Read the case study and evaluate the challenges of diversification and elaborate what are the possible factors which leads to diversification. Summarize the case with your findings and do include examples of theory from the case.

To Diversify or Not To Diversify

by; Constantinos C. Markides

From the Magazine (NovemberDecember 1997)

One of the most challenging decisions a company can confront is whether to diversify: the rewards and risks can be extraordinary. Success stories aboundthink of General Electric, Disney, and 3Mbut so do stories of such infamous and costly failures as Quaker Oats entry into (and exit from) the fruit juice business with Snapple, and RCAs forays into computers, carpets, and rental cars.

What makes diversification such an unpredictable, high-stakes game? First, companies usually face the decision in an atmosphere not conducive to thoughtful deliberation. For example, an attractive company comes into play, and a competitor is interested in buying it. Or the board of directors strongly urges expanding into new markets. Suddenly, senior managers must synthesize mountains of dataincluding internal-rate-of-return calculations, market forecasts, and competitive assessmentsunder intense time pressure. To complicate matters, diversification as a corporate strategy goes in and out of vogue on a regular basis. In other words, there is little conventional wisdom to guide managers as they consider a move that could greatly increase shareholder value or seriously damage it.

But diversification doesnt need to be quite such a roll of the dice. Yes, it always will involve uncertainty; all major business decisions do. And indeed, there is a wealth of good advice about how to approach diversification.¹ But my research suggests that if managers consider the following six questions, they can push their thinking still further to reduce the gamble of diversification. Answering the questions will not lead to an easy go-no-go decision, but the exercise can help managers assess the likelihood of success.

The issues the questions raise, and the discussion they provoke, are meant to be coupled with the detailed financial analysis typical of the diversification decision-making process. Together, these tools can turn a complex and often pressured decision into a more structured and well-reasoned one.

Thus, when managers consider whether or not to diversify, they should ask themselves the following questions:

What can our company do better than any of its competitors in its current market?

Just as it is important to take stock of the pantry before going shopping, so is it crucial for a company to identify its unique and unassailable competitive strengths before attempting to apply them elsewhere. The first step, then, is to determine the exact nature of those strengthswhich I refer to in general terms as strategic assets.

How is such an assessment usually done? Incompletely, Im afraid. The problem is that most companies confuse identifying strategic assets with defining their business. A business is generally defined by using one of three frameworks: product, customer function, or core competencies.²Thus, depending on its approach, Sony could decide that it is in the business of electronics, entertainment, or pocket-ability.

When facing the decision to diversify, however, managers need to think not about what their company does but about what it does better than its competitors. In one sense, pinpointing strategic assets is a market-driven approach to business definition. It forces an organization to identify how it might add value to an acquired company or in a new marketbe it with excellent distribution, creative employees, or superior knowledge about information transfer. In other words, the decision to diversify is made not on the basis of a broad or vague business definition, such as Were in the entertainment business. Rather, it is made on the basis of a realistic identification of strategic assets: Our excellent distribution capabilities could radically improve the performance of the acquired company.

Before diversifying, managers must think not about what their company does but about what it does better than its competitors.

Consider the case of Blue Circle Industries, a British company that is one of the worlds leading cement producers. In the 1980s, Blue Circle decided to diversify on the basis of an unclear definition of its business. It was, the companys managers determined, in the business of making products related to home building. So Blue Circle expanded into real estate, bricks, waste management, gas stoves, bath-tubseven lawn mowers. According to one retired executive, Our move into lawn mowers was based on the logic that you need a lawn mower for your gardenwhich, after all, is next to your house. Not surprisingly, few of Blue Circles diversification forays proved successful.

Blue Circles less focused, business-definition approach to diversification didnt answer the more relevant question: What are our companys strategic assets, and how and where can we make the best use of them?

One company that did ask that questionand reaped the rewardsis the United Kingdoms Boddington Group. In 1989, Boddingtons then chairman, Denis Cassidy, assessed the companys competitive situation. At the time, Boddington was a vertically integrated beer producer that owned a brewery, wholesalers, and pubs throughout the country. But consolidation was changing the beer industry, making it hard for small players like Boddington to make a profit. The company had survived up to that point because its main strategic asset was in retailing and hospitality: it excelled at managing pubs. So Cassidy decided to diversify in that direction.

Quickly, the company sold off the brewery and acquired resort hotels, restaurants, nursing homes, and health clubs while keeping its large portfolio of pubs. The decision to abandon brewing was a painful one, especially because the brewery has been a part of us for more than 200 years, Cassidy says. But given the changes taking place in the business, we realized we could not play the brewing game with the big boys. We decided to build on our excellent skills in retailing, hospitality, and property management to start a new game. Boddingtons diversification resulted in the creation of enormous shareholder valueespecially when compared with the strategies adopted by regional brewers that decided to remain in the business. It also illustrates what happens when a company moves beyond a business-definition approach and instead launches a diversification effort based on its strategic assets.

What strategic assets do we need in order to succeed in the new market?

Once a company has identified its strategic assets, it can consider this second question. Although the question seems straightforward enough, my research suggests that many companies make a fatal error. They assume that having some of the necessary strategic assets is sufficient to move forward with diversification. In reality, a company usually must have all of them.

To diversify, a company must have all the necessary strategic assets, not just some of them.

The diversification misadventures of a number of oil companies in the late 1970s highlight how dangerous it is to go up against a royal flush when all you have is a pair of jacks. Companies such as British Petroleum and Exxon broke into the mineral business they could exploit their competencies in exploration, extraction, and management of large-scale projects. Ten years later, the companies had dropped out of the game. The reason: in addition to the oil companies capabilities, the mineral business required low-cost extraction capabilities and access to deposits, which the oil companies lacked.

Consider as well the experience of the Coca-Cola Company, long heralded for its intimate knowledge of consumers, its marketing and branding expertise, and its superior distribution capabilities. Based on those strategic assets, Coca-Cola decided in the early 1980s to acquire its way into the wine business, in which such strengths were imperative. The company quickly learned, however, that it lacked a critical competence: knowledge of the wine business. Having 90% of what it took to succeed in the new industry was not enough for Coke, because the 10% it did not havethe ability to make quality winewas the most critical component of success.

As in poker, the lesson for companies considering diversification is the same: you have to know when to hold them and when to fold them. If a company is holding only a pair of strategic assets in an industry in which most players have a better hand, theres no point in putting money on the tableunless, that is, the next question can be answered in the affirmative.

Can we catch up to or leapfrog competitors at their own game?

What if Coke had known in advance that it lacked an important strategic asset in the wine-making business? Should it have summarily abandoned its diversification plans?

Not necessarily. Companies considering diversification need to answer another pair of questions: If we are missing one or more critical factors for success in the new market, can we purchase them, develop them, or make them unnecessary by changing the competitive rules of the industry? Can we do that at a reasonable cost?

Consider the diversification history of Sharp Corporation. In the early 1950s, the company decided to leverage its existing strengths in the manufacturing and retailing of radios by moving first into televisions and then into microwave ovens. Sharp licensed the television technology from RCA and acquired the microwave oven technology by working with Litton, the U.S. innovator in that technology. Similarly, Sharp diversified into the electronic calculator business in the 1960s by buying the necessary technology from Rockwell.

The Walt Disney Company has diversified following a similar strategy, expanding from its core animation business into theme parks, live entertainment, cruise lines, resorts, planned residential communities, TV broadcasting, and retailing by buying or developing the strategic assets it needed along the way. For example, Disneys cross-promotional relationships with McDonalds and Mattel gave it an edge in retailing, and its close working relationship with the Florida state government gave the company the expertise it needed in the theme park business.

We can return to Sharp to illustrate how companies lacking crucial strategic assets can build them in-house. In 1969, Sharp invested $21 millionabout one-quarter of the companys equity at the timeto build a large-scale-integrated-circuit factory and a central R&D lab to facilitate entry into the semiconductor business. In the 1990s, it has made even bigger investments in order to bring the company up to speed in the liquid-crystal-display industry. Between 1990 and 1992 alone, Sharp invested $540 million in liquid-crystal-display factories and earmarked an additional $550 million for future investments.

A final option for companies lacking the right strategic assets to play in a new market is to rewrite that markets rules of competition, thereby making the missing assets obsolete. One case in point is Canon, which wanted to diversify from its core business of cameras into photocopiers in the early 1960s. Canon boasted strong competencies in photographic technology and dealer management. But it faced formidable competition from Xerox, which dominated the high-speed-copier market, targeting large businesses through its well-connected direct sales force. In addition, Xerox leased rather than sold its machinesa strategic choice that had worked well for the company in its earlier battles with IBM, Kodak, and 3M.

After studying the industry, Canon decided to play the game differently: The company targeted small and midsize businesses, as well as the consumer market. Then it sold its machines outright through a network of dealers rather than through a direct sales force, and it further differentiated its products from those of Xerox by focusing on quality and price rather than speed. As a result, whereas IBM and Kodak failed to make any significant inroads into photocopiers, Canon emerged as the market leader (in unit sales) within 20 years of entering the business. It was, however, a radically different business because of the way Canon had transformed it.

Not all companies have the skill, financial strength, and managerial foresight to pull off what Canon did. But, together with Sharp and Disney, Canon provides an excellent example for companies considering diversification without all the required strategic assets in hand. Those assets must be obtained one way or another; otherwise, moving forward into new markets is likely to backfire.

Will diversification break up strategic assets that need to be kept together?

If managers have cleared the hurdles that the preceding questions raise, they then need to ask whether the strategic assets they intend to export are indeed transportable to the new industry. Too many companies mistakenly assume that they can break up clusters of competencies or skills that, in fact, work only because they are together, reinforcing one another in a particular competitive context. Such a misjudgment can doom a diversification move.

Managers need to ask whether their strategic assets are transportable to the industry they have targeted.

An academic exercise conducted several times with managers attending London Business Schools executive education program illustrates precisely how easy it is to fall into the trap of breaking up strategic assets that are best left together.³ The executives were asked to decide which new business McDonalds should enter: frozen foods, theme parks, or photo processing. Forty percent of the executives suggested that because the companys main competencies were finding good real-estate locations and offering family entertainment, it should enter the theme park business. Thirty percent singled McDonalds out for its management of distribution outlets and its skill in making products of consistent quality, and suggested that the photo-processing business would be an appropriate diversification move. The remaining 30%pointed to competencies in distribution, food retailing, and relationships with suppliers, and concluded that the frozen-food business made the most sense.