Academic journal article Management International Review

Assessing Product-Market Diversification of U.S. Firms

Academic journal article Management International Review

Assessing Product-Market Diversification of U.S. Firms

Article excerpt

Diversification has become an increasingly important aspect of corporate strategy over the last four decades, both in terms of product and market diversification.

Product diversification emerged in the early years of this century as a result of firms desiring to supply entire lines of inter-related products (Didrichsen 1972). Between 1949 and 1974 alone, the proportion of the largest 500 industrial firms which were diversified rose from 30 to 60 percent (Rumelt 1982).

International market diversification refers to firms which are horizontally- or vertically-integrated across different national sub-markets (Hisey/Caves 1985). This is a more recent development than product diversification. It made up 14.1 percent of the value of total assets controlled by foreign corporations in 1962, 22.3 percent in 1968 (Koptis 1979) and was estimated to be 31 percent in 1975 (Hisey/Caves 1985).

It is evident that the impact of corporate diversification on the risk-return performance has two dimensions: that of the product and of internationalisation.

The Role of Product Diversification in Firm Strategy

Two basic modes of product diversification can be identified: related and unrelated diversification (Wrigley 1970, Rumelt 1974, 1982). Related diversification is where firms diversify within industries while unrelated diversification is where firms diversify across industries. The relative costs and benefits of such diversification are likely to depend upon the inter-relationship between the different business activities of a firm.

The Economic Benefits of Related Diversification

The relative costs and benefits of corporate diversification are likely to depend on how the different business activities of a firm are related to one another. Where separate business activities use a common, indivisible input, a diversified firm can exploit economies of scope. Economies of scope arise not just from tangible input like a common R & D department or a common distribution system but also from intangible assets like brand names and production know-how. Businesses within diversified firms can therefore be related in at least one of two ways. They could be related either because they share markets, distribution systems, product and process technologies, or manufacturing facilities (Ansoff 1965, Rumelt 1974, Teece 1980), or because they rely on common technologies, managerial capabilities and routines and repertoires (Prahalad/Bettis 1986, Kazanjian/Drazin 1987, Winter 1987, Grant 1988). The use of these assets may be transferable at a negligible marginal costs.

The industrial organisation literature recognises that firms can enjoy synergy from diversifying into related businesses. Such diversification facilitates the exploitation of economies of scope where common indivisible inputs are used. Because there is the prospect of opportunism in small number trading relationship, or the existence of information impactedness, economies of scope are difficult to realise using the market mechanism (Kay 1982, Jones/Hill 1988). Hence, overcoming transaction difficulties in exploiting economies of scope via the market mechanism provides an economic rationale for hierarchical exchange through corporate diversification. Corporate diversification strategy can be seen as a way of reducing transaction costs in allocating resources, transferring and processing information, avoiding shirking, and overcoming agency problems (Williamson 1981).

A firm can gain certain kinds of comparative advantages if it has skills or resources that it can transfer into the new market (Porter 1987). A diversified firm can apply particular skills and knowledge acquired in one business to solve problems and exploit opportunities in other businesses (Salter/Weinhold 1978).

Consequently, a firm possessing primarily specific intangible assets is supposed to be a successful one in its national market and to be able to use these capabilities in foreign markets. …

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