FREE online courses on Corporate Strategies - Diversification Strategies - Reasons for Diversification

 

Companies may implement diversification strategies to enhance or increase the strategic competitiveness of the overall organization.  If they are successful, the value of the company increases. Value can be created through either related or unrelated diversification if the strategies enable the company's mix of businesses to increase revenues and/or decrease costs when implementing their respective business-level strategies.

 

Companies may also implement a diversification strategy to gain market power relative to their competitors. Companies may implement diversification strategies that are either value neutral or result in devaluation of the company.  They may attempt to diversify to neutralize a competitor's market power or to reduce managers' employment risk (i.e., the risk of CEO being unemployed when a dominant-business company fails as compared to this risk when a single business fails but is only one part of a diversified company) or to increase managerial compensation because of the positive relationships between diversification, company size, and compensation.

 

Motives to enhance strategic competitiveness:

economies of scope (related diversification) through activity-sharing and the transfer core competencies

market power motives (related diversification) by vertical integration or blocking competitors through multipoint competition

financial economies motives (unrelated diversification) to improve efficiency of capital allocation through an internal capital market or by restructuring the portfolio of businesses

Motives that are value-neutral with respect to strategic competitiveness:

to avoid violations of antitrust regulations

to take advantage of tax incentives

to overcome low performance

to reduce the uncertainty of future cash flows

to reduce overall company risk

to exploit tangible resources

to exploit intangible resources

Managerial or value-reduction motives:

to diversify managerial employment risk

to increase managerial compensation

TABLE: Reasons for Diversification

 

Companies implement diversification strategies for a number of reasons.  These can be classified into three broad sets of motives as shown in Table 5.5.