The article stresses the importance of the relationship between diversification and performance in the related businesses. It is argued that “related diversification enhances performance only when it allows business to obtain preferential access to strategic assets – those that are valuable, rare, imperfectly tradable, and costly to imitate. ” To be more precise, strategic assets are those that offer important source of long run competitive advantage; which are imperfectly tradable, imperfectly substitutable and imperfectly imitable.
Subsequently it goes on to say that eventually the advantage will “decay as a result of asset erosion and imitation by single business rivals. ” And in the long term it is only “competences” which will facilitate building new strategic assets that will allow corporation to sustain profits above average. “Both short and long-run advantages are conditional, however, on organisational structures that allow the firm’s divisions to share existing strategic assets and to transfer the competence to build new ones efficiently. ”
Although there is a lot of academic research into the relationship between diversification and performance, there is still confusion regarding the nature of this relationship. The following aspects of the problem are emphasised throughout the article: 1. Exactly what kind of relatedness between two businesses can allow the business to reap improved returns by diversifying across them, relative to the profits available to single-business rivals in both industries? 2. Is the ability to reap this potential diversification benefits on the diversifier’s adopting a particular organisational structure?
Resource based view of the firm is used to explain strategic relatedness. The authors also argue that existing measures of diversification (ie. Standard Industrial Classification count and Rumelt’s diversification categories) are likely to fail in identifying the opportunities for profitable diversification. That is because; measures do not take into account which strategic assets are common across the two businesses Economies of scope Allows a number of Strategic Business Units (SBU) to exploit any synergies between the number of units to achieve cost or differentiation advantage (or both) over an undiversified rival.
However, this requires the corporate center to set up a mechanism which will acknowledge the shared strategic assets to the SBUs involved. As resource sharing and transfer of skills occurs along the value chain, costs are reduced and/or better differentiated products produced. Standard Industrial Classification count and Rumelt’s diversification categories suffer from limitations as they do not take into account whether those strategic assets shared could be obtained at an equivalent or even lower cost by non diversifiers.
Therefore, relatedness that is based on common inputs does not necessarily mean superior performance: whether it does so depends on whether non diversifiers can access the critical input in some other way. Further it goes on to discuss that diversification enhances performance if it allows a business to gain a preferential access to skills, resources, assets or competencies which can not be purchased, imitated or substituted by the non-diversifiers.
In addition, it says that no single source of diversification advantage can persist indefinitely, because non-diversified competitors will eventually eliminate the competitive advantage either by substitution or replication. The diversifiers will have to invest continuously to increase the strategic assets (for example, skills which are impossible to imitate or replicate), and maintain superior returns. Core Competencies as Catalysts to Asset Building The most important strategic asset for any company is an accumulation of knowledge through experience.
Such an asset is impossible to imitate or substitute for competing single business firms. Therefore, diversified companies have a significant advantage over non-diversified in the sense that diversifiers can transfer their skills and experience among similar value chains, for example to other SBU within their related diversified business. “Core competence accumulated by one division, in effect, acts as a catalyst in building new strategic assets for another division.
Competences can also act as catalysts in the process of adapting and integrating assets that a division has accessed by other routes such as acquisition or alliance. ” Thus companies with similar buyers or channels, or similar value activities like government relations or procurement can enjoy “dynamic relatedness” through asset sharing. Moreover, as this type of relatedness increases, performance of businesses systematically improves.