Companies that pursue related diversification are able to create a diversification premium because they: A. are able to leverage time compression economies. B. can operate beyond the minimum efficient scale. C. are able to increase value due to economies of scope. D. can reduce the value gap created by its products.
The Correct Answer and Explanation is :
The correct answer is C. are able to increase value due to economies of scope.
Explanation:
Related diversification occurs when a company expands its operations into areas that are related to its existing business lines. This strategy is often employed to create a diversification premium, which is the added value that arises from the company’s ability to leverage its existing resources and capabilities across multiple product lines or markets.
One of the key benefits of related diversification is the realization of economies of scope. This refers to the cost advantages that a company can achieve by producing multiple products that share resources or processes. For example, a company that produces both personal care products and cosmetics can utilize the same manufacturing facilities, distribution channels, and marketing expertise for both lines. This leads to lower overall costs and the ability to offer products at competitive prices, ultimately enhancing value.
Additionally, related diversification allows companies to share best practices and innovation across their various segments. By leveraging knowledge, skills, and technologies developed in one area, companies can improve their efficiency and effectiveness in another. This cross-pollination of ideas can lead to enhanced product offerings and better market positioning.
Moreover, companies pursuing related diversification often have a more comprehensive understanding of their market dynamics and customer preferences, which allows them to tailor their offerings more effectively. This enhanced customer insight can lead to increased customer loyalty and higher sales, contributing to the overall value created by the firm.
In contrast, options A, B, and D do not accurately describe the mechanisms through which related diversification generates a diversification premium. Time compression economies focus on speeding up the process of innovation and production, operating beyond minimum efficient scale relates to producing at an optimal capacity, and reducing the value gap pertains to aligning product value with customer expectations, none of which directly capture the essence of economies of scope that drive related diversification’s value enhancement.