Using examples of
specific companies that have diversified across industries, evaluate Porter’s
contention that “diversification generally destroys value”. How do the
arguments of Hamel and Prahalad on core competencies contradict Porter’s views?
Introduction
Basically, diversification refers to
the management concept that provides firms on achieving long-term growth and
remaining at the top of its respective market and industry. While a firm can
possibly sustain financial viability by strategising to diversify, how such a
strategy will affect the competitiveness of the organisation in the future is
now known. As such, diversification can either lead to further success or
devastation to any firm especially when diversification was not properly
planned. Porter supports the latter saying: ‘diversification generally destroys
value.’ An evaluation of Porter’s argument will be the centre of the discussion
as well as the counter-arguments presented by Hamel and Prahalad. The report starts
with the discussion of diversification and its advantages and disadvantages.
Diversification
Basically, diversification forms part of innovative strategies.
Virtually all firms implement particular strategies to create economies of
scope and scale. By choosing diversification strategy, the organisation is basically
considering the market potential of new and existing markets and products as
well as unknown markets and products. The
success or failure of the chosen diversification strategy must conform to the
criteria of suitability, acceptability and feasibility. As such, the choice of such a strategy will
depend on the resources and capabilities of the organizations. There is the
need therefore to make the chosen strategies with the methods of development
that the company is trying to pursue (Spitzer,
2006).
The conceptualisation of diversification
within firms starts from the belief of the firm in becoming a successful
organisation in the future. In doing so, there are attempts to explore the diverse
possibilities, hence, for the purpose of developing different markets and investigate in
the potentials of different innovative and creative ideals and insights and
inputs. Nevertheless, firms may have other reasons to diversify despite the associated
risks (Spitzer, 2006). For example,
these reasons might be to update the modes of production and/or production
technologies, to maximise the production capabilities of the firm, and to
maximise the current capital for other worthy investments (Anand, 2005).
While
there is a need for forecasting the growth of the demand on the product accurately,
the effects of the chosen diversification strategy should be considered by a
firm in a more proactive manner as well (Spitzer, 2006). With this, diversification
can be also considered as a preparation for the worse-case scenarios. There are
three kinds of diversification: vertical, horizontal and lateral. Vertical
diversification refers to differentiating processes of production either of
parts or raw materials at all levels of the production. Horizontal
diversification aims at maximising the firm’s capability of producing new
products that can capture more market share, or even attempting at different
markets. Lateral diversification is the riskiest since the firm can explore any
market that it desires to penetrate.
Advantages and disadvantages of diversification
Supporters of diversification
believe that there shall be no company that would survive without any kind or
form of exploration of the market. If firms do nothing to maintain their
respective levels of competitiveness, they will finally lose their entire
market share and will be forced to leave the market. For one, the markets
follow a trend and conform to a level of fluctuation. A company’s market share
is unstable since it would decline anytime and sales volume would eventually
shrink. One advantage of diversification is that, should a business suffer from
adverse circumstances, the other businesses may not be affected while
diversifying (Anand, 2005). Nevertheless,
strategies adapted by companies vary from organisation to organisation. A
reasonable assumption is that the operational performance could be jeopardised
if there is too much focus on diversification.
However,
diversification is a difficult process and is a risky endeavor. For instance,
by diversifying, the company needs to bring about changes on the operation as
well as on its structure which may disrupt internal processes and momentum.
Such a process is already risky and may be exacerbated by the external
condition of rivals’ market exploration initiatives that can heighten the
competition (Anand, 2005).
As such, it is
critical that the firm will decide on the diversification strategy diligently
as it can affect the growth of the company wherein a wrong choice of strategy
can lead to failure. To arrive at the sufficient strategy, forecasting or
analysing trends accurately would be the single most important tool that any
firm wanting to diversify can utilise. Determining long term goals early on is
also crucial in selecting a diversification strategy suitable for those goals (Spitzer, 2006; Anand, 2005). Otherwise, the firm will become a company that
penetrates into various markets with not much productivity. Such a company may
even face losses because of the fact that the chosen diversification strategy
proved to be insufficient or inadequate for the firm.
Porter’s views about diversification
On the one hand, diversification requires
a sum of resources and capabilities. Shareholders’ value can be ruined in the
sense that the firm may not be able to tap opportunities in a diverse market
instead when it has a clear focus. As Porter puts it, “the corporate strategies
of diversification of most companies have dissipated instead of created
shareholder value”. Porter said of this because of the fact that
diversification slows the growth in the core business and eventually results in
negative synergies. A company, for example, may focus on product
differentiation while penetrating various markets at the same time (Salter and
Porter, 1982).
Diversification’s goal is to move away
from the core activities through providing new product or service to the
consumers despite the higher risks and resource implications. Having said this,
diversification can be considered as a rational approach. This is problematic
since markets and customers do not necessarily behave in rational manner. There
remains the fact that decision making may not be always strategic as it can
lead to wrong assumptions. For one, the management’s vision can be very
subjective and lenient which may lead to wrong decisions (Salter and Porter, 1982). From a product-market perspective,
strategies aim at positioning the firm in its industry which can be done either
by the selection of the optimal mix of product/market combinations or in by
positioning according to stakeholder. Hence it deals with competition on the
product-market level, encompassing concerns about customer needs and
expectations and on low cost or differentiation or diversification as specific
strategies (Anand, 2005).
Specifically, diversification requires new
skills, new techniques and new facilities. Inevitably, this results in physical
and organisational changes, disrupting internal processes in the process. Other
than this, diversification presumes that the company would be able to enter new
markets and develop new products of the shortest time possible. In reality, the process of
developing new product or market may take years depending on what product or
market is being developed – its size, nature and scope. To be successful in the
long-term, the company cannot just diversify into new markets and products
without having the competence to do so. Thereby, diversification requires
careful attention as it may lead the company into the wrong strategic path (Salter and Porter, 1982; Anand, 2005).
One of the recent
failed diversification is that of eBay’s acquisition of Skype. Sheelvant (2007)
noted that Skype was not a strategic fit for eBay’s business model. Talks on
probable synergy between Skype and eBay did not necessarily undergone a
concrete decision making process. Unlike eBay and Paypal that made the
businesses stronger individually and as partners and eventually created a new
opportunity called merchant services, such a level of synergy was not achieved
with Skype. Skype only perceived eBay because of its viral effect being a VOIP
company that is pure communication in nature. EBay’s management was not also
able to leverage skills and the need to gain such in a new market was not
tapped, causing a 13% financial loss as of 2009.
Other examples of
failed diversifications are evident on the case of Warner Music Group (WMG) and
Bic Pen Corporations. In the former, WMG acquired Bulldog Entertainment Group
worth of $16million in the last quarter of 2007. Bulldog Entertainment Group
was known for coordinating tiny concerts in the Hamptons. Due to impairment
charges, WMG eventually met with estimated losses of $30million in the first
quarter of 2008. In 2009, WMG suffered yet another loss in writing-off on Imeem
to which MySpace scooped for well under $1million (Digital Music News, 2010).
For the case of
Bic, Bic Pen Corporations basically sells disposable ballpoint pens. Bic
ventured into disposable cigarette lighters and safety razors as well as
pantyhose. Nevertheless, Bic did not use the process of sharing sales force or
distribution channels. Most Bic pens are sold in drugstores while the pantyhose
were sold in the supermarkets. As such, Bic’s attempted entry into the
pantyhose business had failed because it seemed distant, separated from other
businesses (Brand Failures, 2006).
Diversification as a core competence
For Hamel and Prahalad, core
competencies are the sources of competitive advantage, enabling a company to
launch an array of new products and services. Core competencies are required to
develop core products. Market opportunities are the link with core competencies
and form the basis of new business ventures. As such, without core
competencies, firms can be only considered as with a portfolio of distinct businesses.
Core competencies thereby tie different units of the business into a logical
portfolio. Three ways by which a firm can develop a core competency are through
a wide access to a variety of markets and contributing considerably to the outcome
benefits as well as the non-imitability of the competence by the rivals. With
regards to diversification, the strongest diversification strategy can be
considered in terms of extending the firm’s core competencies which is known as
related diversification (Zook and Allen, 2010).
For the purpose of shaking off the risks
and uncertainties emerging in the current market, diversification can
contribute a lot. Implementation of a diversification strategy can be a core
competence in the long run in two ways. First, diversification ensures the
achievement of long-term goals (Frigo, 2009).
Second,
diversification reduces operational risks. When the company becomes complacent,
it runs the risk of overinvesting in one single market. Risks can be
foreseeable and unforeseeable, diversification process can effectively reduce
the unforeseeable risks. There can be an optimum utilisation of resources for
the firms. For one, diversification can improve competitiveness while the firm
is expanding into new geographic markets. This can be viewed as a respond to
the changing market conditions and evolving customer preferences. Nevertheless,
for a firm to fully maximise diversification, diversification can be rationalised when other core competencies
are kept intact (Franco, 2004).
Examples
of diversification success stories are that of Virgin Media and Canon. Virgin
Media embarked on a merger with Telewest in 2005. Today, the company is
competing on the levels of broadband, landlines, mobiles and TV, making it UK’s
leading communications and media provider and with £366 million on its mobile phone business alone in
2008. Canon initially invested in cameras which were then diversified to
include printers and calculators. Canon had also diversified geographically to
include Europe and the Americas. Today, Canon is known as the world’s largest
electronics manufacturer with £19.5 billion annual revenue (Wright, 2008).
Porter’s views vs Hamel and Prahalad’s views
There
are strategic choices that can provide an organisation bases for its decisions
on what approaches, directions or methods can be used for achieving business
level and corporate level objectives. Hamel and Prahalad’s arguments are
consistent with business level strategies while Porter’s arguments are more
inclined with corporate level strategies. A business-level strategy creates an
environment of better competition since this is a core strategy that the
company forms to describe how it intends to compete in a certain market. In
business level strategy, integrated and coordinated set of commitments and
actions are used to gain competitive advantages by exploring core competencies.
Choices of business level strategy are important as it impacts long term
performance of the firm. Nonetheless, given the complexity of successfully
operating in the global economy, these choices are typically difficult to
decide upon. The purpose of a business level strategy is to create differences
that will distinguish the firm’s position with that of its rivals (Skarzynski
and Gibson, 2008).
As
firms move beyond their traditional business level focus, corporate level
strategies are developed. These strategies specify the actions the firm takes
in gaining the competitive advantages. This requires that the firms should
adopt a long-term perspective and how the changes taking place within the
industry will affect its current business model, its future strategies and its
sustainability. As such, the purpose of having corporate level strategies is
central on enabling the company to sustain and further promote its competitive
advantages as well as profitability. Simply, corporate level strategies are
created to drive the business model over time and determine which business and
functional level strategies should be created to drive long term profitability.
Corporate level strategies therefore deal with organisational plans and change
as the industry and specific market conditions warrant (Gulati, 2009).
Conclusion
How companies
approach their own success in the market will very much depend on their
diversification strategy and the materialization of such. It is not enough the
organizations should plan to diversify when it felt the need to do so, what is
more important is the actions or activities that will accompany strategic
diversification. Diversification also thereby presents an opportunity for the
organisation to deliver what the customers want, need and desires. One of the
goals of diversification is the need to build capacity to create what is not
previously present. Overall attainment of the goal could be thus satisfied by a
diversificative mindset since it can also highlight the development of organisational
capabilities, expertise and competences as counter argued by Hamel and Prahalad.
While this is the case, implementation of diversification can either provide
success or failure to a firm especially that when diversification delivers no
value at all for the firm as what Porter had argued.
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M L 2009, ‘Strategic Risk Management: The New Core Competency,’ Harvard Business Review.
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R 2009, ‘A New Business Strategy: Give Up the Core,’ Harvard Business Blog.
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J F 2006, ‘Diversification,’ Harvard
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C & Allen, J 2010, Profit from the
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