Philips produces a range of electronic home equipment
• Some firms produce unrelated products – unrelated diversification e.g. Saab produces motor cars and fighter aircraft
• Seek to explain why related and unrelated diversification occurs and assess the performance of such diversification
MOTIVATIONS
Economies of scope
• Exist where it is cheaper to produce two or more products within one firm rather than independent firms producing each product
• Other sources of economies of scope come from using firms’ underutilised resources
? Exploit common technologies, assets, distribution channels
• Dominant general management logic
? managers that have invested in management skills believe they can use them across a variety of product markets
Synergy
• A Resource has greater utilisation when used in conjunction with a complementary resource
• Complementarity between resources exist when revenues (costs) are higher (lower) when two resources are owned by one firm rather than two owners
• These resources can be physical but also include non-physical resources as suggested by the RBV
Financial synergies (internal capital market)
• A cash-rich business can cross-subsidise a cash constrained business
? Only successful if profitable investments are made that would not otherwise be made
• Predicated on failure of capital markets to finance profitable projects
Diversifying shareholders’ portfolio
• Diversification ensures a stable cash flow for shareholders
? Managers who have invested in firm-specific skills have more to gain from this than shareholders
? Shareholders can diversify their portfolio of equity holdings
Economising on transactions costs
• The multi-product firm exists where it economises on transactions costs
? alleviate coordination problems
? alleviate ‘hold-up’ problem
• Detrimental effects of vertical integration
? Influence costs
? Costly control systems used to reduce opportunistic behaviour
Managerial reasons
• Corporate governance concerned with ensuring managers act in shareholders’ interests
• Managers use diversification to pursue growth
? buy growth that cannot be achieved internally
? pecuniary and non-pecuniary benefits to managing large firms
• Unrelated diversification may be pursued if limits to related diversification are reached
• Managers invest in firm-specific skills that have lower value outside the firm
? unrelated diversification spreads risk and lowers risk of firm failing
• Manager-specific investments used to entrench incumbent management
STRATEGIES TO ACHIEVE DIVERSIFICATION
• Internal development - invest in resources to allow production of new output
? Managers do not have to share specialised knowledge
? Managers maintain control of firms’ activities
• Mergers and acquisitions - purchase another firm
? Internal development of resources might not be possible or too costly
? Quick method of diversification relative to internal development
• Joint ventures and alliances – two or more organisations share resources and activities
? Pursue common strategy without formal integration
? exploit complementary assets without integration
? learn from partner(s) with intention of bringing activities ‘in-house’
• Licensing – right to manufacture patented product for a fee
? Do not bear costs of developing resources and capabilities for development, production, and distribution
? Difficult to maintain quality control e... displayed 300 characters
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DuPont licensed Teflon production to Chinese firms
PERFORMANCE OF DIVERSIFIED FIRMS
Accounting data
• Firm performance higher with moderate levels of diversification
? Especially when diversification is within a narrow range of markets
? Consistent with exploiting economies of scope and resource complementarity
• High levels of unrelated diversification result in poor performance
? Consistent with managerial motivation
Share price studies
• Performance gains are realised only with related diversification
• When parent firms’ contribute specialised resources performance is superior to firms that diversify using unspecialised resources (e... displayed 300 characters
