Business strategy planning is involved in crafting a path for the business in its chosen product market, to position the product such as to gain a competitive advantage over its competitors and as a long-term phenomenon to enter a new market or develop a new product all in a bid to sustain its competitive advantage. As pointed above in a bid to sustain a competitive advantage or increase the value of the business, some firms diversify. Diversification moves away from its present markets and its present products at the same time. In this article diversification would be discussed under three forms related, unrelated and multinational diversifications.
Related diversification comes about when the organization moves or diversifies into a new product and new market which are considered as related business activities. For example a paper producing company may diversify into book publishing known also as concentric diversification, it is sometimes argued as to whether this is a true form of diversification. The spate of companies using diversification as a form of expansion cannot be over emphasised due to the advantages and the likelihood that similar customers in similar markets might be reached. Some of the reasons for related diversification are discussed here.
The company spreads the risk by engaging into a related product and market using in most instances the same experience. To ensure continuity of supply, a manufacturer may try to own its own supply outlets; say a car manufacturer produces its own components. The aircraft manufacturer, Boeing’s Integrated Defense systems, for example is a subsidiary established to integrate and provide instantaneous, accurate and protected information to decision makers and soldiers in the field when they need it, anytime, anywhere.
Sometimes it is difficult to distinguish when a strategy is a generic differentiation or a related diversification. The rationale for related diversification is strategic. This is to say that firms diversify into businesses with strategic-fit thereby sharing opportunities that may exist in the businesses’ value chains. By strategic-fit is meant when the business identifies the opportunities arising from the environment – shared technology, common labour skills, common distribution channels, similar operating methods – and adapting resources so as to take advantage of them which invariably leads into gaining a competitive advantage to achieve the desired goal.
Another reason for related diversification is that it helps the firm achieve economies of scope. These economies of scope arise from ability to eliminate or reduce cost significantly by operating two or more business under one corporate headquarters; or when cost-saving opportunities can stem form interrelationships anywhere along business value chains. Synergy is another reason for related diversification. This occurs when the combined effect of the two is greater than the sum of the parts. This is a claim by Benetton in 1995 that there were synergies resulting from its diversification.
Unrelated diversification is based on the dominant concept that any company that can be acquired on good financial terms and offers good prospects for profitability is a good business to diversify into. It is basically a financial approach. This is to say that the strategic position of the business gives it the advantage to diversity into an unrelated business expecting financial gains compared to strategic-fit as in related diversification. Firms usually pursuing unrelated diversification as a strategy are referred to as conglomerates with no unifying strategic theme. Until recently the literature on diversification has only been on environment-led perspective thus portraying a narrow benefit beyond the current product and market base of the firm and outside their value chains. The introduction of resource-led perspective broadens the degree of relatedness and its attendant opportunities. Unrelated diversification can be approached by any of the following methods.
Exploitation of the current core competences of the organization by extending existing markets into new markets and new products. It could also come about by the creation of completely new markets. This is usually seen as opportunities coming as a result of the core business, for example Kwik Fit offering insurance services.
The other approach is developing new competences for new market opportunities. Some of the advantages which come with unrelated diversification may include spreading of business risks over a variety of industries; providing opportunities for quick financial gain if bargain-priced firms with big profit potential are spotted thereby enhancing shareholder’s wealth. Again, profit or earnings are greatly stabilised as one industry’s hard times is off set by good times in others.
Nevertheless, certain drawbacks are prevalent in going that path. Achieving these aforementioned advantages, places big demand on corporate management. They had to be extremely small to spot problems. More businesses in a conglomerate, the harder it is for management to judge the strategic plans of business manager in any subsidiary or business unit. It is finally argued that consolidated performance of unrelated businesses tends to be no better than sum of individual businesses or their own or may be worse; unless managers are very talented and focused, unrelated diversification cannot be used to increase shareholder wealth compared to related diversification. It must be noted here that development into new related or unrelated businesses can take any of three forms: internal development – where strategies are developed by building up the organization’s developed resources and competences by taking over another one; and joint developments or strategic alliances where two or more organisations share resources and activities to pursue a strategy.
Multinational diversification is considered as one of four strategic paths for improving a diversified company’s performance once diversification is accomplished. Multinational diversification involves diversify of businesses and diversity of national markets. It presents a big challenge to strategists. Management must devise and execute substantial number of strategies (at least one for each industry with as many multinational variations as is appropriate). In spite of the challenges it poses, multinational diversification strategies have considerable appeal. They offer two avenues for long-term growth in revenues and profitability-one is to grow by entering additional businesses and the other is to grow by extending the operations of existing businesses into additional country markets. Virgin could be said to be pursuing such a strategy.
Furthermore, multinational diversification offers six ways to build competitive advantage:
I. Full capture of economies of scale and experience curve effects. As the firms market and product base increases, it is able to spread cost
Ii.opportunities to capitalise on cross-business economies of scope using the talent available in the business’s value chains
Iii.opportunity to transfer competitively valuable resources from one business to another and from one country to another
iv.ability to leverage use of a well-known and competitively powerful brand name
v.ability to capitalise on opportunities for cross-business and cross-country collaboration and strategic coordination and
vi.Opportunities to use cross-business or cross-country subsidization to wrestle sales and market share from rivals.
It is worth commenting that diversification s one of the most frequently researched areas of business with some research studies specifically attempting to investigate the relationship between diversification as a business strategy and the organisation’s financial performance. For quite sometime researchers suggested that unrelated diversification were deemed unprofitable in comparison with related diversification. Such as car makers’ diversification into car rental. These early research finding were later questioned as to the linkage of diversification to an organisation’s financial performance, However, the main problem has been the failure of organisations to determine the nature or degree of relatedness.
Nagyar (1992) identified two areas of potential relatedness:
i.opportunities for resource leveraging: He argued that two businesses are related if all types of tangible and intangible resources can be achieved by physically transferring resources from one business unit to another; by copying resources form each other and using resources simultaneously e.g. using same brand name.
Ii.Opportunities for strategy alignment: He argued that two businesses are related if the alignment of their market strategies creates benefit. In other words, coordinated behaviour between businesses gives them the needed competitive advantage. For example horizontally related businesses team up to multiply their effective market power on competitors as well as vertically related businesses units may be preferable to independent buyers and suppliers.
Though, diversification may be difficult to achieve fully in practice, diversification may simply be necessary to achieve continuing growth when the current markets become saturated.
We have many more Financial Planning Help Articles Now Available.