DIVERSIFICATION STRATEGIES

Diversification is a much-used and talked about strategy. Diversification means identifying directions of development that take the organization away from both its current products and markets at the same time. In reality, it is not a single strategy but a set of strategies that involve all the dimensions of strategic alternatives. 

Diversification is broadly divided into two types.

(a)   Related diversification, and

(b)   Unrelated diversification

Related diversification is development beyond the present product and market, but still within the broad confines of the ‘industry within which the company operates. Businesses adopting related diversification are corporations that diversified into activities with some apparent similarities to their initial activities. Such diversification is focused on a core skill such as a technology. Chemical, electrical and mechanical engineering are technologies of this type, and firms in these industries were natural and early diversifiers and early adopters of the multi-divisional structure form of organization in response to the growing complexity of the business as product market diversity increased. In the Harvard studies of the early 1970s, such businesses were defined as those in which less than 70 per cent of sales were generated from anyone concern. Firms in technology or skill-based industries, where the skill or technology led naturally to the production of a wide range of end products meeting the needs of a variety of markets, were amongst the earliest diversifiers. While acquisition was an important element in their diversification strategies, significant growth also occurred as a result of internal development.

In relatively specialized industries, such as food, textiles, paper and packaging, and printing and publishing, and without a readily transferable technology, diversification occurred largely by acquisition. Most of these firms endeavored to achieve a strategic fit in which relatedness occurred more through efforts to service common customers and use of common distribution channels.

In the 1970s and 1980s, diversification occurred within both the manufacturing industry and service sectors. By the mid 1990s, related diversification has become the most important single diversification strategy amongst large corporations throughout the developed world, Concurrently with product market diversification, many of these concerns have also adopted international- and an increasing number, global- strategies, dependent upon the industries in which they are engaged.

Basic diversification strategies are:

1.      Concentric diversification

2.      Conglomerate diversification

Concentric or related diversification

            When an organization takes up an activity related to its existing business definition of one or more of a firm’s businesses in terms of customer groups, customer functions or alternative technologies, it is called concentric diversification.

Concentric diversification may be:

(a) Market- related concentric diversification

When a company offers a similar type of product with the help of unrelated technology, it is a market- related concentric diversification. As a company in the sewing machine business diversifies into kitchenware and household appliances sold through a chain of retail stores.

(b) Technology based concentric diversification

            When a company offers a new type of product or service with the help of related technology, it is technology- related concentric diversification.

(c) Marketing and technology- related concentric diversification

            When a company provides a similar type of product or service with the help of related technology, it is marketing and technology related concentric diversification. For example, a raincoat manufacturer begins to provide such items as rubber gloves, or waterproof shoes sold through the same retail outlets.

Conglomerate diversification

Conglomerates are corporations having no obvious strategic fit between the activities of their constituent businesses.

In conglomerate diversification, no linkages exist between the new businesses/products and the existing businesses/products. It is totally unrelated diversification and has no common threat all with the firm’s present position. For example, Ponds India, a leader in personal care products, during later 1970s and early 1980s diversified into leather products, thermometer, and mushrooms, quite unrelated products to the existing businesses, serves as an example for conglomerate diversification.

 Conglomerates are also characterized by a small central office heavily oriented to finance and control plus, acquisition analysis and implementation. Conglomerates were popular in the USA in the late 1960s.At that time it was felt desirable to build a portfolio of strategic businesses at different stages of the life cycle that could financially compensate one another: The success of companies like Litton Industries and Textron strongly supported a conglomerate strategy. Firms adopting a conglomerate strategy did not seek synergy or strategic fit between businesses except financial synergy that could be released by the purchase of companies with restricted debt capacity, underutilized assets and complementary cash- flows. The major difference between concentric and conglomerate diversification is that concentric diversification emphasizes common features in markets, products and technology, whereas conglomerate acquisitions are based principally on profit considerations.

There is some evidence that high acquisition rate conglomerates do successfully perform in terms of return on equity and growth rate as compared to related diversified concerns. Furthermore, despite an apparent trend toward reduced diversification in the late 1980s and encouragement to retreat to the core businesses of the corporation, the number of conglomerates has not diminished significantly. Indeed, there has been a tendency in North American and the UK for diversification to continue, especially with the development of mixed manufacturing and service industry corporations.

During the 1970s the number of conglomerate businesses grew sharply in the USA and the trend spread to other countries including the UK. The failure of Litton Industries and L TV, however, made the conglomerate form unattractive to the US stock market. In the boom years of the stock market in the 1980s, conglomerates against became attractive in the USA, but in the late 1980s conglomerates came under predatory attach, on the basis that breaking them up might greater shareholder value than allowing them to remain intact. This led to the belief that retreating to a core business was a more desirable strategy.

The conglomerate diversification may be resorted to as the firm fears that its product or service line in a business is approaching market saturation or obsolescence. The current product or service is producing more cash than can be usefully reinvested. Tax policy encourages reinvestment in R &D & R&D develops an unrelated product or service line. A firm may diversify to prevent a take over or to attract more experienced executives and to hold better executives who may feel bore in a single product-service business.

A conglomerate strategy provides a number of financial advantages. Business risk can be dispersed across a portfolio of businesses, reducing the risk from over-concentration in anyone industry. Capital can be invested into businesses that justify it in terms of creating shareholder value and withdrawn from cash generating businesses. At one time, the Boston consulting Group thus advocated a conglomerate strategy as a logical outcome -of the active pursuit of a growth share portfolio strategy. Corporate profitability can be stabilized by investments in businesses that are traditionally counter -cyclical to each other. Companies with skills in identifying asset-rich situations and with the skills to turn around ailing businesses that can create shareholder value may also resort to this strategy. Mergers between businesses with complementary asset investment and cash- flow characteristics and/or complementary capital structure can release financial synergy for increasing shareholder value.

However, the management needs of conglomerates are primarily financial and general management skills in turnaround situations. They do not possess operational business skills. Therefore the major conglomerate failures have occurred in high-technology businesses, where the central management fails to recognize projects going out of control despite sophisticated financial reporting systems. Without strategic fit providing operating synergy and competitive advantage, there is a tendency for the component businesses of a conglomerate to do no better than the market average. In addition, tight financial controls might reduce entrepreneurial spirit in the business units while the center provides no real support other than financial. Counter-cyclical businesses often do not actually behave with perfect timing, so failing to smooth the corporate earnings stream.

Thus it is not clear that a conglomerate strategy is less viable than a related diversified strategy. There are many corporations in the developed economies that have little or no relationships between their businesses that are highly successful financially, and are well received by the stock market. Such concerns would include US General Electric, BTR and Hanson Trust.