Diversification: Spreading wings to increase the flight
by: Socrates - Consulting & Strategy Club at IIFT
“Don’t put all your eggs in one basket,” forms part of conventional wisdom. But one of America’s legendary industrialists Andrew Carnegie claimed that diversification was actually a terrible idea. According to him, “put all your eggs in one basket — and watch that basket!”
The word diversification evokes different meanings in different contexts. In marketing it is a form of strategy that seeks to increase profitability through greater sales volume from new products and new markets, sometimes even stretching outside the scope of existing business whereas from financial perspective it is the act to distribute investments in order to average the risk of loss.
Diversification equips to spread the wings and increase the flight but the success of the same depends on its timing, purpose and situation. The purpose can be financial motivations wherein a new revenue stream is being sought out through some strategic realignment or it might be a desperate move to increase revenues by trying to be all things to all people. It might be a channel to unleash the expertise of the company with respect to an untapped market or to shift the market segment as the current product offering has turned redundant But whatever it may be it is risky although a calculated one.
The Walt Disney Company is a prime example of successful diversification. Starting as an animation studio, the company has since become an entertainment powerhouse that encompasses film, television, radio, vacation destinations, merchandise, music, cruise ships etc. After World War 2, demand for film-making services that had been used heavily by the U.S. government during the war effort waned. Driven by financial motivation, the company expanded its footprint into other market segments like television and amusement parks. This approach not only secured the company’s financial success, but also reinforced the company’s already strong brand across seemingly disparate market segments. On the other hands its competitors had to face a tough time as they saw declining revenues due to the advent of television. Disney was successful in overcoming the myopia that it was part of entertainment business and not Hollywood alone.
The Disney example also highlights the importance of approach towards diversification apart from the purpose, timing and situation. Diversification needs to be thoroughly considered and the new product segments need to be complimentary in a logical fashion. It’s rare that a business that brings together wildly disparate offerings will succeed. It takes time to assess potential markets and a comprehensive strategic analysis must be done before going to market.
Eastman Kodak is a perfect example of approach towards diversification going absolutely wrong. In 1980′s Eastman Kodak decided to diversify as its market share was dropping owing to the stiff competition offered by makers of digital camera. Thus it decided to diversify and the sector it chose was pharmaceutical. It decided to acquire Sterling Drugs for $5.1b. This made no sense as pharmaceutical and cameras made no logical consistency until and unless there was a technology to deliver medicines through cameras. There was adverse reaction by various stake holders towards this acquisition and finally after 6 years East Man Kodak sold off Sterling drugs at a loss of $2b.
Thus diversification makes perfect sense except when it makes perfect nonsense. On one hand, diversification spreads the risks, so that decline in one market or product can be offset by booming sales elsewhere. On the other hand, managers in well established companies can easily get carried away in uncharted waters taking the company down with them.
By: Nirjhar Bhattacharya