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Diversification strategy involves expanding organization’s operations by adding markets, services or product to the existing business. The main aim of diversification is to allow the firm to enter lines of business that are different from existing line of business. If the new venture is related to the existing lines of business, then it is called concentric diversification. On the other hand conglomerate diversification takes place when there is no common line of strategic relationship between the fresh and old lines of business. (Thomas n.d.)
Concentric diversification occurs when a company adds related products or markets. The objective of concentric diversification is to obtain strategic fit. Strategic relationship allows a firm to achieve synergy. Synergy is combining two or more parts of an organization to achieve greater total effectiveness together than would be experienced if the efforts of the independent parts were summed. Synergy might be obtained by combining companies with complementary marketing, financial, operating, and management efforts.
Financial synergy can be obtained by combining a firm with sound financial resources but giving less growth opportunities with a firm having great market prospective but weak financial possessions. Companies try to stabilize income by diversifying into businesses with diverse cyclical sales patterns.
Strategic relationship in operations will result in synergy by the balanced mix of operating units to increase overall efficiency. Overall efficiency can be improved by combining two or more units so that research and development or duplicate equipment is eliminated. Another way to obtain operating synergy is possible by Quantity discounts through combined ordering. Yet another way to increase efficiency is to spread into an area that can use by-products from existing operations.
Management synergy can be obtained if administration expertise and experience is applied to different types of situations. The experience gained by a manager in working with unions in one firm might be applied to labour management problems in another company. Situations that appear similar may actually require significantly dissimilar management strategies. Personality clashes and other situational differences may make management synergy difficult to attain. Even though managerial understanding and skills can be transferred, individual executives cannot transfer effectively.
This is second form of diversification strategy. Conglomerate diversification occurs when an organization diversifies into areas that are not related to its current line of business. Synergy may be a consequence of financial resources or the appliance of management expertise; however the main purpose of this type of diversification is improved effectiveness of the acquiring firm. Little concern is given to obtain marketing or production synergy with conglomerate diversification.
The main reason for adopting a conglomerate growth strategy is that prospects in an organizations current line of business are not that attractive. Finding an attractive investment opportunity requires the organization to consider options in other types of business.
Companies also adopt conglomerate diversification approach as a means of increasing the growth rate of the companies. Sales growth may make the company more lucrative to investors. Growth will result in increase of the control and respect of the firm’s top executives. If the new area has development opportunities greater than the current line of business then conglomerate growth will be effective.
But the biggest backdrop about conglomerate diversification strategy is the escalating in administrative related problems associated with operating unrelated line of businesses. Managers from different departments may have different backgrounds and may be hesitant to work together and bring out group efforts. Competition between different strategic business units for resources may include allocating appropriate resources from one division to another. These decisions may create enmity and administrative problems between the units.
Carefulness must also be exercised in entering industry with apparently bright prospects, in particular if the management team lacks ability or experience in the new line of business. Without some understanding of the new industry, a company may be unable to accurately estimate the industry’s capacity to perform. Even if the newly started business is initially successful, it will eventually face obstacles. Executives from the conglomerate will have to involve themselves in the strategies of the new venture at some point. Without sufficient skills or experience, the new business may face dead ends and threats of failure.
Without some form of strategic fit, the joint performance of the individual units will not surpass the performance of the units functioning independently. In actuality, combined performance will come down because of controls positioned on the individual units by the parent corporation. Decision-making may turn out to be slower due to longer review periods and complex reporting systems.
DIVERSIFICATION: GROW OR BUY?
Efforts to diversify may be either internal or external. Internal diversification happens as a firm enters a different, but typically related, line of business but by developing a new line of business for itself. Internal diversification in a company generally involves growing a firm’s product or market base. External diversification may accomplish the same result; however, the company ventures into a new area of trade by purchasing another corporation or business unit. Mergers and acquisitions are common examples of external diversification.
One way of internal diversification is to sell existing products in new markets. An organization may elect to widen its geographic base to cover new clients, either within its home country or in global markets. A business might also practise an internal diversification strategy by discovering new users for its current product. Finally, companies may try to change markets by escalating or declining the price of products to create them more appeal to customers of different earnings levels.
Another way of internal diversification is to promote new products in existing markets. Normally this kind of strategy includes using existing channels of distribution to promote new products. Retailers frequently change product lines to take in new items that come into sight to have good market prospective. Johnson & Johnson included a new line of baby toys to its existing line of things for infants. Packaged-food companies have furthered salt-free or low-fat options to existing product lines.
Conglomerate growth through internal diversification is also a possibility. This strategy would involve promotion new and not related products to new marketplaces. This strategy is the slightest used one amongst the internal diversification strategies, as it is the most risky. It requires the company to enter a new marketplace where it is not established and the company develops and launches a new product. Research and development expenses, as well as advertising expenses, will likely be higher than if existing products were promoted. In effect, the investment and the possibility of failure are much greater when both the market and product are new.
External diversification takes place when a company looks external of its current operations and buys access to new marketplaces or products. Mergers are one general way of external diversification. Mergers take place when two or more firms merge operations to form one company, perhaps with a new name. These companies are usually of comparable size. The objective of a merger is to accomplish management synergy by building a stronger management team. This can be obtained in a merger by combining the management groups from the merged firms.
Acquisitions, next form of external growth, happen when the purchased company loses its identity. The acquiring firm absorbs it. The acquired company and its property may be absorbed into an active business unit or remain together as an independent ancillary within the parent company. Acquisitions typically take place when a big firm purchases a smaller firm. Acquisitions are called pleasant if the firm being purchased is friendly to the acquisition. Unfriendly mergers happen when the administration of the company targeted for acquisition resists being purchased. (Thomas n.d.)
Advantages and Disadvantages of Related Diversification:
The advantage of related strategy is that expansion is easier because you already be on familiar terms with the industry you run in and you can leverage that knowledge.
The drawback of this strategy is that if there is a cyclical downturn in the industry, company will feel the downturn in both the dealership and the detailing business. The blow will be severe. There may also be issues with incorporating two businesses, and with over-estimating the financial earnings.
Advantages and Disadvantages of Unrelated Diversification:
The benefit of buying an unrelated corporation is that companies decrease the risk of placing “all your eggs in one basket” and if the trade, or the industry, is hit hard by the market, or contest, or other success factors, then possessing an unrelated business may also help to offset the slump
Why to invest in unrelated diversification? Companies may be able to invest in a new market or new product that has “peaks” when your business has “valleys”. Several businesses have seasonality highs and lows; if you can buy a business that has a high when your business has a tiny, you can compensate the low periods. (Advantages and disadvantages of Diversification n.d.)
To diversify or not to diversify with respect to online companies
To diversify or not to diversify is one of the trickier questions in front of Internet companies because the blockade to entry is so low for a lot of online business models. The basic difference when it comes to online businesses is that the expenditure of moving into adjacent areas may be appreciably lower than in the physical world. Given the elasticity of the online environment, the tough question for companies is- What kinds of development are synergistic with the central part of business, and which are tangential? It is ambiguous where Google, Amazon and Yahoo will end up with their diversification strategies. Amazon has been leasing out the infrastructure it has used to develop into an e-commerce giant. The company has chiefly two services, EC2, or Elastic Compute Cloud, and S3, or Simple Storage Service, that offer on-demand computing power and online storage, respectively. The services are sold as a usefulness where customers can purchase only the computing power or data storage they utilize. The pricing method at Amazon is fifteen cents per gigabyte per month for its storage service along with twenty cents per gigabyte for data transferred in and out of Amazon’s computing centres. Google has announced Google Docs and Spreadsheets, an online software suite that would compete with Microsoft’s Office. During the same time Yahoo has get hold of a series of firms such as Flickr, a photo sharing website, and del.icio.us, a website for systematizing and sharing web bookmarks, among others. However after this Yahoo senior vice president Brad Garlinghouse expressed grief that the company “lacks a focused, unified vision.” Due to a bevy of acquisitions, Yahoo might be challenging with itself in many areas such as photo-sharing and online video. Any acquisition needs to have some kind of profound business logic behind it. Amazon moved from books to electronics to apparel and now to data storage. Now the problem is what’s their core competency? Is it Book sales or e-commerce? If it’s e-commerce, maybe computing power is just an addition of its existing line of trade. The biggest downside for Amazon is that consumers will come to depend on the company’s infrastructure. Tomorrow if Amazon wants to modify its systems, it can’t since it will have consumers locked into its services. There is a vast downside risk here. Coming to Google it looks like Microsoft, a company that generates just about all of its earnings from one or two businesses. The online companies should think ahead before diversifying in to other businesses. At the same it’s not so advisable to stand still in internet business because competition is high and replication of business model is easier than physical world. But companies should keep certain things in mind before expanding their business like finding natural synergies that can lead to growth. (werbach 2006)
Diversification strategies help companies expand their operations in to different business markets. Companies also adopt diversification strategy to reduce the risk by moving in to several business areas. Concentric diversification occurs when a company adds related products or markets. Conglomerate diversification occurs when an organization diversifies into areas that are unrelated to its current line of business. The main aim of diversification is to allow the firm to go into lines of business that are dissimilar from current operations.
I would like to thank our professor Mr. DM Sezhiyan, Department Of Management Studies, National Institute of Technology, Trichy for his encouragement and support throughout this work. He not only guided me but also helped me with the topic to understand, and communicate it to this paper.
I would also thank Dr. M. PUNNIYAMOORTHY (Head of the Department), National Institute of Technology, Trichy who has been a constant source of motivation and support all through the work.
Finally I would like to thank my family and well wishers for their boundless love and constant encouragement.
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