Beyond focus: Diversifying for value

Companies that manage scope effectively deliver superior returns.
Neil W. C. Harper and S. Patrick Viguerie


f all the things a company can do to improve its total returns to shareholders (TRS), honing its business

focus is acknowledged to be among the most important. Extensive research by both practitioners and academics has produced a general creed that more focused business activity typically generates higher TRS. Yet many CEOs and management teams running successful businesses have a different view based on their day-to-day experiences. Their assertion: leveraging scarce resources across multiple, even diverse businesses, is appropriate and can lead to superior value creation. They argue that at least some critical capabilities are constraining factors, including for example, management talent, or availability of capital. Moreover, they contend, investors implicitly fund strategies and management teams rather than individual projects. To reconcile these perspectives, we examined 267 companies in six industries1 in a sample including a crosssection of US business and broadly tracking the TRS performance of the S&P 500. We classified2 the companies in our sample as focused, moderately diversified, or diversified,3 using publicly reported financial information, data from analyst reports, and interviews with industry experts.4 We then assessed performance in terms of TRS and adjusted for potential differences in risk by looking primarily at excess TRS, or TRS more than the mean of the relevant industry group.

The results should surprise adherants to conventional wisdom. Over the 10-year period from 1990–2000, the focused group tallied an average annual excess TRS of 8 percent, compared with 4 percent for the diversified group (Exhibit 1). But the moderately diversified group notched up 13 percent annual excess TRS and higher median EPS (earnings per share) growth.5 Over a 20-year period, focused and moderately diversified companies again significantly outperformed diversified ones. Our conclusion: some moderately diversified business models can generate shareholder returns that are at least as strong as those generated by more focused models. The “focus is better” argument is not always the right answer, we found. And when it is, it may need a more nuanced explanation.

Diversifying for superior growth
To achieve and sustain the benefits of managing corporate scope, we looked in greater detail at the moderately diversified companies we identified. Several critical themes became clear.

Expanding options as an industr y grows and matures
Moderately diversified strategies can, if carefully applied at the appropriate time in the corporate life cycle, allow corporations to surpass multiple industry or industry subsegment growth cycles (Exhibit 2). For example, consider a company that has been a

Beyond focus: Diversifying for value | 1

Exhibit 1. Moderately diversified companies generated greater excess returns over 10 years
Cumulative excess returns to shareholders; percent 300 Focused Diversified 250 Moderately diversified 236% 13% CAGR Excess returns









0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: McKinsey analysis

single business entity, but finds itself in a rapidly maturing space with growth rates tailing off. As it reaches this point of inflection on its industry S-curve, such a company faces a set of choices to maximize value from the “legacy” business as it matures, to reinvigorate growth expectations and to create a more sustainable entity in the longer term. This typically involves trade-offs among strategies to maximize short-term cash flow, to retain customers and ensure the value of a business well into its maturity, and to leverage customer relationships to build new businesses. Corporations that have successfully carried out this strategy have moderately diversified and leveraged existing strengths. They use these

strengths to take advantage of existing or emerging external discontinuities, such as developments in technology, changes in legislation, or changes in competitive landscape, to develop a strong position on emerging or early-stage business life cycles. Such successful diversification is typically into either somewhat related industries or into new business arenas where there are clear opportunities to leverage developed or emerging capabilities. Consider Broadwing. Broadwing began life as the Cincinnati Bell local telephone company, but recognized in the 1980s that as a standalone and somewhat regulated entity its growth prospects were not highly attractive. Through an exploration of its existing

2 | McKinsey on Finance Winter 2002

Exhibit 2. Moderate diversification allows companies to transcend multiple S-curves at certain points in their life cycles

Liberate business units where net synergies are exhausted Enter new businesses where capabilities match discontinuities Cull underperforming business units rapidly Create multiple strategic options • Moderate diversification allows companies to place several bets on future potential growth opportunities • Strong focus on core business with dynamic moderate diversification generates and sustains higher growth by enabling companies to transcend multiple S-curves



Focus to build capabilities and meet expectations

Moderately diversify to grow

Reshuffle business mix through active trading of portfolio

Source: McKinsey analysis

capabilities the company recognized its strengths in certain telephony-related systems and services including customer care, billing, and telemarketing. In addition, management realized that increasing market demand for third-party provision of such services represented an opportunity. Broadwing built a significant new business to provide call-center and back-office services to third parties that by the late 1990s was larger in terms of revenue than its traditional fixed-line local telephony business. In 1998 it spun off the operation as Convergys, a business with approximately $1 billion in revenue. Over that period the excess returns to the original shareholders, who by 1998 held both Broadwing and Convergys stock, were significant.

Naturally, companies can also add value by (re)imposing a greater degree of focus to transform overly diversified portfolios to a moderately diversified or focused position. Such corporations have refocused their portfolios around related businesses to create an attractive balance between growth and more mature businesses to more effectively leverage capabilities and telegraph their growth potential to the markets. Ivax, for example, was diversified across five businesses for most of the 1990s; its portfolio included generic pharmaceuticals, intravenous products, branded pharmaceuticals, cosmetics, and specialty chemicals. Recognizing that embedded long-term growth prospects were poor in many of these industries, Ivax undertook a bold move to focus its business

Beyond focus: Diversifying for value | 3

Exhibit 3. Strong corporate scope management is associated with higher excess returns
Excess returns versus industry, 1990–2000 Average excess TRS CAGR Definition World-class scope managers 3% Exhibit mostly positive characteristics Exhibit some positive characteristics Exhibit some negative characteristics1 Exhibit mostly negative characteristics

Solid scope managers


Scope management laggards


Poor scope managers


Includes companies with “neutral” net characteristics. Source: Compustat, McKinsey's corporate performance database

portfolio. In the late 1990s it divested its specialty chemicals, cosmetics, and intravenous products businesses and made a series of international acquisitions to extend its more focused activities in branded and generic pharmaceuticals. The result: the company’s stock price has more than tripled since 1998, with more than half of the increase attributable to enhanced long-term growth expectations.

The corporations most successful at transforming their strategies, whether increasing diversification or narrowing their focus, tend to follow some basic principles. They proactively assess their capabilities and scan possible external discontinuities in their industries to shape their focus objectives and then undertake a process of actively trading assets to achieve them. They rapidly sell underperforming businesses before market pressure demands it, but they also sell or otherwise separate successful businesses as soon as the majority of synergies have been captured, so as to achieve the benefits of separation earlier. Such benefits will include improved management focus, targeted management incentive programs, enhanced strategic freedom, and an improvement in the market for corporate control. The impact of applying this approach can be significant—we found that the difference in average annual excess TRS over a 10-year period between “world class scope managers” (those that exhibited mostly positive behaviors based on these principles) and “poor scope managers” (those that exhibited mostly negative behaviors), was 11 percent. That can clearly translate into a significant amount of shareholder value (Exhibit 3). For many executives, putting these principles into action entails a change of mindset. Many management teams are reluctant to part with their strong-performing businesses, even when synergies have long been captured. But their reluctance may mean leaving a significant amount of shareholder value unrealized. For example, on average the value creation for the parent shareholder from a divestiture is about 12 percent.

Scoping out scope
To take advantage of the superior growth they can achieve by diversifying moderately at the appropriate time, companies must have a clear understanding of the degree of focus6 in their existing portfolios and their relative expected long-term growth rate.7 A thoughtful calibration of a company’s starting point along each of these dimensions can help it evaluate opportunities to reshape its corporate portfolio and compare the impact of portfolio moves to other actions to create value.

4 | McKinsey on Finance Winter 2002

In proactively monitoring and matching existing and emerging internal capabilities with external discontinuities, successful scope managers zero in on, for example, changes in technology, regulation, or consumer behavior that may create adjacent opportunities. They do this both in related businesses and in new arenas where their capabilities may provide a source of initial competitive advantage. One moderately diversified company, KimberlyClark, has dynamically reshuffled its portfolio based on its internal capabilities. The company started out in consumer products and newsprint. Over the course of the 1990s, KimberlyClark actively traded its business portfolio, continuously buying, selling, and looking for spin-off opportunities. Management closed a number of smaller, underperforming businesses where opportunities to improve were limited. The company also added to its business mix, to move into additional personal care products, leveraging its skills and capabilities and eventually diversifying into a small but growing health care business. Eventually it even leveraged the capabilities it developed while managing its own corporate jet fleet to build and manage a small airline business, which it ultimately spun off as Midwest Express. The company’s active approach to trading, continuously evaluating the growth potential of existing businesses, and mapping its skills against the needs of those businesses, allowed Kimberly-Clark to generate superior shareholder returns. As a result, the company has maintained long-term growth expectations on a rolling basis at anywhere from 10 percent to 30 percent of its share price.

of the CEO agenda. Yet a consistent view of how best to manage it is elusive. While managers are well-served to maintain a healthy bias towards focus as a starting point, pursuing a range of moderately diversified portfolio strategies, if applied at the appropriate stage in the corporate lifecycle, may help to generate and sustain significant additional growth and superior shareholder returns. MoF

Neil Harper ( is an associate principal in McKinsey’s New York office and Patrick Viguerie ( is a principal in the Atlanta office. Copyright © 2002 McKinsey & Company. All rights reser ved.

Computer hardware, oil and gas, pharmaceuticals, pulp and paper, telecom ser vices, and chemicals. Publicly repor ted revenues by business segment and repor ted Standard Industr y Classification codes are inadequate as the basis for classification, largely because Financial Accounting Standards Board revenue segments are overly broad. We defined “focused” companies as those with at least 67 percent of revenues from one business segment, “moderately diversified” companies as those with at least 67 percent of revenues from two segments, and “diversified” companies as those with less than 67 percent of revenues from two business segments. We excluded conglomerates entirely because they have already been heavily researched and we did not expect new research to reveal new insight. The impact was to change some classifications: AT&T repor ted revenues from two segments—consumer and business—hence classifying it as “moderately diversified,” and while the company does have significant consumer and business telephony operations, it also has a cable and broadband business, and, until recently, a wireless business, suggesting a “diversified” classification. These are the aggregate performance results of 37 moderately diversified companies and are consistent over both the 10 and 20 year periods. Based upon revenue share from different discrete business units. The por tion of stock price accounted for by long-term (greater than five years) market expectations, relative to the mean of industr y peers.






The appropriate breadth of the corporate portfolio, or its scope, is a critical component


Beyond focus: Diversifying for value | 5

McKinsey on Finance is a quar terly publication written by exper ts and practitioners in McKinsey & Company’s Corporate Finance & Strategy Practice. It offers readers insights into value-creating strategies and the translation of those strategies into stock market performance.

McKinsey & Company is an international management consulting firm ser ving corporate and government institutions from 85 of fices in 44 countries. Editorial Board: Editorial Contact: Editor: Managing Editor: Design and Layout: Marc Goedhar t, Bill Javetski, Timothy Koller, Michelle Soudier, Dennis Swinford Dennis Swinford Michelle Soudier Kim Bar tko

Copyright © 2002 McKinsey & Company. All rights reser ved. Cover images, left to right: © Eyewire Collection; © Jonathan Evans/Ar tville; © Ken Or vidas/Ar tville; © Eyewire Collection; © Rob Colvin/Ar tville. This publication is not intended to be used as the basis for trading in the shares of any company or under taking any other complex or significant financial transaction without consulting with appropriate professional advisers. No par t of this publication may be copied or redistributed in any form without the prior written consent of McKinsey & Company.

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