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Focus wins

By now we already know that multitasking was just a fad, and that the key is to focus and make this a behavior. But focus also wins over unrelated diversification, something that some companies have tried and entrepreneurs try often as experiments under the “fail often, fail quick to learn fast” modus operandi.

The difference is that related diversification builds on economies of scope using some products for various related businesses, like Disney does, and unrelated diversification means acquiring business unites that have nothing in common, like Sara Lee did, before splitting up. But why did this happen, and why Tata, an Indian corporation, thrives on unrelated diversification?

First of all let’s discuss the four main invalid reasons for diversification and the one that might have some merits. Diversification of risks simply does not work because managers are way worse than markets in assessing risks. So, acquiring units that seem less risky is not a way of protecting against risk. The same logic applies to cross-subsidization as a reason for unrelated diversification. The truth is that markets outperform managers, and financing one emerging business with the gains of a cash cow unit is not a great idea.

Other companies try to diversify just because they have problems with their core business and they are looking for opportunities. Under pressure, this more often than not ends in a greater disaster. Not as dangerous though than the dubious practice of trying some market manipulation by acquiring a growing business to increase stock market for one that is not performing very well. It was a fad in the 60’s but now we know that unrelated diversification is not working, except the obvious exceptions and the emerging economies.

The exception is given by the so called “governance economies” and General Electric proved for a while that even unrelated diversification might benefit from employing common management systems for a while. For a while Tata, an Indian company, proved that it can be a substitute for institutional weakness and it can grow to a wide number of fields to cover for this. Yet, as economies grow stronger, there is less and less room for unrelated diversification. One more example that focus wins!