Different levels of diversification

Different levels of diversification

Levels of diversification

The nature of diversification in groups of companies takes on many forms. Some diversified group have little connection across parts of the group. For example is Samsung, it has construction and electronics businesses.

 

For the purposes of strategy development, 3 main levels of diversification are identified.

1)    Close-related diversification

The different companies within the group may have different products or services but have some form of close affinity such as common customers, common suppliers or common overheads.

For example, the Unilever group includes separate companies in such businesses as Magnum ice cream and Knorr soups. Each of these company shares similar supermarket customers, some common suppliers and common competitors. It makes commercial sense for such companies to seek out the benefits of co-operation where appropriate.

2)    Distant-related diversification

The different companies in the group are more diversified with quite different products or services using wholly different technologies. However, they may share the same underpinning core competencies or some other area technology or services that would benefit from co-ordination by a central headquarters.

For example, 3M has many diversified businesses but it underpinning core competencies in adhesives and coatings are widely used throughout the group.

Another example is the Japanese company, Canon whose underpinning core competencies in optics are used in a range of applications from cameras to photocopies.

3)    Unrelated Diversification

The different companies in the group have little in common with regard to products, customers or technologies. However, they benefit from the resources of the headquarters with regard to the availability of lower-cost finance, quality of management direction and other related matters.

The examples are Samsung

Benefits of a corporate-level strategy

Corporate level strategy is the value added contribution of the central headquarters of a group of diversified businesses with its own strategy. It is delivered by the headquarters’ decisions on the selection of businesses to be in group, their management in the group and the resources allocated by the centre to individual companies. Corporate purpose is the maximisation of value added and the additional competitive advantage contributed by the central headquarters of the group of companies.

The diversified group should earn above average profits by the special contribution of group’s headquarters over and above the contribution of the individual companies.

Benefits of diversification are delivered in 3 main areas

1)    Internal to the group

a)    Economies of scope (For closed related diversified group)

It refers to cost savings developed by a group when its shares activities or transfers capabilities and competences from one part of a group to another

For example, 2 different companies might share a common sales team or share similar technologies

b)    Core competencies (For closed related and distant-related groups)

It refers to transferring core competencies between companies internally within the group.

c)    Shared activities (For distant-related groups)

For example, companies might share purchasing activities because they have similar raw materials or distribution activities because they have same customers. Such activities occur regularly in many consumer products companies such as Unilever where sugar and supermarkets apply respectively.

2)    External to group

a)    Vertical integration

This occurs when a company chooses to backward integration or forward integration. It creates cost savings such as not having to pay distributors or market power through direct access to customers.

For example, cosmetics retail shop chain Body Shop produces its own products and sells them in its own stores. There is more control over special products and is able to respond to the market trend without having to negotiate with other retailer to stock its products.

b)    Market power

Close related diversified firms in a group co-operates to gain external benefits in terms of increasing negotiating power with customers or lower costs with regard to distribution. Market power exists when a company has lower costs or a superior competitive position as a result of such co-operation.

c)    Competitor blocking

The blocking of competitive activity through providing a wider range of products within a closely related diversified group will result in market power. This affects the competitors from offering products as the products are being offered at a much lower price.

3)    Financial benefits (Often used in unrelated diversification)

 

a)    Lower cost of capital

The central headquarters able to use its greater negotiating power to obtain finance for individual companies than they would obtain independently of the group

b)    Business restructuring

The central HQ may be able to facilitate and finance essential restructuring of a business in the face of competitive pressure beyond the resources of an individual company.

c)    Efficient capital allocation

The central HQ can allocate finance across the group more efficient as a result of its central viewpoint of the needs and returns of individual companies

 

Conclusion

The corporate purpose is the purpose and contribution of the central headquarters of diversified group of companies. Diversified groups brings advantages such as lower risk of overall failure, mutual technical support, strength core competencies and building up company’s resources. Thus, the role of the group headquarters is to identify and manage the financial and other capital resources of the firm to realise these advantages.