Explain the relevance of the following as they relate to building shareholder value via diversification.a. the industry attractiveness testb. the cost of entry testc. the better-off test
What will be an ideal response?
In principle, diversification cannot be considered a success unless it results in added long-term economic value for shareholders. Business diversification stands little chance of building shareholder value without passing the following three Tests of Corporate Advantage:
a. The industry attractiveness test: The industry to be entered through diversification must be structurally attractive (in terms of the five forces), have resource requirements that match those of the parent company, and offer good prospects for growth, profitability, and return on investment.
b. The cost of entry test: The cost of entering the target industry must not be so high as to exceed the potential for good profitability. Since the owners of a successful and growing company usually demand a price that reflects their business's profit prospects, it's easy for such an acquisition to fail the cost of entry test.
c. The better-off test: Diversifying into a new business must offer potential for the company's existing businesses and the new business to perform better together under a single corporate umbrella than they would perform operating as independent, stand-alone businesses.
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