Boring But Valuable
By Cheryl Tan, Consultant, StrategiCom
3 Apr 2008

The Lure of Corporate Diversification
When corporate leaders are asked where they see their business in 10 to 15 years, many that I have met would illustrate a visionary long-term growth scenario involving massive expansion strategies. These strategies, more often than not, involve one or both of these forms of corporate diversification: (1) geographic diversification into foreign markets and (2) industrial diversification into non-core businesses.

The majority of Singapore-grown companies today are perfect examples that subscribe to such a phenomenon. With a relatively tiny domestic market, it is unsurprising that Singapore companies look beyond the shores to broaden their customer base. The invasion of international brands from the West and Japan over the last few decades further fuels this motivation for Singapore companies to do the same by geographically diversifying and conquering new markets.

But the inspiration to pursue industrial diversification is drawn from the success stories of US conglomerates like General Electric (GE) who have diversified from being a electric company – a core competency derived when their founder Thomas Alva Edison invented the electric lamp in 1876 – to one that presently spans across 6 very diverse businesses sectors involving activities from its flagship business in lighting and electrical distribution to capital & financial solutions, healthcare, aviation, energy, oil & gas, transportation and even media and entertainment offerings like networks, cable, film and parks & resorts.

Examples of such diversified role models are also evident on our very own red-dot island. Corporate gems like Fraser and Neave (F&N) and United Industrial Corporation (UIC) share similar GE-like stories. F&N began as a printing company and subsequently diversified to pioneer the aerated water business in Southeast Asia in 1883. From a soft drinks competency, F&N branched into the business of brewing in 1931, dairies in 1959 and glass bottle manufacturing in 1972, property development and management in 1990 and finally in 2000, re-established its roots in publishing & printing. In 1963, United Industrial Corporation (UIC) was incorporated as a manufacturer and distributor of detergent and toiletry products. Today, this listed company has its core business in property development and investment.

Al Reis (Refocusing the Corporation) and Constantinos C. Markides (Diversification, Refocusing, and Economic Performance) cite that the proliferation of companies diversifying, primarily in areas unrelated to their core businesses, started right after the Second World War. Al Reis explains that an explosion of new goods and services that hit the marketplace after the war, coupled with pent-up consumer demand and rapid technological development led to a massive increase in the number and variety of products available to consumers everywhere. From lifestyle appliances like television, video cameras and recorders to equipment and technology that drive information speed and efficiency like computers, plain-paper copiers, hand-phones and  facsimile machines. Choices were abundant.  Lured by these new avenues of business, companies all over the world including General Electric, Daimler-Benz and General Motors, delved into a host of new products and services unrelated to the core areas that they started off with, and expanded in a bid to meet evolving customer demands.

It was also around the same time (in 1950) that geographic diversification, more commonly known as internationalisation, began to take off in a big way. According to William A. McEachern (Economics: A Contemporary Introduction), mergers peaked during 1964 to 1969, especially industrial diversification in the form of conglomerate mergers (i.e. a merger of firms in different industries), which accounted for four-fifths of all mergers.

Management theories provide an insight to companies’ rationale for industrial diversification: (1) spreading the risk of its returns associated with the uncertainty of its core businesses – the pooling of uncorrelated returns from diversified businesses helps the organization achieve profit stability, (2) improving financial performance by investing earnings from core businesses into new ventures that would generate additional profits and (3) accelerating growth Personally, I am of the opinion that the mere excitement of exploring new grounds has spurred many diversification decisions. John G. Matsusaka (Corporate Diversification, Value Maximization and Organizational Capabilities) substantiates the concept of diversification as a dynamic value-maximizing strategy. This view revolves around the notion that organizational capabilities, in particular the skills and abilities of top and middle management, are to some degree transferable across products and industries. The applicability of these valuable capabilities across products and industries are the reason that firms attempt to find a new product or industry in the event of product sales decline. In view that uncertainty is commonplace in determining a good match for organizational capabilities, the obvious solution to the problem for most companies is through experimentation by entering an industry and observing the outcome, which is in fact, diversifying.

The Diversification-Focus Strategy See-Saw
While geographical diversification (or internationalization) continued to be and still is today, embraced by companies around the world as a pivotal approach to growth, industrial diversification on the other hand took on a lot more criticism and abandonment.

A host of authors like Constantinos C. Markides (Diversification, Refocusing, and Economic Performance) and Richard A. Johnson (Antecedents and Outcomes of Corporate Refocusing) noted that industrially diversified corporations in America began to reverse their approach during the 1980s and returned to their core business and competence by down-scoping using multiple divestitures. This evolution of the modern corporation was labeled as “"refocusing," "de-diversifying," "de-conglomerating," and/or "getting back to basics”.  Multiples factors were cited for this dramatic shift. Markides states corporate acquisitions and hostile takeovers forced corporate managers to respond to these threats by shedding unlucrative divisions and subsidiaries and concentrating on boosting the core product lines that have been their company's bread-and-butter. Johnson generalizes these conditions to include changing environmental conditions, firm governance, ineffective strategy, poor performance, and financial restructuring.

However, it was apparent that right after the 1980s stint of divestitures, corporate America re-entered into another wave of merger activity in the latter half of 1990s right into the turn of the millennium. Consider examples like AT&T’s move to enter the local telephone business by acquiring two cable television giants: Tele-Communications and MediaOne Group, Travelers Group merged with Citicorp, forming the world's largest financial services company, Chrysler Corporation merged into Germany's Daimler-Benz AG and Deutsche Bank AG took over Bankers Trust . This time, companies merged to achieve a stronger competitive position in the global markets. The largest mergers in history took place during this period, with the biggest action occurring in the banking, radio and television, insurance, telecommunications and health services sectors. This form of expansion into seemingly related businesses has been attributed to concepts of: (1) economies of scale and scope (synergy) and (2) market power that increases the bargaining power of the organization and/or its market share.

Even though these mergers appeared beneficial at the onset, the results that ensued from this effort must have portrayed otherwise. Recently, I read an article about how the giants of corporate America are increasingly abandoning the diversification strategies that have propelled them to the colossal size they are now, in favour of a more streamlined business model that focuses on its core business and competence. It seems to me that this diversification-to-focus-strategy see-saw has made another full circle since the 1980s and press releases of the world’s most famous players validate this dramatic shift that is once again apparent today.

Purchasing.com (22 Jan 2008): Fujitsu to spin off chip division. Semiconductor price wars force another chipmaker to refocus.
The Wall Street Journal Online (Jan 8 2008): Liz Claiborne Inc. will sell two brands and close a third as part of a strategic review intended to refocus the poorly performing apparel maker and retailer.

Foodnavigator.com (10 Sep 2007): Chr Hansen has announced the sale of its excipients and coating division in the US, in a move designed to further focus its business on its core food ingredients activities.

Edn.com (27 June 2006): Intel Sells Handheld Chip Biz to Marvell Technology Group Ltd. Intel added that the sale will allow the company to refocus its investments on its core businesses, including Intel Architecture-based processors, Wi-Fi, and WiMAX broadband wireless technologies.

Edge: Work-Group Computing Report (24 Jan 2000): Xerox Sees Explosion of Digital, Paper Documents; Company Refocusing to Capture Growth – Company Operations. “The document is our sweet spot,”… “We intend to embrace the document in whatever form it takes – digital or paper.”

Evidence of A Focused Strategy On Financial Performance
The diversification-focus strategy see-saw (2 cycles since the resolution of the Second World War) suggests that the path of focus offers rectification from the way-ward route of diversification. Notably, the concept of focus goes hand-in-hand with the theory that “specialization is productive” – one of the oldest ideas in economics according to John G. Matsusaka (Corporate Diversification, Value Maximization and Organizational Capabilities). While it is a personal belief that concepts which have stood the test of time are perhaps the safest bet, recent studies have also justified that companies which adopt focused strategies have proven to perform financially superior.

One of Constantinos C. Markides’ (Diversification, Refocusing, and Economic Performance) key findings from a data set of 250 of the top Fortune 500 companies is that every firm has its own limit for diversification, beyond which profits will decline. This mirrors the words of Al Reis (Refocusing the Corporation) who remarked that “it should have been obvious that a company cannot keep expanding its product line forever. You reach a point of diminishing returns. You lose your efficiency, your competitiveness and most ominous of all, your ability to manage a diverse collection of unrelated products and services”.

Gordon M. Bodnar, Charles Tang and Joseph Weintrop (Both Sides of Corporate Diversification: The Value Impacts of Geographic and Industrial Diversification) observed over a sample of 20,000 firm-year observations of U.S. corporations from 1987 to 1993, that a firm with international operations (geographic diversification) is valued 2.2% higher than a comparable single-activity domestic firm. However, the value of a multi-activity firm (industrial diversification) is 5.4% lower than a portfolio of comparable single-activity firms. And the financial evidence doesn’t stop there. According to multiple research papers, diversified firms typically trade at a discount relative to single-business firms. These findings suggest that while internationalization has proven its financial worth, the same cannot be said for an unfocused business strategy.

At the other side of the fence, advocates of specialization and focus are quick to testify to the financial rewards that accompanies such a strategy of sacrifice. Warren Buffet, who many acknowledge as the world’s greatest investor is the only person amongst the top 5 of the perennial richest billionaires (Buffet currently ranks 2nd according to Forbes’ 2007 list of the world’s billionaires, behind Bill Gates) who made his fortune from investments, and his wealth did not come by chance. This extraordinary gentleman followed a truly simple and ordinary investment strategy: “put all your eggs in one basket and then watch that basket… diversification is protection against ignorance. It makes very little sense if you know what you are doing.” This concept of focused investing is consistent to the type of companies that Buffet invests in. One of his investment tenets is to select only companies whose business is simple and understandable. Looking at his portfolio over the years, a commonality among his selected companies is the characteristic that they are often focused single-business firms, such as The Pampered Chef (gourmet kitchenware sold through direct sales and in-home parties), The Gillette Company (blades and razors), Justin Brands (western boots), ACME Building Brands (bricks and building products) and Larson-Juhl (wholesale supplier of custom picture-framing materials). Regardless of whether it is the success of his chosen companies or of his focused investment strategy, Buffet’s philosophy in both aspects proves that the realization of growth and risk reduction actually comes with focus.

Andy Grove, co-founder of Intel also believed in the all-eggs-in-one-basket strategy – the likely reason that has helped Intel to become the No. 1 (and still undisputed) micro-processor chip company. Not just in terms of market share (more than 80% as of 2005), but in the profit numbers as well. Samsung – the diversified Korean conglomerate that produces micro-chips in addition to a whole trove of other products such mobile phone, TV, VCR, MP3, Printer, Monitor, Washing Machine, and the list goes on – chalked an enviable 10-year sales revenue of nearly SGD $1.5 trillion. Intel – the focused microchip leader paled with just SGD $400 billion in sales revenue. However when it came down to profits, Samsung managed a mere margin of just 4% (or SGD $57 billion). Intel on the other hand boasted a whopping 21% (or SGD $82 billion) gain. Being focused helped Intel secure a 5 times bigger profit margin percentage than Samsung. Once again, the focused route has proven to be a clear winning strategy.

Branding and Being Focused
Being focused is about being single-minded in your business selections. Aside from the financial incentives mentioned earlier, having a focused strategy makes it easier for others to remember the business that you are in. If you only sell mobile phones like Nokia, chances are that people are more likely to think of you than another competitor, where mobile phones is just one of its many other businesses.
This notion of re-call and top-of-mind awareness has everything to do with branding. Branding, at least in my definition (and the branding team at StrategiCom), is all about finding that one association that your brand owns in the mind and differentiating it from your competitors. Thus, building a strong brand is much easier if you can clearly and simply define what your business is all about.

If you are thinking about diversifying, I hope this article has stopped you in your tracks. For companies who are still in a dilemma about taking the journey of refocusing towards building a more profitable company and a stronger brand, the history and undesirable track records of diversification should suffice as warning signals. The sacrifice of refocusing is foregoing the excitement of diversity and embracing boredom that comes from doing one thing and one thing only, day in and day out. The pot of gold at the end of the rainbow comes from the knowledge that strong brands deliver 365% higher returns on investment than its weaker counterparts. If that isn’t enough, Constantinos Markides (Corporate Refocusing) provides a couple more assurances. First, refocusing represents the natural response of firms to a more volatile external environment and a more competitive capital market. Secondly, over-diversified firms that refocus will achieve improved profitability and a higher market value.

So what would you rather have your company be? Exciting but worthless or Boring but valuable.