You could learn from the previous discussions that a single- business company can diversify its business by adopting several strategies such as new venture or joint venture or acquisition.
In this post, we would discuss the strategies that a diversified company may adopt to strengthen its position and performance.
Once a company gets diversified, it becomes a critical obligation on the part of the corporate managers to manage the affairs of the diversified lines of business effectively.
Each line of business is known as the Strategic Business Unit (SBU). The managers of each SBU are required to formulate generic strategies for improving the firm’s profitability and strengthening its performance.
On top of everything, the corporate managers develop corporate strategies that are pervasive and affect ail SBUS under the corporate umbrella.
Different diversified companies have been found to adopt several corporate strategies at different times in the company’s life. Based on the experience of these companies, today’s diversified companies may follow there for the growth of the companies.
To improve the performance of different lines of businesses, a diversified company may consider any of a combination of the following corporate strategies:
- Divestiture Strategy.
- Harvest Strategy.
- Liquidation Strategy.
- Retrenchment Strategy.
- Turnaround Strategy
- Restructuring Strategy.
- Multinational Strategy.
Selling off a business-unit or a division of a unit is called divestiture. Divestiture strategy is undertaken by a company when a unit fails to’ earn enough profits for the company or when it has a dim prospect of profitability and growth in the future. It is also called ‘divestment strategy,’ which is not usually the first choice of strategy for a diversified company.
However, because of reality, a company may be compelled to get rid of some portion of the business that is not performing to management’s expectations.
Such an operation is a prime target for divestment. Boston Consulting Group (BCG) Model or General Electric’s Business Screen can be used to identify SBUs that need divestiture.
For example, business units identified as “dogs” in the BCG Model are prime candidates for divestment.
A diversified company may gain out of divestiture strategy in certain circumstances.
Divestiture strategy is especially effective when the company finds that one or more than one units are continuously incurring losses for several years, or a particular unit is a misfit with other units of the company, or the company fails to supply needed cash to an ailing company, or the company is unable to provide additional resources required for running the business of the concerned unit. There may be other reasons for divestiture.
Two terminologies are commonly used in the divestiture of business – spinoff and management buyout. Selling off a business-unit to ‘independent investors’ is called spinoff.
Sometimes, a business unit is sold off to its management —known as ‘management buyout.’ In the case of a management buyout, the company’s managers buy the unit.
Usually, the managers raise cash by issuing bonds and then use the cash to buy the shares/stocks of the business unit.
A company opts for divestiture strategy for many reasons. Some of these are;
- Difficulties in managing a large number of business units have instigated many diversified companies to divest certain business- units to focus their resources on the core business.
- The need to narrow down a company’s diversification base sometimes prompts the company to divest a unit or a portion of the unit. The diversification base of a company can be narrowed down through divesting some business units that have no (or little) strategic-fit with its main businesses or that .have no ability. To make a substantial contribution to the earnings of the company.
- A company may sell off a unit when its market, a share is too small to be competitive or when the market is too small to provide the expected rates of return.
- The availability of better alternatives to make a better profit may instigate a company to divest an SBU. Because of limited resources, a company may wish to divert resources from a marginally profitable line of business to one where the same resources can be used to achieve a greater rate of return.
A harvest strategy is also known as an ‘asset reduction strategy.’ Harvest strategy entails decreasing the investment in a business unit and extracting the investment as much as it can.
The company tries to harvest all the returns it can. It reduces the assets to a minimum. When a company adopts a harvest strategy, it halts investment in a business unit to maximize short term cash flow from the unit. Subsequently, the unit is liquidated.
Liquidation strategy is the strategy of writing off a business unit’s investment. This strategy is usually adopted when it becomes difficult to find a buyer for a losing unit.
Generally, the business units that are weak (financially or in terms of managerial performance) follow a liquidation strategy. If a turnaround is not possible, a liquidation (or divestiture) strategy is the last resort.
Since the liquidation strategy is indirect: the indication of management’s admittance of failure, it is the: least preferred strategy.
However, planned liquidation minimizes losses to all stakeholders in the long run.
Many reasons may cause a decline in sales and profits of a company, in a profit-declining company, the strategy-managers may consider retrenchment strategy to recover the situations. This strategy is employed through either cost reduction or asset reduction or a combination of both.
Cost reduction occurs when employees are terminated or laid off, equipment is teased rather than purchasing, advertising campaigns are slowed, down, and other efforts like these are undertaken.
Asset reduction occurs when the company sells any fixed or other assets that are not very essential, elimination of company-owned vehicles for executives or staff transportation, pruning product lines, closing obsolete factories, etc.
The principal purpose of the retrenchment strategy and turnaround strategy is similar – recovering a weak business-unit. Both are designed to fortify the basic distinctive competence of the company.
The ways of recovering may be somewhat different; if the ways are the same, then there will be no difference between reduction and turnaround strategies. When a company is in a weak competitive position, it may apply a turnaround strategy.
Turnaround strategy is the strategy of reversing a weak business-unit to profitability. To make a poor company profitable, management may redeploy additional resources, instead of divestment or liquidation.
However, the company must have enough resources and capable managers to turn the business unit around.
Lee Iacocca applied a turnaround strategy to regain the position of Chrysler Corporation (one of the giant American car manufacturers) in the 1990s and Was tremendously successful.
This strategy works best when the reasons for poor performance are short term, the ailing businesses are in attractive industries, and divesting the money-losers does not make longterm strategic sense.
Turnaround strategy may include the following actions:
- Selling or closing down a losing unit having a poor prospect.
- Changing the present strategy and adopting a different business-level strategy.
- Creating a new venture to earn greater returns.
- Undertaking measures for cost reduction.
It may be noted that a turnaround strategy can be applied for both a single-business company and a diversified company.
Restructuring strategy involves divestment of one or more business units of a diversified company and acquiring new business units. Thus, the business makeup of the diversified company takes a new shape. This strategy calls for reorganizing the business portfolio of the company.
For this purpose, sick business units are sold off, and prospective new business ventures are undertaken.
For example, a diversified company, over 5 years, sells off 2 units, closes down 3 weak units, and adds 4 new lines of business to its business-portfolios. These efforts of the company can be called a restructuring strategy.
Thompson and Strickland have identified seven conditions that prompt a diversified company to undertake restructuring strategy:
- When the long-term performance prospects of the company have become unattractive.
- When one or more of the business-units of the diversified company have been facing hard times.
- When a newly-appointed CEO decides to restructure the diversified company.
- When the diversified company wants to build up a strong presence in a potentially attract new industry.
- When the diversified company needs huge cash for acquiring a very prospective business and so needs to sell off some units.
- When environmental changes force the diversified company to shake-up the existing portfolio to improve corporate performance.
- When changes in markets and/or technologies compel the diversified company to Split the company into separate pieces rather than remaining together.
Multinational Diversification Strategy
A company may follow a strategy of diversifying its business into foreign markets. When a company faces hard times in the domestic market or finds a high prospect in foreign markets, it may undertake a multinational diversification strategy.
A multinational diversification strategy warrants cross-country collaboration and strategic coordination. This strategy becomes effective when it results in competitive advantage and increased profitability.
Multinational diversification offers several ways to build competitive advantage:
- Full capture of economies of scale.
- Opportunities to capitalize on cross-business economies of scope.
- Opportunities to transfer competitively valuable resources from one business to another.
- Ability to leverage the use of a well-known and competitively powerful brand name.
- Ability to capitalize on opportunities for cross-business and cross-country collaboration and strategic coordination.
- Opportunities to use cross-business or cross-country subsidization to outcompete the competitors.