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Diversification Strategy

Diversification Strategy

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Published by: Ashwini Sanil on Jan 11, 2011
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DIVERSIFICATION STRATEGY Prof. K.U. Nayak Dean, MBA Department AIET, Mijar


Ashwini Kumari Varsha Malli Dayanand Ranjith Shetty Manoj Shetty Sharath Kumar


25 TH October 2010



DIVERSIFICATION STRATEGY Diversification is a form of corporate strategy for a company. It seeks to increase profitability through greater sales volume obtained from new products and new markets. Diversification can occur either at the business unit level or at the corporate level. At the business unit level, it is most likely to expand into a new segment of an industry which the business is already in. At the corporate level, it is generally and it is also very interesting entering a promising business outside of the scope of the existing business unit. Diversification strategy is thus defined as a strategy in which the growth objective is ought to be achieved by adding new products or services to the existing product or service line. In the present era, there are various companies with high degree of diversification. For example: Kesoram cotton mills into textiles, cellophane paper, firebricks, east iron pipes, and cement. ITC limited (a cigarette major) into hotel, paper and packaging; L&T (engineering major) into cement, information technology, and shipping.

Types of diversification strategy :
The strategies of diversification can include internal development of new products or markets, acquisition of a firm, alliance with a complementary company, licensing of new technologies, and distributing or importing a products line manufactured by another firm. Generally, the final strategy involves a combination of these options. This combination is determined in function of available opportunities and consistency with the objectives and the resources of the company. 1. Concentric diversification (Related diversification) 2. Conglomerate diversification(Unrelated diversification)

Concentric diversification (Related diversification):
This means that there is a technological similarity between the industries, which means that the firm is able to leverage its technical know-how to gain some advantage. For example, a company that manufactures industrial adhesives might decide to diversify into adhesives to be sold via retailers. The technology would be the same but the marketing effort would need to change. It also seems to increase its market share to launch a



new product which helps the particular company to earn profit. Addition of tomato ketchup and sauce to the existing "Maggi" brand processed items of Food Specialities Ltd. is an example of technological-related concentric diversification.

Features of concentric/related diversification :
1. Focus on internal development: Firms can attempt related diversification through various channels. For example, firms include
  Identify and exploit an underlying technology or skill that defines the way

a set of products is designed or manufactured;
  Start of new products or services where key value-adding activities can be

shared across a wider base of activities;
  Develop and commercialise new products that leverage the firm¶s brand

name recognition, manufacturing skill, or R&D capability; or
  Acquire new business that closely match and complement the firm¶s

existing strengths or distinctive competence in its original activity. 2. Building mutually reinforce businesses: the first stage in building synergy is identifying the potential for close fit among the firm¶s different businesses.For example: in case of sharp, the precision manufacturing skills, flat screen display technologies and innovative R&D used to making wall thin television sets , microwave ovens, DVD players and notebook computers also apply to office and industrial equipment(copier, solar panels). Concentric diversification also requires a close integration of business unit strategy around a core technology or marketing approach. Finding a close fit to build synergies is not easy. Oftentimes companies will discover that their distinctive competencies do not lend themselves well to application in other industries or markets. For example: Marriott corporation found that its expertise in providing high-quality food in its family-oriented restaurants, cafeterias and hotels did not give much capability to compete in top of the line foodie restaurants. As a result , Marriott has refocused its efforts on improving the service, appearance and comfort of its hotel rooms. 3. Making the competence hard to imitate and durable: the third step in building synergy is to make the firms distinctive competence and resources(assets,



technologies capabilities and skills) as distinctive as possible from the competition and enduring over a long period. A truly distinctive skill or competencies enable the firm to lower costs, enhance differentiation, or accelerate learning in ways faster or better than its competitors. Related diversification works best when firms can build a competence that is so distinctive and utilized system-wide that it is nearly impossible for competitors to duplicate it. Durable, specialised assets or skills are key pillar in attaining successful related diversification. 4. Ensuring Managerial fit: finally, a strong fit among the different managers that run the underlying businesses is important. Managers with similar levels of entrepreneurial qualities, technical knowledge, marketing savvy or engineering backgrounds provide an important foundation for building synergies. A convergence of managerial mind sets can reduce the co-ordination costs among the businesses. Transfer or rotation of managers across different business units can help solidify the firm¶s management fit. Shared managerial experiences can produce outlooks that also help reduce the effort and time needed to communicate and co-ordinate activities and expectations among business units. The more closely fitting and related the business units are , the more important tight a managerial fit becomes. This fit helps the management understand both the characteristics of individual businesses and the overarching distinctive competence of the firm. Value creation at both business and corporate levels becomes easier when managers work jointly to develop ways to extend the firms distinctive competence across business.

Types of concentric/ related diversification:
Concentric diversification may be three times: 1) Marketing- Related Concentric Diversification: When a similar type of product is offered with the help of unrelated technology, for example, a company on the sewing machine business diversifies into kitchen ware and household appliances, which are sold to housewives through a chain of retail stores. 2) Technology- Related Concentric Diversification: When a new type of product or service is provided with the help of related technology, for example, a leasing firm offering hire-purchase services to institutional customers also starts consumer financing for the purchase of durables to individual customers.



3) Marketing and Technology Related Concentric Diversification: When a similar type of product (or service) is provided with the help of related technology, for example, a rain court manufacturer makes other rubber-based items, such as, waterproof shoes and rubber gloves, sold through the same retail outlets.

Benefits of concentric/ related diversification:
Several reasons may underlie a company¶s preference for concentric diversification: 1) To counter act cyclical trend: If the company in one industry is subject to cyclical fluctuations, it may be necessary to diversify its business to smoothen its earning flow. 2) Excess cash flow: Where the existing product line has produced a high degree of liquidity through positive cash flows and opportunities exist with favorable rates of return, a company may consider concentric diversification very attractive. 3) Saturation of product market: Another compelling reason for concentric diversification may be saturation of demand in the industry or product market. 4) Managerial expertise: Concentric diversification may also be promoted by the top management¶s inclination to gain managerial expertise in a new field, or new technology, or entry into new markets, or new products. 5) Combining the value chains: Firms can significantly lower costs and increase efficiencies by combining the value chains of multiple businesses, such as manufacturing multiple products in the same manufacturing plant; using the same logistics- warehousing and transportation, across multiple products; and marketing and selling multiple products and services through the same sales force and channels. 6) Leveraging strong brand names: Firms could leverage their existing strong brand names across multiple businesses to help achieve significant market share and customer loyalty. For example, the Indian telecom Bharti Televentures Ltd. (www.bhati.com), new leverages their leading brand name ³Airtel´ (that was originally their brand name for mobile services) across all its other telecom businesses, that includes fixed-line services, broadband and internet services and enterprise voice and data solutions. 7) Creating stronger capabilities: Firms can create stronger competitive capabilities by combining the relative strengths of multiple businesses. For example, Hindustan Lever Limited (www.hll.com) leverages its strong distribution network that was built for FMCG products to distribute their ice-cream brand ³kwality walls´. This combines the brand



strength of kwality wall¶s with the distribution muscle of Hindustan Lever Limited(HLL) to competitive capability difficult for competitors to imitate.

Conglomerate Diversification (Unrelated diversification)
When an organisation adopts a strategy which require taking up those activities which are unrelated to the existing business definition of one or more of its businesses, either in terms of their respective customer groups, customer functions or alternative technologies, it is called conglomerate diversification. The classic examples are ITC, a cigarette company diversifying into the hotel industry. Some other examples are those of Essar Group ( shipping, marine construction, oil support services. And iron and steel ): Shriram Fibers Ltd.(nylon industrial yarn, synthetic industrial fabrics, nylon tyre cords, fluorochemicals auto electrical, hire-purchase and leasing, and financial services).

Features of conglomerate merger:
1) Acquisitions over internal development: The unrelated diversification strategies of conglomerates are designed to acquire, and sell businesses in various industries without the benefit or guide of an underlying distinctive competencies. Unrelated diversification is based entirely on acquiring selling different parts of the firm to maximise corporate profitability. 2) Attempting to beat the market: The economic motive of the unrelated diversification is that the corporation creates value to the extent that it is able to identify attractive acquisition or new business opportunities faster than the market can. All of the companies thought they could make informed bets they could

purchase fast growing, highly profitable businesses for the long term.

Objectives of the conglomerate strategy:
1) Spreading business risk across multiple businesses: The financial and business risk of the corporate is spread across industries, markets and relatively distinct from each other. 2) Optimisation of financial investments: The corporate can prioritise and optimise their financial investment across multiple businesses, including diverting cash flows from cash rich businesses to investment hungry businesses. consumers who are



3) Exploiting corporate resources and management capabilities:

The financial

resource and managerial capabilities of the corporate top management can be effectively leveraged across multiple businesses, to enhance shareholder wealth. 4) To achieve a growth rate higher than what van be realized through expansion. 5) To avail of potential opportunities of profitable investment. 6) To achieve distinct competitive advantage and broader stability. 7) To improve the price earnings ratio and bring about a higher market price of share.

Why do firms Diversify/Reasons for diversification
Firms resort to diversification for many reasons. Analysis shows that compulsions as well as attractions impel firms towards diversification. 1. Growth ambition leads firms to diversification: When the growth ambition of the firm is very high, i.e. when the firm desires extraordinary growth in assets, income and profits, diversification often becomes the choice; neither stability nor intensification may be enough to meet the high ambition. Usually, there are limits to growth that is desired can materialize only through diversification. It is thus natural for firms eager to achieve rapid and big growth, to opt for diversification, since it involves exploiting opportunities outside the current field of the firm and thus provides the firm a larger arena to play in and grow. In other words, firms diversify when their growth objectives are very high and cannot be met within the existing product-market scope. 2. The need to provide flexibility to portfolio : The need to provide flexibility to portfolio serves as another motive for diversification. Diversification provides flexibility to counter vulnerability. Usually, firms with just one business find themselves vulnerable under changing environmental conditions. Even firms with three or more business become vulnerable when they stay on with the same set of business over a long period of time. The firm would be better off and less vulnerable if the risks are spread over a long period of time. Universally, firms view diversification as the long-term solution to the vulnerability inherent in a single/limited number of business preposition(s). That is why the world over, firms keep taking to the diversification route despite the difficulties posed by it. 3. Opportunity serve as attraction for diversification: The main attraction for diversification stems from fresh opportunities. And , there are extraordinary times



when an unusually large number of new opportunities come up in the environment and firms are strongly tempted towards diversification. Mostly new opportunities occurs when the economic and industrial environment undergoes a major change. In India, such a change in the environment occurred in the wake of liberalization, and a multitude of new opportunities. 4. Environmental Uncertainty: Just as a highly robust environment propels firms towards diversification, an environment marked by uncertainty too can form the setting for diversification. In such situations firms make a constant search for new business. Here, the diversification is expected to serve as a cushion for their vulnerability. The strategy of one product, one business and stable income, does not fit an uncertain environment. 5. Scope for higher profitability: A firm may diversify when diversification opportunities promise greater profitability than intensification opportunities. In particular, firms with high growth ambitions are attracted by the profitability potential. They would always be on the look-out for new opportunities that hold the promise of high profitability. They do not mind getting into even totally unrelated areas, ignoring the lower synergy inherent in such propositions. 6. Availability of surplus resources: When a firm has surplus strength and resources exceeding the requirements of existing business, it may find it sensible to diversify, using these strengths and resources. Of course, it would first use them in the intensification of the existing business and take to diversification if the surplus resources exceeded the needs of intensification. 7. Congruence of existing synergies and emerging opportunities : When the firm has in its possession synergies that would be relevant in tapping the emerging opportunities, it may find it attractive to diversify into those opportunities. This would normally be a case of related diversification or concentric diversification. 8. Recasting of mission: Diversification is a part of the basic growth process of a firm. There are instances when a firm fully achieves its originally formulated mission staying within the initial product-market scope. Now the firm will have higher ambitions and a new mission. Since ambitions of firms are not absolute and finite but are in evolution all the time, firms do recast and enlarge their missions over the years. Diversification strategy is a natural choice when a change presents itself for enlarging the firm¶s mission.



Costs of diversification:
The costs of diversification are: 1. Cost of Ignorance: A firm that diversifies into a new area generally knows less about the new field than competitors. It is therefore less able to articulate consumer needs, predict technology developments and foresee environment shifts. This deficiency puts it at a disadvantage when compared with more experienced competitors, increasing the likelihood that it will miss important opportunities and make costly errors. 2. Cost of Neglect: To carry out a diversification program, a firm¶s senior managers must deal with a host of issues. They must first decide that diversification is desirable. Because that is a critical decision, they must work with key individuals inside and outside the firm before reaching a conclusion. 3. Cost of Co-operation: To share a common resource, two businesses must co-operate with each other. Achieving co-operation often entails substantial costs. This issue is especially important to senior managers if firms engaged in related diversification. Among the most significant costs are those of: i) Cost of Communication: to share an activity, businesses must reach agreement on such issues as objectives for the activity, resources to be allocated to it, scheduling of new products, and assignment of personnel to use and a reporting structure for personnel. ii) Costs of Compromise: Businesses involved in co-ordination will sometimes place different priorities on development projects. Decisions ultimately reached may therefore involve compromises that do not fully satisfy the needs of one or both businesses. iii) Cost of Accountability: When a business operates independently, its managers can be held accountable for results. Accountability is reduced if a business is asked to co-operate with other units, since it performance will then be influenced, perhaps to a large degree, by compromises it makes to work with other units.

Benefits of diversification 
A firm can capitalize on its strengths and on areas where they are best at and transfer these competencies to another business.



In synergizing , businesses can increase their collective value which would be more than their individual or separate value.  Reduces risk when the organization is less dependent on just one business activity.  Reduces cost when firms share resources and activities common to the businesses.  There will be knowledge sharing and skills transfer which will be of common gain and benefit for businesses.

Limitation of diversification 
Shared risks in some cases , where diversification is extensive . Different

industries have different and unpredictable business cycles.  The task and responsibility of top executive increases because of need to handle new product, technology and market.  Adequate funds are required to diversification. The internal savings of the business may not be sufficient to finance growth.  Diversification may involve new technology and new market. The existing staff may have experience problem in adapting to this growth pattern.



BIBLIOGRAPHY: 1. Arthur A. Thompson, Jr.,A.J. Strickland III ,John E. Gamble, Arun K. Jain. ³ Crafting and Executing Strategy´, ³Tata McGraw Hill Education Pvt. Ltd´. Edition 16 th, 2010 . Page no. 273-312


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