We're now going to discuss the five-step approach to a diversification decision and the first step is finding synergies. We have seen that synergies is a key driver of diversification. So we need a systematic way to find and identify them. We want to find synergies. Because we're looking at operational synergies, it means that we have to look at the value chain. A value chain is a series of activities that are necessary to produce and deliver a product to your customers. We can actually link this very easily to our initial description of a business in terms of its who, what, how. We can say that the value chain is a description of the how. It's a series of activities that brings or produces a product and brings it to your customers. So the output of a value chain is really a product in terms of the what, delivered to customers, the who. The important point here is that synergies are really in the how, not necessarily in the what or the who. We're looking at operations. We're looking at the how. So you may have heard of an unsolved matrix when thinking about diversification. What that really is doing is comparing the products and customers in the current situation with the new situation. So it's a two-by-two matrix with on the axis, customers and products. For each of these, you can think about existing and new, so existing customers and new customers. Likewise, existing products and new products. I find this framework useful to communicate a diversification decision because it neatly captures whether you're entering a business with the same products or different products with new customers or the same customers. However, I do not find it useful to decide on the diversification move, and the reason is the following. What it really does is comparing the what and the who. We've just seen that the synergies are not in the what and who, rather they're in the how. So one way to see it, customers really is the who, products really is the what. If our diversification is based on synergies, then we cannot infer from this matrix where we should go. Let's walk through an example. Let's say you're working for a sports car manufacturer, for example, the nice Ferrari that you see here, and your boss has identified the theme parks business as a potential attractive business to diversify into. How can we decide whether this move would be good or not? You might think that this example is a bit far fetched. I certainly think so. But, the example will help us think through the different steps. So how do we start? Begin with drawing value chains of the existing business, in this case, that's a sports car business and the value chain for the new business, in this case, the theme parks business. Know that you can draw a value chain of a generic business or one that is specific to the partner. At this stage, it doesn't really matter that much. The value chain can be quite crude, just take three to seven steps which is oftentimes enough detail for us to do the analysis. And notice that we're mixing here primary and support activities. That might be okay for the purposes of our diversification analysis. The goal is structure speculation. So even a crude value chain will help us achieve that goal. We want to run the following thought experiment. Could you justify paying a premium for an acquisition of a well performing themes park business? At this stage, we're not saying that we're going to do an acquisition but we just want to say if we were to do an acquisition, where would the value come from? If we find it difficult to think about what the sources of value would come from, then that's a clear indication that a diversification move is not suitable. The question that we're really asking is, where are the synergies? I'm going to do some speculation here. You may find some synergies more plausible than others, but that's precisely the point. We want to really see where the value potentially could be. I'm going to focus on three. Let's begin with R&D. Perhaps, we as a Ferrari company or a sports car business can help build a new theme park. I think that's a little bit far fetched but perhaps, there's some knowledge that we have as a sports car manufacturer that could be helpful in theme park business. Again, I'm a bit doubtful, but I'm just putting it out there. The next one, branding, is I think more plausible. Perhaps, we could take our brands, the Ferrari brand, and apply it to a new theme park business. If our brand is very strong, people might want to go to the new theme park business because it's associated with our sports car business. This would be a connection type of synergy. And for the last step, maybe there's some value from linking sales with service delivery. Service delivery of the theme parks is very different than the sales of a sports car but maybe we can do some connection type of synergies where we sell our sports car in the theme parks. Perhaps it's a bit unlikely because you would think that sports cars, buying a sports car, is not really an impulse purchase. But again, I'm just putting it out there. If you want to think about the synergies between these two businesses, these would be some of the places where you would start. Now we know, if we are to link these two businesses, where the value would come from. If you have difficulty identifying any value, you know that a potential diversification move will have to be justified on the grounds of it being a bargain: the price being very, very low. Lets move to the next step in our five-step diversification approach.
