Home / Summaries / Summary corporate level strategy / diversification-firm-relationship

DIVERSIFICATION BENEFITS AND COSTS

Q: Why is a firm more likely to diversify into a new business?

Existing business lines can potentially share more inputs with the new business Potential synergy between existing and new businesses is a driving force

Q: When is a firm less likely to diversify into a new business?

Existing business lines are complex Complexity of existing business lines increases as they share more inputs with the new business

Q: What factors should a firm consider in making diversification choices?

Balance potential synergy with coordination costs Evaluate the impact of complexity Avoid diversifying into a highly related industry with complex existing business lines or unrelated industries with straightforward existing business lines

44 important questions on DIVERSIFICATION BENEFITS AND COSTS

What happens to coordination costs with the number of business lines and the amount of interdependencies among them?

Coordination costs increase with the number of business lines and amount of interdependencies
Costs increase faster with the scope of the firm in related diversification compared to unrelated
Marginal coordination costs may surpass synergistic benefits with increased interdependencies

How does the complexity of a firm's existing business lines affect the likelihood of diversifying into a new business?

Complexity is negatively associated with diversifying entry
Input similarity moderates the relationship between complexity and likelihood of diversifying entry
More input similarity leads to stronger negative relationship between complexity and diversification

How were the hypotheses tested related to diversifying entry into new businesses?

Empirical analysis was conducted using historical data from U.S equipment manufacturers
Equipment manufacturers in SIC codes 34-38 were studied for diversifying entries into all manufacturing industries from 1993 to 2003
Results supported the negative association between complexity and diversifying entry and the significance of input similarity

What impact does the interaction between input similarity and complexity have on diversifying entry?

The interaction is significantly negatively associated with diversifying entry
As input similarity increases, the negative link between complexity and diversification strengthens
Higher input similarity leads to increased complexity, reducing the likelihood of diversifying entry due to higher coordination costs

How do control variables like Capital and R&D intensity influence diversifying entry in firms?

Capital and R&D intensity variables are negatively associated with diversifying entry
Firms show a preference for diversification within their own industry when considering these control variables
The negative association suggests a tendency to diversify within their current industry rather than into unrelated businesses

What is the 'RIPPLE' effect mentioned in the text, and how does it relate to diversification?

The 'RIPPLE' effect refers to the adjustment of existing relationships between new and old business lines
Shared inputs between business lines result in a greater 'RIPPLE' effect, increasing the need for relationship adjustments
The effect highlights the challenge of coordinating a complex portfolio, especially in related diversification scenarios

How does the study define and use input similarity as a moderator in the relationship between complexity and diversifying entry?

Input similarity is considered as a moderator that strengthens the negative association between complexity and diversifying entry
The more similarity in inputs, the stronger the relationship between complexity and lower likelihood of diversifying entry
This suggests that increasing input similarity amplifies the impact of complexity on reducing diversification decisions

Why is a firm more likely to diversify into a new business?

Existing business lines can potentially share more inputs with the new business
Potential synergy between existing and new businesses is a driving force

When is a firm less likely to diversify into a new business?

Existing business lines are complex
Complexity of existing business lines increases as they share more inputs with the new business

What factors should a firm consider in making diversification choices?

Balance potential synergy with coordination costs
Evaluate the impact of complexity
Avoid diversifying into a highly related industry with complex existing business lines or unrelated industries with straightforward existing business lines

How does a firm's coordination capacity influence its scope choices?

Limited coordination capacity may lead to substitutive scope choices
Expanding into all markets can create a coordination burden
Freeing up coordination capacity for horizontal diversification by standardizing components and outsourcing activities

What can offset some limitations of coordination costs within a firm?

FIRM-SPECIFIC ORGANIZATIONAL CAPABILITIES are essential
Acquire managerial expertise, develop knowledge and routines, or adapt organizational structure

What does within-industry diversification entail?

- Expanding the range of products within the same business domain

What characterizes related diversification for a firm?

- Expanding into products or services with relationships to the existing business, in a different business domain

What are the advantages of related and unrelated product diversification according to their impact size?

Economies of scope: Related (Large), Unrelated (Small)
Internal capital market: Both Related and Unrelated (Large)
Competition reduction: Related (Large), Unrelated (Medium)
Risk reduction: Related (Small), Unrelated (Large)

What is the main focus of the study "DOES THE DIVERSIFICATION – FIRM PERFORMANCE RELATIONSHIP CHANGE OVER TIME? A META-ANALYTICAL REVIEW." by Schommer, Richter, and Karna (2019)?

Study the relationship between DIVERSIFICATION and FIRM PERFORMANCE over time
Analyze how the decline in levels of diversification has impacted firm performance
Investigate changes in the relationship between related and unrelated diversification and firm performance

What is the theoretical foundation regarding the relationship between levels of diversification and firm performance?

Scholars propose an INVERTED U-SHAPED relationship
Diversification benefits include risk reduction, resource cross-utilization, operational capabilities, and reputation
Common resource use leads to economies of scale and scope

What are the two main insights from the review of the strategy and finance literatures on the diversification-firm performance relationship?

Traditional view: INVERTED U-SHAPED relationship between diversification levels and firm performance
Debate on the effects of both related and unrelated diversification strategies on firm performance
Lack of consensus on whether the strength of diversification effects on performance has CHANGED OVER TIME

How have levels of related and unrelated diversification changed over time according to the findings presented?

Unrelated diversification levels have DECREASED
Related diversification levels have INCREASED
Initial decrease in 1970s and 1980s followed by changes since the mid-1990s

What are some benefits of diversification mentioned in the information provided?

Risk reduction
Resource cross-utilization
Operational capabilities
Economies of scale and scope
Utilization of physical and informational resources

How has the relationship between unrelated diversification and firm performance changed over time according to the study?

Improved significantly over time
Indicates the relationship strengthening between unrelated diversification and firm performance

What is the key argument made regarding the impact of pressure to reduce diversification on firms' strategies and performance?

Pressure to reduce diversification may have more strongly affected firms with negative diversification strategies
Firms with negative diversification strategies likely impacted by the pressure to reduce diversification

How have scholars historically viewed the effect of diversification on firm performance according to the information provided?

Viewed as an INVERTED U-SHAPED relationship
Low related diversification levels and certain diversification types have positive performance effects
High diversification levels or unrelated diversification strategies have negative performance effects

Why have companies stopped diversifying as much as they used to, especially from the late 1970s to the mid-1990s?

Changes in factor markets favor shareholders having more control
Increased competition between companies
Changes in the institutional environment, including deregulation and capital market liberalization

What impact did changes in factor markets have on company diversification levels?

Shareholders gained more control over company decisions
Managers couldn't expand companies just for personal benefit
External rules ensured managers acted responsibly

How did increased competition between companies influence diversification?

Companies focused on existing strengths instead of diversifying
Diversification made American companies less competitive
Increased competition from countries like Japan and Germany

How did changes in the institutional environment impact company diversification levels?

Deregulation and privatization favored reduced diversification
Greater capital market liberalization discouraged diversification
Development of institutional environment in emerging economies closed 'institutional voids'

What shift in company strategy was encouraged in response to changes making diversification less important?

Companies focused on what they were already good at
Encouraged investment in existing lines of business rather than diversifying

Why did firms start focusing on what they were good at and investing in existing lines of business instead of diversifying?

Environmental pressures led firms to select more value-creating diversification strategies
Firms differ in resources and capabilities, leading to varying success in managing diversification
Firms choose diversification levels that match their capabilities, resources, and firm-specific factors for better performance outcomes

In the context of the relationship between diversification and firm performance, what is argued in Hypothesis 2?

The relationship between diversification and firm performance has become more positive over time
Stronger competitive environments differentiate more clearly between firms with higher levels of diversification
Success in unrelated diversification requires superior managerial competencies and inimitable diversification advantages

How are the performance consequences of unrelated diversification expected to have changed over time?

Firms with greater capacities to manage unrelated diversification faced less pressure to de-diversify
Only unrelated diversifiers with superior managerial competencies remain competitive
Resource complementarities in related lines of business are less affected by environmental forces

What is the core argument of Hypothesis 3 regarding the relationship between diversification and firm performance?

The relationship between unrelated diversification and firm performance has improved more over time
The strength of the relationship between related diversification and performance is less affected by environmental forces
Changes in the external environment impact unrelated diversification performance more positively

How did the authors test the hypotheses related to the diversification-firm performance relationship?

Employed meta-analytical regression (MARA)
Used 267 primary studies with 387 effect sizes
Analyzed 150,000 firm-level observations spanning over 60 years of research

What was the proposed reason behind the improvement in the relationship between diversification and firm performance over time?

Firms selecting more value-creating diversification strategies
Avoiding value-destroying ones
Resulting in an aggregate improvement in the diversification-firm performance relationship

How did changes in the external environment impact the relative advantage of using internal capital markets for unrelated diversification?

Changes reduced the relative advantage of internal capital markets for unrelated diversification
Only those relying on firm-specific diversification advantages remained competitive
Superior managerial competencies and inimitable sources of diversification advantages played key roles

What are some variables typically examined in a study analyzing the relationship between diversification and performance?

Independent variable
Dependent variable
Time (Median Year of Data Collection)
Level of Diversification
Type of Diversification (Related, Unrelated, Overall)
Effect sizes of the relationship between diversification and performance

What does the study's analysis reveal about the trends in related and unrelated diversification over time?

Levels of unrelated diversification continuously declined
Levels of related diversification decreased until around 1995 and then increased again
Pressure to de-diversify over time has not been uniform across the samples of firms analyzed

How did the relationship between diversification and firm performance change over time according to H2?

Relationship did not become more positive over time
Temporal effect on overall performance effects of diversification was positive but not statistically significant

What does H3 suggest about the relationship between unrelated diversification and firm performance over time?

Negative relationship between unrelated diversification and firm performance reduced more over time
Negative effects of unrelated diversification on firm performance have been reduced compared to related diversification

What theoretical implication challenges the conventional wisdom regarding the shape of the diversification-performance relationship?

Study challenges the inverted U-shaped relationship
Suggests lesser number of firms pursuing unrelated diversification due to a strengthening competitive environment
The right-hand side of the inverted U-shaped relationship appears to have become flatter over time

What managerial implication is provided regarding decision-making for diversification strategies?

Decision-makers should define strategies based on firm-specific resources and capabilities
The negative effect of unrelated diversification on performance has declined but not turned positive
Negative performance effect of overall diversification has remained negative

How does the study recommend decision-makers approach diversification strategies based on firm-specific factors?

Define strategies considering firm-specific resources and capabilities
Analyze each decision to enter a new line of business carefully
Decide based on the merits of each case

What role does the competitive environment play in the changing dynamics of unrelated diversification over time?

Strengthening competitive environment led to a decrease in the number of firms pursuing unrelated diversification
Performance implications of unrelated diversification appear considerably better over time

How does the study recommend managers evaluate the decision to diversify into a new line of business?

Analyze the decision carefully
Consider the negative impact of unrelated diversification on performance
Assess the merits of each case individually

The question on the page originate from the summary of the following study material:

Summary corporate level strategy

View summary

A unique study and practice tool
Never study anything twice again
Get the grades you hope for
100% sure, 100% understanding

Remember faster, study better. Scientifically proven.