Diversification is being bitten by a storm. You pick up any newspaper and gosh, theirs a new deal or a new merger or a new takeover.
The Big question is: Why are companies drawn to diversification??
Well, there are number of reasons for that.
->They wanna grow and they can only grow so much in their basic businesses.
->They wanna deploy excess Resources; they have Cash, Manpower and Reputation that can be used elsewhere that is underutilized in there core businesses.
Finally I think any discussion of diversification is ultimately going to miss part of the point if we do not recognise that there is a big chunk of ego and glamour involved in diversification. If you look at the covers of your major business publications, one of the best ways of coming on the cover is through diversification that is what the history tells us. I think the excitement of the chase and hunt in buying and selling is often invigorating to many managers.
The key to thinking about diversification is very simple but often forgotten and that is the diversification makes no sense unless the corporation you diversified in does not add value.
Diversification further can be broken into down into two broad categories, they are:
1) Unrelated Diversification
2) Related Diversification
In unrelated diversification we see a couple of schools of thought. One school of thought is that unrelated diversification is just managing a portfolio. You buy good stocks or buy good companies or motivate the managers to perform very well or even leave them alone and allocate resources from one to the other.
Well if we follow the history then I think it becomes clear, this concept doesn’t work at all. There’s another approach to the unrelated diversification and which is much more interesting, it’s called Restructuring. Instead of just buying companies and leave them alone, Good Companies look for companies that are under performing, where the management is not good, in contrast it’s lousy, where the management has left lots of unrealised potential on the table. Where the industry is fundamentally sound, the company has some underlying assets but where there’s just not been enough attention or energy placed on running the business efficiently.
These companies can be bought at a modest premium since they are not glamorous, not high performers; they are not sexy in the industry because in a sexy industry you’ll have to face a lot of bidders and so you will have to pay a high premium.
Instead, good companies go for dull, boring industries. They buy companies relatively cheaply and then they put them through the ringer. They change the management; they cut cost, slash overhead and thus breathe life into them.
They actively intervene; they don’t manage a portfolio in hands off fashion, thy actively intervene to restructure, to turn around, to transform what they buy.
History tells us that any kind of unrelated diversification is risky.
Related diversification as the evidence shows has much higher odds of success.
What do we mean by Relative diversification?
Well, it’s finding businesses where there is a synergy.
Now synergy means 1 + 1 = 3. If you are in a business and you get into another business, synergy means that the two together will create something more than either would do by themselves.
I think one think about corporate strategy is that there is no easy way to create a diversified company. I would like to know your views on this.
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