Every diversification decision is an entry decision
What is the motivation for diversification? What is the process to set up the diversification venture? What are the determinant factors that make diversification successful? And what are the rules to manage diversification? Many firm in mature stage find themselves have little room to grow, difficult to capture more market share and to earn more profit. The future of the established firms could be threatened by industry disruption as innovative start-ups entering the market.
Those more capable incumbents would constantly adapt to the new rules of competition through both innovation and imitation. There are several reasons that would motivate firms to consider diversification. First, the volatile business could cause firms’ earnings uncertain, or the changing business climate could cause firms less profitable than before. EMI Ltd. is a good example, emerged as the Electric and Musical Industries, and then redirected itself towards the development of sophisticated electronic devices during the war.
After the war was over, EMI was struggling to make profits because its business was largely aligned with the defense-related products. So the CT scanning came into birth, after EMI’s vision on the great opportunity this breakthrough medical technology would bring. Second, the greater financial reward would trigger firms to take on new ventures, especially these firms who foresee the growth limitation of their existing core business.
Like Microsoft, it started with the OS business, and then it expanded its business into software applications, Internet Browser, database system and many, many more. Third, a favorable repositioning for the current business and a potential future overall business growth could be another force to motivate firms to consider diversification. Head Ski, after an initial success by selling premium priced Skis, expanded the product lines including poles and skiwear. Whether to diversify the business or not is not an easy decision to make.
It is just like to enter a new industry, the ultimate market size, the predicted growth rate and the future industry structure have to be evaluated and analyzed carefully and thoroughly. Since diversification occurs when a firm develop a new independent unit very different from its core strategy and activities, there are a number of challenges need to be addressed between the new and old business, like how to allocate the resource, whether to utilize the exiting capabilities or develop new ones, or how to approach market with conflicts between the core and venture.
To balance all these critical decisions is part of the process to march on new business development. Usually when a new idea is originated by an employee and accepted by the middle management, the idea will pass on to the upper management for the assessment-very much like venture capitals try to convince investors with their new business ideas. Firms’ top executives and board members evaluate the proposals, and usually the proposal receives resistance due to company’s commitments to existing investments.
The top decision makers have to investigate whether the new business is practical and executable within firm’s technological and institutional constraints, whether the new business adds resources or capabilities that improve the economic performance of core business units and whether the new business is able to create a viable expansion potential for firms’ future. In 1995, when Bill Gates viewed the Internet as the tidal wave and a most important single development to come along since the IBM PC was introduced, he sent out his visionary memo about the future of the Internet and engaged the company with the new Internet revolution venture.
In order to make the new business successful and to improve a firm’s value or lower its cost through continuing innovations, building up dynamic capability is a key activity needs to be enacted repeatedly. Strategies should be developed to address how to produce a greater economic contribution than rivals and how to retain customers and prevent imitation to have a sustainable market. The five factors also need to be taken into consideration are financial capital, resources, capabilities, entrepreneurial management skills, and general management.
Financial capital should be available for the new business hoping for a greater return in the long term. Resource such as a brand or geographical location or operational capacity is value-add asset that contributes to the firm’s performance. Capability is firm’s ability to continuously accomplish tasks at a high level of expertise by using its organization and people. The success of Microsoft’s office suite application largely replied on the heft investments, the Window’s OS brand name and the quality products it brought to the market. Bundling software applications together into a Suite with a discount price is an indeed genuine strategy.
Microsoft also took full advantage of Windows to offer applications by smartly making the software applications and operating system complementary to each other. Therefore, Microsoft could offer customer with more value and lower cost that eventually led the company to take over the software application market. Entrepreneurial management skills are critical when facing the growth challenges like capacity expansion, process innovation and boundary choices. Firm needs to innovate repeatedly to improve their economic contributions, if fail to achieve that, a firm cannot survive the growth stage of industry life cycle.
The lack of entrepreneurial management skills caused EMI Ltd. to commit many decision-making mistakes. First of all, EMI chose to enter the business directly by itself, instead to license the technology through those large diagnostic imaging companies, or enter into joint ventures, or at least distribute the products through vendors. This decision really hindered its growth when facing the aggressive competition from GE, who has a much broader breath of product and who is a leader in medical diagnostics imaging devices line in Untied States.
Secondly, EMI should continue on the product innovation to succeed in this technology driven market, but it was distracted by the small incremental improvements introduced by its competitors and did not focus its limited resources on developing significant technology advancement. EMI failed to leverage its competitive advantage as the first entrant and failed to build up dynamic capability in the long term, which cost them losing the growing momentum, and eventually would be driven out of the market.
The general management skills are necessary when comes to implement the entire strategy, and they are the guidance that leads the new business passing through the whole industry life cycle successfully. Those skills help firms analyze industry to understand the achievement of the firms’ economic contributions and then identify strategy plans to execute. Those skills also help firms build market position and sustain a brand name to grow steadily and constantly.
After Head Ski innovated the technology of metal Skis with a remarkable success, plus the success in selling poles, the company hastened to diversify its business into sportswear-a not so brilliant move. Head Ski’s early success was due to their technology disruptive, even though they have the premium brand name for Skis, the company had not yet build up enough supportive general management skills to set up distribution channels, brand management and marketing strategy for Skiwear-a market which has low entry barrier and easy to be imitated.
To manage a new venture well, we must know how to differentiate it from or integrate into firms’ exiting business and we also need to learn how to coordinate between the venture and the rest of the corporation. When the venture entering into a market requires substantial different mechanisms, then it will be a better idea to separate new business from the firm, having independent resource allocation, incentives system, coordination and control systems.
When the existing resources and capabilities can be served as the foundation for new business development, then the new business should take these available advantages to leverage the scope of economic. EMI’s misjudgment of choosing integration to run the US operation was the cause for the company to face a number of troublesome problems. Despite EMI identified the US as the most profitable market, it was still running a centralized organization based on UK, which made the company lost control over CT Scanner business in US, ranging from differentiable products, manufacturing, marketing, sales muscles to pricing.
While Microsoft’s leveraging its OS Windows advantage to diversify its business into the software application and Internet Browser is a successfully case utilizing integration. In conclusion, every diversification decision is indeed an entry decision. The new ventures have to continuously and consistently demonstrate their executions on growth and innovations and build up barriers preventing competitors from imitating, and have to accumulate more competitive advantage while developing better dynamic capability during the course of industry evolution.