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DIVERSIFICATION
Advantages of Diversification
Companies have increasingly adopted diversification strategy due
to the following reasons:
i. Better use of its resources. By adding up related products to
its existing productportfolio, a company can more effectively
utilize its managerial personnel, marketing
network, research and development facilities, etc.ii. Reduce the
decline in sales. By developing new products the sales revenue and
earnings
can be maintained or even increased. For example, Bajaj Scooters
India Ltd. entered in
the field of mopeds.
iii. More competitive with greater resources, more products and
higher profits, thediversified firm is more competitive than a
single product firm.
iv. Minimize risk. When one line of business faces recession,
another line may be in highgrowth stage. For example, a
well-diversified engineering firm146like Larsen and
Toubro did well even when the engineering industry was facing
recession.v. Use of cash surplus of one business to finance another
business having good potential for
growth.
vi. Economies of scale Diversification adds to size of business
which improves thecompetitiveness of a firm. It offers a lot of
economy in operations because common
facilities can be used for several products.
Limitations of Diversification
1. Huge funds are required for diversification. The internal
savings of the business may notbe sufficient to finance growth.
2.
The functions and responsibilities of top executives increase
because of need to handlenew product, technology and markets. They
may find problems in coordination which
may lead to inefficient operations.3. Diversification may
involve new technology and new markets and the present staff
may
face problems in adjusting to this growth pattern.
4. Diversification may lead to unknown products and markets
leading to more risk.Types of Diversification
1. Horizontal Integration,
2. Vertical Integration,
3. Concentric, and4. Conglomerate
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Horizontal Integration
It involves addition of parallel new products to the existing
product line.This may happen internally or externally, internally,
a company may decide to enter a parallel
product market in addition to the existing product line.
Externally, a company combines with a
competing firm. For example, Sparta Ceramics India Ltd. took
over Neyveli Ceramics andRefractoriness Ltd. (Neycer). Both the
companies are in sanitary ware and tiles business. Two ormore
competing firms are brought together under single ownership and
control. Seven small
cement firms combined and formed Associated Cement Companies
(ACC).
Horizontal integration has the following advantages
I. Wasteful competition among the combining firms is removed.II.
It provides economies of large-scale production and
distribution.
III. It provides better control over the market and increases
the competitiveness of thecompany.
IV.
The firm gets better control over supply and prices of the
product.
Horizontal integration has the following limitations:
I. The firm is not confident of supply of raw materials.II. If
many firms combine to form horizontal integration, there is a risk
of over-
capitalization.
III. The management of the firm may become bureaucratic and
inflexible.IV. The firm may acquire exploit consumers and labor by
becoming a monopoly.Vertical Integration
In vertical integration new products or services are added which
are complementary to the
present product line or service. New products fulfill the firms
own requirements by either
supplying inputs or by serving as a customer for its output. In
vertical integration the firm movesbackward or forward from the
present product or service.
Vertical integration may be of two typesbackward and
forward.
Backward integration: It involves moving toward the input of the
present product. It is aimed at
moving lower on the production process so that the firm is able
to supply its own raw materials
or basic components. For example, a Car manufacturer may start
producing tire tubes; Reliance
Industries Ltd. Has been able to grow largely through backward
integration. It started businesswith textiles and went for backward
integration to produce PFY and PSF critical raw materials
for textiles, PTA and MEG raw materials for PFY and PSF,
propylene raw materials for PTA
and MEG, and finally naphtha for producing propylene.
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Backward integration has the following advantages:
i. Regular supply it ensures regular supply of raw materials or
components.ii. High return on investment It facilitates higher
return on investment for the company as a
whole through better use of overhead facilities
iii.
Competitiveness It improves the competitive power of the
company. As it controls moreelements of the production process, it
has advantages over the uninterested firms in theform of lower
costs, lower prices and lower risks.
iv. Quality control it improves quality control over imports for
the final product.v. Bargaining power It improves the company's
power of negotiation with suppliers on the
basis of known costs.
vi. Tax saving It saves indirect taxes payable on the purchase
of inputs.Disadvantages/Backward integration has the following
limitations:
i. If an existing input producing unit is taken over, it may
involve large investmentii.
By investing heavily in backward integration the developments of
the final products nayget hampered. This in turn may lead to undue
pressure on pricing and sales effort.
iii. In the absence of backward integration the firm may
purchase at a lower cost fromtechnically more efficient suppliers.
With backward integration, this opportunity gets
lost.iv. Any adverse Changes in the economy affecting the
present product market will also
affect adversely the production of inputs.
v. When the divisions using the inputs do not have the freedom
of comparing marketconditions of supply, the problem of transfer
pricing may become acute.
Forward integration: Forward integration means the firm entering
into the business of
distributing or selling its present products. It refers to
moving upwards in theproduction/distribution process towards the
ultimate consumer. The firm sets up its own retail
outlets for the sale of its own products. For example, many
companies like Bata, DCM, Bombay
Dyeing, Raymondsand Reliance have set up their own retail
outlets to sell their fabrics.
Forward integration has the following advantages:
I. The firm can exercise greater control over sales and prices
of its products. This is veryuseful in an oligopolistic market.
II. The firm's own retail stores serve as better source of
customer feedback. Thus the firmgets better control over
quality
III. The firm can improve its profits by reducing the costs of
distribution and the costs ofmiddlemen.
IV. The firm can secure the economies of integration. Handling
and transportation costs canbe reduced.
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