Strategic Reasons to Diversify

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Advanced Business Strategy

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University of Virginia

Advanced Business Strategy

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Cours 2 sur 5 dans Specialization Business Strategy

Advance your strategic analysis skills in this follow-up to Foundations of Business Strategy. In this course, you'll learn the tools to analyze strategy across time (competitive dynamics), industries ( corporate strategy), geographies (international strategy), and institutions (non-market strategy). We'll introduce the tools you need to complete a comprehensive evaluation and understand the strategy dynamics of an industry: Competitive Lifecycle, Internationalization and Stakeholder Analyses, and Diversification Matrices. We'll apply these tools in case studies of industry leaders Disney, Orascom Telecom Holding, Sony, and GE Healthcare India.

À partir de la leçon

Diversification Strategy

Corporate strategy is often a question of diversification. How can firms leverage their current position across markets to build profits? In this module, we'll discuss firm scope and the financial, operational, and strategic reasons to expand and diversify. We'll explore the theory of the firm--or why firms exist and how this relates to their scope. By the end of this module, you'll be able to develop a diversification matrix and apply this tool in a case study about Disney.

Introduction to Competing across Industries5:28

Financial Reasons to Diversify5:31

Operational Reasons to Diversify4:32

Strategic Reasons to Diversify6:52

Why Firms Exist: Theory of the Firm7:59

Limits on Firm Scope4:03

The Right Degree of Diversification2:57

Module Lessons1:04

Rencontrer les enseignants

Michael Lenox
Senior Associate Dean and Chief Strategy Officer
Darden School of Business
Jared Harris
Samuel L. Slover Research Chair in Business Administration
Darden School of Business

So let's continue our conversation of why to diversify.

We've talked about financial reasons, and

could express some doubts about whether those are good reasons to diversify.

We talked about operational reasons to diversify, this idea of synergy.

And talked about that that can be a very legitimate reason to diversify, but

we wanna be cautious.

Now let's talk about some specific strategic reasons why you might diversify.

Number one, eliminate competition by subsidizing a price war.

This is the idea that by having positions in two markets, we can leverage our

successful position in one to compete more successfully in another.

Now, there are some cautions here.

This in fact may be an antitrust violation.

And in fact this is what Microsoft was charged with back in the late 1990s.

The argument was the Microsoft's dominant position in operating systems for

personal computers allowed them

to compete aggressively in adjacent markets such as in Internet browsers.

And in fact, the argument was that Internet Explorer

was basically given away for free when you bought the Microsoft operating system.

And for those who specialized in these browsers,

at the time Netscape, this seemed to be an unfair competitive advantage

that Microsoft was able to leverage there.

Now with any type of antitrust violation of this nature,

what you need are two things to get yourself into trouble.

One is a dominant market position, and to act in an aggressive way.

So, a dominant market position,

a monopolistic position, plus low cost pricing here, will get you in trouble.

So there might be circumstances where this is a legitimate reason but

you've got to be understanding and careful and

I would never endorse doing this in any type of violation of antitrust.

The second thing you might want to think about is ways to

raise rival's cost here by positioning into markets.

This might be done through either backward or forward integration,

especially when you think about vertical integration.

This idea of moving into businesses that are either upstream or

downstream from your core business.

Depending on how your rivals are positioned,

this can give you an advantageous position.

In some cases this can even be called what's called,

vertical foreclosure this would be when a near monopoly position

allows you to foreclose your rivals from getting access to key resources.

Now again, this can be dangerous territory to tread into.

Classic example when Amazon was just emerging,

Barnes & Nobel make an acquisition play for a company called Ingram.

What many people didn't realize is Ingram was a dominant player in the wholesale

book distribution.

At the time, Amazon was using Ingram as almost their exclusive partner for

sourcing books that they were selling online.

The fear was, from Amazon's perspective, that Barnes and Noble could acquire Ingram

and then basically deny them the supply they needed to sell books online.

At the end of the day, the proposed merger between Barnes and Noble and

Ingram fell apart for a variety of reasons.

One of which was concern that this might be prohibited by antitrust.

So again, this is just yet another example that I wanna share with you so

you are aware of these ideas.

But I also wanna very much caution you that there are legal and other reasons

that you want to be very careful when considering these types of strategies.

A third thing to think about is this idea of reducing rivalry through mutual

forbearance.

If we made a political analogy, this would be like mutually assured destruction.

The point is that by having competition in multiple markets

we raise the stakes that companies would not want to fight one another.

In other words, if we compete in one market and

we start to aggressively price against one another then we might end up inducing

a price war in an adjacent market where we're also competing as well.

And if we're competing across enough different markets,

the mutually assured destruction leads to mutual forbearance.

This idea that we won't engage in such fights knowing that it's costs are so

high across these multiple markets.

Now a number of cautions here.

Often the complexity of such a strategy,

makes that type of tacit collusion that I'm arguing about here,

that we won't engage in price competition, difficult to realize.

And when price rivalry does break out, or a price war does break out they tend to be

very severe because now once again you're competing across multiple markets.

In the media industry it's been interesting in recent years.

In the U.S we've had a number of different instances where large integrative players,

let’s say Comcast for example, which owns NBC and also has cable television rights

has argued and competed with companies like Disney, who have entertainment and

media, but do not have downstream distribution like a cable operator.

And have basically used their position to then try to shut down Disney's offerings

on their stations or at least argue and negotiate for better pricing deals there.

So again, it is possible that being

competing in multiple markets may create this mutual forbearance.

But there's also the possibility that this would be very hard to achieve and in fact

might intensify the potential for price wars, and the like, with an industry.

Last but not least, we wanna think about the possibility of minimizing transaction

costs by using a merger to get merging together rather than using markets.

And the core argument here is that it's often costly,

if not impossible, to write a contract between two partners.

And often there are situations where things are not specified in a contract and

that leads to holdup between the partners here.

Now let me give you an example here.

A classic example would be coal mines and coal processing plants.

One could argue that there are very good reasons why you'd want your coal

processing plant to be located near the coal mine.

If one diversifies into both of those productions.

Both the mining and the processing, then one has no worries.

However, if you're kept separate, then one raises the risk that

the co-producer is now locked into the processor nearby, or vice versa.

And in fact, the coal mine as the upstream player might be able to then argue for

higher prices for their coal, knowing the coal processor colocated really wants to

use their coal because it's cheaper to get for transportation reasons and the other.

Now the caution here is that it assumes that trust is

difficult to achieve in market exchange,

that you're gonna have a lot of opportunistic behavior between players.

But it is something to keep in mind and

it has a lot of relevancy when we talk about vertical integration.

Now, we're gonna talk a little bit more here in the lesson about this idea of

transaction costs in a second.

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