Expansion through Diversification & Integration

Expansion through Diversification

Diversification involves a substantial change in the business definition-singly or jointly in terms of customer functions, customer groups, or technologies of one or more of a firms businesses. When a firm is no longer able to grow any more through market penetration/not able to expand in the basic product market or it becomes mature, then it must add new products or markets to its existing business line. This approach towards growth is known as DIVERSIFICATION. DIVERSIFICATION is thus defined as a strategy in which the growth objective is sought to be achieved by adding new products or services to the existing product/service line.

Benefits of Diversification
Reduce earnings volatility Minimize risk by spreading it over several businesses. Move firm into attractive industries Prolong life of firm Improve long-term performance Capture synergies and strategic fit between businesses by capitalising on organisational strengths & minimise weaknesses.

Types of diversification strategy

i) Horizontal diversification Internal diversification External diversification/Co-operative strategies Concentric diversification(OR RELATED DIVERSIFICATION) Conglomerate diversification(OR UNRELATED DIVERSIFICATION)
ii) Vertical diversification(or Vertical Integration) Forward Integration Backward Integration

Horizontal diversification
This is a broad category which includes strategies involving addition of parallel new pdcts/services to the existing prdct/service line. It may b further divided into: Internal diversification External diversification/Co-operative strategies Internal diversification: when new pdct r developed by the firm on its own or creates new pdn facilities in addition to the existing prdct line. Eg: GODREJ originally started with manufacturing steel safes & locks; later added refrigerators, Washing machines, detergents, soaps, etc to its product line. External diversification/Co-operative strategies: if new pdcts/services are added to the existing line of business through Acquisition or Merger with other external firms, then it is called External diversification/Co-operative strategies.

 Horizontal diversification may be further sub-divided into: Concentric(or Related) diversification: related to the existing business definition of 1 or more of a firms businesses involves either: (a)introduction of new pdcts/services to serve similar customers in similar markets with the help of unrelated technology, or (b) introduction of new pdcts/services using technologies similar to the present pdct line. So, the concept is of SYNERGY that 2 businesses will generate more profits together than they could separately. Synergy exists when the value created by businesses working together exceeds the value created by them working independently

Examples: A Co. in the sewing machine business diversifies into kitchenware & household appliances, which r sold to housewives through a chain of retail stores.( market related Concentric diversification) Addition of tomato ketchup, soups, Pasta ,etc to the existing Maggi brand after success of instant noodles(technology related Concentric diversification) Titan Industries Ltd diversified out of watches into designer jewellery & sunglasses. Amul has diversified out of the simple dairy products into related businesses like ice-creams, Choclates,etc.

Concentric diversification is pursued for several reasons like: Offers excess cash flow if the products it produces in one industry is subject to cyclical fluctuations. If there is saturation of demand in the present product market or industry. It may be prompted by the top mgmt s inclination to gain managerial expertise in a new field , or new technology or entering new mkts or products. Concentric diversification into a related industry may be a very appropriate corporate strategy when a firm has a strong competitive position & distinctive competence & so the Co uses this strength as its means of diversification. Economies of Scope i.e. CONCENTRIC DIVERSIFICATION leads to Cost savings that occur when a firm transfers capabilities and competencies developed in one of its businesses to another of its businesses.

Advantages & disadvantages of Concentric/related diversification

ADVANTAGES 1. Concentric diversification enables a firm to attain synergy by exchange of resources & skills. 2. These related diversification strategies help to avail economies of scale & thus tax benefits. DISADVANTAGES 1. Increase in risk & commitment 2. Reduction in flexibility

Conglomerate diversification(OR UNRELATED DIVERSIFICATION)

Addition of dissimilar prdct/services to the existing line of business i.e. diversification into business fields which are not significantly related or similar to the primary business mission. It is taking up of those activities which r unrelated to the existing business definition of its present businesses, either in terms of the customer groups, cust functions or technologies used. A Conglomerate is defined as a firm which has atleast 5 or 6 divisions selling diff. pdcts EXAMPLES: ITC , originally a cigarette Co diversified into agro products, hotel business, paper products, FMCGs, etc. due to constant threat it had in the cigarette business. ESSAR Group , orignally into shipping, marine construction diversified into iron & steel; telecom,etc. DCM Ltd added a wide range of unrelated products to its existing business line of textiles like engineering goods, fertilisers, chemicals, sugar, etc.

The reasons for using Conglomerate diversification strategy may be:

When mgmt realises that the current industry is unattractive or it lacks competence in related pdcts or services in other industries To achieve a growth rate higher than what can b realised through expansion To make better use of financial resources with retained profits xceeding immediate invstmt needs To avail of potential opportunities of profitable investments To achieve a distinct competitive adv & broader stability To spread the risk & gain increased stABILITY.

Advantages & disadvantages of Conglomerate/unrelated diversification

ADVANTAGES 1. Better management & allocation of cash flows leads to a higher return on investments. 2. Reduction of risk by spreading investment in different businesses & industries DISADVANTAGES 1. Diversion of resources & attention to other areas leads to a lack of concentration & facing the risks of managing entirely new businesses.

Vertical Integration/diversification
Backward integrationa firm produces its own inputs/supplies i.e. the firm moves up in the value chain/upstream development & firm serves as its own customer. Forward integrationa firm operates its own distribution system/retail stores for delivering its outputs/downstream expansion i.e. moving towards the end customer & the firm serves as a customer for its own outputs. Vertical integration refers to a firms ownership of vertically related activities. This type of Vertical growth can b achieved by taking over a function that was previously provided by a supplier or by a distributor. Thus Vertical Integration/diversification is a type of growth strategy wherein new pdcts/services are added which are complementary to the existing pdct line. The greater the firms ownership and control over successive stages of the value chain for its product, the greater its degree of vertical integration. Eg: Highly integrated companies such as the major oil companies that own and control their value chain from exploring for oil down to the retailing of gasoline. .

 A make or buy decision is taken when firms wish to negotiate with suppliers or buyers. The cost of making the items used in the manufacture of ones own pdct are to b evaluated against the cost of procuring them from suppliers. if the cost of making r less than the cost of procurement, then the firm moves up the value chain to manufacture the supplies itself. Similarly, if the cost of selling the finished pdcts is lesser than the price paid to the retailers/distributors to do the same thing, then it is profitable for the firm to move down on the value chain. Thus, in Vertical Integration, a Co. attempts to widen the scope of business definition of a firm by combining several activities in the value chain either forward or backwards.

 Vertical integration can be either backward, where the firm takes over ownership and control of producing its own components or other inputs, or forward, where the firm takes over ownership and control of activities previously undertaken by its customers. Just like related & unrelated diversification can be achieved either internally or externally, vertical integration can be also achieved either internally by expanding current operations or externally through acquisitions.

Vertical Integration

Examples of Vertical Integration

Henry Ford used internal Co resources to build his River Rogue plant outside Detroit. The m/fring process was integrated to the point that iron ore entered one end of the long plant & finished automobiles rolled out at the other end into a huge parking lot. So we see that Ford manufactured much of its own steel rather than buy it from suppliers In contrast, Cisco Systems, the maker of internet hardware, chose the external route to vertical growth by purchasing Radiata Inc(a maker of chip sets for wireless networks)

 One of the earliest, largest and most famous examples of vertical integration was the Carnegie Steel company. The company controlled not only the mills where the steel was made, but also the mines where the iron ore was extracted, the coal mines that supplied the coal, the ships that transported the iron ore and the railroads that transported the coal to the factory, the coke ovens where the coal was cooked, etc. Oil companies, (such as ExxonMobil, Royal Dutch Shell, or BP) often adopt a vertically integrated structure. This means that they are active along the entire supply chain from locating crude oil deposits, drilling and extracting crude, transporting it around the world, refining it into petroleum products such as petrol/gasoline, to distributing the fuel to companyowned retail stations, for sale to consumers.

 The Indian petrochemical giant Reliance Industries has integrated back into polyester fibres from textiles and further into petrochemicals. Reliance has entered the oil and natural gas sector, along with retail sector. Reliance now has a complete vertical product portfolio from oil and gas production, refining, petrochemicals, also synthetic garments to retail outlets. Eg: many sugar mils in India have developed their own sugarcane farming.(Backward) Eg: textile mills like DCM, NTC have set up their own retail distribution systems.

Benefits of vertical integration: cost savings that arise from the physical integration of processes. Eg: steel sheets are produced by integrated producers in plants that first produce steel, then roll hot steel into sheet. Linking the two stages of production at a single location reduces transportation and energy costs. To gain control over a scarce resource To guarantee quality control of a key input as well quality control during distribution system. To obtain access to potential customers & true customer feedback. To gain a greater control over sales & prices of its existing output. To secure a regular supply of materials or components particularly when the mkt is dominated by monopolistic firms. Results in Lower uncertainty and higher ROI for the enterprise through better use of overhead facilities For example, an automobile company may own a tire company, a glass company, and a metal company. Control of these three subsidiaries is intended to create a stable supply of inputs and ensure a consistent quality in their final product.

The demerits of Vertical Integration

Higher coordination costs Higher monetary and organizational costs of switching to other suppliers/buyers Monopolization of markets Opportunities of purchasing at a lower cost which may emerge cannot b availed of.

III.RETRENCHMENT STRATEGIES
DO THE CONCEPT & FEATURES OF RETRENCHMENT & MIXED STRATEGY FROM TEXTBOOK-AZHAR KAZMI