Diversified Firms

Essay text:

Philips produces a range of electronic home equipment • Some firms produce unrelated products – unrelated diversification e.g. Saab produces motor cars and fighter aircraft • Seek to explain why related and unrelated diversification occurs and assess the performance of such diversification MOTIVATIONS Economies of scope • Exist where it is cheaper to produce two or more products within one firm rather than independent firms producing each product • Other sources of economies of scope come from using firms’ underutilised resources ? Exploit common technologies, assets, distribution channels • Dominant general management logic ? managers that have invested in management skills believe they can use them across a variety of product markets Synergy • A Resource has greater utilisation when used in conjunction with a complementary resource • Complementarity between resources exist when revenues (costs) are higher (lower) when two resources are owned by one firm rather than two owners • These resources can be physical but also include non-physical resources as suggested by the RBV Financial synergies (internal capital market) • A cash-rich business can cross-subsidise a cash constrained business ? Only successful if profitable investments are made that would not otherwise be made • Predicated on failure of capital markets to finance profitable projects Diversifying shareholders’ portfolio • Diversification ensures a stable cash flow for shareholders ? Managers who have invested in firm-specific skills have more to gain from this than shareholders ? Shareholders can diversify their portfolio of equity holdings Economising on transactions costs • The multi-product firm exists where it economises on transactions costs ? alleviate coordination problems ? alleviate ‘hold-up’ problem • Detrimental effects of vertical integration ? Influence costs ? Costly control systems used to reduce opportunistic behaviour Managerial reasons • Corporate governance concerned with ensuring managers act in shareholders’ interests • Managers use diversification to pursue growth ? buy growth that cannot be achieved internally ? pecuniary and non-pecuniary benefits to managing large firms • Unrelated diversification may be pursued if limits to related diversification are reached • Managers invest in firm-specific skills that have lower value outside the firm ? unrelated diversification spreads risk and lowers risk of firm failing • Manager-specific investments used to entrench incumbent management STRATEGIES TO ACHIEVE DIVERSIFICATION • Internal development - invest in resources to allow production of new output ? Managers do not have to share specialised knowledge ? Managers maintain control of firms’ activities • Mergers and acquisitions - purchase another firm ? Internal development of resources might not be possible or too costly ? Quick method of diversification relative to internal development • Joint ventures and alliances – two or more organisations share resources and activities ? Pursue common strategy without formal integration ? exploit complementary assets without integration ? learn from partner(s) with intention of bringing activities ‘in-house’ • Licensing – right to manufacture patented product for a fee ? Do not bear costs of developing resources and capabilities for development, production, and distribution ? Difficult to maintain quality control e...