UNIT 4- DIVERSIFICATION & MERGERS

DIVERSIFICATION
Diversification is a corporate strategy to enter into a new market or industry which the business
is not currently in, whilst also creating a new product for that new market. Diversification
strategies allow a firm to expand its product lines and operate in several different economic
markets. It refers to a strategic direction that takes companies into other products and/or markets
by means of either internal or external development.

1. Market penetration This involves increasing market share within existing market
segments. This can be achieved by selling more products/services to established
customers or by finding new customers within existing markets.
2. Product development This involves developing new products for existing markets.
Product development involves thinking about how new products can meet customer
needs more closely and outperform the products of competitors.
3. Market development This strategy entails finding new markets for existing products.
Market research and further segmentation of markets helps to identify new groups of
customers.
4. Diversification This involves moving new products into new markets at the same time.
It is the most risky strategy. The more an organization moves away from what it has done
in the past the more uncertainties are created. However, if existing activities are
threatened, diversification helps to spread risk.
FORMS OF DIVERIFICATION
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2 Broad forms of diversification as listed below:

1. Related diversification
It occurs when a company develops beyond its present product and market whilst remaining in
the same area. For example a newspaper company expanding by acquiring a TV station remains
with media sector. It will use its present strengths by using its expertise to develop new interests
in same area.
This form of diversification can further be broken down:
a. Backward diversification, when activities related to the inputs in the
business are developed. For example a newspaper company acquiring a
printing or publishing company.
b. Forward diversification refers to development into activities which are
concerned with a companys output. For example a newspaper company acquiring a
distribution outlet.
2. Unrelated diversification
It is used to describe a company moving its present interests into unrelated markets or
products. For example a company whose core business is media services may diversify
into provision of financial services.

REASONS FOR DIVERSIFICATION

Saturation or Decline of the Current Business
Additional Opportunities
Better Opportunities
Risk Minimization
Benefits of integration
Better Utilization of resources & strengths
Need related diversification
Consolidation
Competitive Strategy
(For explanation of the above points refer Strategic Management by Francis Cherunilam pg 175)

ADVANTAGES OF DIVERSIFICATION
Control of inputs, leading to continuity and improved quality.
Control markets by guaranteeing sales and distribution.
Take advantage of existing expertise, knowledge and resources in the company when
expanding into new activities.
No longer being reliant on a single market
Provide movement away from declining activities
Opportunity to serve more customers in new markets with new products.
Increase in sales, profits, and growth rate & market share.
Synergy

DISADVANTAGES OF DIVERSIFICATION
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 No Guarantee that the firm will succeed in the new business. Many diversifications of a
number of companies have failed.
If new lines of business result in huge losses, it may affect the old business.
Neglecting of the old business or lack of sufficient attention given to the old business.
Competition for the old as well as new businesses.
May result in slowing growth in its core business
Adding management costs
Adding bureaucratic complexity
Highest amount of risk involved.
Complicated rules & regulations in case entry into foreign markets.

TYPES OF DIVERSFICATION

1. Simple Diversification
It refers to a normal and simple diversification. The company enters into a new business line by
introducing a new product or entering a new market. It is the easiest and most simple type of
diversification.

2. Horizontal Diversification
The company adds new products or services that are often technologically or commercially
unrelated to current products but that may appeal to its current customers. This strategy tends to
increase the firm's dependence on certain market segments. For example, a company that was
making notebooks earlier may also enter the pen market with its new product.
When is Horizontal diversification desirable?
Horizontal diversification is desirable if the present customers are loyal to the current products
and if the new products have a good quality and are well promoted and priced. Moreover, the
new products are marketed to the same economic environment as the existing products, which
may lead to rigidity or instability.
3. Concentric Diversification
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In Concentric Diversification, there is a technological similarity between the industries, which

means that the firm is able to leverage its technical know-how to gain some advantage. The
technology would be the same but the marketing effort would need to change.
The company could seek new products that have technological or marketing synergies with existi
ng product lines appealing to a new group of customers. This also helps the company to tap that
part of the market which remains untapped, and which presents an opportunity to earn profit.
A concentric diversification strategy allows a company to add similar products to an already
successful line of business. For example, a computer manufacturer that produces personal
computers using towers begins to produce laptop computers. The technical knowledge necessary
to accomplish the new task comes from its current field of skilled employees. Concentric
diversification strategies also exist in other industries, such as the food production industry.
4. Conglomerate Diversification
The company markets new products or services that have no technological or commercial
synergies with current products but that may appeal to new groups of customers. The
conglomerate diversification has very little relationship with the firm's current business. Though
this strategy is very risky, it could also, if successful, provide increased growth and profitability.
When companies engage in conglomerate diversification strategies, they are often looking to
enter a previously untapped market. Companies can do this by purchasing or merging with
another company in the desired industry. Moving into a totally unrelated industry is often highly
dangerous; as the companys current management is unfamiliar with the new industry. Brand
loyalty may also be reduced if new management does not maintain current product quality.
5. Synergistic Diversification
Synergistic diversification is diversification which results in the realization of synergistic effects.
In business literature, synergy is described as 1+1=3 or 2+2=5 effect which implies that the
result of the combined performances will be greater than if they were gone separately and
independently. Synergy offers a firm the advantage of higher consolidated return on investment
that can be maximally obtained from a single separate firm.
Important Synergies
a. Marketing Synergy- Marketing Synergy occur when products use common distribution
channels, sales promotion & personnel & sales administration.
b. Operating Synergy- Operating Synergy is realized by better utilization of facilities &
personnel, economies in purchasing.
c. Investment Synergy- It results from the use of same production facilities, technology &
material.
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d. Management Synergy- Management Synergy exists if the existing managerial expertise

of the firm will be an advantage to the new business.

Eg: Videocon Co. follows Synergistic Diversification. It has taken advantage of all synergies
mentioned above.

MERGERS
When two or more organizations combine to become one through exchange of stock or cash or
both, it is termed as Merger. A merger is a combination of two companies to form a new
company, while an acquisition is the purchase of one company by another in which no new
company is formed. It is a legal consolidation of two companies into one entity.
ADVANTAGES/REASONS FOR M & A
It helps the firm acquire new technology.
It enables company to start a new business.
Provides the company with marketing infrastructure.
It avoids the gestation period of setting up a new unit.
Helps in eliminating or reducing competition.
Cost of acquisition is less than the cost of acquiring.
Helps a firm boost sales, grow & gain a large market share.
Benefit from Synergies

DISADVANTAGES OF M & A
Indiscriminate acquisitions have landed several companies in financial problems.
When a company is taken over, its problems are also taken over.
The company may not have the experience & expertise to manage the new unit.
Lack of evaluation before acquisition, could prove the acquisition decision wrong.

TYPES OF MERGERS
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1. Horizontal Merger
A merger occurring between companies in the same industry. Horizontal merger is a business
consolidation that occurs between firms who operate in the same space, often as competitors
offering the same good or service. Horizontal mergers are common in industries with fewer
firms, as competition tends to be higher and the synergies and potential gains in market share are
much greater for merging firms in such an industry.
Example: A merger between Coca-Cola and the Pepsi beverage division, for example, would be
horizontal in nature. The goal of a horizontal merger is to create a new, larger organization with
more market share. Because the merging companies' business operations may be very similar,
there may be opportunities to join certain operations, such as manufacturing, and reduce costs.
2. Vertical Merger
A merger between two companies producing different goods or services for one specific finished
product. A vertical merger occurs when two or more firms, operating at different levels within an
industry's supply chain, merge operations. Most often the logic behind the merger is to increase
synergies created by merging firms that would be more efficient operating as one.
Example: A vertical merger joins two companies that may not compete with each other, but exist
in the same supply chain. An automobile company joining with a parts supplier would be an
example of a vertical merger. Such a deal would allow the automobile division to obtain better
pricing on parts and have better control over the manufacturing process. The parts division, in
turn, would be guaranteed a steady stream of business.
3. Conglomerate Merger
A merger between firms that are involved in totally unrelated business activities. There are two
types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with
nothing in common, while mixed conglomerate mergers involve firms that are looking for
product extensions or market extensions. Conglomerate M&A is the third form of M&A process
which deals the merger between two irrelevant companies. The example of conglomerate M&A
with relevance to above scenario would be if health care system buys a restaurant chain.

4. Market Extension Mergers

A market extension merger takes place between two companies that deal in the same products
but in separate markets. The main purpose of the market extension merger is to make sure that
the merging companies can get access to a bigger market and that ensures a bigger client base.

5. Product Extension Mergers

A product extension merger takes place between two business organizations that deal in products
that are related to each other and operate in the same market. The product extension merger
allows the merging companies to group together their products and get access to a bigger set of
consumers. This ensures that they earn higher profits.

ACQUSITION
An Acquisition or Takeover is the purchase of one business or company by another
company or other business entity. Such purchase may be of 100%, or nearly 100%, of the
assets or ownership equity of the acquired entity.
"Acquisition" usually refers to a purchase of a smaller firm by a larger one.
Types-Friendly & Hostile Takeover