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Synergy When companies merge, they can best utilize their resources to reduce operating costs. Better management practices from a high end to low end can be shared in business for overall growth. Through pooled financial resources and risks, efficiencies can be enhanced. 2. Market Power There is high chance of an increase in market share with two companies coming together but it may not result to increased profits. 3. Profit Stability With core business being seasonal, it ensures that other business could lead to better stability in terms of corporate profits. 4. Financial Performance It improves as the core business sustains itself on its money making ventures and utilizes that cash flow to form new ventures that cause additional profits. 5. Growth It is a principle reason for diversification which is quick due to pooled in technology and experience.

Why Do Firms Diversify? We have previously discussed that corporate strategies expand the scope of operations through diversification into new businesses. But, under strict assumptions of an efficient market, there is no obvious rational for one company to acquire another, especially less efficient or unrelated businesses. The theories that attempt to explain why corporations diversify fall into five groups: 1. Economies of scale and scope (synergy). The merger of two companies producing similar products should allow a firm to pool production and attain lower operating costs. The economy may come from reduced overhead or the ability to spread a larger amount of production over lower (consolidated) fixed costs. There may also be differential management capabilities: an efficiently managed firm may acquire a less efficient firm with the intent of bringing better management to the business. Efficiencies can also be gained through pooled financial resources or simply through pooled risk.
Examples of Economies of Scope: Levi Straus jeans for men - expanded to jeans for women and children (exploits product manufacturing capacity) Humana - hospitals and HMO's (exploits shared knowledge of patient care) IBM - mainframes and PC (exploits brand identity/technology through shared marketing/production/distribution efficiencies)

2. Market Power. Mergers and acquisitions can increase a firm's market share when both firms are in the same business. The acquisition by Advance Auto Parts of Sears' Western Auto propels this Virginia-based privately held firm into one the nation's largest retailer of automotive parts. But, market share does not necessarily translate to higher profits or greater value for owners unless it substantially reduces market rivalry. Then, the problem is the prospect of anti-trust action by the Justice Department. 3. Profit Stability. Acquisition of new business can reduce variations in corporate profits by expanding the corporation's lines of business. This typically occurs when the core business depends on sales that are seasonal or cyclical. Farmers plant a spring crop and a fall crop precisely to ensure year-round income from the sale of products.
Hallmark: An Example of Diversification for Profit Stability Perhaps no industry is more subject to seasonal cycles that manufacturers of greeting cards. Predictably, sales are highest at traditional holidays. Privately owned, Hallmark Cards, Inc. and its Ambassador subsidiary have a 44% share of the greeting card market . In 1910 Joyce Hall as an eighteen year old started selling post cards from his rented YMCA room in Kansas City, Missouri. In 1911 Joyce's halfbrother joined the fledgling enterprise and greeting cards were added to the product line. Hall Brothers store was established specializing in postcards, gifts, books and stationary. When a 1915 fire destroyed everything, the brothers obtained a loan, bought an engraving company and began producing greeting cards in time for Christmas. In 1928 the company covered the U.S. market and introduced gift wrap. In 1936 the company introduced the case display for their cards. In 1950 Hall Brothers opened their first greeting card store and in 1951 began its "Hallmark Hall of Fame" television production. The company has consistently expanded its lines of products to insure against the seasonal nature of its core product. In the 1980's Hallmark acquired Binney and Smith, manufacturer of Crayola Crayons and Magic Markers, and Univision, a Spanish language TV network. In 1990 the company acquired Dakin, manufacturer of plush toys. Hallmark also owns the portrait studio chain Picture People and continues to expand its TV programming through Hallmark Entertainment.

Diversification strategies also apply to the more general case of spreading market risks: adding products to the exiting lines of business can be viewed as analogous to an investor who invests in multiple stocks to "spread the risks". Diversification into other lines of business can especially make sense when the core product market is uncertain.
Philip Morris: Diversification Away from the Core Business Anticipating that the cigarette industry would decline in the future, Philip Morris decided to diversify its product offerings and looked for acquisitions of unrelated products to decrease dependence on the future of tobacco. In 1970 it acquired Millers' Brewing for $ 227 million. Miller was the eight largest U.S. brewer with a 4.4% market share. Philip Morris increased Miller production, introduced new lines of products (Miller Malt Liquor, Milwaukee Ale, Miller Ale), acquired Meister Brau in 1972, and in 1975 introduced Miller Lite. By 1972, under Philip Morris Miller grew to the 3rd largest brewer, behind Schlitz; in 1980, Miller overtook Schlitz to become the second largest brewer. Today Philip Morris Companies is a holding company with a diversified product offering: Miller Brewing, General Foods (acquired, 1985), Kraft, Oscar Meyer (acquired, 1981), and Philip Morris. In 1989, tobacco products accounted for 40% of sales, food products ac counted for 51%, and beer accounted for 8%.

Financial theorists argue that the impact of diversified business portfolios for corporations is that the corporation has replaced the traditional role of the investor in picking winners and losers in

industry investments. This raises the agency problem: why should investors protect management from market risks by funding diversification of the firm - the risk minimization benefit accrues to the manager in terms of job security. So, question is: does diversification accrue benefits to investors? 4. Improve Financial Performance. Large firms generate cash that can be invested in other ventures. The firm acts as a banker of an internal capital market.. Sharon Oster cites the example of The Children's Television Network using funds generated by its Sesame Street production to strategically piggyback. That is, the core business sustains itself on its money making ventures, and uses this cash flow to create new ventures that generate additional profits. 5. Growth. Diversification is simply a way to grow. Indeed, some authorities cite growth as the principle reason for diversification. Unlike natural growth which takes time for planning, developing, and implementing a new project, an acquisition or merger can be achieved fairly quickly with a staff, systems, technology and experience immediately available.
TCI: A Growth Company Telecommunications, Inc. (TCI) has been a fast growth communications company, expanding mainly through acquisitions. TCI began in 1956 when a Texas rancher, Bob Magness, sold some cattle to start a cable tv system in Memphis, Texas (a Texas Panhandle town). In 1965 Magness expanded to service small Rocky Mountain towns. In the mid-1970's when tv cable operators were struggling, Magness bought their operations at discount prices and continued to expand. In 1986 he bought United Artists Communications, the largest operator of movie theaters and cable tv franchises. TCI through debt financing continued to acquire communications and cable operations, including part ownership of Turner Broadcasting (TBS, TNN, and CNN). Partial ownership was acquired in BET, Showtime and the Movie Channel, the Discovery Channel, Think Entertainment, and American Movie Classics. As the company also sought growth opportunities outside the cable tv industry, TCI organized as a holding company of three companies, each selling its own stock: TCI Group is the subsidiary housing the firm's original cable systems, whose 14 million subscribers place TCI ahead of Time Warner as the #1 US cable operator. Liberty Media oversees TCI's financial investment in over 90 cable networks, including CNN and Discovery, TCI Music, DMX (a 24-hour commercial-free music station distributed via cable TV, satellite, and custom CDs), The Box Worldwide (interactive music video channel), and Paradigm Music Entertainment (web site and record label). TCI Ventures encompasses everything else, including international cable operations and telephony, Internet, satellite, and national digital video services interests. TCI's investments include stakes in PRIMESTAR and international cable operations and related ventures. TCI in 1980 reported sales of $124 million and in 1996 had sales of $8,022 million, maintaining its high rate or annual growth.