DIVERSIFICATION STRATEGY

AAKER(2001)

INTRODUCTION


Diversification strategy means the firm venture into new business that is currently different from what its is doing. In another words, the firm offers new products and sell it to different market that is differently from its current business. For example: Sime Darby ventures into property business and trading business; EON venture into banking by establishing EON Bank; and UUM ventures into hotel business through EDC Hotel.

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The major factor that makes firm diversifies its business is to make more profit and to lessen the risk of going out of business. If one business is not profitable due to changing technology and changing consumer taste then the firm still can depend on its other businesses.

TYPE OF DIVERSIFICATION


Aaker (2001) classified diversification into two types which are: 1) Related diversification. 2) Unrelated diversification.

RELATED DIVERSIFICATION


Related diversification is where firm enter into new business that is different from what it is doing currently (core business). However, this new business still have some meaningful commonality with the core business.

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The meaningful commonality means, the firm: - can sell to the same customers. - can share or use the same sales force or distribution channels. - can use the same manufacturing plant, office, warehouse or other facilities.

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can use the same brand and share the same image. can share and use the same R&D. Can use and share the same staffs and operating systems. Can use and share the same marketing programs and activities.

SYNERGY


It means the new business have some meaningful commonality and that can share the same assets and competencies with the core business. Thus, related diversification is where the new business has a synergy with the core business.

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Example of related diversification. EON ventures into EON Bank (can share the same customers and thus the same brand name). Felda ventures into palm oil processing (share the same image and raw materials). HPA ventures into herbal education by establishing herbal university. (share the same knowledge in herbal)

MOTIVATIONS FOR RELATED DIVERSIFICATION

1)Utilizing the assets and competencies (including the knowledge). 2)Utilizing and maximizing the brand exposure (able to use brand extension). 3)Export or importing marketing skills. For example Proton ventures into car distribution through Proton Edar. Thus, exporting its customer service and customer relationship into new business.

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4) Exploit the capacity in sales and distribution. For example, TESCO hypermarket ventures into vegetable farming and palm oil processing. Thus it can utilizes its strong distribution channels to increase the sales of new business. HPA one day might ventures into Takaful or Islamic insurance and thus utilizes its vast direct selling agents to promote the new business. This is still related diversification since both businesses share Islamic and Halal image.

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5)Exploit manufacturing skills. For example, Honda ventures into motorcycles, lawn mover, jet ski, snow mobile and other small machine due to its manufacturing skills in car engine and automobiles.

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6) Achieving economies of scale. Economies of scale means we have to get certain number of quantities that can lead us to cost effective. Related diversification do provides economies of scale. For example, Honda has its own new product development testing facility. Now, it can test many new products such as motorcycle, lawn mover and jet ski using this new facility. If Honda use this facility to test new automobiles then it is not cost effective since it has to pay the same number of employees and other operation expenses.

UNRELATED DIVERSIFICATION


This means that the company ventures into new business that has no synergy with its core business. The new business dont share the same image, assets and competencies, employees and customers.

MOTIVATIONS FOR UNRELATED DIVERSIFICATIONS

1.

Managing and allocating cash flow. - The company has a lot of cash and thus it is better to ventures into new business. - For example YTL construction ventures into electricity power generation and supply to TNB. - This company has a lot of cash during property and construction boom during 2006 and 2007. It decides to ventures into this new business since it has extra cash.

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The company also can ventures into new business so that it can ensure good cash flow form the new business (cash cow). For example one of the reason besides having extra cash why YTL ventures into power generating business is because the power generating business is the cash cow that can provides good income to YTL.

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Another example is that one day Sime Darby might venture into Highway toll concession because the toll business can provides good income and cash to Sime Darby.

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2)

Entering business areas that has high ROI prospects. - Company ventures into new business because it wants to get good ROI. Maybe its core business cannot provides good income anymore. - For example, Cigarette makers ventures into food business that has good prospect of ROI.

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3)

Obtaining a bargain price for a business. - Some company ventures into totally new business because it has the opportunity to buy a company for a bargain price. - For example, a private company bought Ducaty Motorcycle for 1 Euro from Proton. Two years later, this company sold Ducaty to Harley Davidson for about 100million Euro.

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4)

Reducing the risk. - Firm can reduce the risk of going out of business when it has many types of business. - For example, Sime Darby has property, trading, hypermarket(Tesco), car distributors, and palm oil plantation.

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6) Tax implication. 7) Obtaining liquid assets. 8) Vertical integration motivations. 9) Defending against take over. 10) Providing executive interest.

RISK OF UNRELATED DIVERSIFICATION



Although there are many motivations that make company ventures into unrelated diversification there are still risks that the firm might face. Among the risks are such as:

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1.

Cannot focus on the core business. - When a company buy a new business its focus might be diverted into this new business. The company has to provides capital, manpower, management and others in order to run the new business. This lead to diversion from the core business that the company is good at and that the company has so much knowledge. At the end the competitors might taken over the core business.

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For example Sime Darby taken over UMBC bank and rename as Sime Bank during 2005-2007. However, after 1997 recession the company sold the bank and refocus on its core business in plantation and property. No more banking.

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2)

Managing the new business may be difficult. - Unrelated diversification means the company has to mange new business that it has no knowledge before. This is very difficult since the company has to figure out new marketing mix, strategies, new employees, new customers, new marketing environments, new assets and competencies and new culture to run the new business.

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For example Sime Darby give one of the reasons that it sold the bank business due to difficulty in managing the bank business. It has no knowledge to run the bank business and it is difficult to run the bank compared to the plantation business.

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3)

The new business that the company bought might be overvalued. During the process of taken over, there are some areas that the company overlook or did not carefully evaluated. This area or aspect can really threaten the new business.

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For example, PETRONAS bought Proton somewhere in early 2000. Later on it sold its share in Prtoton. Some analyst said this is due decreasing market share to inability of Proton to compete against Produa and the effect of Asean Free Trade agreement.

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