Diversification refers to seeking unfamiliar products or markets or both in the pursuit of growth. Every company is best at certain products; diversification requires substantially different knowledge, thinking, skills, and processes. Thus, diversification is at best a risky strategy, and a company should choose this path only when current product/market orientation does not seem to provide further opportunities for growth. A few examples will illustrate the point that diversification does not automatically bring success. CNA Financial Corporation faced catastrophe when it expanded the scope of its business from insurance to real estate and mutual funds: it ended up being acquired by Loews Corporation. Schrafft’s restaurants did little for Pet Incorporated. Pacific Southwest Airlines acquired rental cars and hotels, only to see its stock decline quickly. Diversification into the wine business (by acquiring Taylor Wines) did not work for the Coca-Cola Company. The diversification decision is a major step that must be taken carefully. On the basis of a sample from 200 Fortune 500 firms and the PIMS database (see Article 12), Biggadike notes that it takes an average of 10 to 12 years before the return on investment from diversification equals that of mature businesses. The term diversification must be distinguished from integration and merger. Integration refers to the accumulation of additional business in a field through participation in more of the stages between raw materials and the ultimate market or through more intensive coverage of a single stage. Merger implies a combination of corporate entities that may or may not result in integration. Diversification is a strategic alternative that implies deriving revenues and profits from different products and markets. The following factors usually lead companies to seek diversification:

1. Firms diversify when their objectives can no longer be met within the product/market scope defined by expansion.

2. A firm may diversify because retained cash exceeds total expansion needs.

3. A firm may diversify when diversification opportunities promise greater profitability than expansion opportunities.

4. Firms may continue to explore diversification when the available information is not reliable enough to permit a conclusive comparison between expansion and diversification. Diversification can take place at either the corporate or the business unit level. At the corporate level, it typically entails entering a promising business outside the scope of existing business units. At the business unit level, it is most likely to involve expanding into a new segment of the industry in which the business presently participates. The problems encountered at both levels are similar and may differ only in magnitude. Diversification strategies include internal development of new products or markets (including development of international markets for current products), acquisition of an appropriate firm or firms, a strategic alliance with a complementary organization, licensing of new product technologies, and importing or distributing a line of products manufactured by another company. The final choice of an entry strategy involves a combination of these alternatives in most cases. This combination is determined on the basis of available opportunities and of consistency with the company’s objectives and available resources.

Caterpillar Tractor Company’s entry into the field of diesel engines is a case of internal diversification. Since 1972, the company has poured more than $1 billion into developing new diesel engines “in what must rank as one of the largest internal diversifications by a U.S. corporation.”39 Hershey Foods ventured into the restaurant business by buying the Friendly Ice Cream Corporation, illustrating diversification by acquisition. Hershey adopted the diversification strategy for growth because its traditional business, chocolate and candy, was stagnant because of a decline in candy consumption, sharp increases in cocoa prices, and changes in customer habits. Hershey subsequently sold Friendly in 1988 to a private company, Tennessee Restaurant Co. An empirical study of entry strategy shows that higher barriers are more likely to be associated with acquisition than with entry through internal development. Thus, in choosing between these two entry modes, business unit managers should take into account, among other factors, the entry barriers surrounding the market and the cost of breaching them. Despite high apparent barriers, the entrant’s relatedness to the new entry may make entry financially more desirable. Essentially, there are three different forms of diversification a company may pursue: concentric diversification, horizontal diversification, and conglomerate diversification. No matter what kind of diversification a company seeks, the three essential tests of success are

1. The attractiveness test The industries chosen for diversification must be structurally attractive or capable of being made attractive.

2. The cost-of-entry test The cost of entry must not capitalize all future profits.

3. The better-off test The new unit must either gain competitive advantage from its link with the corporation or vice versa.

Concentric Diversification Concentric diversification bears a close synergistic relationship to either the company’s marketing or its technology, or both. Thus, new products that are introduced share a common thread with the firm’s existing products, either through marketing or production. Usually, the new products are directed to a new group of customers. Texas Instrument’s venture into pocket calculators illustrates this type of diversification. Using its expertise in integrated circuits, the company developed a new product that appealed to a new set of customers. On the other hand, PepsiCo’s venture into the fast-food business through the acquisition of Pizza Hut is a case of concentric diversification in which the new product bears a synergistic relationship to the company’s existing marketing experience. (Recently, PepsiCo spun off Pizza Hut along with Taco Bell and Kentucky Fried Chicken into a new $

8.5 billion-a-year company called Tricon.) Toys “R” Us branched into children’s clothing on the ground that its marketing as well as technological skills (purchasing power, brand name, storage facilities, retail outlets, and sophisticated information systems) would give it an edge in the new business. Similar logic persuaded Honda to diversify from motorcycles to lawn mowers and cars; and Black & Decker from power tools to home appliances. Although a diversification move per se is risky, concentric diversification does not lead a company into an entirely new world because in one of two major fields (technology or marketing), the company will operate in familiar territory. The relationship of the new product to the firm’s existing product(s), however, may or may not mean much. All that the realization of synergy does is make the task easier; it does not necessarily make it successful. For example, Gillette entered the market for pocket calculators in 1974 and for digital watches in 1976.

Later it abandoned both businesses. Both pocket calculators and digital watches were sold to mass markets where Gillette had expertise and experience. Despite this marketing synergy, it failed to sell either calculators or digital watches successfully. Gillette found that these lines of business called for strategies totally different from those it followed in selling its existing products. Two lessons can be drawn from Gillette’s experience. One, there may be other strategic reasons for successfully launching a new product in the market besides commonality of markets or technology. Two, the commonality should be analyzed in breadth and depth before drawing conclusions about the transferability of current strengths to the new product. Philip Morris’s acquisition of Miller Brewing Company illustrates how a company may achieve marketing synergies through concentric diversification. Cigarettes and beer are distributed through many of the same retail outlets, and Philip Morris had been dealing with them for years. In addition, both products serve hedonistic consumer markets. Small wonder, therefore, that the marketing research techniques and emotional promotion appeals of cigarette merchandising worked equally well for beer. Miller moved from seventh to second place in the beer industry in the short span of six years.

Horizontal Diversification Horizontal diversification refers to new products that technologically are unrelated to a company’s existing products but that can be sold to the same group of customers to whom existing products are sold. Aclassic case of this form of diversification is Procter & Gamble’s entry into potato chips (Pringles), toothpaste (Crest and Gleem), coffee (Folgers), and orange juice (Citrus Hill). Traditionally a soap company, Procter & Gamble diversified into these products, which were aimed at the same customers who bought soap. Similarly, Maytag’s entry into the medium-priced mass market to sell refrigerators and ranges, in addition to selling its traditional line of premium-priced dishwashers, washers, and dryers, is a form of horizontal diversification. Mattel’s introduction of clothing items (skirts, shoes, jeans, shirts, and pajamas) for little girls, sizes 4 to 6x, under the Barbie brand name is another example of horizontal diversification. Using the Barbie phenomenon, the company has successfully launched the new business. As a company executive puts it, “Barbie is a designer brand for the little customers, their Calvin Klein.”44 Note that in the case of concentric diversification, the new product may have certain common ties with the marketing of a company’s existing product except that it is sold to a new set of customers. In horizontal diversification, by contrast, the customers for the new product are drawn from the same ranks as those for an existing product.

Other things being equal, in a competitive environment horizontal diversification is more desirable if present customers are favorably disposed toward the company and if one can expect this loyalty to carry over to the new product; in the long run, however, a new product must stand on its own. For example, if product quality is lacking, if promotion is not effective, or if the price is not right, a new product will flop despite customer loyalty to the company’s other products. Thus, while Crest and Folgers made it for Procter & Gamble, Citrus Hill has been struggling, and Pringles has been disappointing, even though all these products are sold to the same “loyal” customers. In other words, horizontal diversification should not be regarded as a route to success in all cases. An important limitation of horizontal diversification is that the new product is introduced and marketed in the same economic environment as the existing products, which can lead to rigidity and instability. Stated differently, horizontal diversification tends to increase the company’s dependence on a few market segments.

Conglomerate Diversification In conglomerate diversification, the new product bears no relationship to either the marketing or the technology of the existing product(s). In other words, through conglomerate diversification, a company launches itself into an entirely new product/market arena. ITT’s ventures into bakery products (Continental Baking Company), insurance (Hartford Insurance Group), car rentals (Avis Rent- A-Car System, Inc.), and the hotel business (Sheraton Corporation) illustrate the implementation of conglomerate diversification. (ITT divested its car rental business a few years ago.) Dover Corp. provides another example of conglomerate diversification. The company, with annual sales of over $3 billion, is a manufacturer with 54 operating companies engaged in more than 70 diverse businesses, from elevators and garbage trucks to valves and welding torches. It is necessary to remember here that companies do not flirt with unknown products in unknown markets without having some hidden strengths to handle conglomerate diversification. For example, the managerial style required for a new product to prosper may be just the same as the style the company already has. Thus, managerial style becomes the basis of synergy between the new product and an existing product. By the same token, another single element may serve as a dominant factor in making a business attractive for diversification. Inasmuch as conglomerate diversification does not bear an obvious relationship to a company’s existing business, there is some question as to why companies adopt it. There are two major advantages of conglomerate diversification.

One, it can improve the profitability and flexibility of a firm by venturing into businesses that have better economic prospects than those of the firm’s existing businesses. Two, a conglomerate firm, because of its size, gets a better reception in capital markets. Overall, this type of diversification, if successful, has the potential of providing increased growth and profitability.