DIVERSIFICATION AS A CORPORATE STRATEGY 1

Diversification as a Corporate Strategy

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Introduction

Diversification has been a central factor in strategic management of most businesses. It is

a strategy in business in which an organization ventures in market field that is different from its

main activity, enabling a spread out rather than specialization. In order to advance their

economic progress, most businesses in the Kingdom of Saudi Arabia have incorporated

diversification into their operations. Corporate diversification in business is one vital way

companies in KSA can use to achieve their vision by 2030. The mostly used strategy for

diversification in Saudi Arabia is internal capacity expansion and this is achieved by adding new

products in their line of business. A large percentage of the top corporations are managed on

factors which include acquisition of highly trained operatives, skilled and competent staff,

Resource Based Value (RBV) and finally, ability to work with and retain quality subcontractors

as well as specialists. Common strengths identified among these corporations are majorly based

on the skill and competency of their technical staff. On the other hand, their weaknesses in

diversification are rooted on the grounds of technology and communication, and also

engagement in a variety of activities that are not actually related to the business. This paper

discusses diversification in business with special focus on Saudi Aramco, detailing the

company’s strategic details and the circumstances that motivated the company to diversify. It

also discusses mode of diversification adopted by the firm and how it is relatable to its resources

and capabilities. Finally, it gives the benefits and implications of the chosen strategy for

diversification in the specific industry for the firm’s management systems and decision making.

Diversification in Saudi Aramco

Strategic Details and Circumstances for Diversification

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Also known as Saudi Arabian Oil Company, Saudi Aramco has recently diversified its

operations and brand by venturing into the fast growing market of natural gas. The company’s

strategy was to become the largest International Oil Company (IOC). Aramco saw that natural

gas is an important fuel and it was soon going to be the fuel of the future dominating the realm of

renewable energy. Natural gas provides a cleaner energy source that bridges energy demand

from coal to renewables. Natural gas is a primary source of stocking the chemical industry

providing the country’s the largest ethylene and propylene production. Saudi Arabia is a big

producer of natural gas but has not grown to become an international player in the market. A

company, Saudi Basic Industries Corp (SABIC) operates 100% on production of the commodity.

Aramco was previously a dominant player in the crude oil and petroleum products industry. It

therefore saw the need to also dominate the hydrocarbon business. As the company sought

greater diversification, it struck a merger deal with SABIC. This was a move intended to gain

benefit from the firm’s experience and technology in chemicals, as it also expanded its own

chemical and refining downstream operations.

Aramco’s merger with SABIC is a perfect strategy to make the company a bigger IOC. A

large percentage of IOCs internationally have dominance in both the downstream and upstream

gas production. SABIC being a major producer of natural gas, is expected to boost Aramco’s

presence in the chemical industry; not only locally but internationally as well. This strategy of

growing its natural gas market both locally and internationally is expected to allow Aramco to be

viewed in the markets as comparable as or most probably more significant than ExxonMobil.

Additionally, the company would be valued at multiple earnings just as the other major IOCs.

Why ExxonMobil? ExxonMobil is the largest IOC that bases its operations on refining and

chemical processing and is valued at a price-to-earnings ratio (P/E) of about 24.

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Mode of Diversification, Resources and Capabilities at Aramco

Aramco on creating a merger with SABIC utilized the acquisition-based mode of

diversification rather than internal growth. Acquisition is the most preferred diversification mode

because it offers a cheaper option as compared to internal growth. Aramco’s diversification in

this case takes the form of an unrelated-diversified business. This is because operations of the

two companies are not related in their production; with one of them producing Petroleum and

Crude oil products and the other producing natural gas. Utilization of acquisition and mergers as

a diversification strategy for Aramco worked out to be effective for the company’s growth. It

was a means for the company to reach out to a larger market that is more vibrant with regard to

pricing, availability of resources and cheap labor. Aramco’s readiness for the change served as

an additional advantage in the merger.

In the upstream (refining), Aramco is the largest crude oil producer operating the world’s

largest oil fields. Having the ninth-largest and eighth-largest natural gas reserves and production

respectively, Aramco does not import of export gas nor does it use large volumes for

downstream (chemical processing) activities in production. Most of the natural gas produced is

sold to utility companies which use it to desalinate water and produces electricity. In addition, it

is utilized by SABIC for transformation of chemicals and fertilizers. Aramco is the fourth-largest

refiner in the world in the downstream. It intends to increase its production capacity from 4.9

million to 10 million barrels per day (b/d). Having little investments in chemicals in joint

ventures with foreign firms, the merger with SABIC would make Aramco a major player

worldwide based on the management and technology in Saudi. At its disposal for becoming a

large IOC, Aramco had internal funds that were raised by the initial public offering (IPO).
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However, as this is not enough for the acquisition, Saudi’s leadership would have to sell some of

its existing holdings and also borrow substantial funds from international financial markets to

finance its immediate acquisition requirements.

Benefits of Diversification for Aramco

Diversification is generally an opportunity for any company to go beyond the scope of

their areas of expertise. Achieving corporate success is essential and this was possible for

Aramco who by acquiring SABIC, were able to increase their revenue. First of all, the merger

was able to create jobs for Saudi nationals in both the engineering and management departments.

This is in line with the country’s vision to create well-paying and high quality technical jobs for

its nationals. Secondly, Aramco was able to realize even more sophisticated ways to expand its

move in the downstream and additionally bypass overreliance on foreign firms such as

DowDuPont. Thirdly, upon acquisition, SABIC came in with its large department of research

which had issued a total of 12,291 patents. In addition to the strong research and development

team in the oil upstream at Aramco, the merger expanded the company’s research in IOCs with a

new venture in chemicals. Finally, since specialized sales efforts are required for more advanced

chemicals, Aramco got to acquire an already established and extensive worldwide marketing

organization. Technical sales in the chemical industry require salespersons that have a deep

understanding of the industry as well as client needs and extensive chemical manufacturing

experience. Aramco had the advantage of hitting the ground running by getting access to

SABIC’s sales organization and therefore eliminate the need to depend on unnecessary joint

ventures.

Implications of Diversification for the Organizational Structure and Decision Making

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The acquisition of SABIC had three major implications on Aramco’s operations. These

implications are a change in management systems, organizational structure and protocol for

making decisions. A 70% acquisition of SABIC meant that Aramco had taken control of the

merged business with its staff being answerable to the management of Aramco. The firm’s CEO

doubles as the minister for energy in the Kingdom of Saudi Arabia. Since SABIC had excellent

management practices amongst its team members, Aramco had no option but to retain and even

promote staff members from SABIC and especially its managers. These key decisions were

made by Aramco’s board and its CEO. However, SABIC had major divisions that would bring

about distraction in the management of Aramco. This was expected to cause redundancies in

both companies which would in turn impact the kingdom’s employment opportunities. The main

impact feared was the tension that would be created among the well-educated and well-paid

employees in the country who relied on the downstream production economy.

Conclusion

In the recent past diversification has become an important corporate strategy for many

businesses. The KSA has not been left behind with some of its top companies such as Aramco

embracing diversification. Aramco’s acquisition of SABIC is an example of unrelated

diversification. It had several benefits for both companies especially in the chemical industry.

However, it also had implications on the organizational structure and management systems.
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References