Diversification Strategy

Fundamentals

Diversification strategy involves two explicit levels of firm strategy: (a) corporate strategy and (b) business strategy. The former entails gathering in the same basket two or more business segments and, therefore, how corporate headquarters is expected to coordinate all the business segments they have chosen to operate. At the corporate level, the challenge is usually to generate synergies among businesses, thereby avoiding the traps of management complexity overload. The latter—that is, business strategy—concerns instead planning and implementing strategic actions to allow each particular business to accrue value and accomplish economic and financial success.

The coordination among business strategies and the role of the corporate headquarters may vary according to the type (or direction) of diversification: related versus unrelated. Related diversification concerns managing the various value chains of a firm’s businesses to allow synergies to emerge, since the value chains between and among business segments are seen as similar or complementary. The potential synergies of related diversification are given by (a) economies of scope, (b) market power, (c) sharing tangible and intangible resources and capabilities, (d) common value chain activities, (e) transferring core capabilities from a business to other businesses, and (f) vertical integration. Unrelated (or conglomerate ) diversification occurs when firms, rather than seeking “strategic fit” and “synergy capture” in the value chains as in related diversification, are motivated to diversify mainly by financial reasons and managerial knowledge and expertise. Consequently, the benefits of unrelated diversification generally do not exceed the ones given by “financial” and “managerial” synergies. While unrelated diversification aims to capitalize on the governance of resources in firms that typically tend to be widely decentralized, conversely related diversification entails an important role for the firm’s headquarters, which is expected to coordinate and reconnect various business units and swell synergies among them. (Alfred Chandler provides an appealing discussion of the “entrepreneurial” and “administrative” role of the HQ.) In the latter case, the goal of adopting the related diversification strategic option is to perform a more proficient transfer of resources and capabilities between and among businesses than alternative transaction modes do.

Since the seminal works of Igor Ansoff, Alfred Chandler, and Richard Rumelt, for almost four decades, the study of the characteristics instrumental to generate or destroy value in related and unrelated diversification strategies and the inquiry about to what extent diversification strategy is able to allow the firm to achieve performances superior to other strategies have taken a central role in the research agendas of two substantial fields of investigation: corporate finance and strategic management. Here, we concentrate on the underpinnings and impact of views and tools cooked up in the strategy realm.

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