The title conveys the meaning of the article. In a large organization such unrelated diversification takes place when an organization diversifies into areas that are unrelated to its current business. The decision to diversify into unrelated areas is generally undertaken by firms in unpredictable industries that are subject to rapid technological change. The obvious purpose is to reduce risk. It is also assumed that by restructuring the group of products of business, the firm would be in a position to add value. Similarity in products, technology or marketing knowledge between the two firms is not an issue here the acquiring firm simply wants to make an attractive investment. Unrelated diversification was a popular strategy 4 or 5 decades ago. For example the ITC’s diversification into edible oils, hotels, financial services etc. is a conglomerate diversification. Likewise another corporate group diversified into agro foods, textiles, paper, airlines, wind energy, tea plantations etc. A giant Paper Industry’s unrelated diversification into chemicals, nylon fibre, leather etc., is another example. Essar the Petroleum company went into shipping, oil, sponge iron, marine construction, telecom, power etc.
Unrelated diversification: Methods
- Buying high – performing companies in an attractive industry
- Buying cash – poor companies that could utilize additional funds for a quick turn around.
- Buying a company whose seasonal and cyclical sales patterns would provide stability to the firm’s total cash flow and profitability.
- Buying a largely debt-free company to improve the acquiring firm’s borrowing power.
Concentric diversification takes care of some common markets, products, or technology, whereas conglomerate diversification is based on profit considerations only. The firm thinks that it is able to spot an attractive investment opportunity faster than the market and commits its resources accordingly. The basic source of value in a conglomerate is senior management’s ability to time the market to buy and sell businesses. Consistent success in such matters however cannot be guaranteed. Unrelated diversification moves have actually destroyed value instead of creating it. Individual businesses may actually be worth more on their own rather than when placed under a larger corporate umbrella with other unrelated units. Companies have failed in most cases because of various reasons, inadequate focus, failure to understand the business fully, competitive disadvantage compared to organization that use related diversification.
Entering a new, unknown field is risky. The firm does not know the extent of competition. It may fail to read the mind of the consumer properly. Technological developments, environmental factors may compel the firm to shift gears continuously.
A company trying to expand through unrelated products may have to divert its attention from its core businesses – at least temporarily. First, it must decide the areas where it wants to operate. If acquisition is the route it must identify suitable targets for purchase. Top managers must integrate the new units with the existing businesses. All these steps would dilute the attention of the firm towards its own original business. The costs of ignorance and neglect might prove to be crippling especially in a highly competitive rapidly changing environment. There are many Indian companies which have gone out of business because of hasty, unrelated diversifications into too many areas.
Indian city based Rupees 700 crore Polyester company’s decision to diversify into cement proved to be suicidal. The group has diverted Rupees 560 crore earmarked for the PTA Purified Terephthalic Acid (PTA) plant. Its decision to venture into print media launching a Telugu Daily was also wrong as the paper made only losses right from inception. The decision to set up a cement plant in Gujarat was a blunder. The plants use lignite instead of the traditional fuel- coal, environmental clearance was not obtained beforehand; the alkaline content of cement was high and the cost of desalination plants for water needs was prohibitive; Rupees 600 crore funds raised for PTA plant were diverted unauthorized and the group started slipping into the red from 1995 onwards. The estimated daily losses from its newspaper were at the Rupees 2.5 lakh a day. The takeover of Ashok Paper Mill from the government of Assam was another mistake because the plant remained closed for 20 years before the group took it over.
For success in diversification the corporate management must undertake thorough industry and competition analysis to identify the prospects of a new venture. Undertake a careful, exhaustive appraisal of internal strengths, weakness; needed resources for managing risk, synergies that could bring in additional benefits etc.
Managerial competence, technical knowhow, relevant expertise in the proposed venture, profitability of the project, entry barriers erected by competitors over the years must also be looked into.
The modern trend is diversification whether related or unrelated is replaced by core competence.