Question

What is the type of diversification does each acquisition involve?

Answer 1

The two types of diversification are:

Related-business diversification-Diversificatio into businesses with similar marketing and distribution characteristics, similar production technologies, or similar science based research activities.

Unrelated-business diversification- diversification into product markets with key success variables unrelated to the key success variables of the acquirer's principal business.

A diversifying acquisition can raise the productivity of capital when the particular skills and one merger partner’s knowledge of the industry are applied to the competitive problems and opportunities facing the other partner. When the reinforcement of skills and resources critical to the success of a business within the combined company leads to higher profitability, value is created for its shareholders. This reinforcement is the realization of synergy.

Investments in markets closely related to current fields of operation can reduce long-run average costs. A reduction in average costs can accrue from scale effects, rationalization of production and other managerial efforts, and technological innovation. For example, a marketing department’s budget as a percent of sales will decline if existing resources can be used to market new or related products.

Business expansion in an area of competence can lead to the generation of a “critical mass” of resources necessary to outperform the competition. In many industries, companies have to achieve a certain size, or critical mass, before they can compete effectively with their competitors.

Diversification into related product markets can enable a company to reduce systematic risks. Many of the possibilities for reducing risk through diversification are implicit in the previous three ways to increase returns because risk and return are closely related measurements