Synergies of Product Diversification Strategy
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Nowadays large firms have to survive in the face of economic competition. They have to keep an eye on the competitors' performance. Managers try to progress and run their businesses well in order to grow and be competitive.
When a large firm has reached a mature life-cycle stage it often has to explore the possibility of how to still grow. Ansoff (cited by Johnson, Scholes and Whittington, 1998) presents four basic growth alternatives: a) increased market penetration, b) market development, c) product development and d) diversification. Choosing the right path is major decision for managers.
Finding out if there are reasons which may lead a large firm to prefer diversification, more specific, product diversification as the growth alternative strategy instead of other strategies is a main question.
Firms who spread their activities and businesses across different product markets that are more or less related between each other are said to follow a product diversification strategy. (Pils, 2009, p.10) Product diversification strategy definition has evolved during the last decades. Some definitions are evolutional and complementary but some others contradict each other (Goold and Luchs, 1993). Therefore, it is important for managers to have a clear definition.
The benefits of product diversification have been divided into two categories depending on the type of diversification: related or unrelated. Related product diversification refers to entries into new products or service businesses that have a connection to the firms existing markets (Peng, 2008). Researches (Hoskisson, 2007) and business experiences (such as Mondi AG, Procter & Gamble, CHR plc., etc.) have proven that some of the benefits of this type of diversification are:
- Operational synergy: economies of scale
- Utilizing excess productive capacity
- Reinvesting earnings
Unrelated product diversification refers to the development of products or services beyond the current capabilities and value network (Johnson et al. 2008).
Some of the benefits and reasons for this type of diversification are:
- Financial synergy: economies of scope
- Increasing market power
- Spreading risk across a range of businesses
The challenge for any large firm, once product diversification is chosen as the growth path, is to decide which type of diversification is most appropriate and what strategic plan to follow.
Product diversification gives also other challenges to managers such as the need of new skills to manage a wider group of businesses, new techniques, sometimes new facilities, large capital to test the viability of the new product, produce it and market the product, hire and train new employees, etc. Therefore, diversification has some inconveniences as it involves taking a step into a territory where the parameters are unknown to the firm (Peng, 2008).
Product diversification can be achieved by acquiring an existing firm in the business it wants to enter, starting up a new business subsidiary or entering into joint ventures.
For large firms knowing the different growth strategies including its benefits and inconveniences is fundamental to giving managers practical recommendations. For a better understanding of these fundamental issues this research will analyze whether related or unrelated product diversification strategy leads large firms to exploit more synergies and creates more value for the firm.
Based on this research question, the following sub-questions are going to be addressed in this research:
- Should large firms, such as Mondi AG, aim to focus on related or unrelated businesses to exploit operational synergies?
- How is Mondi's life cycle related to the 'right time' of diversifying?
- Which recommendations on product diversification strategy can be given to large firms regarding financial synergy?
To answer the above questions, I will present a detailed and methodical literature review on product diversification strategy concept, categories, synergies, its relation with large firms' life cycle and explore the effects of a financial crisis on large firms who have chosen this type of diversification to identify the appropriate strategy for the research goal. This research is based on the hypothesis that related product diversification is the right strategy to be chosen if operational synergies are to be achieved while for financial synergies, unrelated product diversification strategies are more appropriate. The strength of this hypothesis is tested through a case study of a large firm: The Mondi Group.
The Mondi Group has been chosen as the large firm to be explored in this research because it is an international firm with one of its largest teams and headquarters in Austria. 'Trend', an Austrian financial magazine, ranked Mondi as the 13th top Austrian large firm out of 500 firms in 2008 having 5.159,00 Mio. Euro net sales and 26.425 employees' worldwide.
In the 20th century many researchers have written about product diversification strategy (PDS). This research will analyse how PDS is seen by managers because of the larger experience there is nowadays. Diversification has been specially growing after the whole post-war period. Whereas in 1950 only around one third of large firms in France, Germany, and the United Kingdom were diversified, by the 1990s it increased to two thirds or more (Whittington and Mayer 2003).
Size and Product diversification strategy
This research is focused on how large firms have reacted to the different paths of growth. The firm size: small, medium or large is an important parameter while analysing a firm strategy. In the financial and economical studies and researches the relation between size and firm variables remains a controversial subject. Some argue that "size is the primary factor that determines structure" whether others say that "size is irrelevant" (Jackson and Morgan, 1978). In my opinion, it is true that product diversification can be applied both by small and large firms, but I believe that a small firm has more limitations and can not fully develop this strategy in its organization due to limited resources: human, financial and technological. I also believe that as a consequence a firm applying product diversification strategy will increase its size. With larger number of products, the complexity of processes and production is greater. Therefore the craft needed is greater. As mentioned before, some researchers agree with this point of view like the study realized by Dewar and Hage (n.d., cited by Jackson and Morgan, 1978) which suggests that large firms facilitate changes in structure in a way that small firms can not afford. On the other hand, Woodward, Zwerman and Harvey (n.d., cited by Jackson and Morgan, 1978) concluded that instead of size, the production systems used by the firms are more connected and explain better the firm structure and feature. In other words, an efficient production system can explain the success of one large or small firm and therefore the relationship between size and differentiation is not linear.
Diversification and Product Diversification Strategy Terminology
The root of the word is, obviously, "diverse". Pitts and Hopkins (1982) define it as literally meaning "different, unlike, distinct, and separate" (p.620).
Therefore, if this definition is applied to the context of product diversification, we can say that it means firms having their products in various and different lines. Pils (2009) also confirms this definition as he points out that "product diversified firms are understood to be active in multiple, distinct product-markets" (p.10).
The various definitions, forms and ways of managing diversification are the main topics of this research.
Product diversification strategy
There is a common denominator in the way product diversification is defined in the literature. For instance, Pils (2009) defines it as firms spreading their activities and products across different product-markets that are more or less related between each other. He also affirms that product diversification strategy determines which businesses a corporation should be in, defining the scope of the firm's activities and being of high relevance for creating value for the firm. Berry (1971, p.380) defines product diversification as an increase in the number of industries in which firms are active. However, he does not point out that it can be also increasing the number of products in the current industry. Pitts and Hopkins (1982, p.620) consider firms' product diversification if operating multiple different businesses at the same time. Hoskisson (2007), on the other hand, says that the firm's level of diversification is a function of decisions about the number and type of businesses in which it will compete as well as how it will manage the business.
These definitions have surely been influenced by the work of Ansoff (1957) in which he presented diversification as a possible growth strategy as mentioned in the introduction. Ansoff presented two ways of diversification: market diversification and product diversification. Although this research only focuses on the product diversification side, few lines are dedicated to explain the difference and characteristics of these two strategies. Market diversification is a strategy that takes the firm from its existing market to new ones. It exploits the current products and capabilities in new markets looking for geographical spread. This strategy is more and more used in the current times where globalization is facilitating the firm's internationalisation. It also presents some challenges like cultural barriers, adding management costs and government restrictions among others. Product diversification is about adding new product to the firm's portfolio whereas market diversification is about entering in new markets offering the firm's current products.
Reasons and Challenges
Reasons and Motivations for Diversification:
Any firm has a start. Normally starting as a small business it focuses on a single product. This is known as a single business strategy. The natural reasons are commonly due to a lack of cash, experience and know-how. Over time, the resources, capabilities and core competences are rooted and stabilized. At that point, firms may choose product diversified strategy, with two broad categories (related or unrelated).
Large firms use product diversification strategy for a variety of reasons. Pearce and Robinson, (2005) and Hoskisson ( 2007) mention among others, the following reasons:
- To increase the growth rate of the firm
- For a better use of the companies' funds than investing them into internal growth
- To balance the product line
- Diversifying the product line when the firm has reached its mature life cycle
- To increase efficiency and profitability, especially, if there is operational or financial synergy
- To increase the firm's value by improving its overall performance
- To increase revenues or reduce costs
- To match and neutralize competitor's market power
- To reduce managerial risk
- To increase the firm's size and thus managerial compensation
Product diversification challenges
The above mentioned reasons and motivations for PDS can also bring along challenges and costs. One could say that PDS needs new facilities, technologies, skills, know-how, employee and managerial training, etc. It is important to know that it can have a great negative impact on the firms' current products if a new product is launched with the firm's brand name and the product is not well accepted in the market. The reasons for the market rejection can be e.g. lower quality than expected from the firm, high price, poor distribution, etc. At that point, the whole company will be negatively affected by a bad move. This argument is also supported by various authors such as Hoskisson, (2007); Grant, Jammine, and Thomas (1998); Goold and Luchs (1993), (cited by Pils, 2009). They state that some of the challenges are information processing, coordination, and control problems due to increase of information asymmetries difficult for a single business to deal with. In case of applying a PDS a firm has to change its structure and adopt new systems. Moreover Hoskisson (2007) elaborates that the data and information a firm using PDS requires is substantially greater.
Furthermore increasing portfolio diversity may involve inefficiencies due to growing conflict on top management and a lack of adaptability to environmental change.
Product Diversification Strategy Categories: Related & Unrelated Product Diversification Strategy
As mentioned before, there are two broad categories of PDS: Related and Unrelated. Some authors such as Richard Rumel (cited by Lovallo and Mendoca, 2007), Peng (2008) also categorize PDS as: focused, moderately and highly diversified. These three categories are not deeply explored in this research. But to dedicate some words, it should be mentioned that Richard Rumelt, in 1972, was the first person to statistically prove the linkage between corporate strategy and profitability. He concluded that moderately diversified firms outperform more diversified ones. Lovallo and Mendoca (2007) sustain that this finding has been valid more than 30 years of research. Moreover, a contemporary author, Peng (2008), also points out that some moderate level of diversification is the most optimal.
The main focus of this research is whether a related or unrelated strategy is more suitable for large firms while diversifying. Therefore, in the following lines a definition and a detailed explanation of both is presented.
Related product diversification can be defined as a strategy that firms can choose as a growing path. As the word "related" signals, this diversification strategy is focused on products that have a correlation between each other and are related in some way, especially in their core competences. Normally, firms that choose related product diversification as a strategy are sharing a common factor such as the raw material, the technology or the know-how needed to produce different products. Moreover, the products offered by the firm do not necessarily need to be similar. For instance, a firm running a cinema complex and also offering soft-drinks to be sold at the movie theatres is using a related PDS. Even if their products may not be related, they must share some common ground on their value or supply chain. In this case, the customers targeted are the same. Pearce and Robinson,(2005) confirm this by defining related businesses as those relying on same or similar capabilities in order to have success and achieve competitive advantage in their product markets. Major advantages of related PDS are: concentration of strength, exploitation of a market niche, and the development of synergies.
A good example, of a firm applying this strategy is CRH, an Irish company who operates in 35 countries with more than 93.500 employees. The CRH Corporate Social Responsibility Report (2007) states that the firm "is a diversified building materials group which manufactures and distributes building material products from the fundamentals of heavy materials and elements to construct the frame, through value added products that complete the building envelope, to distribution channels which service construction fit-out and renewal." CRH has three closely related core businesses: "primary materials (aggregates, cement, asphalt and ready mixed concrete); value-added building products (pre-cast, architectural, construction accessories, clay, gas, insulation, building envelope products); and specialist building materials" (CRH, 2009). CRH initially decided to diversify to gain economies of scope and also to stretch the corporate parenting capabilities. While CRH diversified its market its power increased and consequently it could afford to "cross-subsidise" one business from the surpluses earned by another, in a way that competitors could not. As an effect, it could drive out competitors.
Before going into further details regarding related PDS, a definition of Unrelated Product Diversification is given. In this case, as the word "unrelated" points out this diversification strategy focuses on firms offering products that have no relation, are not complementary between each other and do not have necessarily the same raw material as their prime and main composition. Moreover, they do not need to share any part of their supply chain (customers, distributor, manufacturer, logistics, etc). For instance, the Easy Group Company is present in several industries and services that have actually no relation. Some of them are: travel companies, car rentals, internet-cafes, cinemas, cosmetics, etc. Stelio Haji-Ionannou, the founder of the company has developed a cost strategy that pretends to apply in all its businesses. It seems that he believes that his formula is valid for any business. Normally the reason why firms choose this path is known to reduce their financial risks.
Peng (2008) refers to unrelated PDS as firms entering into industries new lines that have no evident connections to the present firm line of businesses. Furthermore, Hoskisson (2007) says that unrelated PDS occurs when there are no overlapping capabilities other than financial resources. This strategy is also known in the financial literature as conglomerates (Hoskisson, 2007; Peng, 2008; Pearce and Robinson, 2005)
It has been widely discussed whether related is more successful or unrelated. To be able to answer this fundamental question the following pros and cons are explored:
Related product diversification is characterized by the ease of human resources relocation because the skills and capabilities needed for the introduction of the new products are very similar. On the other hand, unrelated PDS requires recruiting new personnel or training current employees in the new fields. (Tallman, 2003)
Obviously, if a firm chooses unrelated PDS, it will probably not be able to share technologies. Therefore, the investment needed to apply this kind of diversification is greater than by applying a related one. Related PDS is characterised by sharing technologies needed to produce the new products. For example, a firm which produces shampoo and introduces hair conditioner may use the same technology. In that way it reduces the investment costs for the new production and gain economies of scope (also see 2.5). Tallman (2003) confirms that related products can increase the use of existing fixed investments and existing capacity for more purposes and more intensively, gaining efficiencies that reduce costs. Additionally, he says that it can "improve the efficiency of its existing resource infrastructure by increasing the flow of product to a wider range of customers".
For managers it is easier to introduce related products than unrelated ones because they are familiar to the industry and can apply the same or similar strategies. For unrelated ones, managers have to learn about the new products and often the strategy used for the current products is not applicable for the new ones. Therefore, managers should experience new strategies which at the beginning may fail. Prahalad and Hamel (1990), said that it is likely that firm managers of unrelated products may be ineffective because the routines and capabilities they have already developed are not applicable one to one to the entire range of businesses. On the other hand it could be argued that it can be effective as top management can concentrate on financial management and costs controls while leaving operational control with each business unit.
It is easier for competitors to imitate the financial economies of a firm than the operational synergies derived from a related PDS. This is due to the fact that operational synergies derived from the use of current know-how, facilities, capabilities and experiences are more difficult to imitate than realizing that a firm is diversifying into new unrelated products based on the percentage of the revenue it can gain. Therefore, it is less likely that competitors will imitate a firm which introduces new related products. Peng and Delios, (2006), and Khanna and Palepu, (2005), (cited by Hoskisson, 2007) sustain that competitors find it easier to imitate financial economies than replicating the value gained by related PDS from the economies of scope developed through operational relatedness.
The principle control mechanism for related diversification is strategic control with rich communication between corporate and business units' managers. Financial results are obviously not a fair means to measure the functioning of each business unit. One business unit may have low revenues but its main function is to support the others. For unrelated products, the best way to control is exactly the opposite. The emphasis has to be on financial control (return and investment) to evaluate the unit's performance. (Peng, 2008)
When the product a firm is offering is close to a market saturation or obsolescence, the best thing a firm can do is to enter into another market offering unrelated products. In that way the company has an opportunity to grow. It would be a great mistake in a saturated market to introduce related products because the competition is already very high and to get a profitable market share is unlikely.
Another reason would be to stabilize the earnings and dividends of a firm in a cyclical industry. In that case, the firm should diversify into an industry with complementary cycles independent of the relation with the current products.
Firms that are uncomfortable to be dependent on one product line should diversify into other businesses or industries. In that way the risk is spread and all the weight is not in one product line.
All in all the benefits of both categories of diversification do not appear as the result of a magic formula that just happens but as Tallman (2003) and Peng (2008) also sustain it is the result of an active management of resources and capabilities with potential for broader application.
Product diversification synergies need to be explored in more detail. Therefore the following section is dedicated.
Product Diversification Synergies
Pils (2009) explains that the word synergy is derived from the Greek word "synergos" and literally means "working together".
In business terminology, synergy is used to describe the ability of two or more business units or firms to make greater value working together than they would do independently (Goold and Campbell, 1998, p.133). Diversifying a large firm is considered economically positive only if synergetic effects between the different businesses units are achieved. As a consequence, the idea of maximizing synergies as the main objective of diversification strategy is presented below.
The emphasis of product related diversification is on operational synergies because in this strategy production resources are shared to have a cost competitive advantage. In the financial literature, the term operational synergy has been used as a synonym for economies of scope (Tanriverdi and Vendkatraman, 2005). Economies of scope and/or operational synergies are the result of two or more business units that share and transfer factors of production, its resources and capabilities. As a consequence the shared production costs will be lower than production costs of each one separately.
Peng (2008) defines it as competitiveness increase beyond what can be achieved by engaging in two product markets separately. In other words, firms benefit from lowering unit costs by gaining advantage from product relatedness, i.e. "2+2=5".
Some sources of operational synergy are (Peng, 2008):
- Technologies, such as common platforms
- Marketing, such as common brands, and
- Manufacturing, such as common logistics
Conscious of these possible synergies, Zodiac a French large firm who in 1930 was focused on inflatable boats and had strong ties to the French army started to introduce new related products to its portfolio. Zodiac created 5 different divisions having inflatable materials as a common denominator. These divisions have been: marine division (recreation, military, professional, safety of life at sea, environmental solutions); pool division (pool sector and pool care and water cleaning, heating, pumps, filters); airline equipment division (passenger seats and on-board toilets and sanitation systems); aerosafety systems division (aircraft escape slides, parachute systems, helicopter floats, and flexible fuel tanks); technology division and aircraft system division. (Zodiac Aerospace, 2009) Zodiac has benefited from the operational synergies through the use of inflatable products technology and has also used market synergies because it has supplied the same customers with different products.
Conversely, unrelated diversification does not need to have advanced levels of operational relatedness. Rather, each business unit has its own strategic and operational responsibility and the management can focus on the financial synergies. (Tallman, 2003)
Investment synergies are very much related to the operational synergies. It can be argued that one is the consequence of the other or that they are developed hand in hand. Investment synergies are the result of products sharing the same plant, resource and development (R&D) and machinery. This is more probable to happen with a related product diversification because of the previous explanations. For unrelated products, the machinery is improbable the same and each product need its own R&D.
The means obtaining financial synergy is different from obtaining operational synergies. The key role of firms is to identify and find profitable investment opportunities. The parameter to measure if financial synergies are to be achieved is whether managers can exceed the job of identifying and taking advantage of profitable opportunities compared to "external capital markets" (Peng, 2008).
Hoskisson (2007) defines financial synergies as cost savings realized through a better use of financial assets based on investments inside or outside the firm. Competent internal capital distribution can lead to financial synergies and reduces risk between the firm's businesses (Higgings and Schall, 1975).
A firm using unrelated PDS may grow, but only internally in each business unit and will not reach operational efficiencies but financial ones. That means, the revenue of each business unit will be greater when functioning as a conglomerate rather than functioning independently. This idea is supported by Peng (2008) who states that competitiveness increases for each unit financially further than what can be achieved by each unit competing independently as an individual firm.
Many different products that are not necessarily related offer opportunities of high returns. If a firm is only interested in the returns, unrelated product diversification may be a right path of growth.
These occur from sharing salespeople, warehouses, distribution channels, and advertising. Salespeople have more chances to be able to sell to the same customer a wide range of related products than unrelated ones. Salespeople will try to sell a complete pack of product to the same customer and in that way take advantage of the sales synergies that related product diversification presents. Imagine a company selling sport shoes and refrigerators, in a selling process it is more unlikely to be able to sell both products to the same customer than if he would offer sport shoes and sport clothes. On the other hand, if a firm has developed a well-known brand, the use of the brand-name in other products, related or unrelated, can increase and facilitate sales because it can have build before customer loyalty to the brand. For example, Mars chocolate confectionery successful launched ice-creams. Much of it success could be related to the brand name. So, sales synergies do not occur only within related products but also within unrelated ones if the brand name is positively perceived and recognized by the customers.
It arises from managers accumulating experiences from handling problems in one business unit that can be applied and used to solve problems in a related business unit. Even more, the accumulated experience and know-how allows answering faster to the industry trends and challenges. Managers are able to transfer their skills, experiences and strategies (Enz, 2009, p.222). Contrarily, unrelated product managers can not apply the experience gained from solving the problems of one unit to the other in most cases because the problems are specific for each product.
All these synergies can be undermine due to additional layers of management, delays due to organization and information complexity, communication costs for coordination, imaginary synergies that in fact do not exist, incompatible production processes, etc.
Therefore while choosing between related and unrelated PDS the mentioned synergy risks have to be taken into account.
In this section an explanation of how the data for the case study was collected and how it was analyzed is presented. It is important to know how the data was collected because the method chosen affects the final findings. The information and content of The Mondi Group Case Study was obtained through an expert interview with Mr. Wolfgang Kropiunik, Mondi's Marketing Manager of Uncoated Fine Paper. A questionnaire was sent as a guide and overview of the face-to-face interview questions. A meeting for a 40 minutes exploratory semi-structured interview was organized on the 24th of November 2009 at Mondi Headquarter, Vienna.
Mondi Group was chosen as the large firm to be analyzed as it is a large firm with more than 33.000 employees worldwide and has its headquarter in Vienna (Mondi, 2009). Therefore the results presented in this research are very much related to Mondi's functioning and successful method. It might be possible that if the studied firm had been another one, the results of the research question could have been different.
The interview was recorded and the data obtained was transcribed (see appendix). The transcription of the interview allowed a deeper comprehension of Mondi's product diversification strategy, synergies and challenges. Moreover, the recommendations presented to the company (see 4.7) are inspired from the challenges Mr. Kropiunik mentioned during the interview. The interview gave a number of information about Mondi's life cycle, PDS and challenges especially during the current financial crisis
The Mondi Group - Case Study
Mondi is a large and international packaging and paper firm represented in around 35 countries. In 2008, it had revenues of 6.3 billion EUR and about 33.400 employees (Mondi, 2009). It has a strong presence in Western Europe, Russia and South Africa. Mondi's Europe and International Division has its headquarter in Vienna while the corporate headquarter is located in Johannesburg. In Vienna, there are three businesses: Uncoated Fine Paper, Corrugated and Bags & Specialties. Mondi has reached to be fully integrated having the control of its supply chain. "It grows trees, manufactures pulp and paper and converts packaging paper into corrugated packaging and industrial bags, extrusion coated and siliconised materials as well as films and laminates into flexible packaging solutions" (Mondi, 2009).
Mondi Product Diversification Strategy Life Cycle
To understand how Mondi has become one of the largest paper and packaging firms with seven business units, it is important to have a look at its history. The earliest mill was the Neusiedler (Austria) paper mill founded in 1793. Then in 1881, the pulp and paper mill was founded in Frantschach-St. Gertraud, also in Austria. By 1912, this mill was one of Europe's most advanced mills. In 1967 the foundation of Mondi was put in South Africa. After two decades of growth and consolidation in South Africa Mondi came to Europe acquiring a 44% stake in Frantschach and 49% in Neusiedler; and it acquired one of Poland's largest paper mills. In 21st century the acquisition of a kraft paper, bag converting and extrusion-coating business took place; as well as 50% acquisition of a Slovakian mill; 90% of a Russian mill; 100% acquisition of the Frantschach's shares; 54% acquisition of the Turkish corrugated packaging business; dual listing on the London and Johannesburg stock exchanges; and last but not least, in 2008, Mondi announced a new corporate structure. It created two divisions: the European & International Division, and the South Africa Division.
Wolgang Kropiunik, the Head of Marketing at Uncoated Fine Paper for Europe & International, said in an interview on the 24th November 2009 that the present Mondi Group is the result of these many mergers and acquisitions. Through these acquisitions Mondi's portfolio was enlarged and so the company grew. Mr. Kropiunik said that the company focused only on paper manufactories at the beginning: office paper, copy paper, etc. Afterwards, Mondi entered into the packaging area producing kraft paper that can be used for packaging purposes like for food packaging. These two businesses, paper and packaging, grew individually and came under the same Group, Mondi through acquisitions. Once packaging was a Mondi business unit, another step in the paper's supply chain was added. Mondi built up a sack factory because out of the kraft paper, paper sacks could be produced, for example cement sacks. In words of Mr. Kropiunik, this was the next level of Mondi's diversification. When Mondi decided to produce paper bags, the bags were done hand-made and instead of selling the paper to other firms Mondi decided to create a new plant 50 km away from the paper mills and to sew them. In that way a new step was added to the supply chain. This is called forward integration strategy because the firm is being involved in the next step of the supply chain.
The next level of product diversification that Mr. Kropiunik pointed out was adding plastic to Mondi's portfolio in the late 90s. In that way diversification into plastic packaging took place. Applying plastic coating on paper permitted Mondi to enlarge its portfolio and to offer combined bags of paper and plastic called extrusion coating. The introduction of extrusion coating was thanks to the acquisition of AssiDomän kraft paper, bag converting and extrusion coating business. The introduction of plastic in Mondi's portfolio added another business unit to the company called Consumer Flexibles. Consumer Flexibles produces monofilms and printed laminates, industrial packaging, agricultural and barrier films, paper and plastic bags and stand-up pouches. Some of the products Consumer Flexibles is offering nowadays are: microwave packaging, cheese packaging, etc. These products are characterized by the high-end printing quality and end-user functionalities such as easy-opening, pourability or microwaveability.
The Marketing Head of Uncoated Fine Paper further explained that the introduction of plastic beside paper and packaging was to answer the needs of customers and the current trend. The firm had to adapt to the new consumer needs for remaining competitive. He also affirmed that the product diversification strategy was applied at the right time of Mondi's life cycle, which is why the company is successful.
From this explanation, we can conclude that product diversification is linked to the firm's life cycle. It would be unlikely that Mondi could have been successful by offering all kinds of packaging, paper and plastic from the beginning of the firm's life because it would not have had the skills, know-how, technology and financial resources at that time. As Mondi has grown, it has introduced new related business units to answer customer needs and trends. On the other hand, if Mondi had not introduced plastics for packaging at the right time, competitors would have taken the market share and later on would have been more difficult to reposition. Firms should analyze and evaluate when the right time has come to introduce new products and eliminate those which are obsolete. When a firm is in its mature stage of life cycle it has had time to get a profound experience, to know its customers' needs, develop researches and have expertise in its customers' markets and products. Therefore it is the best moment to add related products to the firm's portfolio,
The following timeline presents a summary of the main corporate steps and history:
Mondi Product Diversification Strategy
Mondi is offering a wide range of customized paper and packaging solutions as well as a wide range of specialty products. Therefore Mondi is considered to follow a related PDS with the ability to offer a complete pack of products to its customers. The customers are not anymore interested in one product but in complete a solution. Mondi has around 80 production sites in 30 countries nowadays (Corporate Presentation, 2009). In the Europe & International Division with headquarter in Vienna as mentioned before it has three business units: uncoated fine paper, corrugated and bags & specialties. The following schema permits a better understanding of the business structure:
In the following a description of each European and International business unit is given.
Uncoated fine paper is a leader office paper producer in Europe offering paper for professional printing applications which are sold as cut-size, in folio form and on large reels. Color Copy and IQ, two Mondi brands, are ranked among the market leaders in premium paper applications. It has 5 mills and 17 sales offices. Corrugated business unit is divided into a) containerboard and b) corrugated packaging. Mondi is a major European supplier of virgin and recycled containerboard offering containerboard grades with production sites in Europe, Russia and South Africa. It has 8 mills and 13 containerboard sales offices. Mondi is also a major European manufacturer of corrugated packaging in Europe offering packaging solutions such as shelf-ready packaging, heavy-duty solution as well as big boxes, trays, etc. It has 18 corrugated packaging plants and 5 sales offices. Bags & specialties are divided into four units: a) kraft paper including sack kraft paper, speciality kraft paper; b) bag converting which is the world's largest producer of industrial bags, with over 100.000 different solutions for the cement, construction, chemical, foodstuff, feed, seed and other industries; c) coatings which is a global supplier of plastic and paper-based primary products and services, providing technologies such as extrusion coating, laminating, siliconising and printing; and d) consumer flexibles. Consumer Flexibles is a supplier of monofilms and printed laminates, industrial packaging, agricultural and barrier films, paper and plastic bags and stand-up pouches.
All in all, the firm products are applicable in many areas such as the auto industry, building and construction, chemicals, creative industry, farming and agriculture, food, household, industrial paper and packaging, medical and pharmaceutical, office and printing paper, pet food, photographic and graphic, toiletries and hygiene between others.
A more detailed description of Mondi's products for each industry is now given.
Regarding office and printing paper, Mondi is offering paper for office, offset and pre-print applications, and paper for laser and inkjet printers as well as copy machines. Office paper was originally developed in 1989 and is still Europe's market leader in the color laser paper segment.
For the building and construction industry, Mondi has developed industrial bags, sack kraft paper and flexible paper-based bags, extrusion coated insulation materials and building membranes. Within the cement bags there is a broad variety of standard and special solutions. The range includes corrugated heavy-duty packaging for bulk shipments and flexible paper-based bags for packaging smaller units. The portfolio includes brown, white and Polyethylene-coated paper grades for valve bags. Mondi has also diversified the use of its products by offering insulation materials and building membranes thanks to its expertise in extrusion coating. This new products permit fire retardancy, dimensional stability, thermo-reflection, breathability and noise insulation.
Another area where Mondi's products are used is in the medical and pharmaceutical one. For this industry, Mondi offers sterile packaging and medical devices such as printed laminates and barrier materials, printed gammasterilisable laminates, stand-up pouches and open mouth bags as well as extrusion coated barrier materials for hermetically sealed sachets containing powder products.
For the hygiene and toiletries area, Mondi is offering pouches for liquid personal care products; release liners for self-adhesive applications which are mainly used for self-adhesive feminine care products and frontal nappy tapes; and printed laminates and barrier materials which are mainly used for cosmetic box solutions.
Mondi is in addition providing packaging products to the food industry. It has shelf-ready packaging, single serve pouches, re-closable bags, anti-microbial and dehydrated food packaging, portion packs, composite cans, etc. Mondi has developed containerboards which are resistant to water penetration to protect fruit and vegetables from extreme temperature changes and humid conditions.
Moreover, Mondi is present in further industries like the paper and packaging industry, photographic and graphics, pet food, automotive, chemicals and electronics industries. For the paper and packaging industry, it produces kraft paper and sack kraft paper as well as recycled and virgin containerboard for various applications such as industrial bags, corrugated boxes, consumer and carrier bags, food packaging and protective wrappings. Intended for the automobile industry, Mondi offers special frames and protector bags for vehicle parts as well as barrier materials for automotive panels, etc. In the pet food area, it offers printed laminates and barrier materials, plastic and paper based bags, re-closable bags, shelf-ready packaging, etc.
Mr. Kropiunik stated that product diversification was the result of a quite natural growth strategy. He explained that once the firm had one reliable product the next step was to enlarge the territory or add new products to the existing portfolio. Enlarging territory is sometimes naturally restricted due to transport costs. Therefore new products were added to the portfolio and many lines of business were created and developed.
Mondi's growth is continued through a focused combination of organic expansion and acquisitions (also see 4.4)
The Head of Marketing Uncoated Fine Paper confirmed that Mondi is benefiting from the operational synergies that related PDS offers. He said that it is reached through a cross-product line, benchmarks across product lines. On the other hand, operational synergies are achieved through job rotation in the same business unit to exchange know-how. This is a common practice in the firm which is done more and more. But in the mills or plants there is rarely a transfer from someone who has been working in the Consumer Flexibles area to the printing machines for personal and travel reasons and there is not the need to do so. In fact, the employee training takes place within the business units where people are exchanged between two plants with a very similar product line or portfolio.
Regarding machinery, some can be used for similar purposes. Therefore producing different products can share a portion of production costs. But in fact a paper machine is only a paper machine and has its restrictions to manufacture other products. It can only produce a certain type of paper efficiently and other machines, such as printers and bag manufacturing machines are needed for other purposes. The main challenges PDS presents, in words of Mr. Kropiunik, are: complexity reduction or complexity management. The more product lines or products a firm has, the more it must keep in stock (SKU, stock keeping per unit) and the more complex the product management gets.
Information management is a complex task with or without diversification. The fewer products a company has, the simpler the IT system can be. But a company with a single product sold in large quantities also needs high IT performance systems. Thus Mr. Kropiunik would not consider it an added product diversification challenge.
In theory, skills and capabilities of Mondi's managers can be spread in all the business units. On a practical level this is not possible, affirmed Mr. Kropiunik. This is due to a lack of centralized product management. At Mondi there is no central position to overlook the product development and product management across all the business units. Therefore the know-how and experience accumulated is not shared and put into practice between the different business units immediately. It is only shared in a non-formal flow of information between some product or brand managers and also in the Corporate reports through explanation of best-practices. Moreover each product does not have a head manager but only each business unit and main products and brands. Mr. Kropiunik explained that his business unit, Uncoated Fine Paper, has a clear defined product management because this department is producing a limited set of products around 100 different base products whereas the other units are tailoring more each product to the individual needs of the customer. For example, Bag Converting policy is to develop with the customer a clear definition of how the bag has to look like, which kind of bottom, top lit, outer layer, inner layer, features, functionality, etc. it has to have.
Another synergy from which Mondi benefits, is sales synergy. Sales people have the responsibility to sell a wide range of products and should be aware of the characteristics and functionalities of the various products from the wide range Mondi offers to the different industries. This permits that while a sales person is in a customer transaction, he can inquire about interest in other related products being able to offer a complete solution. As Mondi is focused on related PDS, the customers of different products are often the same. Therefore another related PDS benefit can be seen: customers can be the same for the different products. For instance the customer for supermarket's shelf packaging can be the same as the one for frozen food packaging.
At the same time for around five percent of the employees this is a challenge, signaled Mr. Kropiunik, because not all employees are trained and have wide knowledge about each product. Some senior salespersons have a deep knowledge of kraft paper but not so much of the last business unit Mondi added: Consumer Flexibles. Therefore in an unconscious way they will be focusing more on one specific product or business unit where they feel more comfortable. The solution to this problem or challenge is training. Salespeople have to learn how to develop a complete presentation of the firm's portfolio. Sometimes, the interview partner said, it is just a matter of awareness.
Mondi's Product Diversification through Acquisitions
Mr. Kropiunuk considers that Mondi is not following one specific path of growth like product diversification but also market penetration and product development. Mondi is extending its markets, footprints and diameters.
Mondi's preferred growth approach is mergers and acquisitions said Mr. Kropiunik. He explained that mergers and acquisitions are regardless as the same thing with some financial and technical differences. The company is also involved in some joint ventures owning 51% of the firm and shareholders the other 49%. Owning 100% would be more beneficial he said because other ideas or preferences would not have to be taken into consideration but in some cases for one reason or another it is not possible. It could be due to political conditions, financial resources or simply because the other firm does not want to sell.
Mr. Kropiunik shared his personal experience being responsible for two post merger-acquisitions during two and a half years. He explained that Mondi tried to learn from each acquisition and take the best of the firm but with a clearly defined set of non-negotiable topics. The non-negotiable topics were how the balance sheet and the profit and loss statement should look like. The new firm had to adapt these. Mondi gives a margin of flexibility regarding procurement and processes to the newly acquired firms such as the personnel and production planning.
Procurement is flexible at a first stage because Mondi has experienced that some acquired companies had better conditions with suppliers than they had, and of course Mondi is trying to exploit the better deals. In these cases, acquisitions are very beneficial for the company. Finding out whose procurement is better sometimes is easy. On some occasions it is a complex task. Processes like personnel and production planning are in some cases not aligned to Mondi's policy. But the company has decided to let these issues untouched until the acquired company joins the common IT system. Local investments are stopped. This means, Mondi is no longer investing for example in an Oracle system in a plant because Mondi has a sophisticated SAP solution worldwide available. It usually takes between half a year and two years maximum until the acquired plant migrates into the central system.
While acquiring a new company Mondi has to be very careful about their employees' behavior. Mondi has to avoid a feeling of winners and losers between the employees of Mondi and the acquired firm because it would destroy the confidence and valuable employees would leave the company.
Effects of the current financial crisis on Mondi's strategy
Mondi operates in a highly competitive environment. However, the firm believes that its geographic and product diversification provides some security and protection to the firm. (Mondi, 2009) Once again, a benefit of diversification is corroborated. Prices of Mondi's raw materials and input costs such as wood, pulp and chemichals, have increased substantially in the last years. Increases in price and difficulty in procuring raw materials can cause a very negative effect on the firm. The firm had to restructure its activities and close a corrugated plant in the UK and for more bag-converting plants will be closed in Europe in 2009 (Mondi, 2009). Therefore the current financial crisis is having a short-term impact on the firm and also to the demand of Mondi's products.
Some of Mondi's products have a natural risk due to business cyclicality. The current financial crisis has affected Consumer Flexible showing quite a high resell following the consumer behavior. For instance, it had a significant impact on cement bags which is very much related to the building industry one of the most damaged industries of this crisis. Mr. Kropiunik pointed out that Bag Converting and Kraft Paper are the most affected whereas Consumer Flexible and Uncoated Fine Paper were not so much affected by the crisis. He pointed that it is likely that next year in 2010 it would be harder hit due to augment of unemployment rates.
The best strategy Mondi can follow to cushion the effects of a financial crisis is to extend the value chain in both directions, backward and forward and not to diversify into unrelated product, said the Marketing Manager for Uncoated Fine Paper.
Backward integration for paper refers to owning the woods. It is considered an excellent strategy because the firm can control the whole chain with the advantage of securing the value chain in terms of forest certification. Mondi is putting in practice this strategy in South Africa and Russia which is an outstanding competitive advantage nowadays. Therefore, Mondi, is settling down its own forest and growing trees and so mitigate these risks. This big step toward backward vertical integration is being negatively affected by a great pressure from the customer and supplier side and the lack of credit available due to the current financial crisis. The credit Mondi has available depends on the firms' performance.
Backward integration for plastic would mean owning a company such as Shell. In this sense Mondi has not yet be able to backward integrate and still depends on outsider suppliers and is fully exposed to oil prices. 2007 was a very difficult year for Mondi due to oil price fluctuation. If the company had owned a company like Shell and had been fully backward integrated in the plastic supply chain the impact of the oil fluctuation would have been lessen. To confront this situation Mondi hedged with long term contracts fixing the dollar in a certain rate as many other large firms did. Mondi's product price increased as a consequence but only partially because oil is not the main parameter that counts.
Mondi's earning target before interest and taxes (EBIT) is seven percent and 14 percent return on capital employed (ROCE). Currently, in the middle of the financial crisis the firm is not reaching this target. Although some firms that are in other industries like Telecom or software companies are exceeding this financial target.
Conclusions of Mondi Case Study
This case-study can be concluded in the following points:
- Mondi's mature stage has allowed the company to accumulate expertise in the paper and packaging field and being one of the market leaders
- Mondi's mature stage in its life cycle is related to the success of implementing related PDS and exploiting operational, managerial and sales synergies.
- Mondi's portfolio is the result of mergers and acquisitions and of a natural strategy of growth.
- Mondi is vertically integrated, forward and backward.
- Mondi has added business units and product to answer customer needs.
- Mondi is considered to follow a related PDS able to follow a complete pack of products, called Solutions.
- Mondi's Europe & International Division has three business units: uncoated fine paper, corrugated and bags & specialties.
- Mondi's products are applicable in many industries, e.g. building and construction, medical and pharmaceutical, hygiene and toiletries, paper and packaging, automobile, pet food among others.
- Mondi has followed not only a PDS but also a market development strategy entering in new markets. Market development is in some occasions naturally restricted due to high transport costs.
- Mondi is being benefited from the operational, managerial and sales synergies that PDS offers partially.
- Mondi's main challenge is complexity reduction and management.
- Lack of centralized product management to overlook the product development and management across all business units.
- Mondi's customers are sometimes the same for the different products of each business unit allowing exploiting sales synergies.
- Mondi's preferred growth approach is mergers and acquisitions.
- Some of Mondi's products have a natural risk due to business cyclicality.
- The financial crisis has impacted the building industry and as a consequence all packaging products Mondi offers to this industry such as cement bags. Bag Converting and Kraft Paper are the two business units more affected.
The following recommendations given to Mondi Group are based on the literature and empirical research done:
- Keep focused in offering packaging solutions. Other packaging materials, beside paper and plastic, more environmental friendly shall be added. If a 'green' packaging is developed Mondi should be on time to catch competitor's market power. In that way the firm's value will increase and as a consequence the overall performance.
- To not increase process complexity keep the size of the company. With a bigger size this current challenge would be more...
- Name with different brands the products offered and newly introduce to mitigate the risk of market rejection and as a consequence the other products under the same brand. Using different brands can allow Mondi to offer for example office paper under two different brands with e.g. different price or distribution channels and so attract a higher market share.
- Ask Mondi's managers what Mondi can do better than any of its competitors in its current market. By defining this key question Mondi will have a better chance to succeed in new businesses and products.
- Reinvest earnings in keeping engaged in vertical integration and gaining market power over competitors. It is said that a firm is vertical integrated (backward and forward) when it produces its own inputs created the sources of distribution. Market power would be gained as Mondi develops the ability to save on its operations, reduce costs, improves quality and protects its technology from possible imitation by the competitors. It would also protect the firm from fluctuations of suppliers' prices, especially in moments of financial crisis.
- Use of existing technologies, logistics, plants and capacities for more purposes to gain efficiencies that reduce costs.
- Develop operational synergies instead of financial synergies because the first ones are harder to be imitated by the competitors.
- Continue using acquisitions as the PDS approach but do not avoid joint-ventures and alliances.
- Train salespeople to be aware of Mondi's portfolio and products' characteristics to gain sales synergies. Various products can be sold to the same customer. A constant reminder is needed for sales people to do not lose any sales opportunity.
- Management synergy could be raised by creating channels of information exchange and experiences between managers to solve problems and take decisions.
The first conclusion is that PDS is related to the firm's life cycle. It is in the mature stage where firms have to decide which path of growth to select. If PDS is chosen at the wrong time it can bring the firm to failure. If at the beginning of a firm's life PDS is applied, it is unlikely that the firm will succeed and if it waits to its decline opportunities may have faded away. In the case of Mondi, the Head of Uncoated Fine Paper and the firm history confirm this.
Another conclusion is about the size of the firm. Being a large firm is related to the success of PDS because the firm has more operational and financial resources which allow exploring the best growth path and changes are affordable.
The distinction between the two categories of PDS, related and unrelated, explored in this research permits to conclude that the first one creates value by sharing resources and core competencies. The second one creates value by entering into new businesses where the revenue is higher than investing in the current business.
As explained and presented, related PDS seems to create value for large firms in more ways than unrelated PDS. Therefore it is logical to assume that related PDS should be the preferred growth strategy. Furthermore, related PDS involves less risk in the sense that the manager has already information about the business or new product being introduced. Because of these considerations a preference for this strategy can be argued and defended.
However, the bureaucratic costs of the number of products in a large firm's portfolio and the coordination required between the different products to benefit from the possible synergies might discourage large firms to choose this path of growth. Only if the costs and coordination complexity are less than the benefits of related PDS, this strategy is recommended as in the case of Mondi.
Unrelated PDS on the other hand does not have to deal with the coordination costs between the different products because they are independent one from the other. This strategy implies only the bureaucratic costs of having a large unrelated portfolio. The higher costs related PDS has to bear might cancel the apparent higher profitability it has, making it marginally as profitable as unrelated PDS for some firms.
The choice of the right growth path for a large firm depends on the value added by each one of the strategies compared to the costs that it implies. For related PDS the higher value is created through the commonalities among the skills required to compete in the firm's core competencies and by obtaining gains from synergies, sharing distribution channels and sales networks among the new related products or businesses.
As explained in section 2.4, in some cases unrelated PDS might be more profitable for a large firm than the related strategy. Especially for industries where the products are obsolete, the market is saturated, the industry is cyclical or the firm is uncomfortable depending on one product line.
For this category to be successful, the firm has to make a better allocation of capital through unrelated businesses than through related ones. As explained in this research, unrelated businesses and products operate separately within their business unit and the structure and control has to be designed in a way that each business unit can take its own decisions and work independently. As each product and business is independent with an unrelated PDS, it can be concluded that the organization of the business is less complex because linkages between the different products and business units are not required. On the other hand control is more clearly defined because based mainly on financial statements.
Consequently, whether related or unrelated is a more recommendable growth strategy for a large firm, depends on whether the firm can create more value from expanding the portfolio in the current business or entering into new businesses and therefore offering unrelated products. Both strategies can be of a benefit or of a cost depending on the above mentioned characteristics and industry situations. Successful examples of both strategies are: Nestlé, Kodak, General Electric, Samsung, LVMH, HWL, Honda, Gucci, Walt Disney, Canon, Procter & Gamble among others.
According to this research, it can not be said that only related or unrelated PDS come into view as the best strategy for all large firms. Instead, individual firms have to choose their strategy based on their own characteristics, opportunities and challenges.
Concluding, it can added that not always diversification is the right path of growth. In some cases for example, a strategic alliance can be more profitable. This is true, especially if the cost of acquiring for example a new plant to produce new products is so high that the firm has to surpass its optimal debt. Through a strategic alliance a large firm, like Mondi, can share the costs, risks, and benefits related with offering new products and businesses although the profits must be divided between the partners.
- Berry, C.H. (1971). 'Corporate Growth and Industrial Diversification'. Journal of Law and Economics, Vol. 14, 371-383
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