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chapter

CORPORATE STRATEGY:
DIVERSIFICATION AND
THE MULTIBUSINESS
COMPANY

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

LO1 Understand when and how diversifying into


multiple businesses can enhance shareholder
value.
LO2 Gain an understanding of how related
diversification strategies can produce crossbusiness strategic fit capable of delivering
competitive advantage.
LO3 Become aware of the merits and risks of
corporate strategies keyed to unrelated
diversification.

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8-2

(contd)
LO4 Gain command of the analytical tools for
evaluating a companys diversification strategy.
LO5 Understand a diversified companys four main
corporate strategy options for solidifying its
diversification strategy and improving company
performance.

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8-3

The Four Main Tasks in


Crafting Corporate Strategy
1. Picking new industries to enter and deciding
on the means of entry
2. Pursuing opportunities to leverage crossbusiness value chain relationships into
competitive advantage
3. Establishing investment priorities and steering
corporate resources into the most attractive
business units
4. Initiating actions to boost the combined
performance of the corporations collection
of businesses
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8-4

Strategic Options for


Diversified Corporations

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8-5

Corporate Strategy Alternatives


Vertical
Integration

Diversify into
Related
Businesses

PostDiversification
Strategic
Alternatives

Single Business
Concentration

Diversify into
Unrelated
Businesses

Diversify into
Related &
Unrelated
Businesses

Make new
acquisitions
Divest weak
units
Restructure
portfolio

Retrench

Liquidate

Corporate Strategy Alternatives


Vertical
Integration

Diversify into
Related
Businesses

PostDiversification
Strategic
Alternatives

Single Business
Concentration

Diversify into
Unrelated
Businesses

Diversify into
Related &
Unrelated
Businesses

Make new
acquisitions
Divest weak
units
Restructure
portfolio

Retrench

Liquidate

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Competitive Strengths of a
Single-Business Strategy
Less

ambiguity about Who we are, What we


do, Where we are headed
Energies of firm can be directed down one
business path and keeping strategy responsive
to industry change.
Less chance resources will be stretched too
thinly.
Top Executives can maintain hands-on contact
with core business.
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8-8

Risks of a Single Business Strategy


Putting

all the eggs in one industry basket

If

market becomes unattractive, a


firms prospects can quickly dim

Unforeseen

changes can undermine


a single business firms prospects
Changing customer needs
Technological innovation
New substitutes

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8-9

When Business Diversification


Becomes a Consideration

Diversification is called for when:


There are diminishing growth prospects in the present business
An expansion opportunity exists in an industry whose

technologies and products complement the present business


Existing competencies and capabilities can be leveraged by

expanding into an industry that requires similar resource


strengths
Costs can be reduced by diversifying into closely related

businesses
A powerful brand name can be transferred to the products of

other businesses

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8-10

Building Shareholder Value:


The Ultimate Justification for
Business Diversification

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8-11

Building Shareholder Value:


The Ultimate Justification for
Business Diversification
Diversification

may result in building


shareholder value if it passes three tests:
Industry Attractiveness Testthe target industry

presents good long-term profit opportunities


Cost of Entry Testthe costs of entering the target

industry do not erode its long-term profit potential


Better-Off Testthe firms businesses will perform

better together than as stand-alone firms, producing


a synergistic 1+1=3 effect on shareholder value

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8-12

Approaches to Diversifying
the Business Lineup

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Diversification by Acquisition
of an Existing Business
Most

popular approach to diversification


Advantages:
Quicker entry into target market
Easier to hurdle certain entry barriers:

Acquiring technological know-how

Establishing supplier relationships

Securing adequate distribution access

The

big dilemma is whether to pay a


premium price to buy a successful firm or to
buy a struggling firm at a bargain price
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Entering a New Line of Business


through Internal Development
Is

more attractive when:

The parent firm already possesses the resources

needed to compete effectively.


There is ample time to launch a new business.
Internal entry will cost less than entry via acquisition.
The start-up does not have to compete head-to-head
against powerful rivals.
Adding capacity will not adversely impact supplydemand balance in industry.
Incumbent firms are likely to be slow or ineffective in
responding to an entrants efforts to crack the market.
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Using Joint Ventures to Achieve


Diversification
A

good way to diversify when:

The expansion opportunity is too complex,

uneconomical, or risky to go it alone.


The opportunity in a new industry requires a

broader range of competencies and know-how than


an expansion-minded firm can marshal.
Drawbacks:

Potential for conflicting objectives


Operational and control disagreements
Culture clashes
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Choosing the Diversification Path:


Related Versus Unrelated Businesses
Related

Businesses

Have value chains with competitively valuable

cross-business relationships that present


opportunities for the businesses to perform better
operating under the same corporate umbrella
than they could as stand-alone entities.
Unrelated

Businesses

Have value chains and resource requirements

that are so dissimilar that no competitively


valuable cross-business relationships are present.

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Core Concept
Related
Related businesses
businesses possess
possess competitively
competitively
valuable
valuable cross-business
cross-business value
value chain
chain and
and
resource
resource matchups;
matchups; unrelated
unrelated businesses
businesses
have
have dissimilar
dissimilar value
value chains
chains and
and resources
resources
requirements,
requirements, with
with no
no competitively
competitively important
important
cross-business
cross-business value
value chain
chain relationships.
relationships.

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8-18

FIGURE 8.1
Strategic Themes
of Multibusiness
Corporations

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The Case For Related Diversification


Strategic

Fit

Exists whenever one or more activities comprising

the value chains of different businesses are


sufficiently similar to present opportunities for:

Transferring competitively valuable resources, expertise,


technological know-how, or other capabilities from one
business to another.

Cost sharing between separate businesses where value


chain activities can be combined.

Brand sharing between business units that have common


customers or that draw upon common core competencies.

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Core Concept
Strategic
Strategic fit
fit exists
exists when
when the
the value
value chains
chains of
of
different
different businesses
businesses present
present opportunities
opportunities for
for
cross-business
cross-business skills
skills transfer,
transfer, cost
cost sharing,
sharing, or
or
brand
brand sharing.
sharing.

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FIGURE 8.2

Related Diversification Is Built upon Competitively


Valuable Strategic Fit in Value Chain Activities

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Strategic Fit and Economies of Scope

Stem directly from strategic fit along the value


chains of related businesses when costs can be
cut by:
Operating businesses under same corporate umbrella
Taking advantage of the interrelationships anywhere

along the value chains of different businesses

Advantage:
The greater the cross-business economies associated with

cost-saving strategic fit, the greater the potential for a related


diversification strategy to yield a competitive advantage based
on lower costs than rivals.

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8-23

Core Concept
Economies
Economies of
of scope
scope are
are cost
cost reductions
reductions
stemming
stemming from
from strategic
strategic fit
fit along
along the
the value
value
chains
chains of
of related
related businesses
businesses (thereby,
(thereby, aa
larger
larger scope
scope of
of operations),
operations), whereas
whereas
economies
economies of
of scale
scale accrue
accrue from
from aa larger
larger
operation.
operation.

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8-24

Diversifying into Unrelated Businesses


Involves

diversifying into businesses with:

No strategic fit
No meaningful value chain relationships
No unifying strategic theme
Strategic

approach:

Diversify through acquisition into any industry where

potential exists for enhancing shareholder value


through upward-trending corporate revenues and
earnings and/or a stock price that rises yearly.
While industry attractiveness and cost-of-entry tests

are important, better-off test is secondary.


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8-25

Criteria for Acquisition Candidates in


Unrelated Diversification Strategies

Can the business meet corporate targets for


profitability and ROI?

Is the business in an industry with growth potential?

Is the business big enough to contribute to the


parent firms bottom line?

Does the business have burdensome capital


requirements?

Is the industry vulnerable to inflation, tough


government regulations, or other negative factors?

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8-26

Criteria for Acquisition Candidates in


Unrelated Diversification Strategies

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Building Shareholder Value Through


Unrelated Diversification
Corporate

managers must:

Do a superior job of identifying and acquiring new

businesses that can produce consistently good


earnings and returns on investment.
Do an excellent job of negotiating favorable

acquisition prices.
Do such a good job overseeing and parenting the

firms businesses that they perform at a higher level


than they would otherwise be able to do through their
own efforts alone.

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The Pitfalls of Unrelated Diversification


Demanding

Managerial Requirements:

1. Staying abreast of whats happening in each

industry and each subsidiary.


2. Picking business-unit heads with the requisite

combination of managerial skills and know-how to


drive gains in performance.
3. Discerning the difference between strategic

proposals that are prudent and those that are risky


or unlikely to succeed.
4. Knowing what to do if a business unit stumbles and

its results suddenly head downhill.


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The Pitfalls of Unrelated Diversification


Limited

Competitive Advantage Potential:

Unrelated strategy offers limited competitive

advantage beyond what each individual business can


generate on its own.
Without strategic fit, consolidated performance of an

unrelated group of businesses is unlikely to be better


than the sum of what the individual business units
could achieve independently.

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8-30

Misguided Reasons for Pursuing


Unrelated Diversification

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8-31

Corporate Strategies Combining Related


and Unrelated Diversification

Dominant-Business Firms
One major core business accounting for 5080% of revenues

and a collection of small related or unrelated businesses account


for the remainder

Narrowly Diversified Firms


Diversification into a few (25) related or unrelated businesses

Broadly Diversified Firms


Diversification includes a wide collection of either related or

unrelated businesses or a mixture

Multibusiness Enterprises
Diversification into several unrelated groups of related

businesses
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8-32

Evaluating the Strategy of


a Diversified Company
Step
Step 11

Assess
Assess the
the attractiveness
attractiveness of
of the
the industries
industries the
the firm
firm has
has
diversified
diversified into.
into.

Step
Step 22

Assess
Assess the
the competitive
competitive strength
strength of
of the
the firms
firmsbusiness
business
units.
units.

Step
Step 33

Evaluate
Evaluate the
the extent
extent of
of cross-business
cross-business strategic
strategic fit
fit along
along
the
the value
value chains
chains of
of the
the firms
firmsvarious
various business
business units.
units.

Step
Step 44

Check
Check whether
whether the
the firms
firmsresources
resources fit
fit the
the requirements
requirements
of
of its
its present
present business
business lineup.
lineup.

Step
Step 55

Rank
Rank the
the performance
performance of
of the
the businesses
businesses from
from best
best to
to
worst
worst and
and determine
determine aa priority
priority for
for allocating
allocating resources.
resources.

Step
Step 66

Craft
Craft new
new strategic
strategic moves
moves to
to improve
improve overall
overall corporate
corporate
performance.
performance.
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Evaluating the Strategy of


a Diversified Company
Step 1: Assess the attractiveness of the industries the firm has
diversified into.
Step 2: Assess the competitive strength of the firms business
units.
Step 3: Evaluate the extent of cross-business strategic fit along
the value chains of the firms various business units.
Step 4: Check whether the firms resources fit the requirements
of its present business lineup.
Step 5: Rank the performance prospects of the businesses from
best to worst and determine a priority for allocating
resources.
Step 6: Craft new strategic moves to improve overall corporate
performance.
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Step 1: Evaluating Industry


Attractiveness

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Step 1: Evaluating Industry


Attractiveness

Market size and


projected growth rate

Seasonal and cyclical


factors

Intensity of competition

Emerging opportunities
and threats

Social, political,
regulatory, and
environmental factors

Industry profitability

Degree of uncertainty
and business

Presence of crossindustry strategic fit


Resource requirements
risk

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TABLE 8.1

Calculating Weighted Industry Attractiveness Scores

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Step 2: Evaluating Business-Unit


Competitive Strength

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Step 2: Evaluating Business-Unit


Competitive Strength

Relative market share

Costs relative to competitors costs

Products or services that satisfy buyer expectations

Ability to benefit from strategic fits with sibling


businesses

Number and caliber of strategic alliances and


collaborative partnerships

Brand image and reputation

Competitively valuable capabilities

Profitability relative to competitors


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TABLE 8.2

Calculating Weighted Competitive Strength Scores


for a Diversified Companys Business Units

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FIGURE 8.3
A Nine-Cell Industry
Attractiveness
Competitive
Strength Matrix

Note: Circle sizes are scaled


to reflect the percentage of
companywide revenues
generated by the business unit.

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Strategy Implications of the


Attractiveness/Strength Matrix
Businesses

in the upper left corner

Receive top investment priority


Strategic prescription: grow and build
Businesses

in the three diagonal cells

Are given medium investment priority


Some businesses have brighter or dimmer

prospects than others.


Businesses

in the lower right corner

Are candidates for divestiture or to be harvested to

take cash out of the business


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Step 3: Determining the Competitive


Value of Strategic Fit in
Multibusiness Companies
Value

chain matchups offer competitive


value/advantage when there are:
Opportunities to combine the performance of

certain activities, thereby reducing costs and


capturing economies of scope.
Opportunities to transfer skills, technology, or

intellectual capital from one business to another.


Opportunities to share a respected brand name

across multiple product and/or service categories.

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8-43

Identifying Cross-Business Strategic Fits

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Step 4: Evaluating Resource Fit


A

diversified firms lineup of businesses


exhibits good resource fit when:
1. Each of a firms businesses, individually, strengthen

the firms overall mix of resources and capabilities


2. A firm has sufficient resources to support its entire

group of businesses without spreading itself too thin

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8-45

Core Concept
A
A diversified
diversified company
company exhibits
exhibits resource
resource fit
fit
when
when its
its businesses
businesses add
add to
to aa companys
companys
overall
overall mix
mix of
of resources
resources and
and capabilities
capabilities and
and
when
when the
the parent
parent company
company has
has sufficient
sufficient
resources
resources to
to support
support its
its entire
entire group
group of
of
businesses
businesses without
without spreading
spreading itself
itself too
too thin.
thin.

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8-46

Core Concept
A
A strong
strong internal
internal capital
capital market
market allows
allows aa
diversified
diversified company
company to
to add
add value
value by
by shifting
shifting
capital
capital from
from business
business units
units generating
generating free
free
cash
cash flow
flow to
to those
those needing
needing additional
additional capital
capital
to
to expand
expand and
and realize
realize their
their growth
growth potential.
potential.

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8-47

Determining Financial Resource Fit


Use

a portfolio approach to determine the firms


internal capital market requirements:
Which business units are cash hogs in need of capital

funds to maintain growth and expansion?


Which business units are cash cows with capital

surpluses available to fund growth and reinvestment?


Assessing

the portfolios overall condition:

Which businesses are (or are not) capable of contributing

to achieving companywide performance targets?


Does the firm have the financial strength to fund all of its

businesses and maintain a healthy credit rating?


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8-48

Core Concept
A
A cash
cash hog
hog generates
generates operating
operating cash
cash flows
flows
that
that are
are too
too small
small to
to fully
fully fund
fund its
its operations
operations
and
and growth;
growth; aa cash
cash hog
hog must
must receive
receive cash
cash
infusions
infusions from
from outside
outside sources
sources to
to cover
cover its
its
working
working capital
capital and
and investment
investment requirements.
requirements.

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8-49

Core Concept
A
A cash
cash cow
cow generates
generates operating
operating cash
cash flows
flows
over
over and
and above
above its
its internal
internal requirements,
requirements,
thereby
thereby providing
providing financial
financial resources
resources that
that
may
may be
be used
used to
to invest
invest in
in cash
cash hogs,
hogs, finance
finance
new
new acquisitions,
acquisitions, fund
fund share
share buyback
buyback
programs,
programs, or
or pay
pay dividends.
dividends.

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8-50

Examining a Firms
Nonfinancial Resource Fits

A diversified firm must ensure that it can meet the


nonfinancial resource needs of its portfolio of
businesses:
Does the firm presently have or can it develop the specific

resources and capabilities (e.g., managerial talent, technology


and information systems, and marketing support) needed to be
successful in each of its businesses?
Are the firms resources being stretched too thinly by the

requirements of one or more of its present businesses?


Have recent acquisitions strengthened the firms collection of

resources or are they overtaxing managements ability to


assimilate and oversee the expanded firms businesses?

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Step 5: Ranking Business Units and


Setting a Priority for Resource Allocation
Factors
Factors to
to consider
consider in
in judging
judging
business-unit
business-unit performance
performance
Sales
Sales growth
growth
Profit
Profit growth
growth
Earnings
Earnings contribution
contribution
Cash
Cash flow
flow generation
generation
Return
Return on
on investment
investment
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8-52

Step 5: Ranking Business Units and


Setting a Priority for Resource Allocation
Factors

to consider in judging business-unit


performance:
Sales growth
Profit growth
Contribution to company earnings
Cash flow generation
Return on capital employed in business

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FIGURE 8.4 The Chief Strategic and Financial Options for Allocating

a Diversified Companys Financial Resources


Strategic
StrategicOptions
Optionsfor
for
Allocating
AllocatingCompany
Company
Financial
FinancialResources
Resources

Financial
FinancialOptions
Optionsfor
for
Allocating
AllocatingCompany
Company
Financial
FinancialResources
Resources

Invest
Investin
inways
waysto
tostrengthen
strengthen
or
grow
existing
or grow existingbusiness
business

Pay
Payoff
offexisting
existinglong-term
long-term
or
short-term
or short-termdebt
debt

Make
Makeacquisitions
acquisitionsto
toestablish
establish
positions
in
new
industries
positions in new industriesor
orto
to
complement
existing
businesses
complement existing businesses

Fund
Fundlong-range
long-rangeR&D
R&Dventures
ventures
aimed
at
opening
market
aimed at opening market
opportunities
opportunitiesin
innew
newor
or
existing
businesses
existing businesses

Increase
Increasedividend
dividendpayments
payments
to
shareholders
to shareholders
Repurchase
Repurchaseshares
sharesof
ofthe
the
companys
common
stock
companys common stock
Build
Buildcash
cashreserves;
reserves;
invest
investin
inshort-term
short-termsecurities
securities

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Step 6: Crafting New Strategic Moves to


Improve Overall Corporate Performance
1. Stick with existing business lineup
and pursue opportunities it presents
2. Broaden the firms business scope by
making acquisitions in new industries
3. Divest some businesses and retrench
to a narrower base of business operations
4. Restructure the firms business lineup to
put a new face on its business makeup

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8-55

Sticking Closely with


the Existing Business Lineup
Choosing

not to expand beyond the


current lineup of businesses makes sense
when the firms present businesses:
Offer attractive growth opportunities, good

earnings, and cash flows


Are well-positioned for the future and have good

strategic and resource fits


Have sufficient resources that management can

allocate into areas with the greatest performance


and profit potentials
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Broadening the Diversification Base


Multibusiness

firms may consider adding to


the diversification base when:
There is sluggish revenues and profit growth
There is potential for transfer resources and

capabilities to related businesses


Driving forces are hurting its core businesses
The acquisition of related businesses strengthens the

market positions of one or more of its business units

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8-57

Divesting Businesses and Retrenching


to a Narrower Diversification Base
Retrenchment

to focus resources on
building strength in fewer businesses
requires divesting or eliminating:
Once-attractive businesses in deteriorating markets
Businesses that will have a poor strategic or resource

fit in the firms future portfolio


Cash hog businesses with poor long-term investment

returns potential
Weakly competitively positioned businesses with little

prospect for earning a decent return on investment


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8-58

Core Concept
Corporate
Corporate restructuring
restructuring involves
involves radically
radically
altering
altering the
the business
business lineup
lineup by
by divesting
divesting
businesses
businesses that
that lack
lack strategic
strategic fit
fit or
or are
are poor
poor
performers
performers and
and acquiring
acquiring new
new businesses
businesses
that
that offer
offer better
better promise
promise for
for enhancing
enhancing
shareholder
shareholder value.
value.

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8-59

Broadly Restructuring
the Business Lineup
Radical

surgery on the business lineup


is necessary when portfolio performance
is hampered by:
Too many businesses in slow-growth, declining,

low-margin, or otherwise unattractive industries.


Too many competitively weak businesses.
An excessive debt burden with interest costs that

eat deeply into profitability.


Ill-chosen acquisitions that havent lived up to

expectations.
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Concepts and Connections 8.1


VFs Corporate Restructuring Strategy That
Made It the Star of the Apparel Industry
VF Corporations corporate restructuring that included
a mix of divestitures and acquisitions has provided its
shareholders with returns that are more than five times
greater than shareholder returns provided by
competing apparel manufacturers. In fact, VF delivered
a total shareholder return of 21 percent between 2000
and 2010, and its 2010 revenues of $7.7 billion made it
number 310 on Fortune s list of the 500 largest U.S.
companies. The companys corporate restructuring
began in 2000 when it divested its slow-growing
businesses including its namesake Vanity Fair brand of
lingerie and sleepwear. The companys $136 million
acquisition of North Face in 2000 was the first in a
series of many acquisitions of lifestyle brands that
connected with the way people lived, worked, and
played. Since the acquisition and turnaround of North
Face, VF has spent nearly $5 billion to acquire 19
additional businesses, including about $2 billion in
2011 to acquire Timberland. New apparel brands
acquired by VF Corporation include Timberland, Vans
skateboard shoes, Nautica, John Varvatos, and 7 For
All Mankind sportswear, Reef surf wear, and Lucy
athletic wear. The company also acquired a variety of
apparel companies specializing in apparel segments
such as uniforms for professional baseball and football
teams and law enforcement.

VF Corporations acquisitions came after years of


researching each company and developing a
relationship with an acquisition candidates chief
managers before closing the deal. The company made a
practice of leaving management of acquired companies
in place, while bringing in new managers only when
necessary talent and skills were lacking. In addition,
companies acquired by VF were allowed to keep longstanding traditions that shaped culture and spurred
creativity. For example, the Vans headquarters in
Cypress, California, retained its half-pipe and concrete
floor so that its employees could skateboard to and
from meetings.
In 2010, VF Corporation was among the most profitable
apparel firms in the industry with net earnings of $571
million. The company expected new acquisitions that
would push the companys revenues to $8.5 billion in
2011.
Sources: Suzanne Kapner, How a 100-Year-Old Apparel
Firm Changed Course, Fortune, April 9, 2008, online
edition; and www.vf.com, accessed July 26, 2011.

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