Beginning in the late 1980s, a de-diversification wave swept corporate America, on the premise that conglomerates and highly diversified companies can do better by focusing on their core businesses.
Initially this strategic shift brought benefits: academic research conducted at the time found that all this refocusing, on balance, useful for companies. The reason for this is clear enough: in developed economies where financial markets are efficient, investors do not need companies to diversify risks for them, because they can do that more easily and efficiently themselves. And that, of course, is true: investors can create their own portfolios and divest and redeploy their financial resources at will.
But over time, corporate refocusing began to show signs of a management trendsand possibly even a HARMS one: companies engage in refocusing because that’s what everyone else is doing. The fact that analysts find it easier to analyze and value single-business companies than diversified companies gives more pressure to refocus.
Is it time to rethink the case for diversity?
The problem is that de-diversification spreads to companies that, from a strategic perspective, are already focused, even if they can be in different lines of business. For example, the Dutch electronics giant Philips used to be in businesses such as television, audio, consumer electronics, lightning, medical technology, semiconductors, and semiconductor printing machines. A diverse portfolio of businesses to be sure, but they are all connected by a common technology: electronics. However, Philips is also feeling the pressure to de-diversify and is now firmly focused on health technology. Many other companies have become trading companies.
What analysts and consultants seem to underestimate is that capital is not the only resource that can be redeployed and reconfigured within a diversified corporation. Business school academics have long argued that the logic of diversification is not only about reducing risk: companies diversify into new markets in order to take advantage of underutilized assets or skills from another business that they cannot easily sell or exploit in open market.
Research on “institutional voids,” for example, shows how intangible resources, such as reputation, can be better used and exploited within the limits of a multi-divisional corporation than through market mechanisms. Innovation also benefits: managers can easier to identify and capitalize of business opportunities if they fall within the boundaries of a diversified company than if they occur in the open market. Put differently, the marketplace for ideastechnology, and intangible resources often fail and become inefficient compared to sharing and coordination within an organization, even if this company consists of multiple, autonomous divisions.
Take, for example, the company Euronet (disclosure: one of us works with them). The company has three divisions: an electronic funds transfer division (EFT), which is largely focused on operating ATMs; an epay division, focused on providing payment transactions for retailers, such as payment codes, vouchers, and digital wallets; and a money transfer business, which enables cross-border payments. These three divisions operate autonomously and the top management of Euronet has wisely restrained from formulating and issuing a joint strategy statement.
The international money transfer industry, however, is under way big change in past years, with more expected: new entrants and apps, by companies like Wise, OFX and Moneycorp that have attracted many customers with their user-friendly platforms; Cryptocurrencies are increasingly used for international peer-to-peer money transfers; and the use of electronic payments has increased significantly, especially in developing economies.
Euronet’s money transfer business, however, has been able to adapt and respond to these changes in ways that it would not have been able to do had it not had access to the capabilities and resources of the EFT divisions and epay in the Euronet portfolio. It recently launched a new platform, called Dandelions, which does not just transfer money abroad (as all other players in the industry do), but can do it in real time because it uses the network and the regulatory framework of its parent’s EFT division, including credit , debit, and cash delivery functions. In addition, by integrating Dandelion with the products and technology of its epay division, Euronet gives customers the opportunity to link it directly to their digital wallets and pay, top up on mobile phones and pay the bills.
What allows Euronet to successfully respond to the significant changes occurring in its industry is its ability to quickly integrate people and technology from different parts of the company and innovate. Such a transfer and recombination of knowledge would be almost impossible if the three divisions were cut off as independent companies.
Similarly, before Philips moved most of its divisions to focus on health technology alone, it created many breakthrough innovations by combining knowledge and technology from different division. For example, the “ambient experience“innovation in its health tech division – something that has led to a very significant reduction in patient anxiety (and consequently to an 80% reduction in the use of sedatives and a 70% reduction in the need for re-scan) came from its lighting division. (now defunct). Similarly, its television division’s Ambilight technology (now sold) — a significant innovation and difference in an otherwise largely commoditized market – also from the Lighting division. In addition, most of the technology required for the monitoring functions of the Health Watch range, which offers wearable devices for consumersrelies on the knowledge and developers from its B2B Health tech division.
It’s not just technology that applies to the divisions: Philips knows that its brand and position in the professional sector improves the image and reputation of its products in its consumer products division (now a part for sale).
The examples of Euronet and Philips show that having multiple businesses, even if they are highly independent, creates more options to potentially redeploy non-financial resources rapidly if environments change, or get together again to new innovative solutions.
Having options is especially important in situations of uncertainty and making them is not something that the market, especially individual investors, can do easily. Nor can we expect start-ups and corporate venture units to fill the void. Start-ups cannot easily tap into an array of existing technologies and knowledge sources of other companies, while corporate venturing and scouting units always struggle to use the external technologies they have invested in. Consequently, the excessive concentration of companies has resulted in a negative reduction of a company’s ability for change and adaptation, which can lead to the ownership of a set of businesses. The continued emphasis on focus is particularly unfortunate as changes in the external context today make differentiation more important than ever.
Digital makes diversification more relevant.
Of course, there are costs to such diversification and to running a diversified company: If the company seeks to exploit the intangible resource of reputation, for example, it must also acquire the complementary resources required for running the new line of business. This may include technology, labor, or new supply chains. It may need to operate from a head office where all such expertise is available.
But these costs have been declining over the past decade, mainly due to the increased use of partnerships and business eco-system to help implement a diversification strategy. For example, Vodafone may diversify into banking, to take advantage of its mobile capabilities, without having to create banking products itself, since it operates with a constellation of partners. Of course, the option of working with other companies also existed before, but coordination with other organizations has become easier, and with it more widespread, due to digital technology, which has led to the development of communication technology and technology standard, etc.
While digitalization reduces the costs of diversification, at the same time, it seems to increase the benefits of diversification, especially through the increased importance of data as a strategic resource. Traditionally, less available resources become more difficult to exploit the further a company moves away from its core business. This is the case with physical resources or technological know-how, but even the benefits of an intangible resource such as reputation, for example, have limited spillovers when deployed in an industry that is very different from when where it was originally created.
And then there’s data, which is often used in businesses that are very different from where it started. For example, Alibaba is successful moved to the movies, using behavioral data generated through its e-commerce platform. Apple may harvest behavioral data from Apple watch wearers, which it may analyze and use to develop insights about their nutrition, shopping, entertainment, or health.
The reason is this: with its costs reduced and its benefits increased thanks to digital technologies, the optimal level of diversity is increasing. Therefore, the de-diversification of companies in the last decade took place in a context where further diversification was needed.
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The focus of many companies over the past decade, often done under pressure from boards, analysts and consultants, has been too much. New constellations of businesses will be difficult to analyze or value, but they can also be options for the future, for recombination and adaptation in uncertain times. The forced focus on companies in the past decades has deprived them of an important ability, and that is to be flexible enough to adapt to unpredictable changes. This, ultimately, affects their chances of success and survival.