Integrated Management Case Study LVMH

Read the LVMH case study (in the text) and address the following questions in (overall) not less than 1000 words

Are LVMH’s acquisitions over the years examples of related or unrelated diversification? Illustrate your answer by giving examples.

Does it make good financial and strategic sense for LVMH to compete in all of its current segments? Which of its product lines—Wine and Spirits, Fashion and Leather Goods, Perfumes and Cosmetics, Watches and Jewelry, Selective Retailing, and Others and Holding Companies—do you think is/are most important to LVMH’s future growth and profitability? Should one or more of these current segments be discontinued? Why?

What is your assessment of LVMH’s financial performance over the 2020–2022 period? (Use the financial ratios in the Appendix of the text as a guide in doing your financial analysis.)

Would you recommend that LVMH sell any of its products at Costco? Why or why not?

© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Confirming Pages
CASE 20
LVMH in 2023: Its Diversification
into Luxury Goods
®
John E. Gamble
Texas A&M University-Corpus Christi
I
n 2023 LVMH Moët Hennessy Louis Vuitton was
the world’s most valuable company with a market
capitalization of more than $500 billion and 2022
annual revenues of €79.2 billion. The company’s
portfolio of businesses included some of the most
prestigious brand names in wines, spirits, and champagnes; fashion; watches and jewelry; and perfumes
and cosmetics. The French conglomerate’s business portfolio also included a luxury yacht builder,
a 19th century-styled French amusement park, two
prestigious Parisian department stores, duty free
stores, a retail cosmetics chain, high-end luxury
hotels, and a variety of French media properties. Even
though no one needed LVMH’s products—­certain
vintages of its Dom Pérignon champagne could retail
for well over $1,000, its Givenchy dresses frequently
sold for $5,000 or more, and Bulgari watches carried
retail prices of more than $40,000—the company’s
products were desired by millions across the world.
LVMH CEO Bernard Arnault had been
described as a “wolf in cashmere” because of his
business acumen and track record for acquiring and
growing luxury brands such as Bulgari in 2011 and
Tiffany in 2020.1 Arnault’s success in building and
managing LVMH allowed him to surpass Elon Musk
in 2023 to become the world’s most wealthy individual with a fortune of $212 billion.
The company’s business portfolio began to take
shape in 1987 when Louis Vuitton, known worldwide
for its purses and luggage, merged with the maker of
Moët & Chandon champagne and Hennessy cognac.
LVMH’s current lineup of star luxury brands was
forged by Bernard Arnault, who became CEO of the
company in 1989 and promptly set about acquiring
tho07361_case20_C273-C281.indd
273
such names as Fendi, Givenchy, Celine, and Marc
Jacobs in fashion and leather goods; TAG Heuer,
Bulgari, and Zenith in watches and jewelry; and
Le Bon Marche and Sephora in retailing. By 2023
Arnault had assembled a portfolio of 75 luxury
brands.
Arnault believed LVMH’s collection of star
brands such as Moët & Chandon, Krug, Louis
Vuitton, Givenchy, and Parfums Christian Dior and
its recent acquisition of Tiffany would lead to longterm corporate advantage since star brands had
staying power. “The brand is built, if you wish, for
eternity. It has been around for a long time; it has
become an institution. Dom Pérignon is a perfect
example. I can guarantee that people will be drinking
it in the next century. It was created 250 years ago,
but it will be relevant and desired for another century
and beyond that.”2 A summary of LVMH’s financial
performance between 2020 and 2022 is presented in
Exhibit 1.
COMPANY HISTORY
The history of LVMH’s brand portfolio is traced
to 1743 when Moët & Chandon was established in
the Champagne Province in northeastern France.
Moët & Chandon not only became one of France’s
premier brands of champagne but was also sought
after outside of France with exports accounting for a
large percentage of its sales by the 20th century. The
company first diversified in 1968 when it acquired
Parfums Christian Dior, and a 1971 merger between
Moët & Chandon and Champagne Mercier combined France’s two best-selling brands of champagne.
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Confirming Pages
PART 2
C-274
EXHIBIT 1
Cases in Crafting and Executing Strategy
 VMH Consolidated Income Statements, 2020–2022
L
(€ in millions, except per share amounts)
Revenue
Cost of sales
Gross margin
Marketing and selling expenses
General and administrative expenses
Income (loss) from joint ventures and associates
Profit from recurring operations
Other operating income (expenses)
Operating profit
Cost of net financial debt
Interest on lease liabilities
Other financial income (expenses)
Net financial income (expense)
Income taxes
Net profit before minority interests
Minority interests
Net profit
Earnings per share, basic
Earnings per share, diluted
Number of shares outstanding
Basic
Diluted
2022
2021
2020
€79,184
24,988
54,196
28,151
5,027
37
21,055
(54)
21,001
(17)
(254)
(617)
(888)
5,362
14,751
667
€14,084
€28.05
€28.03
€64,215
20,355
43,860
22,308
4,414
13
17,151
4
17,155
41
(242)
254
53
4,510
12,698
662
€12,036
€23.90
€23.89
€44,651
15,871
28,780
16,792
3,641
(42)
8,305
(333)
7,972
(35)
(281)
(292)
(608)
2,409
4,955
253
€ 4,702
€9.33
€9.32
502,120,694
502,480,100
503,627,708
503,895,592
503,697,272
504,210,133
Source: LVMH 2022 Annual Report.
The company changed its name to Moët-Hennessey
when it again merged in 1971; this time with Jas
Hennessy & Co., the world’s second largest producer
of cognac.
Arnault became majority shareholder, CEO and
chairman of LVMH in 1989 and began an aggressive
acquisition campaign. His execution of a merger with
Louis Vuitton had made LVMH France’s 40th largest company with a collection of such well-known
luxury brands as Veuve Clicquot, Moët & Chandon,
and Dom Pérignon champagnes; Hennessy cognac;
Christian Dior and Givenchy perfumes and cosmetics; and Louis Vuitton leather handbags and luggage.
Arnault remained the company’s largest individual
shareholder in 2023, controlling 6.74 percent of
shares.
tho07361_case20_C273-C281.indd
274
Bernard Arnault believed that LVMH control of
the retail channels where its products were sold was
critical to the success of luxury brands. The use of
company-owned retail locations allowed LVMH to
not only make certain its products were of the highest quality and most elegant, but also allowed the
company to ensure its products were sold by retailers offering the highest level of customer service.
This belief drove the company’s moves into vertical integration into the operation of Louis Vuitton,
Christian Dior, and other designer-label stores in
Paris, New York, Beverly Hills, and other locations
and also led to the $2.5 billion acquisition of DFS
(Duty Free Shoppers) in 1996. San Francisco-based
DFS operated a chain of duty-free boutiques in Asia
and various international airports. Arnault expanded
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Case 20
LVMH in 2023: Its Diversification into Luxury Goods
further into retailing in 1997 with the acquisition
of French cosmetics retailer Sephora and the 1998
acquisition of famous Parisian department stores,
La Belle Jardiniere and Le Bon Marché. The company also acquired Starboard Cruise Services, which
offered duty-free shopping aboard 100 cruise ships
sailing in the Caribbean and elsewhere.
The company’s most noteworthy acquisitions during the 2000s included Fendi in 2003,
Glenmorangie in 2005, Belvedere in 2007, Hublot,
Royal Van Lent, and Dior in 2009, and Bulgari in
2011. Arnault’s buying binge also expanded the company’s range of diversification with the addition of
a French radio network and magazines targeted to
music aficionados and art connoisseurs. The largest acquisition made by Arnault between 2011 and
2020 was the $16.2 billion purchase of Tiffany & Co.
EXHIBIT 2
Confirming Pages
C-275
Bernard Arnault had called Tiffany “the most recognizable and most mythical U.S. brand in the world.”3
Immediately upon the acquisition in 2020, Arnault
began to enhance the brand with an even more exquisite jewelry and watches and a $500 million renovation of Tiffany’s iconic flagship store on the corner
of Fifth Avenue and 57th Street in New York City.
The company’s stock performance from April 2018
through April 2023 is presented in Exhibit 2.
LVMH’s Corporate Strategy Although much of
LVMH’s growth was attributable to the acquisition
of new businesses, Arnault placed an emphasis on
internal growth by exploiting common strategies and
capturing synergies across the portfolio. While the
company organizational structure and operating principles ensured that each business was autonomous,
 arket Performance of LVMH’s Common Stock,
M
April 2018–April 2023
(a) Trend in LVMH’s Common Stock Price
1,000
900
800
Price in €
700
600
500
400
300
200
19
20
21
Year
22
23
Percent Gain
(b) Performance of LVMH’s Stock Price versus the CAC 40 Paris Exchange
210
180
150
120
90
60
30
0
−30
−60
LVMH’s stock price
Performance of 40 largest
French companies traded
on the Euronext Paris
19
20
21
Year
22
23
Source: Bigcharts.marketwatch.com
tho07361_case20_C273-C281.indd
275
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Confirming Pages
PART 2
C-276
Cases in Crafting and Executing Strategy
Arnault demanded that each of the corporation’s
businesses demonstrate commitment to creativity
and innovation and product excellence. The longterm success of LVMH’s brands, in Arnault’s view,
was largely a function of artistic creativity, technological innovation, and the closest attention to every
detail of the production process.
The image and reputation of the company’s
products were seen as equal to the creativity and
craftsmanship employed during the development
and production of LVMH luxury goods since image
was a product dimension that defied logic but caused
consumers to have strong desires for a particular
brand. Arnault believed that image was priceless
and ­irreplaceable and required stringent management control over every element of a brand’s image,
including advertisements, corporate announcements,
and speeches by management and designers.
EXHIBIT 3
Control over the distribution and sale of its products was the final element of LVMH’s corporate strategy and allowed its divisions to listen to customer
needs, better understand their tastes, and anticipate
their desires. LVMH’s ownership of more than 5,664
retail locations in developed countries throughout
the world also allowed the company to refine its
brand’s images with controlled store aesthetics, a
consistent retailing approach, and irreproachable
customer service. LVMH’s retail operations and
broad collection of businesses was grouped into six
business units. Exhibit 3 presents LVMH’s business
portfolio in 2023. LVMH’s performance by business
group for 2021 and 2022 is presented in Exhibit 4.
The company’s consolidated balance sheets for 2021
and 2022 are presented in Exhibit 5. Exhibit 6 illustrates the company’s free cash flows from operations
for 2020 through 2022.
LVMH’S Business Portfolio in 2023
Wines & Spirits
Fashion & Leather Perfumes &
Goods
Cosmetics
Watches &
Jewelry
Selective
Retailing
Other Activities
Moët & Chandon
Dom Pérignon
Veuve Clicquot
Krug
Mercier
Ruinart
Château d’Yquem
Domaine Chandon
Cloudy Bay
Domaine des
Lambrays
Hennessy
Newton
Ardbeg
Château Cheval
Blanc
Glenmorangie
Wen Jun
Chateau Galoupet
Belvedere
Numanthia
Terrazas de los
Andes
Cheval des Andes
Ao Yun
Volcan de mi
Tierra
Eminete
Cova chocolates
Louis Vuitton
Loewe
Celine
Berluti
Loro Piana
Kenzo
Givenchy
Christian Dior
Marc Jacobs
Nicholas Kirkwood
Edun
Fendi
Moynat
Emilio Pucci
Rimowa
Patou
TAG Heuer
Tiffany
Hublot
Zenith
Bulgari
Fred
Chaumet
Repossi
DFS (Duty Free
Shoppers)
Starboard
Cruise Services
Sephora
Le Bon Marché
La Grande
Epicerie de
Paris
24S
Jardin d’Acclimation
amusement and
leisure park
Cova chocolates
Roayl Van Lent yacht
builder
Investir financial
publication
Les Echos daily
newspaper
Connaissance des Arts
art magazine
Cheval Blanc luxury
hotels
Belmond luxury resorts
Radio Classique
Parfums Christian
Dior
Guerlain
Parfums Givenchy
Loewe Perfumes
Kenzo Parfums
Fresh
Benefit Cosmetics
Make Up For Ever
Acqua di Parma
KVD Beauty
Maison Francis
Kurkdjian
Cha Ling
Fenty Beauty by
Rihanna
Stella by Stella
McCartney
Officine Universelle
Buly
Source: LVMH website.
tho07361_case20_C273-C281.indd
276
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Case 20
EXHIBIT 4
Confirming Pages
LVMH in 2023: Its Diversification into Luxury Goods
C-277
 VMH’s Performance by Business Group, 2021–2022
L
(€ in millions)
Revenues
2022
2021
Wine & spirits
Fashion & leather goods
Perfumes & cosmetics
Watches & jewelry
Selective retailing
Other and holding companies
Eliminations and not allocated
Total
€7,099
38,648
7,722
10,581
14,852
1,586
(1,304)
€79,184
€5,974
30,896
6,608
8,964
11,754
1,169
(1,150)
€64,215
Profit from Recurring Operations
Wine & spirits
Fashion & leather goods
Perfumes & cosmetics
Watches & jewelry
Selective retailing
Other and holding companies
Eliminations and not allocated
Total
2022
€2,155
15,709
660
2,017
788
(267)
(7)
€21,055
2021
€1,863
12,842
684
1,679
534
(436)
(15)
€17,151
Operating Investments
Wine & spirits
Fashion & leather goods
Perfumes & cosmetics
Watches & jewelry
Selective retailing
Other and holding companies
Eliminations and not allocated
Total
2022
€440
1,872
409
654
523
1,074
(1)
€4,969
2021
€328
1,131
290
458
370
89
(1)
€2,664
Depreciation, Amortization, and impairment expenses
Wine & spirits
Fashion & leather goods
Perfumes & cosmetics
Watches & jewelry
Selective retailing
Other and holding companies
Eliminations and not allocated
Total
2022
€261
2,431
480
994
1,427
291
(112)
€5,772
2021
€228
2,142
443
860
1,399
294
(113)
€5,253
Source: LVMH 2022 Annual Report.
tho07361_case20_C273-C281.indd
277
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Confirming Pages
PART 2
C-278
EXHIBIT 5
Cases in Crafting and Executing Strategy
LVMH’s Consolidated Balance Sheets, 2021–2022 (€ in millions)
Assets
2022
2021
Brands and other intangible assets
€25,432
€24,551
Goodwill
24,782
25,904
Property, plant, and equipment
23,055
20,193
Right-of-use assets
14,615
13,705
Investments in joint ventures and associates
1,066
1,084
Non-current available for sale financial assets
1,109
1,363
Other noncurrent assets
1,186
1,054
Deferred tax
3,661
3,156
Non-current assets
94,906
91,010
Inventories and work in progress
20,319
16,549
Trade accounts receivable
4,258
3,787
Income taxes
Other current assets
375
338
7,488
5,606
Cash and cash equivalents
7,300
8,021
Current assets
39,740
34,301
Total assets
€134,646
€125,311
Equity, Group share
55,111
47,119
Minority interests
1,493
1,790
Total equity
56,604
48,909
Long-term borrowings
10,380
12,165
Noncurrent lease liabilities
12,776
11,887
Noncurrent provisions and other liabilities
3,902
3,980
Deferred tax
6,952
6,704
Purchase commitments for minority interests’ shares
12,489
13,677
Noncurrent liabilities
46,498
48,413
Short-term borrowings
9,359
8,075
Current lease liabilities
2,632
2,387
Trade accounts payable
8,788
7,086
Income taxes
1,211
1,267
Current provisions and other liabilities
9,553
9,174
Liabilities and Equity
Current liabilities
Total liabilities and equity
31,543
27,989
€134,646
€125,311
Source: LVMH 2022 Annual Report.
tho07361_case20_C273-C281.indd
278
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Case 20
EXHIBIT 6
Confirming Pages
LVMH in 2023: Its Diversification into Luxury Goods
C-279
LVMH’s Statements of Cash Flows, 2020–2022 (€ in millions)
2022
2021
2020
€17,833
€18,648
€10,897
Operating investments
4,969
2,664
2,478
Repayment of lease liabilities
2,751
2,453
2,302
€10,113
€13,531
€6,117
Net cash from operating activities
Operating free cash flow
Source: LVMH 2022 Annual Report.
Wine and Spirits The production of extraordinary
class wine and champagne required considerable
attention to detail and decades-long commitment to
quality. For example, Château d’Yquem’s vineyards
were cultivated over generations and were made
up of vines grown from individually selected seeds.
Also, on nine occasions during the 20th century the
winery rejected an entire harvest, viewing all grapes
from the season as unworthy of the brand. Wine production also required technical expertise to develop
techniques to improve the immune systems of vines
to prevent grape diseases and the skills of master
blenders, who selected combinations of grapes that
would result in exceptional vintages. Not any less
important was the time required to produce fine
wines and champagnes, some of which were aged for
several years prior to distribution.
In 2023 LVMH was the world’s leading champagne producer with strong demand in Europe,
Japan, and emerging countries. The company’s revenues generated from champagne and wines increased
24 percent between 2021 and 2022. The company’s
Hennessy brand was the number one in brand of
cognac and its sales of Glenmorangie and Ardbeg
whiskies and Belvedere vodka allowed the division’s
revenue to increase by 14 percent between 2021 and
2022.
Fashion and Leather Goods The fashion and leather
industry entailed the recruitment of highly talented
and creative designers who were able to create a
line of apparel or accessories that appealed to some
segment of consumers. Designers had considerable
leeway with the direction of their designs since individual tastes and preferences varied considerably
among consumers. Other important elements of creating high-end apparel and leather goods included
the selection of fabrics or leather and the quality of
tho07361_case20_C273-C281.indd
279
construction. LVMH’s Louis Vuitton products were
all hand assembled by craftsmen who had trained
for years perfecting their talents. Apparel and leather
goods were distributed to either third-party retailers
or company-owned retail locations.
LVMH’s Louis Vuitton was the world’s leading
luxury brand and the foundation of LVMH’s Fashion
and Leather Goods division that had increased sales
by 25 percent and operating income by 22 percent
between 2021 and 2022. LVMHs’ fashion and leather
goods division also included such prestigious brands
as Kezno, Marc Jacobs, Berlucci, Christian Dior,
Celine, Loro Piana, and Fendi.
Perfumes and Cosmetics Success in the global cosmetics, fragrance, and skin care industry was largely
attributable to the ability of producers to develop
new combinations of chemicals and natural ingredients to create innovative and unique fragrances
and develop cosmetics that boasted product benefits
beyond cleansing and moisturizing to anti-aging,
anti-pollution, and tissue regeneration. LVMH’s
fragrances, cosmetics and skin care brands were
among the world’s most prestigious and innovative
in their formulations. In addition to product innovation, LVMH’s strategy for the division focused on
heavy advertising and media investments, connection with its Couture brands, and global expansion
of its brands. The revenue of LVMH’s perfumes and
cosmetics division had grown from by 47 percent
between 2020 and 2022 and the division’s operating
profit margin had improved from 1.5 percent in 2020
to 8.5 percent in 2022.
The division’s growth was attributed to its iconic
French fragrances such as Miss Dior and J’adore
by Christian Dior and because of its hit new fragrances such as its men’s fragrance Sauvage and
Acqua di Parma. The division also benefited from
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Confirming Pages
C-280
PART 2
Cases in Crafting and Executing Strategy
the popularity of its Guerlain skin care products and
cosmetics and relatively new American cosmetics
brands such as Benefit, Make Up For Ever, and Fresh
and the success of other new business additions such
as Kenzo Parfums, Maison Francis Kurkdjian, and
Fenty Beauty.
Watches and Jewelry The watch and jewelry industry was much like the fashion and cosmetics and fragrances industries in that it was highly fragmented
with multiple product categories and wide-ranging
price points. The upscale segment of the industry
also reflected the fashion industry’s demand for quality and creative or distinctive designs. The producers
of many exquisite timepieces such as Rolex, Cartier,
and Patek Phillipe maintained long-established lines
not only known for style, but also craftsmanship and
accuracy. Most manufacturers of upmarket watches
also added new models from time to time that were
consistent with the company’s tradition, history,
and style. Watch production involved the development and production of the movement (although
many watch manufacturers purchased movements
from third-party suppliers), case design and fabrication, and assembly. Watches were rarely sold by
manufacturers directly to consumers but were usually
distributed to independent jewelers or large upscale
department stores for retail sale to consumers.
LVMH’s watch and jewelry division was established in 1999 with the acquisitions of TAG Heuer,
Chaumet, and Zenith. The Hublot and Bulgari
brands were added in 2008 and 2011, respectively.
The acquisition of Tiffany in 2020 provided the company with a platform for growth in jewelry and especially high jewelry, which doubled in sales between
2021 and 2022. Some lines offered by Tiffany’s carried price tags beginning at $100,000. LVMH also
added new lines such as T and HardWear, and the
Lock collection. The company was also conducting
a complete renovation of its Fifth Avenue flagship
store at an estimated cost of $500 million. The Fifth
Avenue store reopened in April 2023.
The division revenue had more than doubled
between 2020 and 2022, growing from €3,356 million
in 2020 to €10,581 million in 2022. Similarly, its profit
from recurring operations grew nearly sevenfold from
€302 in 2020 to €2,017 in 2022.
Selective Retailing LVMH’s selective retailing division was made up of DFS and Starboard Cruise
Services duty-free stores, the Le Bon Marché
tho07361_case20_C273-C281.indd
280
department store, and Sephora cosmetics stores.
Le Bon Marché was Paris’ most exclusive department store and Sephora was among the leading
retail beauty chains in Europe and North America.
The Sephora retail chain operated stores in North
America, Europe, Australia, Southeast Asia, and the
Middle East. Sephora carried LVMH’s products and
other prestigious brands of cosmetics, fragrances,
and skin care products including CHANEL, Dolce
and Gabbana, Elizabeth Arden, Hugo Boss, Naomi
Campbell, Gianni Versace, and Burberry.
The division’s 2001 sales grew by more than
46 percent between 2020 and 2022 to reach €14,852.
The division’s profits from recurring operations had
improved from a €203 million operating loss in 2020
to an operating profit of €788 in 2022.
Other Activities LVMH also maintained a business unit made up of media, luxury yacht production, a leisure park, and a luxury hotel chain. LVMH
believed the businesses were important elements of
its business portfolio because of the company’s obligation to be an ambassador for culture and because
of the natural linkage between its luxury brands and
Art de Vivre (translated as “the art of living.”) Media
properties included Investir, France’s leading online
and print daily investment publication, Le Parisien,
a general interest news brand, Radio Classique’s network of radio stations across France, Connaissance
des Arts that was a benchmark art publication and
Les Echos, a leading French daily newspaper.
Jardin D’Acclimation was France’s first leisure and amusement park that opened in 1860 and
included historic amusement rides, a miniature
steam powered train, walking trails, and sitting areas.
LVMH began the Cheval Blanc hotel chain in 2006,
which offered guests the most luxurious accommodations along with world-class services tailored to the
individual requests of each guest. In 2023, LVMH
operated Belmond and Cheval Blanc hotels in prestigious locations across Europe, the Caribbean, and
Asia.
The remaining business included in LVMH’s
Other Activities was Royal Van Lent. The Dutch
yacht maker dated to 1849 and only built custom
designed yachts larger than 50 meters. The massive luxury yachts were sold under the Feadship
brand name and were among the most elegant in the
Mediterranean and the Caribbean. Despite the high
sales prices of Feadship yachts and well-respected
12/28/23 07:25 PM
© McGraw Hill: DRAFT REVIEW COPY – NOT FOR PUBLICATION OR DISTRIBUTION
Case 20
LVMH in 2023: Its Diversification into Luxury Goods
reputations of its other businesses in the division,
LVMH’s Other Activities recorded operating losses
in 2021 and 2022.
LVMH’S PERFORMANCE
IN 2023
In 2023, LVMH’s performance showed no sign of
slowing with its stock price continuing to soar. The
company had become the world’s most valuable company and its CEO, Barnard Arnault had become the
world’s richest person. During the first six months
Confirming Pages
C-281
of 2023, LVMH’s revenues had grown by 17 percent
year-over-year. Selective Retailing led the growth with
30 percent year-over-year growth. Only the Other
Activities unit experienced a decline in revenues
during the first six months of 2023. LVMH management also announced a €1.5 billion share buyback
program that would be completed between March
1, 2023, and July 20, 2023. The company’s management had stated that LVMH “relied on the talent and
motivation of its teams, the diversity of its business
and good geographical balance of its revenue to further strengthen its global leadership position in luxury goods in 2023.”4
ENDNOTES
1
As quoted in Kotov, Nick, and Suzanne
Kapner, “World’s Richest Man Likes the View
Atop Refurbished Tiffany,” The Wall Street
Journal, April 28, 2023.
tho07361_case20_C273-C281.indd
281
2
“The Perfect Paradox of Star Brands: An
Interview with Bernard Arnault of LVMH,”
Harvard Business Review, October 2001, Vol.
79, Issue 9, p. 116.
3
Ibid.
As quoted in “Excellent Start to the Year for
LVMH,” LVMH Press Release, April 12, 2023.
4
12/28/23 07:25 PM
Chapter 8 Diversification Strategies
169
Strategy: Core Concepts and Analytical Approaches
Arthur A. Thompson, The University of Alabama
7th Edition, 2022-2023
An e-book marketed by McGraw-Hill Education
Chapter 8
Diversification Strategies
I think our biggest achievement to date has been bringing back to life an inherent Disney synergy that enables
each part of our business to draw from, build upon, and bolster the others.
—Michael Eisner, former CEO, Walt Disney Company
Fit between a parent and its businesses is a two-edged sword: A good fit can create value; a bad one can
destroy it.
—Andrew Campbell, Michael Gould, and Marcus Alexander
Make winners out of every business in your company. Don’t carry losers.
—Jack Welch, former CEO, General Electric
I
n this chapter, we move up one level in the strategy-making hierarchy, from strategy making in a singlebusiness enterprise to strategy making in a diversified enterprise. Because a diversified company is a
collection of individual businesses, the strategy-making task is more complicated. In a one-business
company, managers have to come up with a game plan for competing successfully in a single industry arena or
a single line of business—the result is what was labeled as business strategy in Chapter 2. But in a diversified
company, the strategy-making challenge involves assessing multiple industry environments and developing a
set of business strategies, one for each industry arena (or line of business) in which the diversified company
operates. And top executives at a diversified company must still go one step further and devise a companywide
(or corporate) strategy for improving the attractiveness and performance of the company’s overall business
lineup and for making a rational whole out of its diversified collection of individual businesses and individual
business strategies.
In the first portion of this chapter, we describe what crafting a diversification strategy entails, when and why
diversification makes good strategic sense, and the pros and cons of related versus unrelated diversification
strategies. The second part of the chapter looks at how to evaluate the attractiveness of a diversified company’s
business lineup, how to decide whether it has a good diversification strategy, and the strategic options for
improving a diversified company’s future performance.
169
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL?
The task of crafting a diversified company’s overall or corporate strategy falls squarely in the lap of top-level
executives and involves four distinct facets:
1. Picking new industries to enter and deciding on the means of entry. Pursuing diversification requires
top-level decisions about which industries to enter (and why these make good business sense) and then,
for each industry, whether to enter by acquiring a company already in the target industry, internally
developing its own new business in the target industry, or forming a joint venture or strategic alliance
with another company.
2. Pursuing opportunities to leverage cross-business value chain relationships and strategic fits into
competitive advantage. The task here is to determine whether there are opportunities to strengthen a
diversified company’s businesses by transferring competitively valuable resources and capabilities from
one business to another, combining the related value chain activities of different businesses to achieve
lower costs, sharing the use of a powerful and well-respected brand name across multiple businesses,
and encouraging cross-business knowledge sharing and collaboration to create competitively valuable
new resources and capabilities.
3. Evaluating the growth and profitability prospects of each of the company’s businesses, establishing
investment priorities for each business, and then using these priorities to steer corporate resources to
individual businesses. Typically, this translates into investing aggressively and pursuing rapid-growth
strategies in attractive businesses with the best profit prospects, investing cautiously in businesses with just
average prospects, initiating profit improvement or turnaround strategies in under-performing businesses
that have potential, and divesting businesses with unacceptable prospects. A corporate parent’s actions
to help strengthen the long-term competitive positions and profitability of its individual businesses can
include providing managerial expertise, funding for desirable new operating improvements and capital
investments, assorted kinds of administrative support from central headquarters, and other resources
that may be useful (which may include acquiring similar businesses and merging their operations into
an existing business).
4. Initiating actions to boost the combined performance of the corporation’s collection of businesses.
Strategic options for improving the corporation’s overall performance include (1) sticking closely with
the existing business lineup and pursuing opportunities presented by these businesses, (2) broadening
the scope of diversification by entering additional industries, (3) retrenching to a narrower scope of
diversification by divesting poorly performing businesses that are no longer attractive or that don’t fit
into management’s long-range plans, and (4) broadly restructuring the entire company by divesting
some businesses and acquiring others so as to put a whole new face on the company’s business lineup.
The demanding and time-consuming nature of these four tasks explains why top executives in diversified
companies generally refrain from becoming immersed in the details of crafting and executing business-level
strategies. Rather, the normal procedure is to delegate lead responsibility for business strategy to the heads of
each business, giving them the latitude to develop strategies suited to the particular industry and competitive
circumstances in which their business operates, and holding them accountable for producing good financial and
strategic results.
Figure 8.1 shows the things to look for in identifying a company’s diversification strategy. Having a clear fix on
the main elements of a company’s diversification strategy sets the stage for evaluating how good the strategy is
and proposing strategic moves to boost the company’s performance.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
170
Chapter 8 • Diversification Strategies
FIGURE 8.1 Identifying a Diversified Company’s Strategy
What is the
company’s approach to
allocating investment
capital and resources
across its present
businesses?
Any effort to
capture the benefits
of cross-business
value chain
relationships?
Is the
company’s
diversification based
narrowly in a few
industries or broadly
in many industries?
A
Diversified
Company’s
Strategy
Are the
businesses the
company has diversified
into related, unrelated
or a mixture
of both?
Is the
scope of company
operations mostly
domestic, increasingly
multinational, or
global?
Any recent
moves to strengthen
the company’s
positions in existing
businessses?
Any recent
moves to divest
weak business
units?
Any recent
moves to
build positions
in new
industries?
When to Consider Diversifying
So long as a company has its hands full trying to capitalize on profitable growth opportunities in its present
industry, there is no urgency to diversify into other businesses. But it is risky for a single-business company
to continue to keep all of its eggs in one industry basket when, for whatever reasons, its long-term prospects
for continued good performance start to dim. Changing industry conditions—new technologies, product
innovation that stimulates the introduction of substitute products, fast-shifting buyer preferences, or intensifying
competition—can undermine a company’s ability to deliver ongoing gains in revenues and profits. Profitable
growth opportunities are typically limited in mature industries and markets where buyer demand is flat or
declining. Thus, diversification always merits strong consideration at single-business companies when industry
conditions take a turn for the worse and are expected to be long-lasting.
However, there are four other instances in which a company becomes a prime candidate for diversifying:1
l
When it spots opportunities for expanding into industries whose technologies and/or products
complement its present business.
l
When it can leverage existing resources and capabilities by expanding into businesses where these same
resources and capabilities are key success factors and valuable competitive assets.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
171
Chapter 8 • Diversification Strategies
l
When diversifying into closely related businesses opens new avenues for reducing costs.
l
When it has a powerful and well-known brand name that can be transferred to the products of other
businesses and help drive the sales and profits of such businesses to higher levels.
The decision to diversify presents wide-open possibilities. A company can diversify into closely related businesses
or into totally unrelated businesses. It can diversify its present revenue and earning base to a small extent (so that
new businesses account for less than 15 percent of companywide revenues and profits) or to a major extent (so
that new businesses produce 30 percent or more of revenues and profits). It can move into one or two large new
businesses or a greater number of small ones. It can achieve multibusiness/multi-industry status by acquiring an
existing company already in a business/industry it wants to enter, forming its own new business subsidiary to
enter a promising industry, and/or forming a joint venture with one or more companies to enter new businesses.
But in every case, a decision to diversify must start with good economic and business justification for doing so.
Moves to Diversify into a New Business Should Pass Three
Tests
Diversification must do more for a company than just spread its business risk across more industries. In principle,
diversification into a new business cannot be considered wise or justifiable unless it offers good prospects of
added long-term economic value for shareholders—value that shareholders cannot capture on their own by
purchasing stock in companies in different industries or investing in mutual funds or exchange-traded funds
(ETFs) to spread their investments across several industries. A move to diversify into a new business stands little
chance of producing added long-term shareholder value unless it can pass three tests:2
1. The industry attractiveness test. Whether an industry is attractive depends chiefly on the presence
of industry and competitive conditions conducive to earning as good or better profits and return on
investment than the company is earning in its present business(es). It is hard to justify diversifying
into an industry where profit expectations are lower than in the company’s present businesses. For an
industry to be attractive it should also have resource/capability requirements that are well-matched to
the resources and capabilities of the company considering entry and offer good opportunities for longterm growth.
2. The cost-of-entry test. The cost to enter the target industry must not be so high it erodes the potential for
good profitability. A Catch-22 can prevail here, however. The more attractive an industry’s prospects
are for growth and good long-term profitability, the more expensive it can be to get into. Entry barriers
for startup companies are likely to be high in attractive industries—if barriers were low, a rush of new
entrants would soon erode the potential for high profitability. And buying a well-positioned company
in an appealing industry often entails a high acquisition cost that makes passing the cost-of-entry test
less likely. For instance, suppose the price to purchase a company is $3 million and the company to be
acquired is earning after-tax profits of $200,000 on an equity investment of $1 million (a 20 percent
annual return). Simple arithmetic requires that the profits be tripled if the purchaser (paying $3 million)
is to earn the same 20 percent return. Building the acquired firm’s earnings from $200,000 to $600,000
annually could take several years—and require additional investment on which the purchaser would also
have to earn a 20 percent return. Since the owners of a successful and growing company usually demand
a price that reflects their business’s profit prospects, it’s easy for the acquisitions of well positioned and/
or attractively profitable companies to fail the cost-of-entry test. One must further recognize that the
true costs of entry entail transaction costs in completing an acquisition deal. These include the costs of
searching for an attractive acquisition target; the costs of evaluating its worth and negotiating a deal; the
fees that often are paid to investment banking firms, lawyers, and others to advise them and assist with
the deal-making process; the legal and accounting costs of conducting due diligence; and the costs of
integrating the acquired company into the parent company’s operations.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
172
Chapter 8 • Diversification Strategies
173
3. The better-off test. Diversifying into a new business must offer potential for the company’s existing
businesses and the new business to perform better together under a single corporate umbrella than they
would perform operating as independent standalone businesses—an outcome known as synergy.
CORE CONCEPT
For example, let’s say Company A diversifies by
Creating added long-term value for shareholders
purchasing Company B in another industry. If A
via diversification requires building a
and B’s consolidated profits in the years to come
multibusiness company where the whole is
prove no greater than what each could have earned
greater than the sum of its parts—such 1 + 1 = 3
on its own, then A’s diversification won’t provide
effects are called synergy.
its shareholders with added value. Company A’s
shareholders could have achieved the same 1 + 1
= 2 result by merely purchasing stock in Company B. Diversification does not result in added longterm value for shareholders unless it produces a 1 + 1 = 3 effect where sister businesses perform better
together as part of the same firm than they could have performed as independent companies.
Diversification moves that satisfy all three tests have the greatest potential to grow shareholder value over the
long term. Diversification moves that can pass only one or two tests are suspect.
CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES
Once a company decides to diversify, its first big strategy decision is whether to diversify into related businesses,
unrelated businesses, or some mix of both (see Figure 8.2). Businesses are said to be related when their value
chains possess competitively valuable cross-business relationships that present opportunities for the businesses
to perform better under the same corporate umbrella than
they could by operating as stand-alone entities. The big
CORE CONCEPT
appeal of related diversification is to build shareholder
Related businesses possess competitively
value by leveraging these cross-business relationships into
valuable cross-business value chain matchups.
competitive advantage, thus allowing the company as a
Unrelated businesses have dissimilar value
whole to perform better than just the sum of its individual
chains containing no competitively useful crossbusinesses. Businesses are said to be unrelated when the
business relationships.
activities that compose their respective value chains are
so dissimilar that no competitively valuable cross-business
relationships are present. One must be careful about assuming different businesses are unrelated just because
their products are quite different. For example, Citizen Watch Company is engaged in three businesses—
watches, machine tools, and flat panel displays—that seem on the surface to be unrelated, but hidden from
view one discovers that these businesses are indeed related because the value chains of all three products
involve production activities that rely heavily on common miniaturization know-how and advanced precision
technologies. The lesson here is that it is not product relatedness that defines a related diversification strategy.
Rather, what makes businesses related is the relatedness of their key value chain activities and the specialized
resources and capabilities that enable these activities.
The next two sections explore the ins and outs of related and unrelated diversification.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
174
FIGURE 8.2 The Three Fundamental Strategy Alternatives for Pursuing
Diversification
Diversify into
Related Businesses
Diversification
Strategy
Options
Diversify into
Unrelated Businesses
Diversify into Both Related
and Unrelated Businesses
The Case for Diversifying into Related Businesses
A related diversification strategy involves building the company around businesses whose value chains possess
competitively valuable strategic fits, as shown in Figure 8.3. Strategic fit exists whenever one or more activities
in the value chains of different businesses are sufficiently
CORE CONCEPT
similar to present opportunities for one or more of the
following:3
Strategic fit exists when the value chains of
l
different businesses present opportunities
Transferring competitively valuable resources
for cross-business resource transfer, lower
and capabilities from one business to enhance
costs through combining the performance of
the competitiveness and performance of a sister
related value chain activities, cross-business
business. Frequently, a company pursuing related
use of a potent brand name, and/or crossdiversification has one or more businesses with
business collaboration to build new or stronger
competitively valuable resources, expertise, and
resources and capabilities that can enhance the
know-how in performing certain value chain
competitiveness of one or more of the company’s
activities that are well-suited to performing closely
businesses.
related value chain activities in a sister business.
General Mills, for example, over several decades
has diversified into a closely related set of food businesses on the basis of a growing collection of
resources and capabilities in the realm of “kitchen chemistry” and food production technologies; it
has drawn upon these resources/capabilities to build a business portfolio via both internal startup and
acquisition that includes such brands as Gold Medal, Pillsbury, Betty Crocker baking products, General
Mills cereals (Cheerios, Wheaties, and Chex), Nature Valley nutrition bars, Cascadian Farms cereals
and vegetables, Annie’s and Progresso soups, Fiber One, Old El Paso, Green Giant, Häagen-Dazs, and
Yoplait. In such instances, prompt and aggressive actions to transfer a portion of these competitively
potent resources and capabilities from one or more of a diversified company’s businesses and redeploy
them to resource and/or capability-deficient businesses can significantly enhance the latter’s performance
of key value chain activities, boost the value it delivers to customers, and significantly improve its
competitiveness and profitability.
Sometimes, however, the transfer of competitively valuable resources and capabilities is reversed,
proceeding from a newly acquired business to existing businesses. For example, when Disney acquired
Marvel Comics, Disney executives immediately made Marvel’s iconic Spiderman, Iron Man, and
Black Widow characters available for use at Disney theme parks, in Disney retail stores, and in Disney
video games. Cross-business resource transfers can be accomplished by shifting personnel with the
requisite expertise and technological know-how from one business to another, instituting in-depth
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
training to boost the capabilities of personnel at resource-deficient businesses, increasing cross-business
knowledge sharing via online systems, enforcing cross-business adoption of best practices and other
desirable operating procedures, and making competitive assets controlled by one business available to
other businesses when appropriate.
l
Combining the related value chain activities of separate businesses into a single operation to achieve
lower costs. In companies pursuing related diversification, it is sometimes feasible to manufacture the
products of different businesses in a single plant
CORE CONCEPT
or use the same warehouses for shipping and
distribution, or have a single sales force (or network
Economies of scope are cost reductions that
of dealers/retailers) for the products of different
flow from operating in multiple businesses.
businesses when they are marketed to the same
Such economies stem directly from strategic fit
types of customers, or have different businesses use
efficiencies along the value chains of related
the same administrative infrastructure (for finance
businesses. However, the cost reductions
and accounting, human resources, information
materialize only after management has
technology, and so on). Such cost-saving benefits
successfully pursued internal actions to capture
along the value chains of related businesses are
them.
called economies of scope—a concept distinct
from economies of scale. Economies of scale are
cost savings that accrue directly from a larger operation—for example, unit costs may be lower in a
large plant than in a small plant, lower in a large distribution center than in a small one, and lower for
large-volume purchases of components than for small-volume purchases. Economies of scope, however,
stem directly from cost-saving strategic fits along the value chains of related businesses that allow sister
businesses to operate more cost efficiently as part of the same company than they can operate as standalone businesses. The greater the cross-business economies associated with cost-saving strategic fits,
the greater the potential for a related diversification strategy to yield a competitive advantage based on
lower costs than rivals.
l
Exploiting use of a well-known and potent brand name. For example, Honda’s name in motorcycles and
automobiles gave it instant credibility and recognition in entering the lawn mower business, allowing
it to achieve a significant market share without spending large sums on advertising to establish a brand
identity. Likewise, Apple’s reputation in PCs made it easier and cheaper to enter the market for digital
music players, smart phones, and connected watches.
l
Cross-business collaboration to create competitively valuable resources and capabilities. Sister
businesses performing closely related value chain activities may seize opportunities to join forces, share
knowledge and talents, and collaborate to create altogether new capabilities (such as virtually defectfree assembly methods or increased ability to speed new and improved products to market) that will be
mutually beneficial in improving their competitiveness and business performance.
All four types of actions to capture strategic fit opportunities along the value chains of related businesses tend
to produce synergistic outcomes: improved competitiveness of one or more businesses and greater ability to
perform better as sister businesses than as stand-alone businesses.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
175
Chapter 8 • Diversification Strategies
176
FIGURE 8.3 Related Businesses Possess Related Value Chain Activities and
Competitively Valuable Cross-Business Strategic Fits
Supply
Chain
Activities
Technology
Operations
Sales
and
Marketing
Distribution
Customer
Service
Competitively valuable opportunities for technology or skills transfer, cost reduction, common
brand-name usage, and cross-business collaboration exist at one or more points along the
value chains of business A and business B.
Supply
Chain
Activities
Technology
Operations
Sales
and
Marketing
Distribution
Customer
Service
Strategic Fit and Competitive Advantage: The Keys to Added Profitability and Gains in
Shareholder Value What makes related diversification an attractive strategy is the opportunity to convert crossbusiness strategic fits into a competitive advantage over business rivals whose operations do not offer comparable
strategic fit benefits.4 The greater the relatedness among a diversified company’s sister businesses, the bigger
a company’s window for converting strategic fits into competitive advantage via (1) cross-business transfer of
valuable skills, technology, competencies, capabilities, and other competitive assets, (2) the capture of cost-saving
efficiencies along the value chains of related businesses via sharing use of the same resources (joint performance of
new product or technology R&D, common use of plants and distribution centers, shared use of the same sales force
or dealer network or customer service infrastructure, and the like), (3) cross-business use of a well-respected brand
name, and/or (4) cross-business collaboration to create new resource strengths and capabilities.5
The competitive advantage potential that flows from the capture of strategic-fit benefits is what enables a
company pursuing related diversification to achieve 1 + 1 = 3 financial performance and the hoped-for gains
in shareholder value. The strategic and business logic is
compelling: capturing strategic fits along the value chains
CORE CONCEPT
of its related businesses gives a diversified company a clear
Diversifying into related businesses and then
path to achieving competitive advantage over undiversified
capturing the existing competitively valuable
competitors and competitors whose own diversification
strategic fit benefits puts sister businesses in
efforts do not offer equivalent strategic-fit benefits.6 Such
position to perform better financially as part of the
competitive advantage potential provides a company with
same company than they could have performed
a dependable basis for earning profits and a return on
as independent enterprises, thus providing a clear
investment that exceeds what the company’s businesses
avenue for boosting shareholder value.
could earn as stand-alone enterprises. Converting the
competitive advantage potential into greater profitability
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.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
Bear in mind three things here. One, capturing cross-business strategic fits via a strategy of related diversification
builds long-term economic value for shareholders in ways they cannot undertake by simply owning a portfolio of
stocks of companies in different industries. Two, the capture of cross-business strategic-fit benefits is possible only
via a strategy of related diversification. Three, the benefits of cross-business strategic fits are not automatically
realized when a company diversifies into related businesses—the benefits materialize only after management has
successfully pursued internal actions to capture them.
The Case for Diversifying into Unrelated Businesses
Whereas related diversification strategies seek to build shareholder value by diversifying only into businesses
with important cross-business strategic fits, the hallmark of
unrelated diversification strategies is managerial willingness
CORE CONCEPT
to enter any industry and operate any business where
The basic premise of unrelated diversification
company executives see opportunity to realize consistently
is that any company or business that can be
good financial results. Companies pursuing unrelated
acquired on good financial terms and has
diversification are often labeled conglomerates because the
satisfactory growth and earnings potential
businesses they have diversified into range broadly across
represents a good acquisition and a good
diverse industries with little or no discernible strategic fits
business opportunity.
in their value chains (as shown in Figure 8.4. Companies
that pursue unrelated diversification nearly always enter
new businesses by acquiring an established company rather than by forming a startup subsidiary within their
own corporate structures or participating in joint ventures. With a strategy of unrelated diversification, an
acquisition is deemed attractive if it passes the industry attractiveness and cost-of-entry tests and if it has good
prospects for attractive financial performance—little, if any, consideration is given to whether the value chains
of a conglomerate’s businesses have any strategic fits.
In companies pursuing unrelated diversification, top executives spend much time and effort screening acquisition
candidates and evaluating the pros and cons of keeping or divesting existing businesses, using such criteria as:
l
Whether the business can meet corporate targets for profitability and return on investment.
l
Whether the business is in an industry with attractive growth potential.
l
Whether a distressed business can be acquired at a bargain price, turned around quickly (with astute
managerial actions and initiatives on the part of the company) into a profitable enterprise with potential
to realize a high return on investment.
l
Whether the business is big enough to contribute significantly to the parent firm’s bottom line.
Unrelated diversification certainly merits consideration when a single-business firm is trapped in or overly
dependent on an endangered or unattractive industry, especially if it has no competitively valuable resources
or capabilities it can transfer to a closely related industry. Unrelated diversification may also be justified when
a company strongly prefers to spread business risks widely, have the flexibility to deploy its capital resources
to maximum advantage by (1) investing in whatever industries offer the best profit prospects (as opposed to
considering only opportunities in industries with related value chain activities) and (2) diverting cash flows from
company businesses with lower growth and profit prospects to acquiring and expanding businesses with higher
growth and profit potentials, without regard to whether these businesses have value chain activities related to the
value chains of any of its present businesses.
However, for an unrelated diversification strategy to be successful in building value for shareholders, it must
grow the company’s profits above and beyond what could be achieved by the businesses operating independently
as standalone enterprises. Unless a diversified company’s collection of unrelated businesses is more profitable
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
177
Chapter 8 • Diversification Strategies
operating under the company’s corporate umbrella than they would be operating as independent businesses, an
unrelated diversification strategy can­not create economic value for shareholders. And unless it does so, there
is no real justifica­tion for pursuing an unrelated diversification strategy, since top executives have a fiduciary
responsibility to maximize long-term shareholder value for the company’s shareholders.
What Is Appealing about Unrelated Diversification? A strategy of unrelated diversification has appeal
from several angles:
l
Business risk is scattered over a set of truly diverse industries. In comparison to related diversification,
unrelated diversification more closely approximates pure diversification of financial and business risk
because the company’s investments are spread over businesses whose technologies and value chain
activities bear no close relationship and whose markets are largely disconnected.7
l
The company’s financial resources can be employed to maximum advantage by (1) investing in whatever
industries offer the best profit prospects (as opposed to considering only opportunities in industries with
related value chain activities) and (2) diverting cash flows from company businesses with lower growth
and profit prospects to acquiring and expanding businesses with higher growth and profit potentials.
l
To the extent that corporate managers are exceptionally astute at spotting bargain-priced companies
with big upside profit potential, shareholder wealth can be enhanced by buying distressed businesses at
a low price, turning their operations around fairly quickly with infusions of cash and managerial knowhow supplied by the parent company, and then riding the crest of the profit increases generated by these
businesses, or else enjoying the capital gains of selling rejuvenated businesses for amounts above the
purchase price.
l
Company profitability may prove somewhat more stable over the course of economic upswings and
downswings because market conditions in all industries don’t move upward or downward simultaneously.
In a broadly diversified company, there’s a chance that market downtrends in some of the company’s
businesses will be partially offset by cyclical upswings in its other businesses, thus producing somewhat
less earnings volatility. (In actual practice, however, there’s no convincing evidence that the 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.)
Unrelated diversification certainly merits consideration when a firm is trapped in or overly dependent on an
endangered or unattractive industry, especially when it has no competitively valuable resources or capabilities
it can transfer to a closely related industry. Unrelated diversification may also be justified when a company
strongly prefers to spread business risks widely and not restrict itself to only owning businesses with related
value chain activities.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
178
Chapter 8 • Diversification Strategies
FIGURE 8.4 Unrelated Businesses Have Unrelated Value Chains and No
Cross-Business Strategic Fits
Representative Value Chain Activities
Business
A
Value
Chain
Product
R&D,
Engineering
and Design
Production
Advertising
and
Promotion
Sales to
Dealer
Network
An absence of competitively valuable strategic fits between the value
chains of business A and business B
Business
B
Value
Chain
Supply
Chain
Activities
Assembly
Distribution
Customer
Service
Building Shareholder Value via Unrelated Diversification—The Essential Role of Astute
Corporate Parenting Given the absence of cross-business strategic fits with which to capture added competitive
advantage, the task of building long-term economic value for shareholders via unrelated diversification hinges
on (1) the business acumen of corporate executives and (2) the parent company having valuable resources and
high-caliber administrative expertise that can enhance the performance of the company’s individual businesses.
In companies committed to a strategy of unrelated diversification, astute corporate parenting plays an essential
role in achieving companywide financial results above and beyond what the individual businesses could achieve
as stand-alone entities. Strong parenting capabilities can help build shareholder value in four important ways:
l
Utilize the business acumen of certain corporate executives in identifying undervalued or underperforming
companies and then further rely on the skills and expertise of these or other corporate executives in
pinpointing achievable ways that the operations of such companies can be overhauled and streamlined
to produce dramatic increases in profitability. Such restructuring can include pruning money-losing
products, closing down or selling portions of the business that are losing money, selling underutilized
assets, reducing unnecessary expenses, improving the appeal of product offerings, reducing administrative
overhead, and the like. Usually, a number of the top executives of a newly-acquired underperforming
business are quickly replaced with seasoned executives brought in specifically to lead the turnaround
efforts, return the business to good profitability, and put it well on its way to becoming a strong market
contender. Diversified companies with one or more corporate executives who have proven turnaround
capabilities in rejuvenating weakly performing companies can often apply these capabilities in a
relatively wide range of unrelated industries. Newell Rubbermaid (whose diverse product line includes
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
179
Chapter 8 • Diversification Strategies
Sharpie pens, Levolor window treatments, Goody hair accessories, Calphalon cookware, and Lenox
power and hand tools—all businesses with different value chain activities) developed such a strong set
of turnaround capabilities that the company was said to “Newellize” the businesses it acquired.
l
Corporate managers advance the cause of adding shareholder value when they have the bargaining
skills to successfully negotiate a low price and other favorable terms in acquiring any new business the
corporate parent decides to enter (thereby helping satisfy the cost-of-entry test). Corporate managers
have further value-adding potential if they are astute in discerning when a particular company business
needs to be sold (because it is on the verge of confronting adverse industry and competitive conditions
and probable declines in long-term profitability) and also in finding buyers who will pay a price higher
than the company’s net investment in the business (so the sale of divested businesses will result in
capital gains for shareholders rather than capital losses).
l
Corporate managers definitely add shareholder value when they possess the skills and business acumen
to do a superior job of overseeing, guiding, and otherwise parenting the firm’s business subsidiaries
that the subsidiaries perform at a higher level than they would otherwise be able to do as a standalone enterprise (thus satisfying the better-off test). Because the senior executives of a large diversified
corporation have among them many years of experience in a variety of business settings, they are often
able to provide first-rate advice and guidance to the heads of the various business subsidiaries on how
to improve competitiveness and financial performance.8 The parenting activities of corporate executives
often includes identifying, recruiting, and hiring talented managers to run individual businesses and
thereby squeeze out better business performance than otherwise might have occurred.
l
Corporate executives of financially strong diversified companies can add shareholder value by astutely
allocating financial resources across the company’s businesses. This can involve shifting funds from
businesses with excess cash (more than needed to fund their operating requirements) to cash-short
businesses with appealing growth opportunities. And there are occasions when corporate executives can
add value by using the corporation’s strong credit rating to raise capital at acceptable interest rates from
external sources and thus provide funds to individual business at lower interest rates than the businesses
would otherwise have to pay as standalone enterprises. A parent company’s ability to function as its
own internal capital market enhances overall corporate performance and increases shareholder value to
the extent that its top executives (1) have access to better information about investment opportunities
internal to the firm than do external financiers, (2) wisely engage in allocating internal cash flows and
borrowed funds to either existing businesses or making new acquisitions, and (3) are able to use the
corporation’s financial strength and credit rating to borrow monies to fund the capital requirements of
individual businesses and do so at lower interest costs than the individual businesses would have had to
pay as independent enterprises (assuming they could have obtained a loan on the strength of their own
balance sheets).
Other Benefits a Corporate Parent Can Provide to Boost the Performance of Its Business
Subsidiaries There are two other commonly employed ways that corporate parents can enhance the financial
performance of their unrelated businesses. One way is by providing them with administrative resources and
expertise that lower the administrative costs of the individual businesses and/or that enhance their operating
effectiveness and/or that lower administrative and overhead costs companywide. The administrative resources
and depth of expertise located at a company’s corporate headquarters are often considerable, enabling it to
effectively and cost-efficiently handle such administrative functions for its subsidiaries as accounting and tax
reporting, financial and risk management, human resource support and services, information systems and data
processing, legal services, and so on. Providing individual businesses with administrative support services creates
value by lowering companywide overhead costs and avoiding the inefficiencies of having each business handle
its own administrative functions. (Of course, this benefit of utilizing a diversified company’s administrative
resources and expertise to support the needs of its individual business is just as much available to corporations
pursuing related diversification as to those pursuing unrelated diversification.)
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
180
Chapter 8 • Diversification Strategies
181
A second way that a parent company can provide value to its unrelated business occurs when a corporate parent
has a well-recognized or highly reputable name or brand that is not strongly attached to a certain product and thus
can readily be shared by many or all of its individual businesses. General Electric, for example, has successfully
applied its GE brand to such unrelated products and businesses as metal additive manufacturing (GE Additive),
medical devices, diagnostics, and clinical accessories (GE Healthcare), aircraft engines, aircraft parts, and
avionics (GE Aviation), wind turbines and hydro power (GE Renewable Energy), electric power generation and
high voltage distribution equipment (GE Power), and financial solutions (GE Capital). Corporate brands that can
be applied and shared in this fashion are sometimes called umbrella brands. Utilizing a well-known corporate
name in a company’s individual businesses has the value-adding potential both to lower brand-building and
reputational costs (by spreading them over many businesses) and to enhance each business’s customer value
proposition by linking its products to a name that consumers trust.
To the extent that corporate parenting skills and other complementary parenting resources can actually deliver
enough added value to individual businesses to yield a stream of dividends and capital gains for stockholders
greater than a 1 + 1 = 2 outcome, a case can be made that unrelated diversification has truly enhanced shareholder
value.
The Path to Enhancing Shareholder Value via Unrelated Diversification For a strategy of unrelated
diversification to produce companywide financial results above and beyond what the businesses could generate
operating as stand-alone entities, corporate executives should pursue five outcomes:
1. Build a portfolio of businesses in unrelated industries by acquiring companies in any industry with growth
and earnings prospects that can satisfy the industry attractiveness test and by acquiring undervalued or
underperforming businesses that present appealing opportunities for being overhauled in ways that will
result in big gains in profitability. Both types of acquisitions raise the chances that a corporation’s entry
into new unrelated businesses can pass the better-off test.
2. Acquire companies at prices sufficiently low to pass the cost of entry test.
3. Develop and nurture outstanding corporate parenting capabilities. Successful deployment of such
capabilities raises the chance that building a portfolio of unrelated businesses will yield 1 + 1 = 3 results
and thus pass the better-off test.
4. Provide individual businesses with administrative expertise and other corporate resources that lower
companywide administrative and overhead costs and enhance the operating effectiveness of individual
businesses.
5. Become skilled in discerning when a particular company business should be sold (because of deteriorating
industry and competitive conditions or other factors that make its long-term profit outlook unattractive)
and also in finding buyers who will pay a price higher than the company’s net investment in the business
(so the sale of divested businesses will result in capital gains for shareholders rather than capital losses).
Astutely managed diversified companies understand the
CORE CONCEPT
nature and value of corporate parenting resources and
develop the skills to leverage them effectively across their
A diversified company has a parenting advantage
businesses. The more adept corporate-level executives
when it has superior corporate parenting
are at effectively building, nurturing, and deploying a
capabilities relative to other diversified companies
rich collection of corporate parenting capabilities, the
and thus is more able to boost the combined
more able they are to create added value for shareholders
performance of its individual businesses through
in comparison to other enterprises pursuing unrelated
high-level guidance, astute allocation of financial
diversification—diversified corporations with top-flight
resources, and various other types of corporateparenting capabilities have what is called a parenting
level resource support.
advantage. When a corporation has a parenting advantage
and when its executives are also uniquely skilled in
identifying weak-performing companies where there are achievable opportunities to boost profits to appealingly
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
182
high levels, then the corporation has credible prospects of pursuing an unrelated diversification strategy that can
deliver 1 + 1 = 3 gains in long-term shareholder value.
The Two Big Drawbacks of Unrelated Diversification Unrelated diversification strategies have two
important negatives:
1. Demanding managerial requirements. Successfully managing a set of fundamentally different
businesses operating in fundamentally different industry and competitive environments is a challenging
and exceptionally difficult proposition.9 The more unrelated businesses that a company has diversified
into, the harder it is for corporate executives to have in-depth knowledge about each business (consider,
for example, that corporations like General Electric, Samsung, 3M, Honeywell, Johnson & Johnson,
and Mitsubishi have dozens of business subsidiaries making hundreds and sometimes thousands of
products). While headquarters executives can glean information about the industry from third-party
sources, ask lots of questions when visiting different business operations, and do their best to learn about
the company’s different businesses, they still remain heavily dependent on briefings from business unit
managers for many of the details and on “managing by the numbers”—that is, keeping close track of the
financial and operating results of each subsidiary and assuming that the heads of the various subsidiaries
have most everything under control so long as the latest financial and operating measures look good.
This can work provided the heads of the various business units are capable and favorable conditions
allow a business to consistently meet its numbers. But the problem comes when things start to go awry
in a business despite the best effort of business unit managers, and top-level corporate executives have to
get deeply involved in helping turn around a business they do not know that much about. Because every
business tends to encounter rough sledding at some juncture, unrelated diversification is a somewhat
risky strategy from a managerial perspective.10 Hard-to-resolve problems in one or more businesses or
big strategic mistakes (sloppy analysis of the industries a company is getting into, discovering that the
problems of a newly acquired business will require considerably more time and money to correct than
was expected, or being overly optimistic about a newly-acquired company’s future prospects) can cause
a precipitous drop in corporate earnings and crash the parent company’s stock price.11 Thus, companies
electing to pursue unrelated diversification strategies are usually well advised to avoid casting a wide
net to build their business portfolios—a few unrelated businesses is often better than many unrelated
businesses.
2. No potential for competitive advantage beyond any benefits of corporate parenting and what each
individual business can generate on its own. Unlike a related diversification strategy, there are no
cross-business strategic fits to draw on for reducing costs, transferring beneficial skills and technology,
leveraging use of a powerful brand name,
or collaborating to build mutually beneficial
Without the added competitive advantage
competitive capabilities and thereby adding to any
potential that cross-business strategic fit provides,
competitive advantage the individual businesses
it is hard for the consolidated performance of an
possess. Yes, a cash-rich and/or managerially adept
unrelated group of businesses to be any better
corporate parent pursuing unrelated diversification
than the sum of what the individual business units
can provide its subsidiaries with much-needed
could achieve if they were independent.
capital, valuable top-management guidance and
advice, and capable administrative know-how, but
otherwise it has little to offer in enhancing the competitive strength of its individual business units.
Moreover, it must be noted that all the benefits accruing from first-rate corporate parenting capabilities
are not exclusively attached to a strategy of unrelated diversification—these same benefits are equally
available to companies pursuing a strategy of related diversification.
The drawbacks of demanding managerial requirements and limited competitive advantage potential greatly
weaken the appeal of an unrelated diversification strategy. Relying on the shrewd acquisition skills of corporatelevel executives and good-to-excellent corporate parenting capabilities to get 1 + 1 = 3 performance from a group
of unrelated businesses is a weaker and less reliable basis for creating shareholder value than is a strategy of
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
Chapter 8 • Diversification Strategies
related diversification where competitively valuable cross-business strategic fits, astute acquisitions on the part
of corporate-level executives, and valuable corporate parenting resources and expertise can all combine to drive
1 + 1 = 3 outcomes. Hence the likelihood that a strategy of related diversification can add more shareholder value
than a strategy of unrelated diversification is indeed high. Real-world evidence supports this conclusion: There
are far more companies pursuing unrelated diversification strategies whose financial results have been mediocre
to poor than those whose financial performance over time has been good to excellent.12 Without exceptional
corporate parenting skills and resources, the odds are that unrelated diversification will produce 1 + 1 = 2 or
smaller gains for shareholders.
Combination Related–Unrelated Diversification Strategies
There’s nothing to preclude a company from diversifying into both related and unrelated businesses. Indeed, in
actual practice, the business make-up of diversified companies varies considerably. Some diversified companies
are really dominant-business enterprises—one major “core” business accounts for 50 to 80 percent of total
revenues and a collection of small related or unrelated businesses accounts for the remainder. Some diversified
companies are narrowly diversified around a few (two to five) related or unrelated businesses. Others are broadly
diversified around a wide-ranging collection of related businesses, unrelated businesses, or a mixture of both.
Also, a number of multibusiness 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. There’s ample room for companies to customize their diversification strategies to incorporate
elements of both related and unrelated diversification, as may suit their own collection of valuable competitive
assets, corporate resources, and strategic vision.
EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY
Assessing the strategies of diversified companies builds on the concepts and methods used for single-business
companies. But there are some additional aspects to consider and a couple of new analytic tools to master. 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 involves six steps:
1. Assessing the attractiveness of the industries the company has diversified into, both individually and as
a group.
2. Assessing the competitive strength of the company’s business units and drawing a nine-cell matrix to
simultaneously portray industry attractiveness and business unit competitive strength.
3. Evaluating the competitive value of cross-business strategic fits along the value chains of the company’s
various business units.
4. Checking whether the firm’s resources fit the requirements of its present business lineup.
5. Ranking the performance prospects of the businesses from best to worst and determining what the
corporate parent’s priorities should be in allocating resources to its various businesses.
6. Crafting new strategic moves to improve overall corporate performance.
The core concepts and analytical techniques underlying each of these steps merit further discussion.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
183
Chapter 8 • Diversification Strategies
Step 1: Assessing Industry Attractiveness
A principal consideration in evaluating a diversified company’s business make-up and the caliber of its strategy is
the attractiveness of the industries in which it has business operations. Answers to several questions are required:
l
Does each industry the company has diversified into represent a good business for the company to be
in—does it pass the industry attractiveness test?
l
Which of the company’s industries are most attractive, and which are least attractive?
l
How appealing is the whole group of industries in which the company has invested?
The more attractive the industries (both individually and as a group) a diversified company is in, the better its
prospects for good long-term performance.
Calculating Industry Attractiveness Scores A simple and reliable analytical tool for gauging industry
attractiveness involves calculating quantitative industry attractiveness scores based on the following measures:
l
Market size and projected growth rate. Big industries are more attractive than small industries, and fastgrowing industries tend to be more attractive than slow-growing industries, other things being equal.
l
The intensity of competition. Industries where competitive pressures are relatively weak are more
attractive than industries where competitive pressures are strong.
l
Emerging opportunities and threats. Industries with promising opportunities and minimal threats on the
near horizon are more attractive than industries with modest opportunities and imposing threats.
l
The presence of cross-industry strategic fits. The more one industry’s value chain and resource
requirements match up well with the value chain activities of other industries in which the company
has operations, the more attractive the industry is to a firm pursuing related diversification. However,
cross-industry strategic fits are not something that a company committed to a strategy of unrelated
diversification considers when it is evaluating industry attractiveness.
l
Resource and capability requirements. Industries having resource/capability requirements within the
company’s reach are more attractive than industries where the requirements could strain corporate
financial resources and/or capabilities.
l
Seasonal and cyclical factors. Industries where buyer demand is relatively steady year-round and not
unduly vulnerable to economic ups and downs tend to be more attractive than industries where there are
wide swings in buyer demand within or across years. However, seasonality may be a plus for a company
that is in several seasonal industries if the seasonal highs in one industry correspond to the lows in
another industry, thus helping even out monthly sales levels. Likewise, cyclical market demand in one
industry can be attractive if its up-cycle runs counter to the market down-cycles in another industry
where the company operates, thus helping reduce revenue and earnings volatility.
l
Social, political, regulatory, and environmental factors. Industries with significant problems in such
areas as consumer health, safety, or environmental pollution or those subject to intense regulation are
less attractive than industries where such problems are not burning issues.
l
Industry profitability. Industries with healthy profit margins and high rates of return on investment are
generally more attractive than industries with historically low or unstable profitability.
l
Industry uncertainty and business risk. Industries with less uncertainty on the horizon and lower overall
business risk are more attractive than industries whose prospects for one reason or another are uncertain,
especially when the industry has formidable resource requirements.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
184
Chapter 8 • Diversification Strategies
Each attractiveness measure is then assigned a weight reflecting its relative importance in determining an
industry’s attractiveness—not all attractiveness measures are equally important. The intensity of competition
in an industry should nearly always carry a high weight (say, 0.20 to 0.30). Strategic-fit considerations should
be assigned a high weight for companies with related diversification strategies and dropped from the list of
attractiveness measures altogether for companies pursuing unrelated diversification. Seasonal and cyclical
factors should generally be eliminated (or perhaps assigned a low weight) except in situations where they are
obviously relevant. The importance weights must add up to 1.0.
Next, every industry is rated on each of the chosen industry attractiveness measures, using a rating scale of 1
to 10 (where a high rating signifies high attractiveness and a low rating signifies low attractiveness). Keep in
mind here that the more intensely competitive an industry is, the lower the attractiveness rating for that industry.
Likewise, the higher the capital and resource requirements associated with being in a particular industry, the
lower the attractiveness rating. Weighted attractiveness scores are then calculated by multiplying the industry’s
rating on each measure by the corresponding weight. For example, a rating of 8 times a weight of 0.25 gives
a weighted attractiveness score of 2.00. The sum of the weighted scores for all the attractiveness measures
provides an overall industry attractiveness score. This procedure is illustrated in Table 8.1.
TABLE 8.1 Calculating Weighted Industry Attractiveness Scores
[Rating scale: 1 = Very unattractive to company; 10 = Very attractive to company]
Industry Attractiveness Assessments
Industry A
Industry B
Industry C
Industry
Importance Attractiveness Weighted Attractiveness Weighted Attractiveness Weighted
Attractiveness
Weight
Rating
Score
Rating
Score
Rating
Score
Measures
Market size and
projected growth
0.10
8
0.80
3
0.30
5
0.50
rate
Intensity of
0.25
8
2.00
2
0.50
5
1.25
competition
Emerging
opportunities and
0.10
6
0.60
5
0.50
4
0.40
threats
Cross-industry
0.20
8
1.60
2
0.40
3
0.60
strategic fits
Resource
0.10
6
0.60
5
0.50
4
0.40
requirements
Seasonal and cyclical
0.05
9
0.45
5
0.25
10
0.50
influences
Social, political,
regulatory, and
0.05
8
0.40
3
0.15
7
0.35
environmental
factors
Industry profitability
0.10
5
0.50
3
0.30
6
0.60
Industry uncertainty
0.05
5
0.25
1
0.05
10
0.50
and business risk
Sum of
importance
1.00
weights
Weighted
overall industry
7.20
2.95
5.10
attractiveness scores
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
185
Chapter 8 • Diversification Strategies
Interpreting the Industry Attractiveness Scores Industries with a score much below 5.0 probably do not
pass the attractiveness test. If a company’s industry attractiveness scores are all above 5.0, it is probably fair to
conclude that the group of industries the company operates in is attractive as a whole. But the group of industries
takes on a decidedly lower degree of attractiveness as the number of industries with scores below 5.0 increases,
especially when industries with low scores account for a sizable fraction of the company’s revenues.
For a diversified company to be a strong performer, a substantial portion of its revenues and profits must come
from business units in industries with relatively high industry attractiveness scores. It is particularly important
that a diversified company’s principal businesses be in industries with a good outlook for growth and aboveaverage profitability. Having a big fraction of the company’s revenues and profits come from industries with
slow growth, low profitability, intense competition, or other troubling conditions or characteristics tends to drag
overall company performance down. Business units in the least attractive industries are potential candidates for
divestiture, unless they are positioned strongly enough to overcome the unattractive aspects of their industry
environments or they are a strategically important component of the company’s business make-up.
Step 2: Assessing Business Unit Competitive Strength
The second step in evaluating a diversified company is to appraise the competitive strength of each business unit
in its respective industry. Doing an appraisal of each business unit’s strength and competitive position not only
reveals its chances for success in its industry but also provides a basis for ranking the units from competitively
strongest to competitively weakest and sizing up the competitive strength of all the business units as a group.
Calculating Competitive Strength Scores for Each Business Unit Quantitative measures of each
business unit’s competitive strength can be calculated using a procedure similar to that for measuring industry
attractiveness. The following factors are used in quantifying the competitive strengths of a diversified company’s
business subsidiaries:
l
Relative market share. A business unit’s relative market share is defined as the ratio of its market share
to the market share held by the largest rival firm in the industry, with market share measured in unit
volume, not dollars. For instance, if Business A has
Using relative market share to measure
a market-leading share of 40 percent and its largest
competitive strength is analytically superior to
rival has 30 percent, A’s relative market share is
using straight-percentage market share.
1.33. (Note that only business units that are market
share leaders in their respective industries can have
relative market shares greater than 1.0.) If Business B has a 15 percent market share and its largest rival
has 30 percent, B’s relative market share is 0.5. The further below 1.0 a business unit’s relative market
share is, the weaker its competitive strength and market position vis-à-vis rivals. A 10 percent market
share, for example, does not signal much competitive strength if the leader’s share is 50 percent (a 0.20
relative market share), but a 10 percent share is actually strong if the leader’s share is only 12 percent
(a 0.83 relative market share). This is why a company’s relative market share is a better measure of
competitive strength than a company’s market share based on either dollars or unit volume.
l
Costs relative to competitors’ costs. Business units that have low costs relative to those of key competitors
tend to be in a stronger position in their industries than business units struggling to maintain cost parity
with major rivals. The only time a business unit’s competitive strength may not be undermined by
having higher costs than rivals is when it has incurred the higher costs to strongly differentiate its
product offering and its customers are willing to pay premium prices for the differentiating features.
l
Ability to match or beat rivals on key product attributes. A company’s competitiveness depends in part
on being able to satisfy buyer expectations with regard to features, product performance, reliability,
service, and other important attributes.
l
Ability to benefit from strategic fits with sister businesses. Strategic fits with other businesses within the
company enhance a business unit’s competitive strength and may provide a competitive edge.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
186
Chapter 8 • Diversification Strategies
l
Ability to exercise bargaining leverage with key suppliers or customers. Having bargaining leverage
signals competitive strength and can be a source of competitive advantage.
l
Brand image and reputation. A widely known and respected brand name is a valuable competitive asset
in most industries.
l
Other competitively valuable resources and capabilities. Valuable resources and capabilities, including
important alliances and collaborative partnerships, enhance a company’s ability to compete successfully
and perhaps contend for industry leadership.
l
Profitability relative to competitors. Business units that consistently earn above-average returns on
investment and have bigger profit margins than their rivals usually have stronger competitive positions.
Moreover, above-average profitability signals competitive advantage, whereas below-average
profitability usually denotes competitive disadvantage.
After settling on a set of competitive strength measures that are well matched to the circumstances of the various
business units, weights indicating each measure’s importance need to be assigned. A case can be made for
using different weights for different business units whenever the importance of the strength measures differs
significantly from business to business, but otherwise it is simpler just to go with a single set of weights and
avoid the added complication of multiple weights. As before, the importance weights must add up to 1.0. Each
business unit is then rated on each of the chosen strength measures, using a rating scale of 1 to 10 (where a high
rating signifies competitive strength and a low rating signifies competitive weakness). In the event the available
information is too skimpy to confidently assign a rating value to a business unit on a particular strength measure,
it is usually best to use a score of 5—this avoids biasing the overall score either up or down. Weighted strength
ratings are calculated by multiplying the business unit’s rating on each strength measure by the assigned weight.
For example, a strength score of 6 times a weight of 0.15 gives a weighted strength rating of 0.90. The sum of
weighted ratings across all the strength measures provides a quantitative measure of a business unit’s overall
competitive strength. Table 8.2 provides sample calculations of competitive strength ratings for three businesses.
Interpreting the Competitive Strength Scores Business units with competitive strength ratings above
6.7 (on a scale of 1 to 10) are strong market contenders in their industries. Businesses with ratings in the 3.3
to 6.7 range have moderate competitive strength vis-à-vis rivals. Businesses with ratings below 3.3 have a
competitively weak standing in the marketplace. If a diversified company’s business units all have competitive
strength scores above 5.0, it is fair to conclude that its business units are all fairly strong market contenders in
their respective industries. But as the number of business units with scores below 5.0 increases, there’s reason
to question whether the company can perform well with so many businesses in relatively weak competitive
positions. This concern takes on even more importance when business units with low scores account for a sizable
fraction of the company’s revenues.
Copyright © 2022 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.
187
Chapter 8 • Diversification Strategies
TABLE 8.2 Calculating Weighted Competitive Strength Scores for a Diversified
Company’s Business Units
[Rating scale: 1 = Very weak; 10 = Very strong]
Competitive Strength Assessments
Business A in Industry A Business B in Industry B Business C in Industry C
Competitive Strength
Measures
Importance
Weight
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Relative market share
Costs relative to
competitors’ costs
Ability to match or beat
rivals on key product
attributes
Ability to benefit from
strategic fits with sister
businesses
Bargaining leverage
with suppliers/
customers
Brand image and
reputation
Other valuable
resources/capabilities
Profitability relative to
competitors
Sum of importance
weights
Weighted overall
competitive strength
scores
0.15
10
1.50
2
0.30
6
0.90
0.20
7
1.40
4
0.80
5
1.00
0.05
9
0.45
5
0.25
8
0.40
0.20
8
1.60
4
0.80
8
0.80
0.05
9
0.45
2
0.10
6
0.30
0.10
9
0.90
4
0.40
7
0.70
0.15
7
1.05
2
0.30
5
0.75
0.10
5
0.50
2
0.20
4
0.40
1.00
7.85
3.15
5.25
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive
Strength The industry attractiveness and competitive strength scores can be used to portray the strategic
positions of each business in a diversified company. Industry attractiveness is plotted on the vertical axis, and
competitive strength on the horizontal axis. A nine-cell grid emerges from dividing the vertical axis into three
regions (high, medium, and low attractiveness) and the horizontal axis into three regions (strong, average, and
weak competitive strength). As shown in Figure 8.5, scores of 6.7 or greater on a rating scale of 1 to 10 denote
high industry attractiveness, scores of 3.3 to 6.7 denote medium attractiveness, and…