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Diversification Notes

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Diversification For over 100 years, diversification has been key to corporate strategy. The growing power
of conglomerates such as Standard Oil even forced regulation as early as 1890 ­ the
Sherman Anti­trust Act. There are conceptual benefits to diversifying if certain
requirements are met, but not all strategic efforts have resulted in the desired outcome. I
will start with the requirements of successful diversification and its potential benefits,
contrast these to the costs of managerial motivated strategies, and finish with evidence on
diversification's true impact.
Productive resources are often under­utilised by firms, perhaps due to R&D or marketing
efforts changing needs over the product life cycle. These may be applied to additional
activities at low marginal cost. Capabilities could be replicated and indivisible resources
may be used for a new product range, i.e. using Virgin's brand name across all business
units transfers marketing benefits. Shared resources thus spread the cost over several
products.
Even if economies of scope are available, the new market must be attractive to enter. The
intensity of existing competition and barriers to entry need to be considered. Furthermore,
the redeployed resources must provide some sustainable competitive advantage for
diversification to be worthwhile, where the benefits override the costs. For instance,
Apple used marketing and engineering knowledge to develop iTunes when entering the
MP3 market to generate sustainable competitive advantage. Rockwell successfully
replicated expertise in technology and best management practice from Aerospace into
navigation systems and printing control systems. Teece (1980) identified that transaction costs must also be significant, so that a market
relationship is not more advantageous than internalising control. Market failures often
increase transaction costs. Asset specificity can greatly encourage diversification.
Contracting poses several threats. There are hold up risks, problem of small numbers,
misappropriated knowledge and pricing tacit resources. Also, internally diversified firms
do not need to worry with Arrow's fundamental paradox of the credibility of contract
information. Unified governance
prevents disputes over pricing and
allocation, and corporate level
advantages can be enjoyed.
Diversification strategies often arise
from surplus capital generated from
current business units. This can be
returned to shareholders or used for
growth. Firstly, internal finance often
costs less than external funds, due to risk
premiums added by information
asymmetry or the need for effective
governance. Moreover, diversification

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