Be Careful with Benefits of Diversification - Misconceptions and Generalizations

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Be Careful with Benefits of Diversification - Misconceptions and Generalizations
Stefka Nenkova, Student (University), Netherlands, Premium Member
According to Reel and Luffman (1986) the reason behind diversification lies within the benefits connected to a broader product-market base. However, they also point out that before being lured by the benefits from implementing such strategy, one should carefully consider the problems surrounding it. Precautions are necessary, because problems that present no threat to one organization could easily destroy another one. Reed and Luffman (1986) argue that there is no single simple solution to such problems, and they try to dissolve the generalizations concerning the topic of diversification that are made when people are trying to find such a "golden egg".

Ansoff (1965) distinguished horizontal diversification, concentric diversification and conglomerate diversification. Even if he named his matrices “Growth vectors in diversification”, his point - of GROWTH being the main objective of diversification - is sometimes disregarded. The labels by Ansoff are then put to all kinds of diversification, regardless of the main reasons behind the implementation of such strategy (Reel and Luffman, 1986).

Rumelt (1974) tries to avoid that problem by including all types of diversification, not only those which have growth as their main goal. He then classifies diversification into four main types: Related, Related-Constrained, Dominant and Dominant-Constrained, wherein the constrained types refer to diversifying not far from the core business of the company, thus being “constrained” to it.

Confusion arises when an attempt to mix these two systems is made. Namely, when conglomerate strategy is regarded as supposedly equal to unrelated diversification, which leads to wrong conclusions like: “all unrelated diversifications must be acquisitions”, “acquisition must be virtually synonymous with diversification” and “diversification by acquisition results in a conglomerate” (Reel and Luffman, 1986). Similarly, when an attempt to replace the concepts of horizontal, vertical and concentric growth with dominant and related diversification strategies is made, many misunderstandings arise.

In an attempt to clear all these misunderstandings and generalizations, Reel and Luffman (1986) discuss the reasons and benefits surrounding diversification, which can be seen in the following figures.

In addition, Reel and Luffman (1986) point out that in order to truly utilize even part of the potential from a diversification, substantial effort is needed from the diversifying firm as the benefits are not “automatic”. Before initiating diversification, extensive market analysis, analysis of materials, supplies, technological development and production processes are necessary. They state: "We see a need for less emphasis on the shorthand methods of describing diversification and more emphasis on the potential of the strategy and under what circumstances the benefits can be of meaningful value”. Moreover they claim that the facts surrounding diversification are neither all good or all bad and most problems are firm-specific. Therefore individual solutions are needed.

Reed, R. and Luffman, G. A. (1986) “Diversification: The Growing Confusion”, Strategic Management Journal, Vol. 7, No. 1 (Jan. - Feb., 1986), pp. 29-35
Ansoff, H. I. (1965) “Corporate Strategy”, McGraw-Hill, New York
Rumelt, R. P. (1974) “Strategy, Structure and Economic Performance”, Harvard Business School (Division of Research), Boston, Massachusetts.

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