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Diversification Debate
Conglomerate diversification, which is involves
diversification into unrelated areas, is very common in
India. Despite its popularity, it is considered to be a highly
controversial investment strategy.
1. Most of the businesses are characterized by cyclicality.
It is desirable that there are at least two to three distinct
lines of business in a firm’s portfolio. It helps a company
in reducing its overall risk exposure.
2. It expands opportunities for growth. When the existing
business reaches saturation it is natural to look at other
businesses where growth opportunities exist. While the
prospects of succeeding in the new line of business are
often uncertain, the immense potential acts as an
irresistible bait.
3. Though a good device for reducing risk exposure and
widening growth possibilities, conglomerate diversification
more often than not tends to dampen average profitability.
Guidelines for Conglomerate Diversification
Conglomerate diversification, in general, dampens
profitability and in some cases jeopardizes the existence of
the firm.There are some practical guidelines in this respect:
1. If you lack financial sinews to sustain the new
project during the ‘learning period’, avoid
grandiose diversification projects.
2. Realistically examine whether you have the critical
skills and resources to succeed in the new line of
business.
3. Ensure that the diversification project has a good fit
in terms of technology and market with the existing
business.
4. Try to be the first or a very early entrant in the field
you are diversifying into. This will protect you from
serious competitive threat in the initial years.
5. Where possible, adopt the following sequence:
marketing-sub – contracting – full manufacturing.
6. Seek partnership of other firms in areas where you
are vulnerable or competitively weak.
7. If the failure of the new project can threaten the
company’s existence, float a separate company to
handle the new project.
8. Remember that meaningful conglomerate
diversification represents the greatest challenge to
corporate vision and leadership.
9. Guard against bandwagon mentality and empire-
building tendencies.
2.6 Investment in Capabilities
Empirical evidence suggests that companies that perform
well have organizational capabilities that enable them to
exploit opportunities. Organizational capabilities are
combinations of human skills, organizational procedures
and routines, physical assets, and the systems of
information and incentives that improve performance
along particular dimensions. Such capabilities are indeed
organizational assets. There are five specific capabilities:
External Integration Capability
Internal Integration Capability
Flexibility
The capacity to Experiment
The capacity to Cannibalize
Allocating Resources to Build Capabilities:
Identify the capabilities that the firm should develop
and ensure that there is a firm organizational
commitment to them.
Develop a capital budget for capabilities and a
proper system of authorization and accounting for
expenditures relating to capabilities.
Translate the desired capabilities into appropriate
goals and rewards that are clearly understood and
used by people throughout the organization.
Link compensation of managers to improvements
in speed, quality, and flexibility.
Strategic Planning and Capital Budgeting
Capital expenditures, particularly the major ones, are
supposed to sub-serve the strategy of the firm. Hence, the
relationship between strategic planning and capital
budgeting must be properly recognized. The following
exhibit presents a way of defining this relationship. As
emphasized in the exhibit, capital budgeting should be
squarely related to corporate strategy.
The challenge for a company lies in developing a capital
allocation system which accommodates investment in
capabilities without sacrificing the benefits of a formal
financial analysis.
Environmental Managerial Vision, Corporate
Assessment Values & Attitudes Appraisal
Strategic Plan