Many well-known companies are involved in a wide range of businesses that seem to have little in common. A diversified company is one that operates in multiple, often unrelated, industries.
Defining a Diversified Company
A diversified company is a business that operates in two or more distinct industries, a sharp contrast to a specialized company that focuses on a single product or industry. The defining characteristic of a diversified firm is the distinctness of its business lines, which may target different customers, use separate technologies, and require unique management expertise.
Companies can achieve diversification through internal development, mergers, or acquiring firms in different sectors. A primary challenge for such an organization is maintaining strategic focus across its varied operations. The structure often takes the form of a parent company overseeing multiple subsidiary businesses.
Each subsidiary in a diversified structure runs independently with its own management team and operational autonomy, but ultimately reports to the parent company’s senior management. This model allows the parent company to mitigate risks associated with being in a single market and can lead to cost reductions by sharing resources across business units.
Types of Diversification Strategies
Related Diversification
Related diversification occurs when a company expands into a new business area that has a strategic fit with its existing operations. The new venture is similar to or complements the company’s current business, allowing for the sharing of resources or capabilities. There is often a technological similarity between the industries, which enables the firm to use its technical knowledge to gain an advantage.
For instance, a company that manufactures industrial adhesives might enter the consumer adhesives market. While the end customer is different, the core technology for producing the adhesives remains the same. Similarly, a television cable provider acquiring an internet company is an example of related diversification, as both are services within the telecommunications sector.
Unrelated Diversification
Unrelated diversification, often associated with conglomerates, involves a company expanding into industries that have no significant relationship to its core business. The new products or services are not connected to the company’s current offerings in terms of technology, customers, or distribution channels. This strategy is pursued when a company sees an opportunity for growth in a completely new field.
A classic example is a computer company deciding to produce stationery. The two product lines serve different customer needs, require different manufacturing processes, and are sold through different marketing channels. Companies pursuing this path often do so by acquiring an existing firm in the target industry, as it can be difficult to build the necessary expertise from the ground up.
Horizontal Diversification
Horizontal diversification involves a company introducing new, unrelated products to its existing customer base. The goal is to leverage the relationship with current customers by offering them more items to buy, even if those items are outside the company’s traditional area of expertise. This strategy can increase a company’s reliance on specific market segments.
A common illustration is a bookstore that begins to sell coffee and pastries to its patrons. The bookstore’s primary product is books, but it adds a new, unrelated product to enhance the customer experience and generate additional revenue from the people who already visit the store.
Vertical Diversification
Vertical diversification, also known as vertical integration, is a strategy where a company expands its operations into different stages of its own production path. This can happen in two directions. Backward integration occurs when a company takes control of its supply chain, such as a car manufacturer acquiring a tire company.
Forward integration involves moving closer to the end customer by taking over distribution or sales functions, such as a film studio buying its own chain of movie theaters. In both cases, the company expands its control over the value chain of its existing industry. This can increase efficiency and reduce reliance on outside suppliers or distributors.
Why Companies Choose to Diversify
One motivation for a company to diversify is risk reduction. By operating in multiple, unrelated industries, a company can shield itself from economic downturns that may heavily impact a single sector. If one part of the business is performing poorly, strong performance in another area can provide stability and balance the overall financial results.
The pursuit of growth is another driver of diversification. When a company’s primary market becomes saturated or offers limited opportunities for expansion, entering new markets can open up fresh revenue streams. Diversification allows a company to move into industries with higher growth potential than its current one.
Companies also diversify to achieve economies of scope, which are cost advantages that result from sharing resources across different business units. These shared resources can include distribution channels, marketing campaigns, or technological platforms. By leveraging existing assets in new ventures, a company can lower its overall costs.
Diversification can also be a strategy to increase market power. By operating in a variety of industries, a company can build a larger brand presence. This expanded footprint can lead to greater name recognition, enhanced credibility, and a stronger competitive position.
Advantages and Disadvantages of Diversification
A primary advantage of a well-executed diversification strategy is increased financial stability. Spreading investments across different industries makes a company less vulnerable to a downturn in any single market, leading to more consistent earnings. This structure can also create synergy, where different business units work together to create more value than they could individually, and the sharing of knowledge between divisions can spur innovation.
Another benefit is the potential for enhanced brand recognition. A company that operates in various sectors can become a household name, with its brand visible to a wider range of consumers. This broad exposure can build trust and loyalty, which may benefit all the business units under the corporate umbrella.
However, diversification is not without its challenges. A major disadvantage is the risk of losing focus, as management’s attention is spread across multiple businesses. This can lead to a lack of deep expertise in any single industry and may result in slower decision-making. The complexity of managing diverse operations can also lead to increased bureaucracy.
There is also the risk of negative synergy, where the different business units fail to integrate properly or even clash. A company can grow too large and inefficient, leading to a situation where the conglomerate structure destroys value. In such cases, the company might be forced to divest some of its businesses to regain efficiency and strategic clarity.
Famous Examples of Diversified Companies
The Walt Disney Company is a prominent example of diversification. While it began with animation, it has expanded into a vast entertainment and media conglomerate. Its business segments include theme parks, film studios like Walt Disney Pictures and Marvel Studios, and broadcast networks such as ABC and ESPN. The company also has a significant presence in streaming with Disney+, Hulu, and ESPN+.
Amazon is another clear illustration of successful diversification. Starting as an online bookstore, it has grown into a global giant with operations spanning e-commerce, cloud computing, and digital streaming. Its key business units include its online retail marketplace, Amazon Web Services (AWS), and its Prime Video streaming service. Amazon also moved into physical retail with its acquisition of Whole Foods Market.
Johnson & Johnson provides a classic example of diversification within the healthcare sector. The company operates three distinct business segments: Consumer Health, which produces brands like Band-Aid and Tylenol; Pharmaceutical, which develops prescription drugs; and MedTech, which offers a broad array of medical devices. This structure allows the company to serve different needs across the healthcare landscape.