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TESTBANK: CHAPTER 13
Diversification Strategy
True/False Questions
1. Diversification has been a key source of value creation for most of the firms that have dared to
expand beyond the boundaries of their own industry.
[See p.342]
2. The dominant trend of the past two decades has been for companies to expand beyond their core
businesses.
[See p.342]
3. 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?
[See p.342]
4. 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” reflects the belief that industry specific
knowledge was not important to the corporate management of diversified firms.
[See p.341]
5. The history of diversification features two periods: 1950 to 1980, when the trend was to
diversify, and 1980 to today when most large firms refocused on their core businesses
[See p.344]
6. A major reason for the trend to corporate refocusing after 1980 was a shifting of corporate goals
from growth to profitability.
[See p.344]
7. The primary motive for diversification during the period 1960-1980 was the quest to create
shareholder value.
[See p.344]
8. Corporate diversification that reduces the unsystematic risk of a company’s securities will result
in those securities being higher valued by the stock market.
[See p.344]
9. Diversification that reduces the risk of bankruptcy is more beneficial to shareholders than to
managers.
[See p.344]
10. According to Michael Porter, industry attractiveness is a sufficient justification for
diversification.
[See p.347]
11. The critical test of whether diversification will create shareholder value is whether it will
contribute to competitive advantage.
[See p.347]
12. When a firm is diversifying through acquiring a firm in another issue, the critical issue is
whether the synergies that can be realized will offset the acquisition premium paid.
[See p.347]
13. Economies of scope may be viewed as economies of scale that are exploited over multiple
products.
[See p.348]
14. If a utility company supplies both gas and electricity to its customers, it can exploit economies
of scope in billing and customer service.
[See p.348]
15. The potential to exploit economies of scope in common resources is an adequate justification
for diversification.
[See pp.349-350]
16. If a company can exploit economies of scope in its intellectual property either through
licensing or through diversification, the transaction costs of licensing are likely to be a major
factor in its choice between the two.
[See p.350]
17. 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.
[See p.350]
18. In principle, the information advantages of a diversified company mean that internal capital
markets are more efficient than external capital markets, but in practice internal capital markets
tend to allocate funds to subsidise poor performing subsidiaries.
[See p.351-352]
19. 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.
[See p.352]
20. The continuing dominance of conglomerate firms in many emerging countries reflects the
underdeveloped capital and labor markets of these countries.
[See p.353]
21. Empirical evidence on the relationship between diversification and profitability shows that
diversification has a negative impact on profitability.
[See pp.353-354]
22. Empirical studies of the outcomes of corporate refocusing initiatives show that divesting
diversified businesses increases profitability and generates positive returns for shareholders.
[See p.354]
23. 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
[See p.354]
24. Tata Group, the Virgin Group, and Berkshire Hathaway each seem to comprise independent
businesses with few relationships with one another, Hence these companies lack strategic logic.
[See p.355]
Multiple Choice Questions
25. Tyco International’s decision to split into three separate companies was motivated by:
[See p.341]
26. Diversification decisions by firms involve the following key issues:
[See p.342]
27. The key drivers of diversification during the period 1950-80 were:
[See p.344]
28. The emergence of “conglomerates”—widely diversified companies—during the 1960s and
1970s was a result of:
[See p.344]
29. Diversification whose sole impact is to reduce the variability of profits does not create value
for shareholders because:
[See p.346]
30. Porter’s “three essential tests” help to determine:
[See pp.346-347]
31. When diversification combines two businesses in different industrial sectors, the key
determinant of whether the diversification creates value is whether the diversification:
[See p.347]
32. 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:
[See p.353]
33. When a company in industry A acquires a company in industry B, Porter’s “better-off” test is
satisfied when:
[See p.347]
34. The key difference between economies of scale and economies of scope:
[See p.353
35. Which of the following is not an example of an economy of scope from diversification?
[See pp.348-349]
36. The British fashion company, Burberry, is considering diversifying into the hotel business. Its
optimal strategy is to:
[See p.350]
37. Despite the heterogeneity of the goods and services supplied by General Electric (e.g.
locomotives and consumer credit), we can consider GE’s diversification to be into strategically
related industries because:
[See p.355]
38. Where do general management capabilities generally reside within the diversified firm?
[See p.355]
39. An alternative approach to Porter’s “three essential tests” in evaluating the value-adding
potential of diversification is:
[See p.356
40. The failure of empirical research to find unambiguous evidence that related diversification
outperforms unrelated evidence points to:
[See p.354]
41. What does the expression “conglomerate discount” mean?
[See p.353-354]
42. The statement: “Economies of scope in shared resources do not provide a sufficient
justification for diversification” is:
[See pp.349-350]
43. Which is a more efficient mechanism for allocating capital among different businesses: the
internal capital allocation of diversified firms or the external capital market?
[See p.351]
44. The internal labor market provides a large, diverse firm with the chance to make savings, by:
[See p.352]
45. Several decades of empirical evidence indicates that the relationship between diversification
and performance:
[See pp.353-354]
46. To determine whether a firm’s diversification is related or unrelated, we need to consider:
[See pp.355-356]
47. “Strategic relatedness” (as distinct from “operational relatedness”) in diversification refers to:
[See p.355]
