Deck 12: Diversification Strategy

Question 1

The primary motive for diversification during the period 1960-1980 was the quest to create shareholder value.

Answer 1

False

Question 2

Economies of scope may be viewed as economies of scale that are exploited over multiple products.

Answer 2

True

Question 3

A critical advantage of diversified over specialized firms is in their allocation of human resources where diversified firms can utilize their superior information on their employees to allocate individuals according to their proven abilities.

Answer 3

True

Question 4

A dominant trend in corporate strategy over the past three decades has been for companies to expand their product scope.

Question 5

Diversification has been an important source of value creation for most of the firms that have dared to expand beyond the boundaries of their own industry.

Question 6

When a firm is diversifying through acquiring a firm in another industry,the critical issue is whether the synergies that can be realized will offset the acquisition premium paid.

Question 7

18,The principle of "parenting advantage"-that a company should own a business only if it is able to add more value to that business than any other potential parent-is a more rigorous criterion for justifying diversification than Michael Porter's "three essential tests."

Question 8

The critical test of whether diversification will create shareholder value is whether it will contribute to competitive advantage.

Question 9

According to Michael Porter,industry attractiveness is a sufficient justification for diversification.

Question 10

If a company can deploy its intellectual property in a different industry,the higher are the transaction costs of licensing that intellectual property,the more likely it is that the firm will choose to diversify into that industry.

Question 11

The capital asset pricing model predicts that corporate diversification that reduces the unsystematic risk of a company's securities will result in those securities being higher valued by the stock market.

Question 12

Diversification that reduces company specific ("unsystematic")risk is beneficial to the company's bondholders since it reduces the risk of default.

Question 13

Diversification decisions by firms involve two key issues: how attractive is the industry to be entered and can the firm establish a competitive advantage within it?

Question 14

The history of diversification since the mid-20^th century features two periods: during 1950 to 1980,the trend was to diversify;since 1980,most large companies have refocused upon their core businesses.

Question 15

Harold Geneen's statement that: "Telephones,hotels,insurance-it's all the same.If you know the numbers inside out,you know the company inside out" is basically correct: the essentials of a business are revealed by its metrics;industry-specific knowledge is not essential to the effective running of a business.

Question 16

If a utility company supplies both gas and electricity to its customers,it can exploit economies of scope in billing and customer service.

Question 17

Demand-side economies of scope can justify diversification by a firm even if it doesn't achieve cost savings from supplying multiple products.

Question 18

Economies of scope in organizational capabilities can be exploited as effectively through contractual agreements with firms in anther industry as through diversifying into that industry.

Question 19

In principle,the information advantages of a diversified company mean that internal capital markets are more efficient than external capital markets.In practice internal capital markets tend not to reallocate investment funds from poorly-performing subsidiaries to highly-performing subsidiaries.

Question 20

A major reason for the trend to corporate refocusing after 1980 was a shifting of corporate goals from growth to profitability.

Question 21

Porter's "three essential tests" help to determine:

A)The likely impact of diversification upon risk
B)The potential for diversification to create shareholder value through boosting profitability
C)The impact of diversification on stakeholders
D)How the financial markets would react to a diversification.

Question 22

The British fashion company,Burberry,is considering diversifying into the hotel business.Its optimal strategy is to:

A)Set up its own luxury hotel chain-that way it can appropriate all the profits from the venture
B)License its brand to an existing hotel operator-that way it can avoid the costs and risks of having to invest in all the resources and capabilities required by the hotel business
C)Stay away from hotels all together since this business is unrelated to Burberry's core fashion business
D)Establish a separate start-up company,Burberry Hotels,in which Burberry Group retains a minority equity holding

Question 23

The continuing prominence of large,highly diversified business groups in many emerging market countries (e.g.Tata Group in India)is mainly the result of:

A)The political connections of a few leading business leaders
B)High transaction costs in capital and labor markets in these countries which favor the deployment of resources within large diversified corporations
C)Barriers to direct investment which protect these companies from overseas competition
D)The failure of emerging market business leaders to appreciate the benefits of refocusing

Question 24

The general trend of the past four decades has been for companies to divest their "noncore" businesses.Exceptions to this trend include:

A)Large e-commerce companies such as Amazon,Alphabet,Alibaba,and Tencent
B)Large business groups in emerging market countries
C)Both (a)and (b)
D)Neither (a)nor (b)-the refocussing trend is general across sectors and across countries.

Question 25

Diversification decisions by firms involve the following key issues:

A)The attractiveness of the industry to be entered and the potential for competitive advantage
B)The potential for the diversification to increase growth and reduce risk
C)The opportunities for exploiting economies of scope in resources and capabilities
D)The benefits of synergy relative to the costs or coordination.

Question 26

The continuing dominance of highly-diversified business groups in many emerging countries is a result of the less developed capital and labor markets in these countries.

Question 27

When a company in industry A acquires a company in industry B,Porter's "better-off" test is satisfied when:

A)The competitive advantage of the business B is increased
B)The competitive advantage of business A is increased
C)The competitive advantage of either or both businesses in increased
D)There are shared resources and capabilities between the two businesses

Question 28

Tata Group,the Virgin Group,and Berkshire Hathaway are holding companies that comprise largely independent businesses with few relationships with one another.Inevitably,these groups lack significant potential to add value to the individual businesses.

Question 29

Diversification whose sole impact is to reduce the variability of profits does not create value for shareholders because:

A)Shareholders are interested in return more than in risk
B)The most important risks (such as a global financial crisis or the collapse of the Euro)are systemic in nature,against which diversification offers little protection
C)The risk which is relevant to stock market valuations is perceived risk--this bears little relationship to profit variability
D)If investors can spread risk by diversifying their portfolios,diversification adds no additional value in terms of risk spreading.

Question 30

Tyco International's decision to split into three separate companies was motivated by:

A)The scandal involving its former CEO
B)The belief that Tyco's businesses could achieve greater flexibility and growth as independent companies than as subsidiaries of Tyco
C)The belief that the synergies among Tyco's businesses were outweighed by the costs of Tyco's corporate HQ
D)The recognition that Tyco was subject to a "conglomerate discount."

Question 31

The key drivers of diversification for most of the 20^th century were:

A)Shareholder value maximization
B)The quest for growth and risk reduction
C)The desire to escape mature sectors and enter new,technology-based industries
D)The quest to exploit economies of scope.

Question 32

When diversification combines two businesses in different industrial sectors,the most important determinant of whether the diversification is likely to create value is whether the diversification:

A)Changes the debt/equity ratio of the combined company
B)Is between businesses with similar values and management systems
C)Causes management to lose its focus on its core business
D)Offers opportunities for sharing resources and capabilities.

Question 33

Diversification that reduces unsystematic risk is likely to be associated with less variance of a firm's cash flows.This is likely to benefit:

A)Shareholders,because they are sensitive to all forms of risk
B)Bondholders,because greater variability of cash flows increases a firm's vulnerability to default on payments to bondholders
C)Both groups
D)Neither group

Question 34

The key difference between economies of scale and economies of scope:

A)Economies of scale relate to manufacturing activities;economies of scope relate to a wide range of functions
B)Economies of scale relate to expanding the output of a single product;economies of scope relate to expansion across multiple products
C)There is no practical difference
D)Scale economies are relevant to business strategy;economies of scope to corporate strategy.

Question 35

One reason for the inconsistent findings over the relative performance of related diversification and unrelated diversification is uncertainty and imprecision over what constitutes related diversification

Question 36

Empirical studies of the outcomes of corporate refocusing initiatives show that divesting diversified businesses increases profitability and generates positive returns for shareholders.

Question 37

The expression "conglomerate discount" means:

A)The ability of a widely diversified firm to exploit economies of scope to reduce its overall costs
B)The willingness of stock exchanges to offer discounted listing fees in order to attract highly diversified firms
C)The stock market tends to value diversified companies at less than their break-up value
D)The lower rates of return that highly diversified companies offer to their shareholders.

Question 38

Which of the following is not an example of an economy of scope from diversification?

A)Samsung Group applying its Samsung brand name across a wide range of products
B)Royal Dutch Shell engaging in forest development in order to offset some of the carbon dioxide produced by its petroleum business
C)Amazon using its server capacity to enter cloud computing and web hosting
D)Fuji Film applying its thin-film,coatings,and polymer technologies not only to photographic film,but also to cosmetics.

Question 39

The emergence of "conglomerates"-widely diversified companies-during the 1960s and 1970s was a result of:

A)The desire of companies to escape low growth industries
B)The belief that the tools of strategic and financial management could be applied to any type of business
C)The willingness of some CEOs to ignore shareholder interests and order to build large corporate empires
D)Loose monetary policies that increased the availability of corporate finance.

Question 40

Empirical evidence on the relationship between diversification and profitability shows that diversification has a negative impact on profitability.

Question 41

Several decades of empirical evidence indicates that the relationship between diversification and performance:

A)Varies between countries
B)Is mainly positive
C)Is neither consistent nor systematic
D)Is negative unless the diversification is between closely-related industries

Question 42

The principle difference between the "parenting advantage" framework and Porter's "three essential tests" in evaluating the value-adding potential of diversification is:

A)The "corporate parenting" framework focuses on the role of the corporate headquarters
B)Porter's "three essential tests" emphasizes shareholder value creation;the "parenting advantage" considers value creation for all stakeholders
C)Porter's "three essential tests" considers whether diversification creates shareholder value;"parenting advantage" considers whether a firm's ownership of a business creates more value than any other potential parent might
D)Porter's value chain analysis applies to diversification decisions;"parenting advantage" applies to diversification and divestment decisions

Question 43

The main difference between two businesses being strategically related rather thasn operationally related is:

A)Strategic relatedness involves the application of common general management systems and capabilities to the two businesses;operational relatedness involves the sharing of resources
B)Strategic related is about corporate-level synergies;operational relatedness involves business-level synergies
C)Operational relatedness requires a multidivisional structure;for strategic relatedness,a holding company structure sufficed
D)Operational relatedness requires that the different products share production plants and distribution systems;strategic relatedness does not.

Question 44

Which is a more efficient mechanism for allocating capital among different businesses: the internal capital allocation of diversified firms or the external capital market?

A)The internal capital allocation process of diversified firms
B)The external capital market
C)It depends on the effectiveness of the specific firm's capital allocation process
D)It depends on the effectiveness of the specific firm's capital allocation process and the efficiency of the capital market in the country where the firm is located.

Question 45

The failure of empirical research to find unambiguous evidence that related diversification outperforms unrelated evidence points to:

A)The fact that firm performance is the outcome of many factors of which diversification strategy is only one
B)Reverse causation: it may be that poorly performing firms are more likely to take the risk of unrelated diversification
C)Difficulties in determining whether diversification is related or unrelated
D)All the above.

Question 46

The statement: "Economies of scope in shared resources do not provide a sufficient justification for diversification" is:

A)Correct: Cost savings form shared resources are of little value unless there are also organizational capabilities that can be transferred between the businesses
B)Correct: to justify diversification economies of scope need to be supported by transactions costs in the market for the particular resources
C)Incorrect: economies of scope are sufficient grounds for diversification on their own
D)Incorrect: the benefits from economies of scope need to exceed the administrative costs of the corporate HQ.

Question 47

Despite the heterogeneity of the goods and services supplied by LVMH (e.g.leather bags and shoes,wine and spirits,fashion clothing,jewelry and watches),we can consider LVMH's diversification to be into strategically-related industries because:

A)Most of its products are sold at airport,tax-free shops
B)LVMH benefits from massive economies of scope through centralizing common functions such as purchasing,R&D,manufacturing,and marketing
C)LVMH's portfolio balances mature,cash-generating businesses with growing,cash-using businesses
D)The different business all require global marketing to high income consumers,hence draw upon similar management capabilities.

Question 48

"Strategic relatedness" (as distinct from "operational relatedness")in diversification refers to:

A)The ability to use very different marketing strategies that fit with different countries
B)The ability to sell similar products
C)The ability to apply similar strategies,resource allocation procedures,and control systems across the businesses
D)The ability to maximize the allocation of financial resources across the businesses

Question 49

To determine whether a firm's diversification is related or unrelated,we need to consider:

A)Whether the businesses are within the same two-digit class of the Standard Industrial Classification
B)Whether the two businesses have either common customers or utilize a common technology
C)Whether the two businesses share some of the same resources and capabilities
D)Whether the two businesses are in the same stages of their industry life cycles.

Question 50

The internal labor market provides a large,diverse firm with the chance to make savings,by:

A)Developing senior managers with wide experience
B)Relying less on external recruitment consultants
C)Having first-hand knowledge of a large pool of internal recruits for transfer between businesses
D)All of the above