© 2000 John Petroff
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© 2000 John Petroff |
5)- Corporate diversification efforts
Articles have appeared in academic financial journals indicating that diversification by companies is not necessary because investors can perform a diversification that serves their needs better. Such articles forget that although shareholders are the most important stakeholders in a corporation, they are not the only group directly interested in the company. Employees and managers are definitely directly affected by instability of corporate sales. To reduce this instability, diversification is clearly recommended. One form of diversification has just been alluded to above in globalization of markets and alliances with foreign partners. Another diversification can be across product lines. The most obvious fields of opportunities lie in complementary products because these products are very close to firm's core competence. For instance, a leather goods manufacturer may want to merge with a sporting goods company, or other luxury items. Acquiring firms in one's own industry (i.e. horizontal integration), or suppliers and distributors (i.e. vertical integration) achieves some additional diversification while at the same time increasing efficiency by eliminating duplicate functional departments, but such diversification fails to reduce a major proportion of commercial risk which stems from the business cycle (discussed in next section).
To reduce the impact of business cycles, firms to acquire should come from industries which sales are least correlated with sales of the acquiring company. For instance, a company that has cyclical sales (i.e. sales that correlate with the business cycle), such as a steel producer, could merge with a company in a counter-cyclical industry, such as mining. Another example would be a cyclical leisure industry company such as hotel and travel company, merging with a defensive industry, such as food or soft drink company. The danger in these sorts of mergers is that the new parent company may not have the needed expertise in running newly acquired operations, and may make mistakes comparable to those in new product introduction.
Mergers can indeed fail, especially if conflicts arise among divisions of comparable magnitude but with different objectives and management philosophies. If a company has already gone through a number of mergers, it has learned the skills of absorbing new talent into is ranks, redirecting corporate vision, building consensus and maintaining harmony among disparate and conflict-prone divisions. Such company has become a conglomerate. But it remains to be seen if investors and customers are also satisfied. For, such a conglomerate cannot stop at just being what it has become, but must find within its people an entrepreneurial spark that will bring new products and ideas flowing, which is clearly not an easy thing to do in a highly structured and stable establishment. To uncover the true colors of the conglomerate banner, an analyst must now go beyond accounting numbers and industry statistics. It is an evaluation of management that is needed on the basis of whether management sets goals that are achievable, whether it has the support and commitment of the entire staff, whether it has assembled the most skilled team for the task, and whether its plans are clearly spell out and understood by all.
See review questions Q-14C5.1 through Q-14C5.9.
See research assignments R-14C5.1 and R-14C5.2.
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