVs have shown to fail miserably under highly volatile demand and rapid changes in product technology. Reasons for forming a joint venture Internal reasons 1. Build on company's strengths 2. Spreading costs and risks 3. Improving access to financial resources 4. Economies of scale and advantages of size 5. Access to new technologies and customers 6. Access to innovative managerial practices Competitive goals 1. Influencing structural evolution of the industry 2. Pre-empting competition 3. Defensive response to blurring industry boundaries 4. Creation of stronger competitive units 5. Speed to market 6. Improved agility Strategic goals 1. Synergies 2. Transfer of technology/skills 3. Diversification Examples • Sony Ericsson (Sony + Ericsson) • The Nokia Siemens Networks (Nokia + Siemens AG) • Sony BMG Music Entertainment Sony Music Entertainment (part of Sony) + Bertelsmann Music Group (part of Bertelsmann) • Mittal- Arcelor • TATA- Corus. MERGERS AND ACQUISITIONS Corporate Strategies in M&A: Gain market share Economies of scale Enter new markets Acquire technologies Strategic Benefit Complementary resource Tax shields Utilisation of surplus funds Managerial Effectiveness Integrate vertically The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity. Acquisition An acquisition, also known as a takeover or a buyout, is the buying of one company (the ‘target’) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Another type of acquisition is reverse merger, a deal that enables a private company to get publicly listed in a short time period. A reverse merger occurs when a private company that has strong prospects and is eager to raise financing buys a publicly listed shell company, usually one with no business and limited assets. Achieving acquisition success has proven to be very difficult, while various studies have showed that 50% of acquisitions were unsuccessful. The acquisition process is very complex, with many dimensions influencing its outcome. This model provides a good overview of all dimensions of the acquisition process. Merger In business or economics a merger is a combination of two companies into one larger company. Such actions are commonly voluntary and involve stock swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons. Motives behind M&A The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance: • Synergy: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins. • Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices. • Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products. • Economy of scale: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts. • Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company. • Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below). • Resource transfer: Resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.