Every organisation outgrows the existing business at some point. Ambition overtakes possibilities in a single business. Besides, traditional wisdom recommends diversification of risk. Never put all your eggs in one basket, goes the adage.
But empirical evidence suggests that diversification is fraught with high levels of failure rate (some studies pegged the rate as high as 75 per cent). By this data, can we term diversification a bad strategy? That’s perhaps not the way to look at it. Managing a diversified corporation requires different managerial skills and approach, and very few firms possess it. GE is one classic example.
In a diversified corporation, the task of the top management is not to strategise for each business — that is best left to the CEO or the Profit Centre Head of the individual businesses. The top management is expected to take a call on more pertinent questions, such as
Which business to be in? Which business to enter and exit?
How to allocate resources among various businesses?
How to make the magic ‘synergy’ happen?
These are about doing the right things, whereas business strategy is all about doing things right.
Lesson in history
Historically, diversification evolved differently in advanced verses underdeveloped countries. The impetus was different.
The Western and advanced economies saw an explosion of opportunity after the Second World war — reconstruction happened on a massive scale. Companies that were already successful had the money, managerial bandwidth, and ambition to exploit every possible opportunity that came their way.
Beyond a point, however, load on top management went out of control and led to the famous ‘profit-less’ growth phase — the top line grew, but the bottom line didn’t. They realised it was just not possible to keep adding businesses endlessly and hope to be in control.
BCG to the rescue
The Boston Consulting Group (BCG) came to their rescue with the famous ‘BCG Matrix’. The top managements had to simply plot their businesses on a 2x2 matrix, where, one axis contained relative market share (your share divided by the market share of the largest player) and the other, growth.
Businesses that got slotted in high relative market share and low growth quadrant, were termed ‘Cash Cows’ and the ones with high relative market share and high growth were termed ‘Stars’. The BCG matrix suggested that you take cash out of the ‘Cash Cows’ (since they are matured businesses with not much future) and invest them in ‘Stars’ (which do have a future). This way, you balance your portfolio. You don’t have to know zilch about any of these businesses.
Top managements of diversified companies got a handle on managing diversity for the first time — all they had to do was ensure that they had enough ‘Cash Cow’ businesses to fund the hungry ‘Stars’. This was manna from the heaven.
Unfortunately, the story doesn’t end here. Many other forces were at work, and a time came in the early 1990s when stock markets were discounting the shares of ‘conglomerates’ — companies that had diversified into many unrelated businesses.
The logic was simple. Investors realised that they were better equipped to ‘diversify’ their risk, as they had more flexibility to pull out their investment in a sector that was headed south, far more easily and quickly than a company that had diversified into that business.
Firms cannot exit businesses quickly. They demanded that, to make up for this ‘higher risk’, companies show that they are adding more value than companies that are single businesses in the industries in which they operate. This led to the breaking up of many corporations like Westinghouse, Hansons Trust, IT&T etc.
This was the limitation of blindly adopting the BCG matrix and presuming that as long as they allocate ‘Cash’ with that logic, they got the strategy right.
What went wrong?
It was simply that cash ceased to be the scarcest resource. The un-stated assumption behind the BCG matrix is that cash is limited, and to be internally generated. It was a good assumption during the 1960s and 1970s, when institutions didn’t exist for providing industrial credit. Today, you can manage a portfolio full of Stars alone.
Today, the business environment is dynamic and nothing stands still. Ideas like core competency, synergy, resource-based view of strategy have emerged.
Next week, we will look at Corporate Strategy.
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