(Solved Homework): An ice-cream manufacturer is proposing to acquire a soup manufacturer on the basis that, first,…

An ice-cream manufacturer is proposing to acquire a soup manufacturer on the basis that, first, its sales and profits will be more seasonally balanced and, second, from year to year, sales and profits will be less affected by variations in weather. Will this risk spreading create value for shareholders? Under what circumstances could this acquisition create value for shareholders

Expert Answer

This is a classic case of Un-Related Diversification for Risk minimisation. From a shareholder’s perspective, any strategic expansion / diversification has to be backed up by a corresponding rise in revenue.

If we analyse the situation from the revenue perspective, then this seasonally-balanced diversifiaction will work only when peak in ice-cream demand during summer months is equal to peak in soup-demand during winter months. This is an idealised scenario and may not work in reality.

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One way to make absolutely sure that the risk-spreading strategy works for shareholders is to outsource soup-manufacturing operations to a nearby local vendor who will use the company’s brand name to attract customers during winter months/ months with projected high soup-demand instead of investing money in a new soup setup. This will ensure revenue during months when the company’s principal revenue-generating activity, i.e. ice cream manufacturing does not yield substantial revenue. At the same time the company does not incur additional investment for a new setup and staff.

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