Academic journal article Journal of Small Business Management

Antecedents and Propensity for Diversification: A Focus on Small Banks

Academic journal article Journal of Small Business Management

Antecedents and Propensity for Diversification: A Focus on Small Banks

Article excerpt

Due to the changing regulatory, economic, technological, social, and competitive environments, diversification strategies have proliferated among large U.S. banking institutions during the 1980s. To compete successfully in the 1990s, small community banks must also adapt their strategies in the dynamic financial institutions industry. This article presents a 1988 survey of 94 small community bank chief executive officers (CEOs). The study addresses the CEOs' intentions to diversify into nontraditional banking areas over a three- to five-year time frame. It also identifies certain environmental and organizational factors that influence the small banks' propensity to diversify. The relationship between the Ceos' intentions to diversify and their perceptions of market and competitive forces, aversions to risk, and the banks' size and past performances also are examined.

A dearth of empirical research addresses the factors influencing the decision to diversify. In this vacuum, community banks present an excellent opportunity to study the diversification decisions made by small businesses. Community banks, usually defined as commercial banks that serve a local community and have less than $500 million in assets, are small businesses in an industry dominated by larger regional and money-center banks.

This study captured the community banks' diversification intentions at a time when the changing regulatory and competitive environment made diversification important to consider. Although a focus on small banks limits its generalizability to other small businesses, it develops a testable framework for understanding the diversification decision among small businesses in other industries. Moreover, the focus on one industry offers a number of methodological advantages, which will be discussed later.


What leads an undiversified firm to seriously consider the prospect of diversification? Why might one firm in an industry be more attracted to diversification when competitors of a similar size are not? Can we identify those aspects of the firm's environment, industry, organization, and decision-making process that are associated with a propensity to diversify? This article will address these questions.

In a review of research on the topic of corporate diversification, Ramanujam and Varadarajan (1989) found only a few empirical studies related to the factors influencing a firm's decision to diversify. However, the literature on strategic management is replete with conceptual models that suggest the conditions under which diversification might be appropriate (Ansoff 1965, Reed and Luffman 1986, Ramanujam and Varadarajan 1989). These models indicate that diversification may be driven by (1) external conditions such as mature markets, product obsolescence, growth or profit opportunities, changing economic and socio-political environments; (2) internal aspects of the organization, such as excess resources in the form of plant capacity or cash or distinctive skills that can be transferred to new product markets; (3) management objectives, such as growth, earnings, or stability; or (4) a combination of these factors. In general, these conceptual models provide a rich basis for developing testable hypotheses regarding the decision to diversify.

While there has been only limited research on how firms decide to diversify, an extensive body of research relates to the effectiveness (ex-post facto) of diversification efforts. Rumelt's (1982) classic work on diversification established that the relatedness of a diversification to a firm's core business could affect corporate returns. Subsequent studies recognized that risk (typically measured in terms of the variance of profits) and returns had to be considered in assessing the outcomes of diversification (Bettis and Mahajan 1985, Chang and Thomas 1989). These ex-post facto studies provide strategic managers with clues about the forms of diversification that might be pursued and the inherent risk in diversifying. …

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