Diversify!
Finding the right approach to diversification.
Diversification is back! After years of focusing on their core business to achieve growth, companies are increasingly interested in a wider portfolio to jump start their business. Capital markets are also starting to see the benefits.
In search of the elusive magic formula that spells growth, companies have started to turn away from an overly focused approach. The 'all eggs into one basket' strategy has required companies to engage in price wars and other strategies to push competitors out of the market just to achieve required returns. A new Roland Berger study shows that half of these firms grow mainly by winning market share from their competitors.
Enter diversification: "Weak growth forces many companies to look for promising business segments outside of their core business," says Hauke Moje, Partner at Roland Berger Strategy Consultants and author of the new study, "Diversification done right!"
Moje bases his assessment on the empirical research conducted for the study. The consultants examined developments at 1,200 large international companies between 1995 and 2004. Authors found that the degree of diversification had no significant impact on ROS (Return on Sales) and ROCE (Return on Capital Employed). But significantly, 80% of the diversified companies had grown in terms of sales and EBIT (vs. 73% of the focused ones) over that time period. The study examined companies from Europe (44%), the United States (33%) and Japan (23%). Slightly more than half of these companies generated annual sales between EUR 10 billion and EUR 100 billion.
Based on this international data, Roland Berger consultants surveyed 40 companies in Germany only to find an increasing willingness to invest in business segments outside of their core product line. But they are taking a cautious, strategic approach, the findings prove. "Although companies are diversifying again, they are placing special emphasis on a structured selection process with clearly defined criteria," Moje notes. Nearly 80% of the respondents used benchmarks and industry analysis to determine the 'right fit' for their business. More than a third closely monitored current market trends to help them identify both the right time to widen their business spectrum and which types of segments to include.
A new opportunity for investors
Companies are not the only ones eyeing diversification as a new opportunity. The survey showed that investors - especially major shareholders, owning families and private equity companies - were increasingly willing to provide financing – but not without considerable demands, expert Moje notes. "Investors expect new business segments to produce EBIT margins of around 15% – within four or five years!" 55% of the companies surveyed were able to generate a clearly higher return. Only 21% of the companies surveyed did not meet their return targets in the new business segment.
Thus, diversification can be highly attractive, if done right!
In search of the elusive magic formula that spells growth, companies have started to turn away from an overly focused approach. The 'all eggs into one basket' strategy has required companies to engage in price wars and other strategies to push competitors out of the market just to achieve required returns. A new Roland Berger study shows that half of these firms grow mainly by winning market share from their competitors.
Enter diversification: "Weak growth forces many companies to look for promising business segments outside of their core business," says Hauke Moje, Partner at Roland Berger Strategy Consultants and author of the new study, "Diversification done right!"
Moje bases his assessment on the empirical research conducted for the study. The consultants examined developments at 1,200 large international companies between 1995 and 2004. Authors found that the degree of diversification had no significant impact on ROS (Return on Sales) and ROCE (Return on Capital Employed). But significantly, 80% of the diversified companies had grown in terms of sales and EBIT (vs. 73% of the focused ones) over that time period. The study examined companies from Europe (44%), the United States (33%) and Japan (23%). Slightly more than half of these companies generated annual sales between EUR 10 billion and EUR 100 billion.
Based on this international data, Roland Berger consultants surveyed 40 companies in Germany only to find an increasing willingness to invest in business segments outside of their core product line. But they are taking a cautious, strategic approach, the findings prove. "Although companies are diversifying again, they are placing special emphasis on a structured selection process with clearly defined criteria," Moje notes. Nearly 80% of the respondents used benchmarks and industry analysis to determine the 'right fit' for their business. More than a third closely monitored current market trends to help them identify both the right time to widen their business spectrum and which types of segments to include.
A new opportunity for investors
Companies are not the only ones eyeing diversification as a new opportunity. The survey showed that investors - especially major shareholders, owning families and private equity companies - were increasingly willing to provide financing – but not without considerable demands, expert Moje notes. "Investors expect new business segments to produce EBIT margins of around 15% – within four or five years!" 55% of the companies surveyed were able to generate a clearly higher return. Only 21% of the companies surveyed did not meet their return targets in the new business segment.
Thus, diversification can be highly attractive, if done right!
For more information:
Finding the right approach to diversification
Companies are using various filter mechanisms to define target industries, the study found. Initially, the basic value filter (1) eliminates business segments with poor images. The market filter (2) then weighs the specific elements of the relevant market. Marketability, average returns and competitive structure are key elements, compared to government and economic influence, which play a secondary role. The strategic filter (3) examines the ease with which core business can be transferred from the current to the new business segment. All surveyed companies rated this requirements as "very important." Client structure and labor intensity of the target industries are considered to be less crucial.
The regional filter (4) examines the political stability of the target region. Investors avoid locations with considerable political risks. As a fifth filter, the survey participants listed other assessment criteria. Number one was employee skills followed by government aid and transaction project size.
After deciding on a new business segment, management must have a plan in place to ensure seamless integration into the company. Survey respondents felt most strongly about centralized management of the new segment in the first few years. Over the long term, however, business leaders felt that decentralized operational management was preferable. "Ultimately, the right balance of centralized power and decentralized flexibility is crucial to the success of a diversified company," Moje says.
Companies are using various filter mechanisms to define target industries, the study found. Initially, the basic value filter (1) eliminates business segments with poor images. The market filter (2) then weighs the specific elements of the relevant market. Marketability, average returns and competitive structure are key elements, compared to government and economic influence, which play a secondary role. The strategic filter (3) examines the ease with which core business can be transferred from the current to the new business segment. All surveyed companies rated this requirements as "very important." Client structure and labor intensity of the target industries are considered to be less crucial.
The regional filter (4) examines the political stability of the target region. Investors avoid locations with considerable political risks. As a fifth filter, the survey participants listed other assessment criteria. Number one was employee skills followed by government aid and transaction project size.
After deciding on a new business segment, management must have a plan in place to ensure seamless integration into the company. Survey respondents felt most strongly about centralized management of the new segment in the first few years. Over the long term, however, business leaders felt that decentralized operational management was preferable. "Ultimately, the right balance of centralized power and decentralized flexibility is crucial to the success of a diversified company," Moje says.
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