Advantages and Disadvantages of Diversification

DIVERSIFICATION 1. Introduction Diversification refers to a strategic direction that takes companies into other products and/or markets by means of either internal or external development. There are basically two broad forms of diversification as listed below: Related diversification, occurs when a company develops beyond its present product and market whilst remaining in the same area. For example a newspaper company expanding by acquiring a TV station remains with media sector. It will use its present strengths by using its expertise to develop new interests in same area. This form of diversification can further be broken down:

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Backward diversification, when activities related to the inputs in the business are developed. For example a newspaper company acquiring a printing or publishing company.

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Forward diversification, refers to development into activities which are concerned with a company’s output. For example a newspaper company acquiring a distribution outlet.

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Horizontal diversification, occurs when a company develops interests complementary to its current activities. For a company may integrate its activities to include all aspect of the value chain; design, manufacture, market and distribute.

Unrelated diversification is used to describe a company moving its present interests into unrelated markets or products. For example a company whose core business is media services may diversify into provision of financial services.

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2. Alternative methods for carrying out diversification 

Internal development

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External, through acquisition or strategic alliances

Managers should bear in mind that the acquisition alternative should be seen as both a risk and an opportunity, therefore a clear promotion and management development strategy must be in place at the time of the take over. In order to test the effectiveness of acquisition as an alternative strategy the following five simple rules may be used as suggested by Drucker:

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The acquiring company must consider what value it can add to the acquired business. This may include management, technology and distribution.

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A common core of unity must exit between the businesses in terms of markets, products and technology etc

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The acquiring company’s management must understand the business being acquired

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The acquiring company must put a quality management team quickly into the acquired business

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The acquiring business must retain the best management from both businesses.

3. Reasons for diversification 

Efficiency gains, where an organisation has underutilized resources and competences that it cannot effectively close or sell then it makes business sense to use the resources and competences by diversifying into a new activity.

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Increasing market power, an organisation can afford to cross-subsidize one business from the surpluses earned by another in a way that competitors may not be able to.

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Stretching corporate parenting capabilities into markets and products.

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Responding to market decline

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Spreading risk

4. Advantages and disadvantages of diversification in relation to the case study Advantages 

Control of inputs, leading to continuity and improved quality. For instance 1984 and 1985 NewsCorp acquired Twentieth Century Fox and six television stations of the Metromedia Broadcasting Group in the US. These acquisition provided the company with a wider platform for consolidation of its related activities through access to studios for making films and television Programmes.

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Control markets by guaranteeing sales and distribution. This can arise through a combination of linkages in the value chain. For example where production and distribution channels are combined, or where a company uses its well-established brand names or corporate identity to gain benefits in new markets

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Take advantage of existing expertise, knowledge and resources in the company when expanding into new activities. This may result in transfer of skills, such as research and development knowledge and sharing of resources.

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Provide better risk control through no longer being reliant on a single market

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Provide movement away from declining activities

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Spread risk by avoiding having all eggs in one basket

Disadvantages 

May result in slowing growth in its core business

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Adding management costs.

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Adding bureaucratic complexity. In addition to direct financial costs, there may additional bureaucratic complexities necessitated by the need to coordinate and control core activities with additional activities.

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Losses may be incurred during market consolidation process resulting in some business units being subsidized by other profit making units. This was experienced by NewsCorp the performance of Sky Television resulted financial losses of nearly ₤10 million per month were incurred despite all the stringent cost reduction measures being put in place in line with the overall strategic vision of NewsCorp.

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May result in negative synergies

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Diversification through acquisition across national boundaries may result in the organisation having to deal with varying intricacies of the political and legal requirements of the different countries in which the organisation has controlling interests. For example Rupert Murdock was not allowed as a non US citizen to have more than 25 % of any company with a broadcasting licence. As s result he was compelled to become a US citizen in 1985.

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Diversification through acquisition May result in failure where there is a mismatch between core competencies or experiences of the acquirer and acquired businesses.

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