Diversifying

This textbook extract describes the different levels of diversification with different corporate strategies. It also
provides clear reasons behind why firms diversify.
Corporate-Level Strategy
A corporate-level strategy specifies actions a firm takes to gain a competitive advantage by selecting and
managing a group of different businesses competing in different product MARKETS . Corporate-level
strategies help companies select new strategic positions positions that are expected to increase the firms value.
The decision to take actions to pursue growth is never a risk-free choice.
Given that the diversified firm operates in several different and unique product MARKETS and probably in several
businesses, it forms two types of strategies: corporate level (or company-wide) and business level (or
competitive). Corporate-level strategy is concerned with two key issues: in what product markets and businesses
the firm should compete and how corporate headquarters should manage those businesses.
Levels of diversification
Diversified firms vary according to their level of diversification and the connections between and among their
businesses. Figure 1 lists and defines five categories of businesses according to increasing levels of diversification.
The single and dominant-business categories denote relatively low levels of diversification; morefully diversified
firms are classified into related and unrelated categories. A firm is related through its diversification when its
businesses share several links; for example, businesses may share products (goods or services), technologies, or
distribution channels. The more links among businesses, the more constrained is the related-ness of
diversification. Unrelatedness refers to the absence of direct links between businesses.
Figure 1 Levels and Types of Diversification
Low levels of Diversification
Single business: 95% or more revenue comes from a single business.
Dominant business: Between 70% and 95% of revenue comes from a single business.
Moderate to High Levels of diversification
Related constrained: Less than 70% of revenue comes from the dominant business and all businesses
share product, technological and distribution linkages.
Related linked (mixed related and unrelated): 70% of revenue comes from the dominant business
and there are only limited links between businesses.
Very High Levels of Diversification
Unrelated: Less than 70% of revenue comes from the dominant business and there are no common
links between businesses.
A. Low levels of diversification
A firm pursuing a low level of diversification uses either a single or a dominant-business, corporate-level
diversification strategy. A single-business diversification strategy is a corporate-level strategy wherein the firm
generates 95 per cent or more of its sales revenue from its core business area. For example, Wm Wrigley Jr
Company, the worlds largest producer of chewing and bubble gums, historically used a single-business strategy
while operating in relatively few product MARKETS . Wrigleys trademark chewing gum brands include Spearmint,
Doublemint and Juicy Fruit, although the firm produces other products as well such as Sugar-free Extra, introduced
in 1984.
In 2005 Wrigley shifted from its traditional focused strategy when it acquired the confectionery assets of Kraft
Foods Inc. As Wrigley expanded, it may have intended to use the dominant business strategy with the
diversification of its product lines beyond gum; however, Wrigley was acquired in 2008 by Mars, a privately held
global confectionery company (the maker of Snickers and M&Ms).
With the dominant-business diversification strategy, the firm generates between 70 and 95 per cent of its total
revenue within a single business area. United Parcel Service (UPS) uses this strategy. Recently, UPS generated
56 per cent of its revenue from its US package delivery business and 28 per cent from its non-US package
business, with the remaining 17 per cent coming from the firms non-package business such as logistic services.
Although the US package delivery business currently generates the largest percentage of UPSs sales revenue, the
firm anticipates that in the future its other two businesses will account for the majority of revenue growth. This
expectation suggests that UPS may become more diversified, both in terms of its goods and services and in the
number of countries in which those goods and services are OFFERED .
B. Moderate and high levels of diversification
A firm generating more than 30 per cent of its revenue outside a dominant business and whose businesses are
related to each other in some manner uses a related diversification corporate-level strategy. When the links
between the diversified firms businesses are rather direct, a related constrained diversification strategy is being
used. Campbell Soup, Procter & Gamble and Merck & Company all use a related constrained strategy, as do some
large cable companies. With a related constrained strategy, a firm shares resources and activities between its
businesses.
The diversified company with a portfolio of businesses that have only a few links between them is called a mixed
related and unrelated firm and is using the related linked diversification strategy (see Figure 1). General Electric
(GE) use this corporate-level diversification strategy. Compared with related constrained firms, related linked firms
share fewer resources and assets between their businesses, concentrating instead on transferring knowledge and
core competencies between the businesses. As with firms using each type of diversification strategy, companies
implementing the related linked strategy constantly adjust the mix in their portfolio of businesses as well as make
decisions about how to manage these businesses.
A highly diversified firm that has no relationships between its businesses follows an unrelated diversification
strategy. United Technologies, Textron, Samsung and Hutchison Whampoa Limited (HWL) are examples of firms
using this type of corporate-level strategy. Commonly, firms using this strategy are called conglomerates.
HWL is a leading international corporation committed to innovation and technology with businesses spanning
the globe. Ports and related services, telecommunications, property and hotels, retail and manufacturing, and
energy and infrastructure are HWLs five core businesses. These businesses are not related to each other, and the
firm makes no efforts to share activities or to transfer core competencies between or among them. Each of these
five businesses is quite large; for example, the retailing arm of the retail and manufacturing business has more
than 6200 stores in 31 countries. Groceries, cosmetics, electronics, wine and airline tickets are some of the
product categories featured in these stores. This firms size and diversity suggest the challenge of successfully
managing the unrelated diversification strategy. However, Hutchisons CEO Li Ka-shing, has been successful at not
only making smart acquisitions, but also at divesting businesses with good timing.
Reasons for diversification
A firm uses a corporate-level diversification strategy for a variety of reasons (see Table 1). Typically, a
diversification strategy is used to increase the firms value by improving its overall performance. Value is created
either through related diversification or through unrelated diversification when the strategy allows a companys
businesses to increase revenues or reduce costs while implementing their business-level strategies.
Other reasons for using a diversification strategy may have nothing to do with increasing the firms value; in fact,
diversification can have neutral effects or even reduce a firms value. Value-neutral reasons for diversification
include those of a desire to match and thereby neutralize a competitors MARKET power (such as to neutralize
another firms advantage by acquiring a similar distribution outlet). Decisions to expand a firms portfolio of
businesses to reduce managerial risk can have a negative effect on the firms value. Greater amounts of
diversification reduce managerial risk in that if one of the businesses in a diversified firm fails, the top executive of
that business does not risk total failure by the corporation. As such, this reduces the top executives employment
risk. In addition, because diversification can increase a firms size and thus managerial compensation, managers
have motives to diversify a firm to a level that reduces its value. Diversification rationales that may have a neutral
or negative effect on the firms value.
Table 1 Reasons for Diversification
Value-Creating Diversification
- Economies of scope (related diversification)
Sharing activities
Transferring core competencies
- MARKET Power (related diversification)
Blocking competitors through multi-point competition
Vertical integration
- FINANCIAL economies (unrelated diversification)
Efficient internal capital allocation
Business restructuring
Value-Neutral Diversification
- Antitrust regulation
- Tax laws
- Low performance
- Uncertain future cash flows
- Risk reduction for firm
- Tangible resources
- Intangible resources
Value-Reducing Diversification
- Diversifying managerial employment risk
- Increasing managerial compensation