Businesses must diversify to survive!

By: Prof. Enrique Soriano

IS IT about profitability? Yes but there are other reasons why a company must diversify. Compellingly, diversification mitigates any danger in the event of an economic downturn. It also spreads the risks when the industry where you operate is in a slump. Or perhaps competition has started to erode your market share.

Over a long period of time, the literature on corporate diversification has focused almost exclusively on large, publicly held firms.  However, within the last few years, there have been some works published, dealing with diversification issues in small and medium sized firms  but also in family businesses (Iacobucci & Rosa, 2005).  Whereas some authors hold the view that family businesses engage in significantly less diversification than non-family firms, others describe diversification as a prevalent long-term strategy among family businesses.  Examples of big family business groups in the Philippines are the Ayala, Aboitiz and the Gokongwei Group.  Some of the most enduring family businesses started in one industry (trading) before growing into diversified companies with many lines of businesses.

Diversification is entering new markets with new products. Sometimes you just need to bust out and try something new like if you’re a pharmaceutical firm buying into a condiments company (UNILAB), an alcohol firm entering the water business (Asia Brewery); or a canned tuna company going into the food business (Century Tuna).

Many companies appreciate the need to diversify but few use it as a way of relating to their markets. Fundamentally, this strategy is about creating new products with new product life cycles and making the existing ones obsolete. By doing so, firms launch new products that are developed not just for current customers but for new ones. To execute this strategy, you usually manage a merger, an acquisition, or a completely new business venture.

Global and highly innovative companies like Facebook, Amazon and all the pharmaceutical companies are into diversification.   A company’s diversification strategy can be either related or unrelated to its original business. Related diversification makes more sense than unrelated because the company shares assets, skills and capabilities. It means entering in multiple industries that are able to share a common pool of corporate resources and capabilities. These are businesses where sales force, advertising, and distribution activities can be shared, exploiting closely related technologies.

In Asia however, many successful companies are opportunistic. We are referring to conglomerates such as San Miguel Corp of the Philippines, Salim Group of Indonesia and the CP Group of Thailand where they continue to buy unrelated businesses from Telecoms to infrastructure.

To a family business, diversification is a way to extend their capabilities into new lines of business.  The diversification will turn out profitable if the capabilities become a renewed capability in the new segment. Diversification may have two main costs for family business groups:

• The need of adding capabilities outside those of the family, be it through the hiring of professional managers, or through partnerships with other shareholders that incorporate the needed new abilities.
• An increase in complexity in the family group that may affect negatively its organization. In any case, the incorporation of outsiders to the group reduces the firm’s control by the family and may require an increase in monitoring effort.

Why Diversification Matters for Family Businesses

Anyone who has invested money has heard about the importance of diversification in a portfolio to hedge against losing too much money when markets retreat. Diversification can be equally important to businesses that may face serious threats during turbulent economic times or  when disruptive technologies enter the marketplace and big competitors move in. Although family businesses are known for their nimbleness and ability to react quickly to changing times, diversifying lines of business and expanding products and services can offer additional security when times get tough.

 

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Prof Enrique Soriano is a World Bank/IFC Governance Consultant, Senior Advisor of Post and Powell Singapore and the Executive Director of Wong + Bernstein, a research and consulting firm in Asia that serves family businesses, family offices and family foundations.

 

He is an associate member of the Singapore Institute of Directors (SID) and an advisor to business families worldwide, a sought after governance speakers, and the author of many articles and publications, including two best-selling Family Business books (Ensuring Your Family Business Legacy). To know more about his books, you can email esoriano@wongadvisory.com