Diversification has gained much more attention by the management scholars during last few decades. Diversification has been playing a pivot role in firms’ growth. The study addresses the issue of organizational factors that affects the outcomes of diversification. Previous literature has been studied extensively and an attempt is made to conclude how different organizational factors influence the effectiveness of firms’ diversification and how these factors are to be taken care of. The results provide strong implications for executives to exercise diversification and to take care of its related factors to sustain its growth and competitive advantage.
Diversification characterizes a distinguishing departure from current businesses operational procedures to acquiring or establishing new business, which are capable to provide synergetic benefits by the proper balancing of strengths and weaknesses of two business units (Rasoava et al, 2003). The risk attached with the firm’s existing position is found to be greater than the risk of firm’s diversification into new business. Diversification into new business is always considered as a most risky task and it should be taken into action after careful investigation of alternatives. As it is game of opportunity and risk so a proper balance is required to get advantage to go into new business. A firm is considered to have capabilities on which it would get competitive edge when it intended to inter into an unrelated business. Such competitive edge, in turn, entails that a firm has some distinguishing competence to establish a new venture. Distinguishing competence is expected to drive the acquisition plan and determine the firm’s choice of precise strategies and expected to enjoy synergetic benefits. BCG matrix provided by British Consulting Group is considered as a hallmark to determine the financial capabilities of Strategic Business Units in multi-business corporations. The too much cash produced by the cows would go to financing promising tentative ventures. The succeeding ventures would fall in the category of stars and when their market matures, produce excessive cash to launch new ventures. The remainder of the paper is organized as follows; the next section reviews some significant studies on the critical factors that potentially effects the results of diversification, and final part consists of discussion and conclusion which also suggesting some implications for executives and future avenues for researchers.
The factors that decide the success or failure of firm’s diversification heavily based upon the proper combination of aspiration and capabilities. Milton (1986) provides a model that exhibits a proper fit among firm’s distinctive capability, firms competence to manage diversification and desired level of benefits. Three levels of managers are contrasted in this model with low, medium and high level of synergetic benefits. The valid approach for a firm desirous of financial synergy is to develop a combination of business with necessary financial factors. The better the synchronization between financial strengths and weaknesses, the greater level of synergy is expected for the whole corporation (Milton, 1986).
According to Rasoava et al, (2003), several motivational drives are found due to which firms go for diversification includes the enhancement of stock value, & growth rate of the firm, better utilization of funds and assets instead of internal investment, revenue growth, sustaining competitive advantage, to enhance and sustain efficiency and profitability. But there is traditional wisdom for the guidance of managers as diversification may increase the firm’s profitability, while on the other hand, as the risk attached to it, it may sometime leads firm to the undesirable outcomes (Markides, 1997). These outcomes include reduce organizational fit, instability in earning, loss of strategic focus and lower profitability and efficiency (Biggadike, 1979; Porter 1996; Zook and Allen, 2001). It is difficult for a firm to first recognize its strength and weaknesses and in order to have a balanced fit with the new venture (Markides 1997).
As the high risk is found to be attached with diversification, it may provide the result such as improper fit with instability and loss of strategic focus in the current and new venture, diversification strategies that my reduce the level of this risk and promise high profitability are required (Davis and Devinney, 1996; Porter, 1996; Markides, 1997). To gain sustainable profitability, diversification strategies must include the themes such presence of core business, diversification into the business that are much more close to the existing business and to leverage the skills from existing business. Zook (2001) postulates that most business could not gain the desirable growth due to improper diversification strategies. In order to gain desired objectives, firms must evaluate first their key assets related to diversification. For instance, firm must identify its customers, competences, products, distribution channel and other strategic assets like patents, position and brands and then logically diversify the firms into closely related venture (Zook, 2001). Managers must know the competitive advantage of their firms at the time of diversification (Markides, 1997).
To gain financial synergy, a firm must have to be much rational in its financial and strategic calculation. Parent company usually not involved actively in the managing acquisitions, however it must be capable enough to justify the value of acquisition in financial perspective. Financial constraints such as reduction of corporate risk, tax losses and other financial factors should be analyzed very carefully (Rasoava et al, 2003). To achieve the successful diversification firm must recognize and understand the true strengths and key assets, extending the strategic position and acquiring the full potential of the core business (Chatterjee and Wernerfelt, 1988; Amit and Livant, 1989; Campbell and Goold; 1995, Porter, 1996; Zook and Allen, 2001). Porter (1996) suggests that firms must not destabilize its current competitive advantage. Diversifying firms should leverage their capabilities and resources into all the areas in which such resources may contribute to gain and sustain competitive advantage (Collis and Montgomery, 1995). It is therefore noted that diversifying firms must not loose their strategic focus. Porter (1987) reported than less than10% companies experienced successful diversification while more than 70% companies that diversified their business into related areas (Porter, 1987; Zook, 2001). Zook and Allen (2001) propose that consistent growth model is that of the strong central business that get benefit from continuous reinvestment, responding constantly to environmental changes, and leveraging the competitive edge developed by these competences into new channels, market or geographies and channels.
Porter (1996) postulated that firms erode their competitive edge which is based upon their original focused market through diversification by compromising strategically and permitting inconsistencies among their current business and new venture. This is in connection with the Porter’s (1987) findings in which he was of the view that firms must analyze their core business very carefully which is found to be a foundation stone of corporate diversification. Firms extend their product lines, addition of new features in the products, benchmarking and acquiring other business when face pressure to proceed in grown-up market (Rasoava et al, 2003). Such practices usually provide top line growth such a growing revenue but decline in overall firm’s profitability. Porter (1996) quoted an example of Maytag Corporation which extends its business, diversified into other appliances and acquired other businesses as well result in the increase in revenue but decline in return on sale. In this connection, Zook and Allen (2001) reported that the firms which grow their revenue rather than profitability did not experience the increase in economic value on long term basis.
Porter (1996) reports some factors due to which firms fail to gain desired outcomes through diversification. Those factors include first, when firms attempt many ways instead of sing to gain the competitive advantages as happened with Maytag Corporation. They experienced in several brands in unrelated position. Secondly when firms fail to achieve strategic alignment between their corporate strategies and acquired products, features and services. Third Companies which failed to get the desired outcomes from diversification, extend their business into the market where they have nothing special to offer.
Information asymmetry is found to be another reason of failure of firm’s diversification. According to the one school of thought, diversification is found to be positively linked to synchronization and economies of scope (Chandler 1992). On the other hand, Stulz (1990) suggested that the level of Information asymmetries greater, the over-investment and misallocation of physical and human resources will be higher. Keeping in view the both school of thought, the agency costs is found to be a strong predictor of the firm profitability than synchronization and economies of scope Berger and Ofek (1995).
Rasoava et al, (2003) offers the following recommendation to make the diversification a success story. Competitive advantage, as its nature, is not as much sustainable as required therefore firms should continuously invest to sustain their competitive advantage. Beside this firms must carefully analyze their core business before going into diversification. Companies should also examine whether new venture will provide added value to the core business or vise versa. In case of multi-business, corporations must evaluate its strategic business units (SBU) in term of their core business and if an SBU does not provide the desired outcomes as expected, it should be liquidated before investing more on such ventures.
In the light of discussion, it can be noted that the organizational factors which influence the success of diversification should be examined very carefully. This issue has still been unattended in Pakistani context. To fill this gap an attempt has been made to analyze the theories and draw the conclusion on the basis of previous studies conducted in western context.
Discussion and Conclusion
The issue of success or failure of firm’s diversification has remained a matter of great concern during past few decades. The present research attempted to draw some conclusion on the basis of previous literature and theories conducted to explore the factors due to which firms experience success or failure of diversification. In the light of above mentioned literature it is concluded that the strategic alignment of core business with new venture, positioning in product/services lines, reinvestment, communication and proper match between firm’s strengths and weakness are favorable for firms in getting the diversification. Communication gap and improper match between firms’ strategies and new or acquiring firms and lack in strategic alignment lead firms to the failure of diversification. Furthermore, constant and well equipped attempts should be made on continuous basis to investigate the environments and extract opportunities and threats from that information. Successful diversification leads firms to higher profitability, expansion in businesses and high shareholder value. To gain financial synergy, a firm must have to be much rational in its financial and strategic calculation. Parent company usually not involved actively in the managing acquisitions, however it must be capable enough to justify the value of acquisition in financial perspective.
The author also put emphasis on the need to have a careful insight by the executives on different dimensions of firms’ diversification and how to avoid diversification failure and how to enjoy the potential benefits of diversification. Manager should take appropriate measure to improve communication and environmental screening methods. Organization should take necessary measures to develop the favorable inclination of discussed above critical factors with the diversification. The study has some limitations as well. First of all, organizational factors that influence the result of diversification should be analyzed empirically. Secondly, all factors should be analyzed carefully to get the accurate picture. The study can further be extended by including other organizational factors such as organizational culture and change management and analysis of applicable methods of launching new business or hunting new opportunities