Contemporary Diversification via Internal Corporate Venturing
Robert P. Garrett, Jr.
Diversification involves the selling of new products in new markets—simultaneous novelty in both dimensions, products and markets, is an essential element of diversification. According to this definition, product development is not considered to be diversification because although it involves developing and selling new products, the products are delivered to markets that are already targeted by the firm. Similarly, market development involves selling a firm's existing products to new groups of customers. This scope of diversification was defined by Ansoff, who developed a typology (Figure 4.1) for categorizing growth strategies based on the two dimensions of product and market novelty.1
Although diversification involves newness on both dimensions of Figure 4.1, some diversification strategies are related to a firm's existing businesses. This type of related diversification exists when there are physical linkages (in terms of products or geographical markets) or knowledge linkages between the businesses of a diversified firm. There are a variety of drivers for related diversification. First, separate products may arise naturally from a shared input; thus a firm finds itself in possession of two or more diverse products due to its own processes. Second, fixed production units may not be fully utilized for a single product, causing a firm to
Figure 4.1. Adaptation of Ansoff's Typology of Growth Strategies
wish to fill existing production capacity with new products. Third, there may be economies of joint production of networked products (the airline industry is a good example). Fourth, a firm may possess intangible assets that can be shared between products (e.g., multiple products can be supported by common R&D). In sum, growth through diversification stems from the discovery of varied and previously unrealized uses for a firm's resources.2 Through diversification, a firm leverages its existing resources to discover new products and services, thereby expanding its pool of resources.
MOTIVATION FOR DIVERSIFICATION
An economic rationale for diversification exists when the common ownership and operation of multiple businesses allows for better performance than that obtained merely by adding the performance of the businesses had they operated independently.3 Superior performance outcomes are realized from diversification because a firm is able to share and leverage its assets and capabilities across multiple businesses, resulting in economies of scope.4 Economies of scope are obtained when a firm is able to lower average costs by producing two or more products. This makes diversification efficient if the products are based on common firm resources and/ or knowledge. For example, a sales force selling multiple products can do so more efficiently than if they are selling only one product since the cost of travel is distributed over a larger revenue base. However, as the degree of diversification increases, costs may increase significantly if the firm attempts to coordinate businesses that have little in common.5 When firms engage in unrelated diversification, top managers often have little firsthand knowledge of a particular division's industry, technology, or geographic region; thus managerial costs increase.6 This had led researchers to believe that there is an inverted U-shaped relationship between diversification and performance, with small amounts of diversification resulting in increases in performance, but too much diversification resulting in poorer performance.7
The performance effects of diversification have been researched extensively in the strategy and finance literature. Much of this literature focuses on the economic rationale behind the diversification-performance relationship, and reflects the two types of diversification, related and unrelated, described earlier. Since related diversification involves operating businesses in related industries, opportunities exist for the firm to share operating assets and capabilities across businesses. In contrast, with unrelated diversification, opportunities to share operating assets and capabilities across businesses are limited. As a result, related diversification is believed to lead to better performance than unrelated diversification because although the former leverages business synergies, the latter requires more learning and monitoring, and allocates resources inefficiently.8
Although the literature is theoretically and empirically rich, the empirical findings have not been consistent. Resources can be applied in different ways that result in different productive uses or services, whether or not the resultant products are related or unrelated to the organization's core business(es).9 On the one hand, related diversification enables resources to be used in complementary combinations, allowing new businesses to leverage existing firm resources, and in return, develop them for better use when re-leveraged by the core businesses.10 For example, PCTEL, a designer, developer, and distributor of antenna solutions for cellular networks, recently used internal diversification initiatives to develop capabilities in WiMAX, a family of telecommunications protocols that provide fixed and mobile Internet access. PCTEL was able to leverage their knowledge of antenna solutions to create a new market entry in WiMAX. At the same time, they were able to use the WiMAX business and its partners to generate new knowledge about communication standards and protocols that they could apply to their more mature businesses. Both new and core businesses thus benefited from resource sharing and development in related diversification. To the extent that new growth builds upon an organization's prior experience, the lessons learned in past diversification initiatives can also be leveraged to exploit future diversification opportunities.11 The general direction of diversification is thus closely related to the nature of existing resources, how they have been used in the past, and the type and range of products and services they can be combined to render.
On the other hand, empirical evidence finds that firms diversify more broadly than predicted by theory that prescribes related diversification.12 Not only do firms engage in unrelated diversification but recent research indicates that unrelated diversification performs at a premium.13 Due to this recent evidence, scholars have increasingly argued that favoring related diversification for reasons of resource synergies and leveraging past learning may give an incomplete view of diversification. Diversification into domains related to the core businesses of the parent company certainly affects the ability of the parent to provide resources and knowledge to the new businesses. However, two arguments suggest that the value of these resources may be diminished if there is significant overlap between the businesses. First, when resources are shared, the allocation of the resources may be contentious as managers spend time and energy fighting for access to them.14 Overcoming these disputes may distract managers from more value-creating activities. Second, when diversified businesses are too similar to the core businesses, the expected performance of the new businesses is likely to match that of the core businesses. Rather than creating truly novel developments that corporate managers might have envisioned, business managers may pursue innovations that are closely aligned with those of existing businesses in order to sustain current customers and products. Christensen called this the "innovator's dilemma," where business managers are hamstrung by the close alignment of businesses and are limited in their ability to think outside the box.15 In essence, related diversification often pursues the "low hanging fruit" to leverage existing corporate assets, whereas unrelated diversification has the potential for higher performance by delivering truly disruptive and innovative new product revenue streams.