DIVERSIFICATION STRATEGY

Group No. 9

SUBMITTED TO : SUBMITTED BY:

PROF.JASWAL SINGH MANDEEP SINGH(500802507)

DARPAN SINDWANI (509

AMANDEEP S. MAAN(500902004)
 GURINDER S. GILL(50000000)

DIVERSIFICATION

Diversification strategies are used to expand firms' operations by adding markets, products,
services, or stages of production to the existing business. The purpose of diversification is to
allow the company to enter lines of business that are different from current operations. When the
new venture is strategically related to the existing lines of business, it is called concentric
diversification. Conglomerate diversification occurs when there is no common thread of strategic
fit or relationship between the new and old lines of business; the new and old businesses are
unrelated.

MOTIVES FOR DIVERSIFICATION

GROWTH :- (1) the desire to escape stagnant or declining industries has been one of the most
powerful motives for diversification (tobacco, oil, defense).

(2)But, growth satisfies management not shareholder goals.

(3)Growth strategies (esp. by acquisition), tend to destroy shareholder value

RISK:-Diversification reduces variance of profit flows

SPREADING :- (1) But, does not normally create value for shareholders, since shareholders
can hold diversified portfolios.

(2) Capital Asset Pricing Model shows that diversification lowers unsystematic risk not
systematic risk.

PROFIT: - For diversification to create shareholder value, the act of bringing different
businesses under common ownership must somehow increase their profitability.

DIVERSIFICATION IN THE CONTEXT OF GROWTH STRATEGIES

Diversification is a form of growth strategy. Growth strategies involve a significant increase in

performance objectives (usually sales or market share) beyond past levels of performance. Many
organizations pursue one or more types of growth strategies. One of the primary reasons is the
view held by many investors and executives that "bigger is better." Growth in sales is often used
as a measure of performance. Even if profits remain stable or decline, an increase in sales
satisfies many people. The assumption is often made that if sales increase, profits will eventually
follow.

Rewards for managers are usually greater when a firm is pursuing a growth strategy. Managers
are often paid a commission based on sales. The higher the sales level, the larger the
compensation received. Recognition and power also accrue to managers of growing companies.
They are more frequently invited to speak to professional groups and are more often interviewed
and written about by the press than are managers of companies with greater rates of return but
slower rates of growth. Thus, growth companies also become better known and may be better
able, to attract quality managers.
Growth may also improve the effectiveness of the organization. Larger companies have a
number of advantages over smaller firms operating in more limited markets.

1. Large size or large market share can lead to economies of scale. Marketing or production
synergies may result from more efficient use of sales calls, reduced travel time, reduced
changeover time, and longer production runs.
2. Learning and experience curve effects may produce lower costs as the firm gains
experience in producing and distributing its product or service. Experience and large size
may also lead to improved layout, gains in labor efficiency, redesign of products or
production processes, or larger and more qualified staff departments (e.g., marketing
research or research and development).
3. Lower average unit costs may result from a firm's ability to spread administrative
expenses and other overhead costs over a larger unit volume. The more capital intensive a
business is, the more important its ability to spread costs across a large volume becomes.
4. Improved linkages with other stages of production can also result from large size. Better
links with suppliers may be attained through large orders, which may produce lower costs
(quantity discounts), improved delivery, or custom-made products that would be
unaffordable for smaller operations. Links with distribution channels may lower costs by
better location of warehouses, more efficient advertising, and shipping efficiencies. The
size of the organization relative to its customers or suppliers influences its bargaining
power and its ability to influence price and services provided.
5. Sharing of information between units of a large firm allows knowledge gained in one
business unit to be applied to problems being experienced in another unit. Especially for
companies relying heavily on technology, the reduction of R&D costs and the time
needed to develop new technology may give larger firms an advantage over smaller,
more specialized firms. The more similar the activities are among units, the easier the
transfer of information becomes.
6. Taking advantage of geographic differences is possible for large firms. Especially for
multinational firms, differences in wage rates, taxes, energy costs, shipping and freight
charges, and trade restrictions influence the costs of business. A large firm can sometimes
lower its cost of business by placing multiple plants in locations providing the lowest
 cost. Smaller firms with only one location must operate within the strengths and
weaknesses of its single location.

CONCENTRIC DIVERSIFICATION

Concentric diversification occurs when a firm adds related products or markets. The goal of such
diversification is to achieve strategic fit. Strategic fit allows an organization to achieve synergy.
In essence, synergy is the ability of two or more parts of an organization to achieve greater total
effectiveness together than would be experienced if the efforts of the independent parts were
summed. Synergy may be achieved by combining firms with complementary marketing,
financial, operating, or management efforts. Breweries have been able to achieve marketing
synergy through national advertising and distribution. By combining a number of regional
breweries into a national network, beer producers have been able to produce and sell more beer
than had independent regional breweries.

Financial synergy may be obtained by combining a firm with strong financial resources but
limited growth opportunities with a company having great market potential but weak financial
resources. For example, debt-ridden companies may seek to acquire firms that are relatively
debt-free to increase the lever-aged firm's borrowing capacity. Similarly, firms sometimes
attempt to stabilize earnings by diversifying into businesses with different seasonal or cyclical
sales patterns.

Strategic fit in operations could result in synergy by the combination of operating units to
improve overall efficiency. Combining two units so that duplicate equipment or research and
development are eliminated would improve overall efficiency. Quantity discounts through
combined ordering would be another possible way to achieve operating synergy. Yet another
way to improve efficiency is to diversify into an area that can use by-products from existing
operations. For example, breweries have been able to convert grain, a by-product of the
fermentation process, into feed for livestock.

Management synergy can be achieved when management experience and expertise is applied to
different situations. Perhaps a manager's experience in working with unions in one company
could be applied to labor management problems in another company. Caution must be exercised,
however, in assuming that management experience is universally transferable. Situations that
appear similar may require significantly different management strategies. Personality clashes and
other situational differences may make management synergy difficult to achieve. Although
managerial skills and experience can be transferred, individual managers may not be able to
make the transfer effectively.

CONGLOMERATE DIVERSIFICATION

Conglomerate diversification occurs when a firm diversifies into areas that are unrelated to its
current line of business. Synergy may result through the application of management expertise or
financial resources, but the primary purpose of conglomerate diversification is improved
profitability of the acquiring firm. Little, if any, concern is given to achieving marketing or
production synergy with conglomerate diversification.

One of the most common reasons for pursuing a conglomerate growth strategy is that
opportunities in a firm's current line of business are limited. Finding an attractive investment
opportunity requires the firm to consider alternatives in other types of business. Philip Morris's
acquisition of Miller Brewing was a conglomerate move. Products, markets, and production
technologies of the brewery were quite different from those required to produce cigarettes.

Firms may also pursue a conglomerate diversification strategy as a means of increasing the firm's
growth rate. As discussed earlier, growth in sales may make the company more attractive to
investors. Growth may also increase the power and prestige of the firm's executives.
Conglomerate growth may be effective if the new area has growth opportunities greater than
those available in the existing line of business.

Probably the biggest disadvantage of a conglomerate diversification strategy is the increase in

administrative problems associated with operating unrelated businesses. Managers from different
divisions may have different backgrounds and may be unable to work together effectively.
Competition between strategic business units for resources may entail shifting resources away
from one division to another. Such a move may create rivalry and administrative problems
between the units.
Caution must also be exercised in entering businesses with seemingly promising opportunities,
especially if the management team lacks experience or skill in the new line of business. Without
some knowledge of the new industry, a firm may be unable to accurately evaluate the industry's
potential. Even if the new business is initially successful, problems will eventually occur.
Executives from the conglomerate will have to become involved in the operations of the new
enterprise at some point. Without adequate experience or skills (Management Synergy) the new
business may become a poor performer.

Without some form of strategic fit, the combined performance of the individual units will
probably not exceed the performance of the units operating independently. In fact, combined
performance may deteriorate because of controls placed on the individual units by the parent
conglomerate. Decision-making may become slower due to longer review periods and
complicated reporting systems.

DIVERSIFICATION: GROW OR BUY?

Diversification efforts may be either internal or external. Internal diversification occurs when a
firm enters a different, but usually related, line of business by developing the new line of
business itself. Internal diversification frequently involves expanding a firm's product or market
base. External diversification may achieve the same result; however, the company enters a new
area of business by purchasing another company or business unit. Mergers and acquisitions are
common forms of external diversification.

INTERNAL DIVERSIFICATION

One form of internal diversification is to market existing products in new markets. A firm may
elect to broaden its geographic base to include new customers, either within its home country or
in international markets. A business could also pursue an internal diversification strategy by
finding new users for its current product. For example, Arm & Hammer marketed its baking soda
as a refrigerator deodorizer. Finally, firms may attempt to change markets by increasing or
decreasing the price of products to make them appeal to consumers of different income levels.
Another form of internal diversification is to market new products in existing markets. Generally
this strategy involves using existing channels of distribution to market new products. Retailers
often change product lines to include new items that appear to have good market potential.
Johnson & Johnson added a line of baby toys to its existing line of items for infants. Packaged-
food firms have added salt-free or low-calorie options to existing product lines.

It is also possible to have conglomerate growth through internal diversification. This strategy
would entail marketing new and unrelated products to new markets. This strategy is the least
used among the internal diversification strategies, as it is the most risky. It requires the company
to enter a new market where it is not established. The firm is also developing and introducing a
new product. Research and development costs, as well as advertising costs, will likely be higher
than if existing products were marketed. In effect, the investment and the probability of failure
are much greater when both the product and market are new.

EXTERNAL DIVERSIFICATION

External diversification occurs when a firm looks outside of its current operations and buys
access to new products or markets. Mergers are one common form of external diversification.
Mergers occur when two or more firms combine operations to form one corporation, perhaps
with a new name. These firms are usually of similar size. One goal of a merger is to achieve
management synergy by creating a stronger management team. This can be achieved in a merger
by combining the management teams from the merged firms.

Acquisitions, a second form of external growth, occur when the purchased corporation loses its
identity. The acquiring company absorbs it. The acquired company and its assets may be
absorbed into an existing business unit or remain intact as an independent subsidiary within the
parent company. Acquisitions usually occur when a larger firm purchases a smaller company.
Acquisitions are called friendly if the firm being purchased is receptive to the acquisition.
(Mergers are usually "friendly.") Unfriendly mergers or hostile takeovers occur when the
management of the firm targeted for acquisition resists being purchased.

DIVERSIFICATION: VERTICAL OR HORIZONTAL?

Diversification strategies can also be classified by the direction of the diversification. Vertical
integration occurs when firms undertake operations at different stages of production.
Involvement in the different stages of production can be developed inside the company (internal
diversification) or by acquiring another firm (external diversification). Horizontal integration or
diversification involves the firm moving into operations at the same stage of production. Vertical
integration is usually related to existing operations and would be considered concentric
diversification. Horizontal integration can be either a concentric or a conglomerate form of
diversification.

VERTICAL INTEGRATION

The steps that a product goes through in being transformed from raw materials to a finished
product in the possession of the customer constitute the various stages of production. When a
firm diversifies closer to the sources of raw materials in the stages of production, it is following a
backward vertical integration strategy. Avon's primary line of business has been the selling of
cosmetics door-to-door. Avon pursued a backward form of vertical integration by entering into
the production of some of its cosmetics. Forward diversification occurs when firms move closer
to the consumer in terms of the production stages. Levi Strauss & Co., traditionally a
manufacturer of clothing, has diversified forward by opening retail stores to market its textile
products rather than producing them and selling them to another firm to retail.

Backward integration allows the diversifying firm to exercise more control over the quality of
the supplies being purchased. Backward integration also may be undertaken to provide a more
dependable source of needed raw materials. Forward integration allows a manufacturing
company to assure itself of an outlet for its products. Forward integration also allows a firm more
control over how its products are sold and serviced. Furthermore, a company may be better able
to differentiate its products from those of its competitors by forward integration. By opening its
own retail outlets, a firm is often better able to control and train the personnel selling and
servicing its equipment.
Since servicing is an important part of many products, having an excellent service department
may provide an integrated firm a competitive advantage over firms that are strictly
manufacturers.

Some firms employ vertical integration strategies to eliminate the "profits of the middleman."
Firms are sometimes able to efficiently execute the tasks being performed by the middleman
(wholesalers, retailers) and receive additional profits. However, middlemen receive their income
by being competent at providing a service. Unless a firm is equally efficient in providing that
service, the firm will have a smaller profit margin than the middleman. If a firm is too inefficient,
customers may refuse to work with the firm, resulting in lost sales.

Vertical integration strategies have one major disadvantage. A vertically integrated firm places
"all of its eggs in one basket." If demand for the product falls, essential supplies are not
available, or a substitute product displaces the product in the marketplace, the earnings of the
entire organization may suffer.

HORIZONTAL DIVERSIFICATION

Horizontal integration occurs when a firm enters a new business (either related or unrelated) at
the same stage of production as its current operations. For example, Avon's move to market
jewelry through its door-to-door sales force involved marketing new products through existing
channels of distribution. An alternative form of horizontal integration that Avon has also
undertaken is selling its products by mail order (e.g., clothing, plastic products) and through
retail stores (e.g., Tiffany's). In both cases, Avon is still at the retail stage of the production
process.

DIVERSIFICATION STRATEGY AND MANAGEMENT TEAMS

As documented in a study by Marlin, Lamont, and Geiger, ensuring a firm's diversification
strategy is well matched to the strengths of its top management team members factored into the
success of that strategy. For example, the success of a merger may depend not only on how
integrated the joining firms become, but also on how well suited top executives are to manage
that effort. The study also suggests that different diversification strategies (concentric vs.
conglomerate) require different skills on the part of a company's top managers, and that the
factors should be taken into consideration before firms are joined.

There are many reasons for pursuing a diversification strategy, but most pertain to management's
desire for the organization to grow. Companies must decide whether they want to diversify by
going into related or unrelated businesses. They must then decide whether they want to expand
by developing the new business or by buying an ongoing business. Finally, management must
decide at what stage in the production process they wish to diversify.

IGOR ANSOFF MODEL

The Ansoff Product-Market Growth Matrix is a marketing tool created by Igor Ansoff and
first published in his article "Strategies for Diversification" in the Harvard Business Review
(1957). The matrix allows marketers to consider ways to grow the business via existing and/or
new products, in existing and/or new markets – there are four possible product/market
combinations. This matrix helps companies decide what course of action should be taken given
current performance. The matrix consists of four strategies:

 Market penetration (existing markets, existing products): Market penetration occurs

when a company enters/penetrates a market with current products. The best way to
achieve this is by gaining competitors' customers (part of their market share). Other ways
include attracting non-users of your product or convincing current clients to use more of
your product/service, with advertising or other promotions. Market penetration is the
least risky way for a company to grow.
  Product development (existing markets, new products): A firm with a market for its
current products might embark on a strategy of developing other products catering to the
same market (although these new products need not be new to the market; the point is
that the product is new to the company). For example, McDonald's is always within the
fast-food industry, but frequently markets new burgers. Frequently, when a firm creates
new products, it can gain new customers for these products. Hence, new product
development can be a crucial business development strategy for firms to stay
competitive.
 Market development (new markets, existing products): An established product in the
marketplace can be tweaked or targeted to a different customer segment, as a strategy to
earn more revenue for the firm. For example, Lucozade was first marketed for sick
children and then rebranded to target athletes. This is a good example of developing a
new market for an existing product. Again, the market need not be new in itself; the point
is that the market is new to the company.
 Diversification (new markets, new products): Virgin Cola, Virgin Megastores, Virgin
Airlines, Virgin Telecommunications are examples of new products created by the Virgin
Group of UK, to leverage the Virgin brand. This resulted in the company entering new
markets where it had no presence before.

The matrix illustrates, in particular, that the element of risk increases the further the strategy
moves away from known quantities - the existing product and the existing market. Thus, product
development (requiring, in effect, a new product) and market extension (a new market) typically
involve a greater risk than `penetration' (existing product and existing market); and
diversification (new product and new market) generally carries the greatest risk of all. In his
original work, which did not use the matrix form, Igor Ansoff stressed that the diversification
strategy stood apart from the other three.

While ansoff are usually followed with the same technical, financial, and merchandising
resources which are used for the original product line, diversification usually requires new skills,
new techniques, and new facilities. As a result it almost invariably leads to physical and
organizational changes in the structure of the business which represent a distinct break with past
business experience.
For this reason, most marketing activity revolves around penetration.

ADVANTAGES AND DISADVANTAGES OF DIVERSIFICATION

 Control of inputs, leading to continuity and improved quality. For instance 1984 and
1985 NewsCorp acquired Twentieth Century Fox and six television stations of the
Metromedia Broadcasting Group in the US. These acquisition provided the company with
a wider platform for consolidation of its related activities through access to studios for
making films and television Programmes.
  Control markets by guaranteeing sales and distribution. This can arise through a
combination of linkages in the value chain. For example where production and
distribution channels are combined, or where a company uses its well-established brand
names or corporate identity to gain benefits in new markets

 Take advantage of existing expertise, knowledge and resources in the company when
expanding into new activities. This may result in transfer of skills, such as research and
development knowledge and sharing of resources.

 Provide better risk control through no longer being reliant on a single market

 Provide movement away from declining activities

 Spread risk by avoiding having all eggs in one basket

DISADVANTAGES
 May result in slowing growth in its core business

 Adding management costs.

 Adding bureaucratic complexity. In addition to direct financial costs, there may

additional bureaucratic complexities necessitated by the need to coordinate and control
core activities with additional activities.

 Losses may be incurred during market consolidation process resulting in some business
units being subsidized by other profit making units. This was experienced by NewsCorp
the performance of Sky Television resulted financial losses of nearly ₤10 million per
month were incurred despite all the stringent cost reduction measures being put in place
in line with the overall strategic vision of NewsCorp.
 May result in negative synergies
 Diversification through acquisition across national boundaries may result in the
organization having to deal with varying intricacies of the political and legal
requirements of the different countries in which the organization has controlling interests.
For example Rupert Murdock was not allowed as a non US citizen to have more than 25
% of any company with a broadcasting license. As s result he was compelled to become a
US citizen in 1985.

 Diversification through acquisition May result in failure where there is a mismatch

between core competencies or experiences of the acquirer and acquired businesses.