The urgency of diversification is due to the possibility of ensuring a high level of competitiveness, innovative development, improving the efficiency of functioning in a market economy.
The purpose of conglomerate diversification
In conditions of permanent variability of the external environment, due to increasing globalization, scientific and technological progress, competition, financial and economic crisis, etc., companies seek to ensure sustainable development of their activities in the long run. Diversification is considered to be one of the most effective tools for solving this problem. So, what is conglomerate diversification?
Thanks to its implementation, business entities have the opportunity to adapt to the appropriate environment in which they operate, strengthen their competitive position in market segments, and make maximum and effective use of development opportunities.
Diversification is defined as the process of emergence of new forms and activities of the enterprise, as a result of which it is possible to achieve risk minimization and the formation of an effective management structure. In addition, diversification encourages the dynamism of a market economy, rapid changes in demand, the emergence of various industries and product markets. Due to diversification, the company diversifies its sources of income. With the help of diversification, companies are discovering new markets, and in order to gain a competitive advantage in already developed markets, they can use new technologies.
The strategy of conglomerate diversification is that the firm expands through the production of new products that are sold in new markets and are not technologically related to the production of previous products. This is one of the most difficult development strategies, as its implementation depends on many factors: staff competence, seasonality in the market, the availability of the necessary financial resources.
The profitability of the conglomerate as a whole largely depends on the ability of the management to anticipate the prospects of the industry and the ability to profitably manage the components of the portfolio of the conglomerate’s business and depends on market factors (stability of demand, competition, consumer tastes) and time, risk. This type of diversification requires the greatest financial costs and can only be done by large enterprises
Diversification: How to save the existing business?
Most companies resort to diversification when they create financial resources beyond what is necessary to maintain a competitive advantage in primary areas of business. Diversification can be done in the following ways: through the domestic capital market; restructuring; transfer of specific arts between strategic areas of management; separation of functions or resources.
Among the motives (causes) of conglomerate diversification, the most typical are the following:
- balancing cash flows. Thus, to reduce dependence on external financing, the company can acquire a firm whose competitive position will ensure stable cash flows;
- more rational use of financial resources. Cash flows from divisions in stagnant industries can be used by new divisions operating in growing industries;
- opportunities to acquire a new business at a low price. Such opportunities exist in declining industries, where firms seek to exit business quickly, minimizing future losses;
- risk reduction. Significant dependence on one product line can stimulate conglomerate diversification. In addition, initiating conglomerate diversification can be aimed at overcoming the cyclical nature of core business;
- interests of management staff. In the event of a decline in the core business, contract managers may be interested in conglomerate diversification, primarily because of the need to retain employment;
- protection against absorption. Conglomerate diversification may make a firm unattractive or unavailable for acquisition by another firm;
- tax deductions. With the help of conglomerate diversification, the possibility of differentiating the tax regimes of the corporation’s divisions often allows reducing the total tax payments.