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    Advance Corporate Strategy

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    Passionate_to_Learn
    The document discusses how diversification can add value for firms. Economies of scope from related diversification has the clearest logic for value addition by lowering costs. Motives like increasing market power and financial economies also potentially improve performance but advantages are not always realized. Internal capital markets have information advantages over external markets but also risks like escalating commitment to failing businesses.

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    Advance Corporate Strategy

    Uploaded by

    Passionate_to_Learn
    35 views2 pages
    The document discusses how diversification can add value for firms. Economies of scope from related diversification has the clearest logic for value addition by lowering costs. Motives like increasing market power and financial economies also potentially improve performance but advantages are not always realized. Internal capital markets have information advantages over external markets but also risks like escalating commitment to failing businesses.

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    The document discusses how diversification can add value for firms. Economies of scope from related diversification has the clearest logic for value addition by lowering costs. Motives like increasing market power and financial economies also potentially improve performance but advantages are not always realized. Internal capital markets have information advantages over external markets but also risks like escalating commitment to failing businesses.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    35 views2 pages

    Advance Corporate Strategy

    Uploaded by

    Passionate_to_Learn
    The document discusses how diversification can add value for firms. Economies of scope from related diversification has the clearest logic for value addition by lowering costs. Motives like increasing market power and financial economies also potentially improve performance but advantages are not always realized. Internal capital markets have information advantages over external markets but also risks like escalating commitment to failing businesses.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    Advanced Corporate Strategy

    ST104x

    How does diversification add value

    We have discussed so far, the various motives for diversification. As you may have already
    inferred from our discussion so far, there are some motives that have the potential to add
    value to the firm while there are other motives that may or may not add value and some
    motives that lead to value destruction.

    Of all the motives for diversification, the one with the clearest logic for value addition and,
    thereby, superior firm performance is economies of scope. By sharing activities or resources
    across multiple businesses, a firm can incur lower costs, which, in turn, can improve a firm’s
    performance. These economies of scope will be higher when the firm’s businesses are related
    to each other. Thus, we can strongly expect that firms with related diversification will perform
    better than those firms that are not diversified or those that are diversified into unrelated
    businesses.

    Motives such as increasing market power and creating financial economies also have the
    potential to improve firm performance but the potential is often not fully realized. In the case
    of market power, there is sufficient competition in many industries such that firms are rarely
    in a position to use their monopoly power in one business to capture market share or raise
    prices in another industry.

    In the case of financial economies, the advantage that internal capital markets have over
    external capital markets is that the internal providers of capital such as the Corporate Office
    have access to more information or better information than the external providers of capital
    and thus are in a better position to decide whether to invest and how much to invest in a
    particular business.

    However, this advantage is balanced by disadvantages such as escalation of commitment


    whereby the Corporate Office may fund a business even when it is not viable. It is relatively

    © All Rights Reserved, Indian Institute of Management Bangalore


    Advanced Corporate Strategy

    ST104x

    easier for an external capital provider to walk away from a failing business compared to an
    internal provider of capital.

    Further, the different businesses in a diversified firm may compete for funds from the
    corporate office and the final allocation of capital by the corporate office may not be the best
    way to allocate capital due to all the politicking and influence activities that go on inside a
    firm. Again, external capital markets may handle such influence activities better than internal
    capital markets.

    A discussion of how firms can improve their financial performance by reducing their tax
    burden through diversification is beyond the scope of this course. When firms diversify
    because of low performance in their existing business, the motive is easy to understand.
    However, it is difficult to predict how such diversification will affect their performance. Finally,
    motives such as diversifying employment risk, managerial agency and hubris can be expected
    to destroy value as discussed next.

    © All Rights Reserved, Indian Institute of Management Bangalore

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