Portfolio Management and Diversification

Understanding Concepts

Key Concepts of the Chapter

Vertical integration is a key concept from the chapter and is a strategy whereby a company owns or controls the supply chain from end to end. In other words, the company produces its own inputs, instead of relying on suppliers. The benefit of this is that it gives the company greater control over its costs and production process, as well as greater flexibility to respond to changes in customer demand. However, another important concept is outsourcing and this is really the opposite of vertical integration. It is the process of contracting with a third party to provide goods or services. Typically, outsourcing arrangements are made with companies located in other countries, in order to take advantage of lower labor costs or other benefits. While outsourcing can help businesses reduce costs and improve efficiency, there are also some risks associated with this practice. For example, outsourced workers may not have the same level of skills or commitment as in-house employees, and there may be communication difficulties due to cultural differences. In addition, businesses that outsource too much risk becoming too dependent on their contractors, which could lead to problems if the relationship is terminated. That is why some companies prefer vertical integration.

There are two main types of vertical integration to know that are important to this key concept: backward and forward (Lin et al., 2014). Backward vertical integration occurs when a company acquires its own suppliers. For example, a textile manufacturer might buy a yarn producer. Forward vertical integration occurs when a company acquires its own distributors or retailers. For example, a clothing retailer might open its own factories. In short, vertical integration can be an effective way to increase efficiency and reduce costs—but it has some risks, such as angry suppliers and a loss of focus on the core business.

Other key concepts from the chapter include the four basic growth strategies: market penetration, product development, market development, and diversification. Market penetration is when a company focuses on selling more of its existing products to its existing markets. Product development is when a company creates new products for its existing markets. Market development is when a company sells its existing products to new markets. And finally, diversification is when a company sells new products to new markets. Each of these growth strategies has its own risks and rewards, and the right strategy will depend on the specific situation.

The chapter also describes related, unrelated, and conglomerate diversification concepts. Related diversification occurs when a company expands into a new market or product area that is similar to its current businesses. For example, a company that manufactures furniture might expand into manufacturing home decor items such as rugs and curtains. Related diversification can be a way to leverage a company’s existing strengths and knowledge to enter new markets. In contrast, unrelated diversification occurs when a company expands into a new market or product area that is not related to its current businesses. For example, a company that manufactures cars might expand into the food industry. Unrelated diversification can be riskier than related diversification because it often requires the company to develop new skills and knowledge. Finally, conglomerate diversification occurs when a company expands into a new market or product area that is completely unrelated to its current businesses. For example, a company that manufactures computers might expand into the aerospace industry. Conglomerate diversification is the most risky type of diversification because it often requires the company to develop completely new skills and knowledge (Scholes, 2019).

Finally, the chapter discusses how a corporate parent adds or destroys value. When the corporate parent is too involved, it can stifle innovation and limit growth potential. On the other hand, when the corporate parent is not involved enough, it can fail to provide the resources and support that subsidiaries need to be successful. The key is to find the right balance between involvement and independence. It concludes with a discussion of the concept of portfolio management and how corporate strategy can be a fool’s errand and that external investors are better at setting divisional strategies (Scholes, 2019).

Summary

The arguments for and against diversification for Berkshire Hathaway are numerous. Diversification allows the company to spread its risk across a number of different sectors and industries. This can protect the company from the potentially damaging effects of a downturn in any one particular industry. In addition, diversification can also lead to increased profits, as businesses that are unrelated to each other can often complement each other. For example, a company that manufactures car parts could benefit from owning a chain of car dealerships. On the other hand, opponents of diversification argue that it can lead to a loss of focus, as companies attempt to manage too many different businesses at once. They also argue that it can be difficult to find unrelated businesses that complement each other in terms of their products or services. Ultimately, whether or not Berkshire Hathaway should pursue diversification is a decision for the company's management team to make.

Corporate Strategy Q’s

Luxottica and GrandVision have evolved over time by making strategic acquisitions and diversifying portfolios across the supply chain. Luxottica went public on the NYSE. GrandVision grew out of the merger of Pearle divisions. Luxottica would later merge with Essilor to become the biggest optical company in the world. GrandVision on the other hand is set up so that subsidiaries are close to their own markets. What can be concluded from each is that GrandVision is more decentralized by Luxottica is more centralized in terms of external investors having power.