Related diversification

Related diversification
See also
Tuck-In Acquisition Lateral integration Conglomerate diversification Market Challenger Horizontal diversification strategy Lateral diversification strategy Strategic Buyer Disruptive business model Distinctive competencies

Related diversification is a development strategy that goes beyond current products and markets, but remains within its capabilities (e.g. technology) or value networks (e.g. developed distribution channels) (Y. M. Zhou, 2007, p. 3-4). This strategy group also includes vertical integration decisions, which mean the expansion of a company's activities to include activities that are specific to the preceding (backward integration) or subsequent (forward integration) links in the value chain in which the company participates, in relation to the company's existing activities (Y. M. Zhou, 2007, p. 3-4). A related diversification is one in which the two undertakings involved have significant common features which offer the potential to generate economies of scale or synergies based on the exchange of skills or resources. In related diversification, the resulting combined activity should be able to achieve a higher return on investment due to higher revenues, lower costs or reduced investments attributable to types (A. I˙brahim, Y. Ihsan, 2011, pp. 1497). Diversification is the art of entering product markets other than those in which the company is currently involved.

An important issue in any decision to diversify is whether there is indeed a real and significant area of commonality that will benefit the final return on investment. In the absence of such a significant commonality, diversification may still be justified, but the justification will have to be different (A. I˙brahim, Y. Ihsan, 2011, pp. 1497).

Related diversification objectives

Diversification in the economy is a branching, diversifying production, extending it into various, distant fields. It is used mainly in order to offset losses incurred in one industry with profits made in another (A. Martínez-Campillo, 2016, pp. 86-87). It is the opposite process to specialisation. It usually requires new knowledge and skills, as well as new resources. Related diversification consists in going beyond the branch of industry in which it has operated so far, but retaining the links in the form of technology or the supported market (A. Martínez-Campillo, 2016, pp. 86-87). Related diversification consists in introducing minor modifications to the products offered so far (with minor changes in the manufacturing technology), enabling them to be offered to buyers who have not been in the sphere of interest of the company so far. These may be, for example, variants and types of products, improved or dedicated to a special group of customers (A. Martínez-Campillo, 2016, pp. 86-87).

Scope of related diversification

Related diversification may include its area (E. Santarelli, H.T. Tran, 2018, pp. 9.):

• the range of products or services within the enterprise's activities,
• customers and suppliers,
• the geographic areas of the undertaking's activities,
• the means by which capital may be raised.

Assumptions of related diversification

Related diversification provides the potential for synergies through the exchange of skills, technologies or resources (P. Kannan, DR. R. Saravanan, 2012, pp. 65-68). One business unit must have skills or resources that it can export to another company and vice versa.

Thus, the first condition for successful related diversification is to identify the skills and resources that can be exported and to become aware of the necessary elements that can be taken over from the other company on a mutually beneficial basis (P. Kannan, DR. R. Saravanan, 2012, pp. 65-68).

The second condition for successful implementation of the process of related diversification is to find a suitable business partner who can use the offered resources and skills and deliver the ones that are needed by a company that does not have them (P. Kannan, DR. R. Saravanan, 2012, pp. 65-68).

The third condition is whether the organisational integration necessary to exchange resources and skills, technologies and know-how in the process of diversification between the two companies is possible (P. Kannan, DR. R. Saravanan, 2012, pp. 65-68).

Objects and forms of related diversification

Skills and resources that can usefully be imported or exported can take different forms, such as (E. Santarelli, H.T. Tran, 2018, pp. 9-11):

• Brand name - a well known and valued brand is a valuable resource for the benefit of both companies,
• Marketing skills - usually the company has or does not have strong marketing skills in a given market. Therefore, a frequent motive for diversification is the export or import of marketing talents.
• Service - a small company can often create or enter the market and deal well with an innovative product. As the market matures, the need for strong organization of services becomes important. A smaller company may then consider joining forces with a larger company that has a service organisation that can be adapted to the product involved,
• Research and development and product promotion - a company may be highly qualified in research and development and production of new products, but may lack marketing or promotion skills,
• Excess capacity utilisation - one type of resource that is often easily exchanged is overcapacity (E. Santarelli, H.T. Tran, 2018, pp. 9-11).

Determinants of related diversification

The factors determining the diversification of a company may be different, but the most typical are (E. Chirani, M. Effatdoost, 2013, pp. 24-26.):

• Uncertainty of the environment,
• Lack of development and specialisation prospects,
• Competitive pressure,
• Size of the company (as the size of the company increases, the degree of diversification increases),
• Financial situation of the company,
• Surplus or shortage of physical resources (E. Chirani, M. Effatdoost, 2013, pp. 24-26).

Benefits of related diversification

Related diversification can sometimes result in economies of scale. For instance, two smaller firms producing consumer products may not be able to afford efficient sales forces, a new product development or testing programme, or storage and logistics systems (A. Martínez-Campillo, 2016, pp. 86-119). However, both companies may be able to operate at an efficient level. Similarly, two merged firms may be able to justify a costly piece of automated production equipment (A. Martínez-Campillo, 2016, pp. 86-119).

Related diversification of the company creates many opportunities in the development of the activity of the company. A positive aspect of the discussed strategy may be (A. Martínez-Campillo, 2016, pp. 86-119):

• Development and maximization of the pace of development of the enterprise,
• Economical use of resources,
• Strengthening the position on the market with increased security.

Risk in related diversification

Even related diversification can be risky. There are three main problems. First of all, there is no relationship and potential synergy (M. Eukeria, S. Favourate, 2014, pp. 184-185). Strategists delude themselves that there is a synergistic justification not on the basis of judgment supported by accurate external and self-reflection, but through manipulation of semantics (M. Eukeria, S. Favourate, 2014, pp. 184-185).

Secondly, potential synergy may exist but is never realised due to implementation problems. This happens when a diversification movement involves the integration of two organisations that have fundamental differences and/or one of the two organisations does not have the ability or motivation to undertake the necessary programmes to make diversification work (M. Eukeria, S. Favourate, 2014, pp. 184-185).

Thirdly, possible antitrust violations in the West and MRTP (monopoly law and restrictive business practices) in India pose additional risks in the event of a takeover or merger. Ironically, as the degree of kinship and the potential for synergies increases, the likelihood of a competition problem or MRTP increases (M. Eukeria, S. Favourate, 2014, pp. 184-185).

In addition, the undesirable effects of associated diversification may be management difficulties, problems resulting from the company's specialization, and loss of reputation and prestige, and thus, also customers and profitability (M. Eukeria, S. Favourate, 2014, pp. 184-185).

Examples of Related diversification

• McDonald's: McDonald's is a great example of related diversification. McDonald's started out as a hamburger restaurant but has since expanded to include a variety of other fast food items, such as salads, wraps, smoothies, and even breakfast items. McDonald's has also diversified its business model by offering customers the ability to customize their meals, offering delivery and mobile ordering, and introducing a loyalty program. McDonald’s is an example of a company that has been able to effectively use related diversification to expand its product offering and business model.
• Apple: Apple is another example of related diversification. The company started out with computers and software but has since diversified into music, mobile phones, tablets, and wearables. Apple has also made significant investments in research and development to develop new products and services, such as its Apple Pay service and the Apple Music streaming service. Apple is a great example of a company that has been able to leverage its existing capabilities to diversify into new markets.
• Amazon: Amazon is another example of related diversification. The company started out as an online bookstore but has since expanded to include a variety of other products and services, such as Amazon Prime Video, Amazon Music, and Amazon Web Services. Amazon has also developed its own line of products, such as the Kindle e-reader and the Echo smart speaker. Amazon is an example of a company that has been able to effectively use related diversification to expand its product offering and business model.

Limitations of Related diversification

• The main limitation of related diversification is that it requires a significant investment of resources. Companies need to invest time, money, and personnel to identify related markets and products, develop new skills and capabilities, and build new relationships.
• Additionally, related diversification can lead to a lack of focus, as the company may be spread too thin across different markets, products, and customers. This can make it difficult to remain competitive and efficient in any single market.
• Related diversification can also be difficult to manage due to its complexity. Companies may need to invest in a variety of new systems and processes in order to manage the new products and markets, which can add significant costs and complexity.
• Related diversification also carries a risk of failure, as the company may not be able to develop the necessary skills, relationships, and capabilities to succeed in the new markets and products. This can lead to significant losses of resources and time.

Other approaches related to Related diversification

• Market penetration: This involves expanding the sale of existing products in existing markets. It is a low-risk strategy as it does not involve entering any new markets or introducing any new products.
• Product development: This involves introducing new products to existing markets. It can be a relatively low-risk strategy, as the company is familiar with the existing markets.
• Horizontal integration: This involves the acquisition of a business that is in the same industry and at the same stage of production as the existing business. It is a high-risk strategy as it involves the addition of significant costs and complexity.
• Vertical integration: This involves the acquisition of a business that is either in an upstream or downstream position in relation to the existing business. It is a high-risk strategy as it involves a large capital investment and can lead to higher costs.

In summary, related diversification is a strategy in which the two undertakings involved have significant common features which offer potential to generate economies of scale or synergies based on exchange of skills or resources. Other related strategies include market penetration, product development, horizontal integration and vertical integration, each of which presents different levels of risk.

References

• Chirani E., Effatdoost M., (2013), Diversification Strategy, a Way Toward the Competitive Advantage, Kuwait Chapter of Arabian Journal of Business and Management Review Vol. 3, No.1; Sep. 2013.
• Eukeria M., Favourate S., (2014), Diversification as a Corporate Strategy and Its Effect on Firm Performance: A Study of Zimbabwean Listed Conglomerates in the Food and Beverages Sector, International Journal of Economics and Finance; Vol. 6, No. 5.
• I˙brahim A., Ihsan Y., (2011), The Relation between Diversification Strategy and Organizational Performance: A Research on Companies Registered to the Istanbul Stock Exchange Market, Procedia Social and Behavioral Sciences 24.
• Kannan P., Saravanan DR. R., (2012), Diversification - Strategies for Managing a Business, Excel International Journal of Multidisciplinary Management Studies Vol.2 Issue 5, May 2012.
• Martínez-Campillo A., (2016), The benefits of related and unrelated diversification strategies in the Spanish context: What is the difference that executive leadership style can make?, Leadership, vol. 12, nº 1.
• Santarelli E., Tran H. T., (2018), Diversification Strategies and Firm Performance: A Sample Selection Approach, University of Bologna, Department of Economics.
• Zhou Y. M., (2007), Related Diversification and Structural Complexity, Steven M. Ross School of Business University of Michigan.

Author: Sara Pilch