Question

Under what conditions will a related diversification strategy not be a source of competitive advantage for a firm?

Answer 1

Unrelated Diversification is a form of diversification when the business adds new or unrelated product lines and penetrates new markets. For example, if the shoe producer enters the business of clothing manufacturing. In this case there is no direct connection with the company´s existing business - this diversification is classified as unrelated.

The economic logic of a diversification strategy rests on the assumption that certain economies of scope can be obtained more efficiently by a firm owing a number of businesses than by equity holders acting on their own. The family firm will pursue a strategy of highly related diversification if the firm as a whole to get certain economies of scope that family members acting on their own cannot. However, family members may also want to minimize their risks because the majority of their portfolio is invested in this firm. If a strategy of highly related diversification positions the firm in certain product-market areas where the risks are high, the firm may decide on a somewhat less related diversification strategy.

Now, In immense it's the key to value creation in a related diversification strategy to exploit economies of scope more efficiently than what is possible by equity holders acting on their own. The related diversified firm succeeds because it has a competitive advantage based on scope economies. If the related diversified firm does not exploit economies of scope then it will not have a competitive advantage. It is possible that the relatedness is based on relatively loose links among the businesses such that there is no great possibility of economies of scope.

Considering the following list of strategies:-

The Coca-Cola Corp. replaces its old diet cola drink (Tab) with a new diet cola drink called Diet Coke.

Likewise,Pepsi Co distributes Lay’s Potato Chips to the same stores where it sells.

Then,Pepsi.K-Mart extends its licensing arrangement with Martha Stewart for four years. Wall-Mart uses the same distribution system to supply its Wall-Mart stores, its Wall-Mart Super Centers (Wall-Mart stores with grocery stores in them), and its Sam’s Club.

Likewise,Head Ski Company introduces a line of tennis rackets. General Electric borrows money from Bank America at 3% interest and then makes capital available to its jet engine subsidiary at 8% interest.

Sometimes the unrelated diversification is based on the available expertise and experience of the human resources that can be utilized in completely unrelated fields. For example, if the owner of a trade company is competent in the field of computer design, they can open an internet store to sell goods and also expand activity by adding web page design services etc.

In this way the unrelated diversification can be accomplished using one of the following methods:

• Using the existing basic competences of the company and expanding from existing markets into new ones and starting new lines of production.
• Penetrating completely new markets. Usually such opportunity can be identified as a result of the main company business. For example a car dealer may start offering financial services by developing a car leasing scheme and selling cars through leasing.
• Developing new competences to use new market opportunities.

• The unrelated diversification is based on the concept that any new business or company, which can be acquired under favorable financial conditions and has the potential for high revenues, is suitable for diversification. This is essentially a financial approach; it is implemented when the research determines that this unrelated diversification in a completely new field would bring significantly higher revenues compared to the competitive firms on the basis of similar products, services, markets or complementing strategies. A good example of this kind of diversification, that brought high profits for a certain period of time, is that during recent years of growth many companies entered the construction market despite their significantly different field of main business activity. In this case, however, the lack of expertise and experience, and the insufficient knowledge of the market can lead to serious problems.