diversification

An example is the manufacturer of introducing new flavour of drink. Since accounting conventions make these variables unreliable, financial economists prefer market returns or discounted cash flows as measures of performance. ROA is the most frequently used performance measure in previous studies. Articles lacking in-text citations from December All articles lacking in-text citations. References in periodicals archive? According to Calori and Harvatopoulos , there are two dimensions of rationale for diversification.

Abstract. Prior work has shown an association between diversification strategy and profitability. This paper replicates that association using more recent and complete data and goes on to investigate the sources of the association.

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Markides and Williamson show that strategic relatedness is superior to market relatedness in predicting when diversifiers related outperform unrelated ones. Others however argue, it is not management conduct so much, but industry structure that governs firm performance Christensen and Montgomery , Montgomery Besides diversification types and industry structure, researchers have also looked at the ways firms diversify.

Simmonds examined the combined effects of breadth related vs. Among studies of acquisitions the results are mixed. Some report that related acquisitions are better performers than unrelated ones Kusewitt , or there is no real difference among them Montgomery and Singh Some studies on breadth and performance find relatedly diversified firms perform better than firms that are unrelatedly diversified Rumelt , , Others show confounding effects in firm performance because of diversification category and industry Christiansen and Montgomery , Montgomery Recent studies suggest service firms should not diversify Normann , whereas, Nayyar , shows that in the service industry diversification ased on information asymmetry is positively associated with performance, whereas diversification based on economies of scope is negatively associated with performance.

It also appears there is a limit on how much a firm can diversify; if a firm goes beyond this point its market value suffers and reduction in diversification by refocusing is associated with value creation Markides Apart from the empirical evidence, the efficient market hypothesis EMH holds that competition among investors for information ensures that current prices of widely traded securities are the unbiased predictors of their future value, and that current prices represent the net present value of its future cash flow.

Evidence supports the existence of weak, semi- and near-strong forms of market efficiency Fama Finally, corporate takeovers discipline managers who waste shareholder resources and bust-ups promote economic efficiency by reallocating assets to higher valued uses or more efficient uses Jensen and Ruback , Lehn and Mitchell Taken together, the evidence and arguments presented above seems to suggest that diversified firms i.

Our null hypothesis H0 is that: Highly diversified firms should perform less well than moderately diversified and single product firms. There are numerous arguments and findings against the null hypothesis proposed above.

In certain markets, an investor may face assets constraint in constructing a portfolio, restricting diversification opportunities Levy Farrelly, and Reichenstein show that total risk rather than systematic risk alone, better explains the expertly assessed risk of stocks.

Jahera, Lloyd and Page , find well-diversified firms have higher returns regardless of size. DeBondt and Thaler , , argue that the market as a whole overreacts to major events. Prices shoot up on good economic news and decline sharply on bad news. According to Brown and Harlow , , investors hedge their bets and over react or under react to important news by pricing securities below their expected values.

As uncertainties decrease, stock prices adjust upwards, regardless of the direction of the impact of the initial event.

The post-event adjustment in prices tends to be greater in the case of bad news than in the case of good news. Haugen also casts doubts on the validity of the EMH. Finally, Fama and French , changing their earlier stance, argue that the capital asset pricing model CAPM is incapable of describing the last fifty years of stock returns, and the beta is not an appropriate measure of risk.

This implies that a stockholder may not be better positioned to diversify his portfolio of stocks as compared to a corporate manager as implied by the null hypothesis. On the basis of this discussion, we could argue that market inefficiency may not allow investors to optimally allocate their resources.

It can put managers, especially good ones, in a more advantageous position to diversify their product market portfolios and thereby improve firm performance. Thus, our alternate hypothesis H1 is: Thus, on average, diversified firms as a class should perform better than moderately diversified or single-product firms. The approach used in this study is akin to that of military historians who examine past battles and in the context of operational tactics conclude that combatants with greater orce material and manpower tend to win more often.

Those with insufficient force need the advantage of mobility and surprise to neutralize superior force in order to win. These insights, based on outcomes of many battles, allow historians to disengage from contingencies and specificities of stewardship and terrain. This does not imply that situational specifics should be ignored in planning military campaigns. The finding only points out the general truth of certain tactics. Similarly, in the context of the conduct of business strategy, we could also first examine the performance of diversified firms without regard to specifics of strategy, like type, breadth, modality and industry, and figure out if in general, the average performance of diversified firms is better than that of undiversified firms.

The diversification literature is unable to demonstrate that diversification type, breadth, modality, and industry have consistent and predictable impact on performance. We therefore treat these as situational contingencies and do not take them into account.

Earlier studies of diversification use cross sectional data, small samples and single measures of performance. We on the other hand, examine a large sample of firms with data over a seven year period. We use about two thousand firms, and multiple performance measures. The starting point of our main study is , the earliest data point for segment information available on the Compustat database.

Accounting and market returns, their variability, coefficient of variation, and the Sharpe Index are the independent performance variables. The study also tests the robustness of classification of firms based on SR ratios.

For this part of the study, the data is available from It also tests the robustness of results based on the extent of performance and the degree of diversification.

According to Calori and Harvatopoulos , there are two dimensions of rationale for diversification. The first one relates to the nature of the strategic objective: Diversification may be defensive or offensive.

Defensive reasons may be spreading the risk of market contraction, or being forced to diversify when current product or current market orientation seems to provide no further opportunities for growth. Offensive reasons may be conquering new positions, taking opportunities that promise greater profitability than expansion opportunities, or using retained cash that exceeds total expansion needs.

The second dimension involves the expected outcomes of diversification: Management may expect great economic value growth, profitability or first and foremost great coherence with their current activities exploitation of know-how, more efficient use of available resources and capacities. In addition, companies may also explore diversification just to get a valuable comparison between this strategy and expansion. Of the four strategies presented in the Ansoff matrix, Diversification has the highest level of risk and requires the most careful investigation.

Going into an unknown market with an unfamiliar product offering means a lack of experience in the new skills and techniques required. Therefore, the company puts itself in a great uncertainty. Moreover, diversification might necessitate significant expanding of human and financial resources, which may detract focus, commitment, and sustained investments in the core industries.

Therefore, a firm should choose this option only when the current product or current market orientation does not offer further opportunities for growth.

In order to measure the chances of success, different tests can be done: Because of the high risks explained above, many companies attempting to diversify have led to failure. However, there are a few good examples of successful diversification:. From Wikipedia, the free encyclopedia. This article includes a list of references , but its sources remain unclear because it has insufficient inline citations.

According to Calori and Harvatopoulos , there are two dimensions of rationale for diversification. The first one relates to the nature of the strategic objective: Diversification may be defensive or offensive. Defensive reasons may be spreading the risk of market contraction, or being forced to diversify when current product or current market orientation seems to provide no further opportunities for growth.

Offensive reasons may be conquering new positions, taking opportunities that promise greater profitability than expansion opportunities, or using retained cash that exceeds total expansion needs. The second dimension involves the expected outcomes of diversification: Management may expect great economic value growth, profitability or first and foremost great coherence with their current activities exploitation of know-how, more efficient use of available resources and capacities.

In addition, companies may also explore diversification just to get a valuable comparison between this strategy and expansion. Of the four strategies presented in the Ansoff matrix, Diversification has the highest level of risk and requires the most careful investigation.

Going into an unknown market with an unfamiliar product offering means a lack of experience in the new skills and techniques required. Therefore, the company puts itself in a great uncertainty. Moreover, diversification might necessitate significant expanding of human and financial resources, which may detract focus, commitment, and sustained investments in the core industries.

Therefore, a firm should choose this option only when the current product or current market orientation does not offer further opportunities for growth. In order to measure the chances of success, different tests can be done: Because of the high risks explained above, many companies attempting to diversify have led to failure.

However, there are a few good examples of successful diversification:. From Wikipedia, the free encyclopedia. This article includes a list of references , but its sources remain unclear because it has insufficient inline citations.

Richard Rumelt

Rumelt's diversification ratio is widely used within studies that address this corporate strategy (Montgomery, ) and it is reported to overcome the drawbacks of the traditional approaches. Richard Rumelt and Kate Rumelt, Richard Post Rumelt (born November 10, ) is an American organizational theorist, and Emeritus Professor at the UCLA Anderson School of Management, known for his work in the field of strategy, strategic planning, strategic management, and strategy dynamics. It is aimed to compare the relationship between diversification strategy and organizational performance in Belgium, a developed country and in Turkey, a developing country. The study will provide the managers wishing to grow their firms by diversifying scientific findings.