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However, not all companies diversify to increase the value
of the overall company. Some
attempts at diversification are implemented to prevent the value of the company
from decreasing.
When companies are able to earn above-average or superior
returns in a single business, they have little incentive to diversify. However,
low performance may provide an incentive for diversification, as a
low-performing company may become more risk seeking in an effort to improve
overall company performance. On the other hand, it has been shown that lower
returns are related to greater (not lower) levels of diversification.
In response to low returns (or poor performance), companies
often choose to seek greater levels of diversification. At some point, however, poor performance
slows the pace of diversification, often resulting in restructuring divestitures
of businesses to lower the level of company diversification.
FIGURE 5.5 Relationship between Diversification and
Performance
As Figure 5.5
illustrates, companies exhibiting low performance in their dominant businesses
often implement related-constrained diversification strategies which, to some
point, result in increased performance.
In search of even higher performance, related-diversified companies may
continue to diversify, but elect to acquire unrelated businesses. Because the company's core competencies
do not create value in unrelated businesses, company performance decreases.
Companies also may implement diversification strategies
when their products reach maturity (in the product life cycle) or are threatened
by external factors that the company cannot overcome.
Thus, companies may view diversification as a survival
strategy. For example tobacco companies like ITC are diversifying because of
future demand uncertainty that resulted from attacks on smoking and the ban on
events sponsorships.
Uncertainty can also be derived from supply sources as well
as demand conditions.
As you will recall from the discussion earlier in this
chapter, companies that diversify in pursuit of economies of scope take
advantage of linkages between primary value-creating activities to realize
synergy from sharing.
Synergy exists when the value created by business units
working together exceeds the value the units create when working independently.
However, these linkages--and the interrelatedness or interdependencies that
result--produce joint profitability between business units and the flexibility
of the company to respond may be adversely affected, increasing the risk of
failure.
To eliminate this risk, companies may do one of two things: (1) operate in more certain environments
to reduce the level of technological change and choose not to pursue potentially
profitable, yet unproven product lines or (2) constrain or reduce the level of
activity-sharing, thus foregoing the potential benefits of synergy
However, these decisions could lead to further
diversification to diversify into industries where more certainty exists or to
additional, but unrelated diversification