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Diversification "out of the box"

2008

The present crisis shakes up markets and creates new opportunities for growth, also through diversification. Many cases studies show that the secret to success is not so much in the selection of a specific diversification strategy, but rather in its consistent implementation.

Strategy and management must be consistent

The first crucial issue involves setting up a consistent portfolio logic: should the company's value be raised through economies of scale and scope resulting from complementary business? Or does management think that, as a conglomerate, it can increase the value of the various businesses better than individual owners could. Based on this decision, a both consistent and effective management system must be developed. This involves various strategic imperatives:

Complementary diversification: Finding and realizing synergies

Successful players select their businesses after analyzing the potential synergies. The portfolio is complemented with related business segments, ideally using a replicable growth formula. In doing so, it is important to always consistently follow own rules and KPIs and not get distracted by "unusually" attractive opportunities. Of course, the more the core business is suffering, the more difficult it is to follow this recommendation. However, a shift in business may indeed be necessary to set the foundation for additional growth. For instance, Harman, an audio and infotainment equipment supplier, successfully migrated to become a systems supplier for the auto industry by acquiring Becker, a manufacturer of car stereos.

When managing diversification, headquarters must exercise considerable support functions and encourage and monitor the sharing of knowledge and resources. Stipulated targets should not be written in stone, but focus more on long-term action. Ultimately, it is important to also permit differences in management approaches. For example, it is possible to link pharmaceutical and biotech businesses, but it also makes sense to use different KPIs and requirements.

Conglomerates: constantly examining your own value contribution

When selecting businesses, successful conglomerates use criteria that permit standardized financial management, while also ensuring similar strategic success factors. This is illustrated by Haniel, which focuses on retail and service companies that have specific strategic components such as system features, or a leading brand position. The focus is less on growth and more on raising value. This means spinning off businesses that have already passed their zenith in the group. Rata Tata, the CEO of the company of the same name, underscores this goal. He states that "we have to check each and every company to see if it can stand on its own two feet, would be better off merged with another company, spun off or shut down".

Successful conglomerates have a lean strategic holding company as their headquarters. Here top skills in corporate finance, consulting und value management are consolidated. Value enhancement of the individual companies is supported by applying management techniques and best practices. Ambitious goals are stipulated and rigorously followed up on to ensure they are met. The Australian Wesfarmers Group focuses on return on equity and return on sales, which it links to reporting and compensation. According to CEO Eastwood, the relatively straightforward KPIs are "every time, everywhere"; in other words: omnipresent and absolutely binding.

Consistent action is the key to success

Acting consistently in accordance with the stated success factors has top priority. A positive example of this can be seen at Deutsche Post. The acquisition of Williams Lea offers an excellent platform for further growth in and around electronic document management and also provides process synergies along the value chain.

Numerous examples show what can happen if the targeted portfolio logic and actual selection and management of businesses do not fit together. For example, the financial market penalized the acquisition of Skype by eBay with a 40% drop in share price. There was simply no idea how the massive synergies could be realized that would be necessary to justify the purchase price. Even more drastic is the case of Vivendi Universal. The company was supposed to be set up as the "General Electric of Entertainment". This failed due to the lack of operational synergies and insufficient value generated by headquarters. The list of failures goes on and on.

Outlook

Diversification can serve as a recipe for success. However, the strategy selected is not the only decisive factor. The portfolio logic, selection of portfolio elements and adequate design of the management system must also all come together to produce a consistent whole.

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