Related Diversification Related Diversification. Related Diversification is the most popular distinction between the different types of diversification and

Related Diversification Related Diversification. Related Diversification is the most popular distinction between the different types of diversification and is made with regard to how close the field of diversification is to the field of the existing business activities. Related Diversification occurs when a company adds to or expands its existing line of production or markets. For this assignment, consider your own company or one that you know well. Assume your company opted to pursue a strategy of related diversification and respond to the following questions. 

What industries or product categories could it diversify into that would allow it to achieve economies of scale?
Identify at least two or three such industries or product categories?
Describe the specific kinds of cost savings that might accrue from entry into each?
Incorporate our coursework (Thompson text and other material) from this week into your above responses.

Submission Details: 

Your analysis should be between 1000 -1500 words.
Incorporate a minimum of at least our course text and one non-course scholarly/peer reviewed source in your paper.
All written assignments must include a coverage page, introductory and concluding paragraphs, reference page, be double-spaced, and proper in-text citations using APA guidelines.

References:

Professor feedback:
  Please review the submission guidelines.  Also, review APA for propper formating and Reference Page. Your source material does not meet standards. chapter 8 Corporate Strategy: Diversification and the Multibusiness Company
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This chapter moves up one level in the strategy-making hierarchy, from strategy making in a single-business enterprise to strategy making in a diversified multibusiness enterprise. Because a diversified company is a collection of individual businesses, the strategy-making task is more complicated.
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Learning Objectives
After reading this chapter, you should be able to:
Explain when and how business diversification can enhance shareholder value.
Describe how related diversification strategies can produce cross-business strategic fit capable of delivering competitive advantage.
Identify the merits and risks of unrelated diversification strategies.
Use the analytic tools for evaluating a firm’s diversification strategy.
Understand the four main corporate strategy options a diversified firm can employ to improve its performance.

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In the first portion of this chapter, we describe what crafting a diversification strategy entails, when and why diversification makes good strategic sense, the various approaches to diversifying a company’s business lineup, 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.

What Does Crafting a Diversification Strategy Entail?

STEP DESCRIPTION

Step 1: Picking new industries to enter and deciding on the means of entry.

Step 2: Pursuing opportunities to leverage cross-business value chain relationships and strategic fit into competitive advantage.

Step 3: Initiating actions to boost the combined performance of the corporation’s collection of businesses..

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The task of crafting a diversified company’s overall corporate strategy falls squarely in the lap of top-level executives and involves three distinct steps.

When to Consider Diversifying
A firm should consider diversifying when:
Growth opportunities are limited as its principal markets reach their maturity and buyer demand is either stagnating or set to decline.
Changing industry conditions—new technologies, inroads being made by substitute products, fast-shifting buyer preferences, or intensifying competition—are undermining the firm’s competitive position.

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As long as a company has plentiful opportunities for profitable growth in its present industry, there is no urgency to pursue diversification. But growth opportunities are often limited in mature industries and markets where buyer demand is flat or declining. In addition, changing industry conditions—new technologies, inroads being made by substitute products, fast-shifting buyer preferences, or intensifying competition— can undermine a company’s ability to deliver ongoing gains in revenues and profits.

Strategic Diversification Options
Sticking closely with the existing business lineup and pursuing opportunities presented by these businesses.
Broadening the current scope of diversification by entering additional industries.
Retrenching to a narrower scope of diversification by divesting poorly performing businesses.
Broadly restructuring the entire firm by divesting some businesses and acquiring others to put a whole new face on the firm’s business lineup.

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The demanding and time-consuming nature of these four tasks explains why corporate executives 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 environment in which their business operates, and holding them accountable for producing good financial and strategic results.

How Much Diversification?
Deciding how wide-ranging diversification should be:
Diversify into closely related businesses or into totally unrelated businesses?
Diversify present revenue and earnings base to a small or major extent?
Move into one or two large new businesses or a greater number of small ones?
Acquire an existing company?
Start up a new business from scratch?
Form a joint venture with one or more companies to enter new businesses?

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The decision to diversify presents wide-ranging possibilities. A company can diversify into closely related businesses or into totally unrelated businesses. It can diversify its present revenue and earnings base to a small or major extent. It can move into one or two large new businesses or a greater number of small ones. It can achieve diversification by acquiring an existing company, starting up a new business from scratch, or forming a joint venture with one or more companies to enter new businesses. In every case, however, the decision to diversify must start with a strong economic justification for doing so.

Opportunity for Diversifying
Strategic diversification possibilities:
Expand into businesses whose technologies and products complement present business(es).
Employ current resources and capabilities as valuable competitive assets in other businesses.
Reduce overall internal costs by cross-business sharing or transfers of resources and capabilities.
Extend a strong brand name to the products of other acquired businesses to help drive up sales and profits of those businesses.

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In every case, however, the decision to diversify must start with a strong economic justification.

Building Shareholder Value: The Ultimate Justification for Diversifying
Testing Whether Diversification Will Add Long-Term Value for Shareholders:
The industry attractiveness test.
The cost-of-entry test.
The better-off test.

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Diversification must do more for a company than simply spread its business risk across various industries. In principle, diversification cannot be considered wise or justifiable unless it results in 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 to spread their investments across several industries. A move to diversify into a new business stands little chance of building shareholder value without passing the three Tests of Corporate Advantage.

Three Tests for Building Shareholder Value through Diversification
The industry attractiveness test:
Are the industry’s profits and return on investment as good or better than present business(es)?

The cost of entry test:
Is the cost of overcoming entry barriers so great as to cause delay or reduce the potential for profitability?
The better-off test:
How much synergy (stronger overall performance) will be gained by diversifying into the industry?

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To add shareholder value, diversification into a new business must pass the three tests of corporate advantage:
The industry attractiveness test
The cost of entry test
The better-off test

Better Performance through Synergy

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Creating added value for shareholders via diversification requires building a multibusiness company in which the whole is greater than the sum of its parts; such 1 + 1= 3 effects are called synergy.

FIGURE 8.2 Three Strategy Options for Pursuing Diversification

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Figure 8.2 shows the range of alternatives for companies pursuing diversification.

Approaches to Diversifying the Business Lineup
Diversifying into New Business:
Existing business acquisition.
Internal new venture (start-up).
Joint venture.

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Diversification by Acquisition
of an Existing Business
Advantages:
Quick entry into an industry.
Barriers to entry avoided.
Access to complementary resources and capabilities.

Disadvantages:
Cost of acquisition—whether to pay a premium for a successful firm or seek a bargain in a struggling firm.
Underestimating costs for integrating acquired firm.
Overestimating the acquisition’s potential for added shareholder value.

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Acquisition is a popular means of diversifying into another industry. Not only is it quicker than trying to launch a new operation, but it also offers an effective way to hurdle such entry barriers.
An acquisition premium, or control premium, is the amount by which the price offered exceeds the pre-acquisition market value of the target company.

Entering a New Line of Business
through Internal Development
Advantages of new venture development:
Avoids pitfalls and uncertain costs of acquisition.
Allows entry into a new or emerging industry where there are no available acquisition candidates.

Disadvantages of corporate intrapreneurship:
Must overcome industry entry barriers.
Requires extensive investments in developing production capacities and competitive capabilities.
May fail due to internal organizational resistance to change and innovation.

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Achieving diversification through internal development involves starting a new business subsidiary from scratch. Internal development has become an increasingly important way for companies to diversify.
Corporate venturing, or new venture development, is the process of developing new businesses as an outgrowth of a firm’s established business operations. It is also referred to as corporate entrepreneurship or intrapreneurship since it requires entrepreneurial-like qualities within a larger enterprise.

When to Engage in Internal Development
Factors Favoring Internal Development:
Low resistance of incumbent firms to market entry.

Ample time to develop and launch business.

Availability of in-house skills and resources

Cost of acquisition higher than internal entry.

Added capacity affects supply and demand balance.

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Generally, internal development of a new business has appeal only when (1) the parent company already has in-house most of the resources and capabilities it needs to piece together a new business and compete effectively; (2) there is ample time to launch the business; (3) the internal cost of entry is lower than the cost of entry via acquisition; (4) adding new production capacity will not adversely impact the supply– demand balance in the industry; and (5) incumbent firms are likely to be slow or ineffective in responding to a new entrant’s efforts to crack the market.

Using Joint Ventures to Achieve Diversification
Joint ventures are advantageous when diversification opportunities:
Are too large, complex, uneconomical, or risky for one firm to pursue alone.
Require a broader range of competencies and know-how than a firm possesses or can develop quickly.
Are located in a foreign country that requires local partner participation or ownership.

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Entering a new business via a joint venture can be useful in at least three types of situations.
First, a joint venture is a good vehicle for pursuing an opportunity that is too complex, uneconomical, or risky for one company to pursue alone.
Second, joint ventures make sense when the opportunities in a new industry require a broader range of competencies and know-how than a company can marshal on its own.
Third, companies sometimes use joint ventures to diversify into a new industry when the diversification move entails having operations in a foreign country.

Risks of Diversification by Joint Venture
Joint ventures have the potential for developing serious drawbacks due to:
Conflicting objectives and expectations of venture partners.
Disagreements among or between venture partners over how best to operate the venture.
Cultural clashes among and between the partners.
Dissolution of the venture when one of the venture partners decides to go their own way.

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Partnering with another company has significant drawbacks due to the potential for conflicting objectives, disagreements over how to best operate the venture, culture clashes, and so on. Joint ventures are generally the least durable of the entry options, usually lasting only until the partners decide to go their own ways.

Choosing a Mode of Market Entry

The question of: The question:

The Question of Critical Resources and Capabilities. Does the firm have the resources and capabilities for internal development?

The Question of Entry Barriers. Are there entry barriers to overcome?

The Question of Speed. Is speed crucial to the firm’s chances for successful entry?

The Question of Comparative Cost. Which is the least costly mode of entry, given the firm’s objectives?

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The choice of how best to enter a new business—whether through internal development, acquisition, or joint venture—depends on the answers to four important questions. Transaction costs are the costs of completing a business agreement or deal, not including the price of the actual deal. They can include the costs of searching for an attractive target, the costs of evaluating its worth, bargaining costs, and the costs of completing the transaction.

Choosing the Diversification Path: Related versus Unrelated Businesses
Which Diversification Path to Pursue?
Related Businesses.
Unrelated Businesses.
Both Related and Unrelated Businesses.

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Once a company decides to diversify, it faces the choice of whether to diversify into related businesses, unrelated businesses, or some mix of both.
Related businesses possess competitively valuable cross-business value chain and resource matchups.
Unrelated businesses have dissimilar value chains and resource requirements, with no competitively important cross-business relationships at the value chain level.

Diversification into Related Businesses
Strategic fit opportunities:
Transferring specialized expertise, technological know-how, or other resources and capabilities from one business’s value chain to another’s.
Sharing costs by combining the related value chain activities of different businesses into a single operation.
Exploiting common use of a well-known brand name.
Sharing other resources (besides brands) that support corresponding value chain activities across businesses.
Engaging in cross-business collaboration and knowledge sharing to create new competitively valuable resources and capabilities.

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Strategic fit exists whenever one or more activities constituting the value chains of different businesses are sufficiently similar in present opportunities for cross-business sharing or transferring of the resources and capabilities that enable these activities.

Pursuing Related Diversification
Generalized resources and capabilities:
Can be deployed widely across a broad range of industry and business types.
Can be leveraged in both unrelated and related diversification situations.

Specialized resources and capabilities:
Have very specific applications which restrict their use to a narrow range of industry and business types.
Can typically be leveraged only in related diversification situations.

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The resources and capabilities that are leveraged in related diversification are specialized resources and capabilities that have very specific applications; their use is restricted to a limited range of business contexts in which these applications are competitively relevant. Because they are adapted for particular applications, to have value, specialized resources and capabilities must be utilized by particular types of businesses operating in specific kinds of industries; they have limited utility outside this designated range of industry and business applications. This is in contrast to general resources and capabilities (such as general management capabilities, human resource management capabilities, and general accounting services), which can be applied usefully across a wide range of industry and business types.

Identifying Cross-Business Strategic Fits along the Value Chain
Potential Cross-Business Fits:
Sales and marketing activities.
R&D technology activities.
Supply chain activities.
Manufacturing-related activities.
Distribution-related activities.
Customer service activities

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Cross-business strategic fit can exist anywhere along the value chain—in R&D and technology activities, in supply chain activities and relationships with suppliers, in manufacturing, in sales and marketing, in distribution activities, or in customer service activities.

FIGURE 8.1 Related Businesses Provide Opportunities to Benefit from Competitively Valuable Strategic Fit.

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Figure 8.1 illustrates the range of opportunities to share and/or transfer specialized resources and capabilities among the value chain activities of related businesses. It is important to recognize that even though general resources and capabilities may be shared by multiple business units, such resource sharing alone cannot form the backbone of a strategy keyed to related diversification.

Strategic Fit, Economies of Scope, and Competitive Advantage
Using economies of scope to convert strategic fit into competitive advantage can entail:
Transferring specialized and generalized skills or knowledge
Combining related value chain activities to achieve lower costs.
Leveraging brand names and other differentiation resources.
Using cross-business collaboration and knowledge sharing.

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The greater the cross-business economies associated with resource sharing and transfer, the greater the potential for a related diversification strategy to give individual businesses of a multibusiness enterprise a cost advantage over their rivals.

Economies of Scope Differ from
Economies of Scale
Economies of scope:
Are cost reductions that flow from cross-business resource sharing in the activities of the multiple businesses of a firm.

Economies of scale:
Accrue when unit costs are reduced due to the increased output of larger-size operations of a firm.

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Economies of scope are cost reductions that flow from operating the same essential activities in multiple businesses (a larger scope of operation).
Economies of scale accrue from the lower variable costs of outputs from a larger-size operation.

ILLUSTRATION CAPSULE 8.1 Examples of Companies Pursuing a Related Diversification Strategy
Which of the three companies is pursuing a diversification strategy most focused on growth by acquisition? on growth by internal growth? on cross-business fits?
Based on the related diversification strategies of the three companies, is the successful pursuit of growth by a single form of related diversification likely to lead to sustainable competitive advantage?
How is the scale and scope of the strategic fits present in these companies related to their success in their markets?

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From Strategic Fit to Competitive Advantage, Added Profitability, and
Gains in Shareholder Value
Capturing the cross-business strategic-fit benefits of related diversification:
Builds more shareholder value than owning a stock portfolio.
Only possible via a strategy of related diversification.
Yields value in the application of specialized resource and capabilities.
Requires that management take internal actions to realize them.

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Diversifying into related businesses where competitively valuable strategic-fit benefits can be captured puts a firm’s businesses in position to perform better financially as part of the firm than they could have performed as independent enterprises, thus, providing a clear avenue for boosting shareholder value and satisfying the better-off test.

The Effects of Cross-Business Fit
Fit builds more value than owning a stock portfolio of firms in different industries.
Strategic-fit benefits are possible only via related diversification.
The stronger the fit, the greater its effect on the firm’s competitive advantages.
Fit fosters the spreading of competitively valuable resources and capabilities specialized to certain applications and that have value only in specific types of industries and businesses.

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Capturing the benefits of strategic fit along the value chains of its related businesses gives a diversified company a clear path to achieving competitive advantage over undiversified competitors and competitors whose own diversification efforts don’t offer equivalent strategic-fit benefits. Such competitive advantage potential provides a company with a dependable basis for earning profits and a return on investment that exceeds what the company’s businesses could earn as stand-alone enterprises.

ILLUSTRATION CAPSULE 8.2 The Kraft-Heinz Merger: Pursuing the Benefits of Cross-Business Strategic Fit
Why did Kraft choose to seek a merger with Heinz rather than starting its own food products subsidiary?
What are the anticipated results of the merger?
To what extent is decentralization required when seeking cross-business strategic fit?
What should Kraft-Heinz do to ensure the continued success of its related diversification strategy?

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Illustration Capsule 8.1 describes the merger of Kraft Foods Group, Inc. with the H. J. Heinz Holding Corporation, in pursuit of the strategic-fit benefits of a related diversification strategy.

Diversification into Unrelated Businesses

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Achieving cross-business strategic fit is not a motivation for unrelated diversification. Companies that pursue a strategy of unrelated diversification often exhibit a willingness to diversify into any business in any industry where senior managers see an opportunity to realize consistently good financial results.
With an unrelated diversification strategy, company managers spend much time and effort screening acquisition candidates and evaluating the pros and cons of keeping or divesting existing businesses using the criteria listed in this slide

Building Shareholder Value via
Unrelated Diversification

Type Details

Astute corporate
parenting by management. Provide leadership, oversight, expertise, and guidance.
Provide generalized or parenting resources that lower operating costs and increase SBU efficiencies.

Cross-business allocation of financial
resources. Serve as an internal capital market.
Allocate surplus cash flows from businesses to fund the capital requirements of other businesses.

Acquiring and restructuring undervalued companies. Acquire weakly performing firms at bargain prices.
Use turnaround capabilities to restructure them to increase their performance and profitability.

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Corporate parenting is the role that a diversified corporation plays in nurturing its component businesses through the provision of:
Top management expertise
Disciplined control
Financial resources
Other types of generalized resources and capabilities such as long-term planning systems, business development skills, management development processes, and incentive systems
A diversified firm has a parenting advantage when it is more able than other firms to boost the combined performance of its individual businesses through high-level guidance, general oversight, and other corporate-level contributions.

The Path to Greater Shareholder Value through Unrelated Diversification

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For a strategy of unrelated diversification to produce company-wide financial results above and beyond what the businesses could generate operating as stand-alone entities, corporate executives must do three things to pass the three tests of corporate advantage:
Diversify into industries where the businesses can produce consistently good earnings and returns on investment (to satisfy the industry-attractiveness test).
Negotiate favorable acquisition prices (to satisfy the cost of entry test).
Do a superior job of corporate parenting via high-level managerial oversight and resource sharing, financial resource allocation and portfolio management, and/or the restructuring of underperforming businesses (to satisfy the better-off test).

The Drawbacks of Unrelated Diversification
Pursuing an Unrelated Diversification Strategy
Demanding Managerial Requirements
Limited Competitive Advantage Potential
Monitoring and maintaining the parenting advantage.
Possible lack of cross-business strategic-fit benefits.

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Misguided Reasons for Pursuing
Unrelated Diversification
Poor Rationales for Unrelated Diversification:
Seeking a reduction of business investment risk.
Pursuing rapid or continuous growth for its own sake.
Seeking stabilization of earnings to avoid cyclical swings in businesses.
Pursuing personal managerial motives.

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Companies sometimes pursue unrelated diversification for reasons that are entirely misguided. Because unrelated diversification strategies at their best have only a limited potential for creating long-term economic value for shareholders, it is essential that managers not compound this problem by taking a misguided approach toward unrelated diversification, in pursuit of objectives that are more likely to destroy shareholder value than create it.

Combination Related-Unrelated
Diversification Strategies
Related-Unrelated business portfolio combinations may be suitable for:
Dominant-business enterprises.
Narrowly diversified firms.
Broadly diversified firms.
Multibusiness enterprises.

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Structures of Combination Related-Unrelated Diversified Firms
Dominant-business enterprises:
Have a major “core” firm that accounts for 50% to 80% of total revenues and a collection of small related or unrelated firms that accounts for the remainder.
Narrowly diversified firms:
Are comprised of a few related or unrelated businesses.
Broadly diversified firms:
Have a wide-ranging collection of related businesses, unrelated businesses, or a mixture of both.
Multibusiness enterprises:
Have a business portfolio consisting of several unrelated groups of related businesses.

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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 competitive asset profile and strategic vision. Combination related–unrelated diversification strategies have particular appeal for companies with a mix of valuable competitive assets, covering the spectrum from general to specialized resources and capabilities.

Steps in Evaluating the Strategy of a Diversified Firm
Assess the attractiveness of the industries the firm has diversified into, both individually and as a group.
Assess the competitive strength of the firm’s business units within their respective industries.
Evaluate the extent of cross-business strategic fit along the value chains of the firm’s various business units.
Check whether the firm’s resources fit the requirements of its present business lineup.
Rank the performance prospects of the businesses from best to worst and determine resource allocation priorities.
Craft strategic moves to improve corporate performance.

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Strategic analysis of diversified companies builds on the concepts and methods used for single-business companies. 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.

Step 1: Evaluating Industry Attractiveness
How attractive are the industries in which the firm has business operations?
Does each industry represent a good market for the firm to be in?
Which industries are most attractive, and which are least attractive?
How appealing is the whole group of industries?

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A principal consideration in evaluating the caliber of a diversified company’s strategy is the attractiveness of the industries in which it has business operations. The more attractive the industries (both individually and as a group) that a diversified company is in, the better its prospects for good long-term performance.

Calculating Industry-Attractiveness Scores:
Key Measures
Market size and projected growth rate.
The intensity of competition among market rivals.
Emerging opportunities and threats.
The presence of cross-industry strategic fit.
Resource requirements.
Social, political, regulatory, environmental factors.
Industry profitability.

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A simple and reliable analytic tool for gauging industry attractiveness involves calculating quantitative industry-attractiveness scores based on these measures.

Calculating Industry Attractiveness from the Multibusiness Perspective
The question of cross-industry strategic fit:
How well do the industry’s value chain and resource requirements match up with the value chain activities of other industries in which the firm has operations?
The question of resource requirements:
Do the resource requirements for an industry match …

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