Question 1

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

Accepted Answer

The primary motive for diversification during the period 1960-1980 was often to stabilize earnings by spreading business risks across different industries, rather than the modern emphasis on creating shareholder value through focus and core competency.

Question 2

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

Accepted Answer

Economies of scope refer to the cost savings that a company can achieve by producing multiple products together rather than separately. It is often viewed as a type of economies of scale where the company leverages its existing resources, expertise and capabilities to produce a range of products, resulting in lower costs per unit.

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.

Accepted Answer

Diversified firms have the opportunity to utilize their knowledge on the strengths and weaknesses of their employees to allocate them to tasks where they can excel. This results in more efficient utilization of human resources as compared to specialized firms where employees may be limited to one area of expertise.

Question 4

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

Accepted Answer

The answer of A dominant trend in corporate strategy over...

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.

Accepted Answer

Diversification can create value, but it often leads to challenges such as lack of focus, increased complexity, and potential misallocation of resources, which can outweigh the benefits for many firms.

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.

Accepted Answer

This statement is true. When a firm acquires a company in another industry, there may be potential synergies in terms of cost savings, increased market power, and access to new markets or technologies. However, the acquisition price must be justified by the expected benefits and potential future earnings of the combined companies. If the synergies do not outweigh the acquisition premium paid, the acquisition may not be a wise investment decision.

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."

Accepted Answer

The statement compares two criteria for justifying diversification - the principle of "parenting advantage" and Michael Porter's "three essential tests." It argues that the principle of "parenting advantage" is a more rigorous criterion as it requires a company to demonstrate that it can add more value to a business than any other potential parent, whereas Porter's tests may not necessarily ensure that a company has a competitive advantage in owning a business.

Question 8

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

Accepted Answer

Diversification can create shareholder value only if it contributes to competitive advantage. If diversification does not lead to a competitive advantage, it may not generate any value and could even destroy value for shareholders. Competitive advantage can come from a range of factors such as economies of scale, scope, learning effects, and synergies between businesses. Therefore, the critical test of diversification's impact on shareholder value is whether it enhances the company's competitive advantage.

Question 9

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

Accepted Answer

According to Michael Porter, industry attractiveness alone is not a sufficient justification for diversification. Companies should consider their internal strengths and weaknesses, as well as the degree of fit and potential synergies between businesses before deciding to diversify.

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.

Accepted Answer

This statement is true. If the transaction costs of licensing intellectual property are high, it may be more cost-effective for a company to directly enter into that industry through diversification rather than licensing.

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.

Accepted Answer

The capital asset pricing model (CAPM) suggests that only systematic risk (market risk) is rewarded by the market, and thus, reducing unsystematic risk (specific to a company) through diversification does not affect a security's value according to CAPM, as investors can diversify such risk themselves.

Question 12

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

Accepted Answer

By reducing company specific risk through diversification, the company becomes less vulnerable to the negative impact of a single event or a series of events that could lead to default. This provides greater security for bondholders as it reduces the likelihood of default, thus making it beneficial for them.

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?

Accepted Answer

This statement accurately reflects the two key considerations in diversification decisions by firms.

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.

Accepted Answer

The statement accurately reflects the history of diversification in the mid-20th century.

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.

Accepted Answer

While understanding a company's financial metrics is crucial, industry-specific knowledge is also essential for effective business management. Different industries have unique challenges, regulations, customer expectations, and operational requirements that financial metrics alone cannot fully capture or address.

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.

Accepted Answer

Economies of scope refer to the cost-saving advantages that a company gains by producing multiple products/services together. In the case of a utility company supplying both gas and electricity, they can enjoy economies of scope in billing and customer service as they can use the same billing system and customer service staff to handle both services, reducing costs and increasing efficiency.

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.

Accepted Answer

The answer of Demand-side economies of scope can justify diversification...

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.

Accepted Answer

Economies of scope in organizational capabilities often involve leveraging shared resources, knowledge, and processes across different but related product lines or services within a single organization. While contractual agreements with firms in another industry can provide some benefits, they may not fully capture the efficiencies and synergies that come from diversifying into that industry and integrating operations internally. Diversification allows for more direct control and coordination across different activities, potentially leading to greater cost savings and innovation compared to what can be achieved through arm's-length contractual relationships.

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.

Accepted Answer

In theory, diversified companies can leverage information advantages to allocate capital more efficiently internally than what might be achieved through external markets. However, in practice, these firms often struggle to reallocate resources effectively from underperforming to high-performing divisions, due to various internal biases, informational asymmetries, and agency problems.

Question 20

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

Accepted Answer

The statement is true. After the 1980s, corporations focused on profitability rather than growth, which led to a trend of corporate refocusing. This was due to changes in the economic environment, as well as pressure from shareholders and investors to achieve higher returns on investment.

Quiz 12: Diversification Strategy