6.2 Diversification Strategies

Diversification strategies can be related or unrelated, each with unique benefits and challenges. Companies diversify to reduce risk, exploit economies of scope, increase market power, and pursue growth opportunities. These strategies can lead to expanded markets and improved efficiency.

However, diversification also carries risks like increased managerial complexity and resource allocation challenges. Success factors include strategic fit, market attractiveness, resource availability, and effective implementation. Companies must carefully weigh these factors when considering diversification.

Types and Motives of Diversification Strategies

Related vs unrelated diversification

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• Related diversification involves expanding into new businesses or markets closely connected to the firm's existing core business, allowing the company to leverage its current resources, capabilities, or knowledge (computer manufacturer entering smartphone market, fast-food chain offering healthier menu options)
• Unrelated diversification entails entering entirely new businesses or markets unconnected to the firm's current core business, requiring the acquisition of new resources, capabilities, or knowledge (car manufacturer acquiring financial services company, software company investing in real estate development)

Motives for firm diversification

• Risk reduction spreads risk across multiple businesses or markets, reducing dependence on a single product, service, or market (Coca-Cola offering various beverage categories)
• Exploiting economies of scope enables sharing resources, capabilities, or knowledge across different businesses, reducing costs and improving efficiency (Amazon leveraging its distribution network for multiple product categories)
• Market power increases bargaining power with suppliers or customers and reduces competition by entering new markets (Microsoft's expansion into gaming consoles with Xbox)
• Growth opportunities tap into new sources of revenue and profit, overcoming limitations in the firm's current market (Netflix's expansion into original content production)

Risks and Success Factors of Diversification Strategies

Risks of diversification strategies

• Managerial complexity increases difficulty in managing and coordinating multiple businesses, potentially leading to conflicts between different business units (Time Warner's challenges in managing its diverse media properties)
• Resource allocation poses challenges in effectively allocating resources across different businesses, risking overinvestment in underperforming businesses (General Electric's struggles with its diverse portfolio)
• Cultural differences can hinder the integration of different organizational cultures, potentially causing cultural clashes and reduced employee morale (Daimler-Chrysler merger's cultural integration issues)
• Lack of synergy makes it difficult to realize expected synergies between different businesses, risking overestimation of the benefits of diversification (AOL-Time Warner merger's failure to achieve anticipated synergies)

Factors in diversification success

• Strategic fit measures the degree to which the new business aligns with the firm's existing strengths and capabilities, emphasizing the importance of identifying and leveraging potential synergies (Disney's successful acquisition of Pixar)
• Market attractiveness considers the growth potential and profitability of the new market, along with the level of competition and barriers to entry (Uber's expansion into food delivery with Uber Eats)
• Resource availability assesses the firm's ability to acquire and allocate the necessary resources for diversification, highlighting the importance of financial strength and managerial talent (Alphabet's ability to fund diverse projects like self-driving cars and biotech research)
• Implementation effectiveness evaluates the quality of the firm's planning and execution of the diversification strategy, as well as its ability to adapt and respond to challenges during the implementation process (Walmart's successful expansion into e-commerce with the acquisition of Jet.com)