Horizontal Integration and Diversification

The term horizontal diversification refers to the unrelatedness or diversity of the organization's products and markets. A conglomerate is a widely diversified firm with unrelated products and markets.

Conversely, the term horizontal integration refers to the relatedness of the organization's products and markets. A highly concentrated organization, or one built on pure concentration, offers similar products or services in narrow markets.

To insulate the organization from risk of downturns in one product or market, or to spread financial risk, some organizations diversify horizontally into products or markets that are not closely related to its core business. For example, a chemical company that acquires a pharmaceutical company finds itself interacting with new products with new kinds of employees in new markets with new kinds of customers. An acute care hospital that acquires a home health agency must become expert at delivering new forms of health care services in new distribution channels away from the core hospital. To diversify financial variability, the organization enters into many unrelated markets with different earnings streams. In financial theory, this evens out the fluctuations in the corporate earnings by reducing the variability of the total earnings stream. Such an organization finds itself in unrelated industries in which it has limited core competence. A hospital that starts a restaurant or parking garage is diversifying away from its core competence of health care. Many hospitals contract out food services or parking services, because few hospitals have competencies in those areas.

The organization facing diversification needs to ask itself two very important questions. First, how important is it to be expert in its business lines? If its reputation for excellence is part of its culture and strategy, then it may wish to contract out the noncore operations and focus on the core processes, products, and services. Management and staff energy can then concentrate on the chosen business, products, and customers. Second, how important is it to smooth out earnings variability? If the organization can manage variability of cash flow with strong market positions in core competencies, then the organization may not need the diversity of earnings streams offered by diverse products and services.