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Growth and risk reduction thru diversification

There are several potential aspects of diversification within a corporation. With the growth of

globalisation, multicultural diversification is becoming increasingly important. While this is

probably one of the most intricate and discussed forms of diversification, this review will

focus on what is known as corporate diversification. The definition of a diverse corporation is

a firm that is active in distinct businesses simultaneously (Pitts and Hopkins, 1982).

Corporate diversification can be divided into related and unrelated diversification. Related

diversification is a strategy that is pursued to make use of the relationships between the firms.

Unrelated diversification is on the other hand used to exploit the benefits of financial

connections between the firms (Hill & Hoskisson, 1987). It is said that the decision whether

to diversify or not is one of the most challenging for a company, although there are a number

of success stories the risks are high (Abratt, February & Rijamampianina, 2003). An example

of corporate diversification is The Port of Taurangan’s acquisition of several core business

related companies. The areas the port diversified into are fairly close to their core business,

and business units are therefore able to share market resources and make use of other

relationships between the units. This review will discuss, based on management theories

whether diversifying into the new business areas will affect the ports financial performance.

It will then conclude by looking at whether The Port of Taurangan’s strategy can be

profitable.

There are several characteristics that can help determine the success of a corporation, such as

a strong core business, closely located business units and that the business units can exploit

some of the skills the core business possesses (Abratt, 2003). Ghemawat (1986) suggested
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some of the same aspects. He suggested that for the diversification to have a positive

influence on the corporation’s economy the firms need to be able to share market resources

without affecting the costs on big scale (Ghemawat, 1986). Abratt (2003) argues that related

diversification strategy has a higher success rate than unrelated. In unstable markets and

when the business units are easily affected by changes in supply etc. unrelated diversification

can make it easier for the corporation. Even though the market or supply changes, they have

several business units that are not affected by that market. Hence, even if one of the business

units has a bad economic period, the corporation can still generate revenue through the

business units that are not affected (Green & McNaughton). The motivations for

diversification are many. Increased stock value, growth rate, improved stability and revenue

growth are some that in a large scale could affect the economy of the corporation (Abratt,

2003).

Even though there are several apparent positive aspects of diversification, there is very little

wisdom, which can guide the managers when they are making their choice about

diversification. Since the decision whether to diversifying or not is one of the most

challenging task for a company, the lack of wisdom makes it even harder. Because of the risk

related to diversification, it can sometimes lead to undesirable outcomes like loss of focus,

reduced organisational fit and ultimately negatively impact the corporation’s financial

performance (Abratt, 2003). The economic theories of specialisation being productive and

efficient, is argued to be one of the main reasons why it is thought that diversification will not

have a positive affect on a corporations financial performance (Holweg & Markides, 2006).

Van der Stede (2000) identifies budgetary slack as one of the disadvantages for diverse
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corporations. Budgetary slack is more difficult to detect for a manger in a diverse corporation

because he/she is less familiar with every aspect of the business units (Van der Stede, 2000).

Highly diversified corporations are also found to have less market power then core business

focused corporations. Product diversification is also found to have negative influence to the

business unit’s value (Holweg & Markides, 2006).

Abratt (2003) states that only 10% of corporations who have tried an unrelated diversification

strategy over the last decade have gained profit. The same research shows that corporations

trying to diversify around the core business (related diversification) have a greater chance of

gaining profit (Abratt, 2003). Newer research states that growth thru a related diversification

strategy is very likely to have a positive influence on the corporation’s economy (Van der

Stede, 2000; Francisco, 2004; Abratt, 2003; Holweg, 2004). Francisco, Juan & Felipe (2004)

argues that one reason why related diversification has a positive influence on the economy is

the cut of costs, due to economies of scale. So, even though the risks are high the possible

outcomes if done correctly are tempting for most corporations. Diversification is one of many

processes in the chase for sustainable competitive advantage (Abratt, 2003). It is also one

argued that the risk reduction by diversifying will enhance stockholder and shareholder

wealth in the long term (Blackburn, Lang & Johnson 1990). Because of significant

investments in distribution channels, the profit will not increase in the short term for most

corporations following a diversification strategy. (Francisco, 2004)

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The Port of Tauranga acquisition of several core related businesses is risky because of the

lack of wisdom around diversification strategies. But in this case the business units are able

to share market resources and exploit relationships, which according to Ghemawat (1986) is

one of most important thing if a corporation want to increase revenue by following a

diversification strategy. Port of Tauranga will also have a great chance of accomplishing

economies of scale because the business units can use each other as suppliers, which will be

profitable for the corporation. Even though it can be harder to manage a diverse corporation

because the manager is not able to be as familiar with every aspect of the business units, if

the managerial positions are delegated to the right people diversification can be very

profitable. Because the Port of Tauranga CEO diversifies the corporation around the core

business the riskiness of diversification is minimized. This paper will therefore conclude by

stating that the growth thru a related diversification strategy was a risky but most likely

profitable decision.
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