Conglomerate Diversification /unrelated Diversification/ Strategies
Conglomerate diversification is growth strategy that involves adding new products or services that are significantly different from the organization's present products or services. Conglomerat diversification occurs when the firm diversifies into an area(s) totally unrelated to the organization current business.
Most conglomerate diversifications are based on the rationale that expansion into unrelated industries has a very attractive potential:
"... the basic premise of unrelated diversification is that any company that can be acquired on good financial terms represents a good business to diversify into" (Thompson and Strickland ).
Typically, corporate strategists screen candidate companies using such criteria as:
- Whether the business can meet corporate targets for profitability and return on investment.
- Whether the new business will require substantial infusions of capital to replace fixed assets, fund expansion, and provide working capital.
- Whether the business is in industry with significant growth potential.
- Whether the business is big enough to contribute significantly to the parent firm's bottom line.
- The potential for union difficulties or adverse government regulations concerning product safety or the environment.
- Industry vulnerability to recession, inflation, high interest rates, or shifts in government policy.
Three types of companies make particularly attractive acquisition targets:
- Companies whose assets are "undervalued" - opportunities may exist to acquire such companies' for less than full market value and make substantial capital gains by reselling their assets and businesses for more than their acquired costs.
- Companies that are financially distressed.
- Companies that have bright growth prospects but are short on investment capital.
Unrelated diversification has appeal from several financial angles:
- Business risk is scattered over a variety of industries, making the company less dependent on any one business.
- Capital resources can be invested in whatever industries offer the best profit prospects; cash from businesses with lower profit prospects can be diverted to acquiring and expanding businesses with higher growth and profit potentials. Corporate financial resources are thus employed to maximum advantage.
- Company profitability is somewhat more stable because hard times in one industry may be partially offset by good time in another.
- To the extent that corporate managers are astute at spotting bargain-priced companies with big upside profit potential, shareholder wealth can be enhanced.
However, there are two biggest drawbacks to unrelated diversification: the difficulties of managing broad diversification and the absence of strategic opportunities to turn diversification into competitive advantage.
Despite these drawbacks, unrelated diversification can be a desirable corporate strategy.