facebookIs it good that a company is diversified? I'm not sure whether I should diversify in one. How do I know if the company is over-diversified? - Seedly



18 Apr 2019


General Investing

Is it good that a company is diversified? I'm not sure whether I should diversify in one. How do I know if the company is over-diversified?

Discussion (2)

What are your thoughts?

Isaac Chan

Isaac Chan

13 Mar 2019

Business at NUS

Whether it's good for a company to be diversified really depends. Some industries require strong product focus, but others require you to diversify and take on more product lines to appeal to a large audience or attain revenue and cost synergies.

I mentioned Starbucks in a post recently, where because they tried to diversify their food line items, they actually lost focus on their coffee products. This was quite an issue until recently they moved their focus back to coffee. This move had a advantages.

Firstly, stronger branding in the coffee industry to differentiate yourself from other players. Secondly, economies of scale from increased focused, and improved quality of their products. So I think starbucks is a case where you shouldn't be diversifying your business, and just getting your core products right.

I think signs of overdiversification occurs when quality of your products starts to drop, costs starts to rise and people are confused about what your branding is.

Well, you'll have to see if their diversified operations are more trouble than they are worth. It used to be a typical strategy to acquire verticals (the companies along the supply chain) and leverage on their assets for your own benefit, or even to create conglomerates by entering completely new markets to "diversify risk" but now this strategies have fallen rather out of fashion. This is because of 2 main things:

When firms purchase verticals AND effectively manage them so they keep their verticals low cost, then yes, it is a better option. However, if you take a look at Ford or GM, their over acquiring of verticals and having locked in contracts with their subsidiary companies have resulted in rising costs due to lack of need to remain competitive, and generally reduces the profit margins of these parent companies, especially when they grow extremely large. If you take a look at Japanese Automakers like Toyota, they don't actively purchase verticals because they want them to remain competitive (since they have to keep fighting with other suppliers to get Toyota's Contracts), and offer lowest cost contracts, so that Toyota is able to create affordable cars while maintaining their profit margins.

secondly, I think we can all agree that a Sony is grevious committer of the "over-diversification" fault. They grew so large, encompassing so many different types of electronics that they failed to move efficiently to market trends, and resulted in almost all of their sectors losing favour when compared to rising competitors like Samsung, Phillips etc who focused on their strengths. "he who protects everything, protects nothing" it is along this line of wisdom that firms should not try to take the market share in everything - let the better people do it. Excel in their own market, and the money will grow.

As for whether it is over-diversifed, take a look at their production capacities, and their different business unit performances. If they are not seeing much growth, having too much excess capacities, Alarming cost to turnover ratio, you can be sure that these companies are far too diversified.

A conductor that runs a smaller, more well trained band is surely to perform better over a larger, disorganised one. Doesn't matter how many instruments are there, what matters is the synergy.

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