Diversification and Corporate Strategy

At its simplest level, diversification is a way for businesses to spread risk across many different industries. A single-business company is more likely to suffer much larger effects from economic downturns or technological innovations than a more diversified company. The ultimate goal of any diversification strategy is not merely to reduce risk but should also be to grow shareholder value. It is the job of top-level corporate managers to determine a company’s overall diversification strategy. Thompson, Strickland, and Gamble (2009) outline four main areas of responsibility for corporate managers in the realm of diversification strategy. These include:

1. Deciding what new industries to enter and determining the most successful path to entry given the company’s current position. Which industries make sense in terms of the overall corporate strategy? Does the company have capabilities similar to those required to be successful in the target industry? Does the company have access to large amounts of free capital? How much weight will a company’s brand carry in a new industry? The answers to these questions can help management determine whether to enter a new industry. The answers will also help to determine the best diversification method to pursue, whether it is through acquisition, joint venture or partnership, or building a new business unit entirely internally.

2. Recognizing and selecting opportunities that will increase the performance of individual business units as well as overall company performance. It is important for corporate managers to choose business ventures that can benefit from the resources of the larger company and build competitive advantages. Astute managers can recognize opportunities to acquire or partner with businesses that lack a certain skills or resources that their company possesses. In reaching out to these companies managers can increase profitability. Another facet of this is the ability to identify underperforming business units and make the decision to pull out of non-profitable lines of business.

3. Building sustainable competitive advantage by leveraging cross-business value chain relationships and strategic fits. Diversifying into related businesses allows companies to gain economies of scope in value chain activities. This leads to increased profitability for the newly formed or acquired business unit as well as increased profitability for the larger company.

4. Prioritizing diversification opportunities and corporate resources. Understanding the financial performance and contributions of various business lines is key to the successful implementation of a diversification strategy. Management must identify strong performers and growing business opportunities and divert company funds to areas that will offer the most benefit.

There are three main avenues to diversification that companies can take. The first is diversification through acquisition. Diversification through acquisition can allow the company to enter new markets relatively quickly. The second involves starting a new business using company resources. Diversification through internal startup is relatively expensive and time-consuming. The third main method for diversification is the joint venture. Diversification through joint venture or strategic partnership can allow two companies to share the risks involved in starting a new business. This method can also allow partners to gain access expertise in areas where they currently have none. Determining which of these methods to use is dependent upon overall company positioning and corporate strategy.

A critical aspect of diversification decisions is whether a company will expand into related or unrelated businesses. The hallmark of related businesses is that these businesses, if added to the company, will create competitively valuable “cross-business value chain match-ups”(p. 244). Expanding into related industries allows the company to develop synergies, creating a scenario where the whole is greater than the sum of its parts. In a 2006 interview Paul Johnson, the managing director of Renaissance, said that the company planned to expand into distribution of non-IT brands by utilizing the company’s “core strengths” of managing and marketing brands and experience in warehousing and distribution (Bathgate, 2006).

Diversifying into related areas also allows companies to build on and reap the benefits from core competencies. Core competencies allow companies to streamline activities and learn from experience across businesses. Casio is able to coordinate between its miniaturization capabilities, materials technologies and processing technology. This allows the company to succeed whether making calculators, TVs or watches (Prahalad and Hamel, 1990).

Diversifying into unrelated industries can provide increased revenues and potentially less risk than diversifying into related businesses. Understanding the overall strategic goals of diversification, whether into related or unrelated industries, will help managers to evaluate the company’s diversification strategies.

The text outlines six key steps in understanding and evaluating a company’s diversification strategy. These include industry attractiveness, business-unit competitive strength, competitive advantage potential of cross-business strategic fits, resource fit, performance prospects for business-units and assigning priority for resource allocation, and formulating new strategic moves to improve corporate performance. By analyzing each of these factors managers can work to ensure a cohesive and successful diversification strategy.

Evaluating industry attractiveness focuses on the broader picture of corporate diversification. First managers must determine the attractiveness of an industry in its own right. This involves understanding whether the industry is growing, stagnant, or in decline. Understanding the competitive forces in the industry is also very important in this stage. Markides (1997) recounts the experience of Kao, a Japanese consumer-goods company. The company developed a technology that could be used to smooth the surface of clothing as well as magnetic tapes. After an extremely successful launch of a new product line in its detergent division using the new technology, Kao decided to transfer the same technology for use in floppy-discs. What the company failed to recognize was that there were already many competitors in the market offering substitute products, leaving Kao with no competitive advantage. Understanding the opportunities within an industry if vitally important to success. The next step of the process is to determine the most attractive and the least attractive of all the industries in which the company is currently involved. The final aspect involves analyzing the attractiveness of all industries that the company is involved in as a group.

After understanding industry attractiveness it is important that managers understand the competitive strength of the business-unit. This essentially means understanding where a business unit stands in its industry. When done across the company this can give the manager a view into the strengths and weaknesses of the company’s diversification portfolio. This can then guide decisions about resource allocation and also the decision to pull out of certain businesses.

The next step is understanding the competitive advantage potential of cross-business strategic fits. Strategic fit simply means that value chains of separate businesses within the company’s portfolio can work together to share resources, lower costs through combining activities, build new or stronger competitive capabilities, and leverage brand name recognition to improve revenues. Some fashion companies have leveraged the high quality luxury status of their brands in order to strike out into the luxury hotel arena. As noted in a 2006 article, many different high-end players in the fashion market, including Bulgari and Versace, have successfully used their brand to gain access to the hotel market. These companies are able to charge high prices as a result of the luxury and status that their brand brings into the new venture (Galbraith, 2006).

After understanding strategic fit, resource fit should be analyzed. Resource fit means that businesses in the company’s portfolio generally add to a company’s resource strengths. It also means that there is correlation between the resources of a company and the key success factors of the industry in question. A vitally important aspect of resource fit is ensuring that the company has adequate resources to cover all areas of its business, without “spreading itself too thin.”

The next step in the process is ranking the prospects of business units and allocating resources. Many factors are involved in these rankings including sales growth, profit growth, return on investment and contribution to overall company earnings. Resources should be directed towards business units with the best growth and profit outlooks and strong strategic and resource fit.

After managers have gone through the previous five steps they are ready to finalize impressions and form the next move in the company’s diversification strategy. Thompson, Strickland, and Gamble (2009) identify five main paths diversified companies will take after analyzing their current diversification position. The first type of reaction is for companies to make little change to what the company is already doing. This makes sense when the businesses are performing well overall and demonstrate clear growth potential. The next option is for the company to broaden its diversification base into new industries. This may involve either related or unrelated diversification. The third possibility is exiting some businesses and focusing on a more narrow base of operations. This involves getting out of businesses that lack competitive strengths, strategic or resource fits, or are in unattractive industries. This allows the company to focus resources on the more profitable businesses in its portfolio. The fourth reaction is to completely restructure the company’s diversification lineup. This involves divestiture of some old businesses and the acquisition of new business opportunities. The fifth possibility involves the decision to go after an international diversification policy, allowing the company to enter into more businesses as well as markets. It is the job of top management to determine which of these strategies will lead to long-term profitability of the company’s diversification portfolio.

Questions and Concerns

There are only a few concerns with the chapter on diversification and corporate strategy. The text spent less than a page (p. 241) discussing issues surrounding the question of when to diversify. It would have been helpful to have a more thorough discussion of when a company should diversify. Table 8.1, calculating weighted industry attractiveness scores (p. 260) and Table 8.2, calculating weighted competitive strength scores for a diversified company’s business units (p. 263) were fairly confusing. The text did not provide background on these methods. Some questions that came up were:

How were these methods, calculating weighted industry attractiveness scores and weighted competitive strength scores, developed? By whom?

How often are these methods used?

Are these methods the “standard” for determining industry attractiveness and competitive strength?

One final concern about the chapter was the lack of attention given to companies that are diversified into both related and unrelated industries. While the text did acknowledge that there are companies that do both it did not really go further in the explanation. Questions that arose as a result were:

How do companies make these decisions?

How do these companies decide what portion of company resources will be devoted to related vs. unrelated business ventures?

Recommendations

Overall this text provides an excellent introduction to diversification and corporate strategy. The text is written in a manner that is easy to read and understand. Complex topics are broken down into small sections with bullet points. Important points are also reiterated in boxes alongside the main body of text. In general the tables and figures provided are easy to understand and follow. There are also several short exercises throughout the chapter which help to reinforce the concepts that were just covered. In addition questions at the end of the chapter help to reinforce the material and also provide sources where students can go for additional information on the topic.

Resources

Bathgate, A. (2006, August 1) Renaissance in diversification. The Dominion Post, 3. Retrieved from LexisNexis database.

Galbraith, R. (2006, November 11) The luxury brand hotels; Now you can not only wear Versace, Bulgari or Armani, you can stay there. The Business.

Markides, C. C. (1997). To Diversify or Not to Diversify. Harvard Business Review, 75(6), 93-99.

Prahalad, C., & Hamel, G. (1990). The Core Competence of the Corporation. Harvard Business Review, 68(3), 79-91.

Thompson, A.A., Strickland, A.J.&Gamble, J.E. (2009) Crafting and Executing Strategy. New York, NY: McGraw-Hill Irwin.