Graham Kenny rues that diversification has become the leper of management: something you certainly don’t touch! “Stock markets have become great punishers of diversifiers, hitting them with a ‘conglomerate discount’ in share trading. The message has gone out: diversification is bad, focus is good. The former has even been lampooned as ‘di-worsification,’” he writes in ‘ Diversification Strategy ’ >(www.vivagroupindia.com) .
For starters, the book defines diversification as the variation between businesses within the company; and the variation can be by products or services. “The degree of diversity is determined by two factors. The first is the degree of difference in one dimension, such as products produced. The second is the number of dimensions in variation – products produced, customer type, technology employed, delivery mechanism, and so on.”
Successful diversifiers show tremendous discipline in their performance measurement and capital allocation, Kenny says, citing as examples General Electric, ITC, Wesfarmers, and Bidvest. Revenue is measured at division and corporate levels, and profitability of growth is assessed through ROI metrics such as ROTC (return on total capital), ROCE (return on capital employed), and ROFE (return on funds employed).
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The author cautions diversified companies against ‘easy money,’ that is, allocating funds between divisions at below-market rates of return. This can lead to slack decision-making in divisions and eventually, if not corrected, may bring about corporate collapse, he observes.
Contrary to popular notion that the focused firms are the norm, Kenny sees a widespread adoption of diversification among small and large businesses, in both the private and the public sectors. “Far from being freaks, diversified businesses are normal.” Look, however, beyond the ‘share market hype or press hysteria,’ he advises investors.
The book identifies seven actions of successful diversifiers, including: Establish a supporting corporate centre, select capable division managers, install appropriate performance measures, set effective incentives, align the corporate culture, secure competitive advantage, buy well and integrate.
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Diversified firms can learn a lot from focused firms and vice versa, Kenny concludes. “A diversified company is a collection of focused firms. So it stands to reason that any diversified company would do well to study their focused counterparts,” he argues.
Similarly, focused firms can learn from diversified companies how to handle diversity. “Successful diversified firms are masters at keeping it simple and at establishing systems and procedures that ensure it remains that way.”
Focussed insights on diversification.