The two general types of diversification strategies are related diversification and unrelated diversification. Businesses are said to be related when their value chains possess competitively valuable cross-business strategic fits; businesses are said to be unrelated when their value chains are so dissimilar that no competitively valuable cross-business relationships exist.11 Most companies favor related diversification strategies to capitalize on synergies as follows:
- Transferring competitively valuable expertise, technological know-how, or other capabilities from one business to another
- Combining the related activities of separate businesses into a single operation to achieve lower costs
- Exploiting common use of a well-known brand name
- Cross-business collaboration to create competitively valuable resource strengths and capabilities12
Diversification strategies are becoming less popular because organizations are finding it more difficult to manage diverse business activities. In the 1960s and 1970s, the trend was to diversify to avoid being dependent on any single industry, but the 1980s saw a general reversal of that thinking. Diversification is still on the retreat. Michael Porter, of the Harvard Business School, commented, “Management found it couldn’t manage the beast.” Businesses are still selling, closing, or spinning off less profitable or “different” divisions to focus on their core businesses. For example, ITT recently divided itself into three separate, specialized companies. At one time, ITT owned everything from Sheraton hotels and Hartford Insurance to the maker of Wonder Bread and Hostess Twinkies. About the ITT breakup, analyst Barry Knap said, “Companies generally are not very efficient diversifiers; investors usually can do a better job of that by purchasing stock in a variety of companies.” Rapidly appearing new technologies, new products, and fast-shifting buyer preferences make diversification difficult.
Diversification must do more than simply spread business risks across different industries; after all, shareholders could accomplish this by simply purchasing equity in different firms across different industries or by investing in mutual funds. Diversification makes sense only to the extent that the strategy adds more to shareholder value than what shareholders could accomplish acting individually. Any industry chosen for diversification must be attractive enough to yield consistently high returns on investment and offer potential across the operating divisions for synergies greater than those entities could achieve alone. Many strategists contend that firms should “stick to the knitting” and not stray too far from the firms’ basic areas of competence.
A few companies today, however, pride themselves on being conglomerates, from small firms such as Pentair Inc. and Blount International to huge companies such as Textron, Berkshire Hathaway, Allied Signal, Emerson Electric, GE, Viacom, Amazon, Google, Disney, and Samsung. Conglomerates prove that focus and diversity are not always mutually exclusive. In an unattractive industry, for example, diversification makes sense, such as for Philip Morris, because cigarette consumption is declining, product liability suits are a risk, and some investors reject tobacco stocks on principle.
1. Related Diversification
Alcoa recently diversified further into the jet-engine parts industry by acquiring Firth Rixson Ltd. for nearly $3 billion. The move away from total reliance on aluminum puts Alcoa in position to become a major player in the aerospace jet-engine market. Jet engines utilize a lot of aluminum but still this strategy is best classified as related diversification rather than forward integration due to the new high-tech competencies required.
With its new Apply Pay product being linked with iBeacon so stores can detect and locate iPhone users via a Bluetooth wireless signal as they enter the premises, Apple recently entered the online payments business, competing directly with PayPal. Using their iPhone and/or Apple Watch, consumers can now make retail purchases by tapping their device at participating checkout registers. Apple is basically diversifying into the banking business with these new products, but the threat to PayPal in particular is spurring eBay and Google to cooperate in this arena.
The guidelines for when related diversification may be an effective strategy are as follows.13
- An organization competes in a no-growth or a slow-growth industry.
- Adding new, but related, products would significantly enhance the sales of current products.
- New, but related, products could be offered at highly competitive prices.
- New, but related, products have seasonal sales levels that counterbalance an organization’s existing peaks and valleys.
- An organization’s products are currently in the declining stage of the product’s life cycle.
- An organization has a strong management team.
2. Unrelated Diversification
Privately held Mars Inc., best known for its M&M chocolates and its Mars and Snickers candy bars, recently became the world’s largest pet-food company, purchasing 80 percent of Procter & Gamble’s pet-food brands for $2.9 billion, to go with its own Whiskas, Pedigree, and Royal Canin pet brands. Mars has over 25 percent market share in the global pet-food industry, slightly ahead of Nestle S.A., which owns Purina and Friskies.
Google now offers an electric-powered driverless car that has no steering wheel, brake, or gas pedal; rather, the car is equipped with buttons for go and stop, and travels at a top speed of 25 mph. Further diversifying, Google recently acquired Skybox Imaging to collect and provide data from the sky using satellites that collect daily photos and video of the Earth. With the acquisition, Google is also trying to cover the globe with fast Internet access from the sky, using balloons, drones, and satellites.
Honda Motor Company diversified in 2015 by developing, producing, and marketing its first business jet, named the HondaJet HA-420 that has a range of 1,180 miles and a top speed of 420 knots, and can carry seven passengers. This new product competes directly with the Cessna Citation M2 and Embraer Phenom 100E business jets. These business jets sell for about $4.5 million each.
An unrelated diversification strategy favors capitalizing on a portfolio of businesses that are capable of delivering excellent financial performance in their respective industries, rather than striving to capitalize on value chain strategic fits among the businesses. Firms that employ unrelated diversification continually search across different industries for companies that can be acquired for a deal and yet have potential to provide a high return on investment. Pursuing unrelated diversification entails being on the hunt to acquire companies whose assets are undervalued, companies that are financially distressed, or companies that have high-growth prospects but are short on investment capital.
Given below are 10 guidelines when unrelated diversification may be an especially effective strategy.14
- Revenues derived from an organization’s current products or services would increase significantly by adding the new, unrelated products.
- An organization competes in a highly competitive or a no-growth industry, as indicated by low industry profit margins and returns.
- An organization’s present channels of distribution can be used to market the new products to current customers.
- New products have countercyclical sales patterns compared to an organization’s present products.
- An organization’s basic industry is experiencing declining annual sales and profits.
- An organization has the capital and managerial talent needed to compete successfully in a new industry.
- An organization has the opportunity to purchase an unrelated business that is an attractive investment opportunity.
- Financial synergy exists between the acquired and acquiring firm. (Note that a key difference between related and unrelated diversification is that the former should be based on some commonality in markets, products, or technology, whereas the latter is based more on profit considerations.)
- Existing markets for an organization’s present products are saturated.
- Antitrust action could be charged against an organization that historically has concentrated on a single industry.
Source: David Fred, David Forest (2016), Strategic Management: A Competitive Advantage Approach, Concepts and Cases, Pearson (16th Edition).