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Madhusudhan orporate diversification has long been the engine of new product
development. Yet, of all the outstanding characteristics of business
Prasad Varanasi firms, perhaps the most inadequately treated aspect is the
diversification of their activities1. This article examines the core issues behind
product diversification — its conceptualisation, categorisation and
measurement, and the rationale behind constructing a theoretical framework
of diversification – through the Traditional Theory and Neoclassical Theory
approaches of Economics, and the managerial explanation or the doctrine of
managerialism. It surveys the studies on diversification and firm performance,
in particular those that have addressed themselves to the relationship between
a firm’s degree of diversification and subsequent performance – a question
that has been in the forefront of issues relating to corporate strategy.
Diversification has been employed by business firms since early days. In its
early application, diversification came either by intuition or by accident. In
several cases, the desire to reduce the risk of an existing line of business led to
organisations embarking on a new project. Historically, in India, business
houses floated firms and projects which had great diversity of products,
processes, markets and technology.
Diversification emerged as a phenomenon coincidental with rapid spurts in
technology and breakthrough research in electronic and digital control systems
that produced revolutionary changes in consumer and capital markets and
substantially leveraged the utilisation of the resources of an organisation.
Governmental policies and regulations can also be considered as a spur to
corporate diversification in countries like India.
Montogmery2 identifies three basic reasons that drive a firm’s decision to
Madhusudhan Prasad Varanasi is Associate diversify. The first one, identified as the Market-power view, is seen in
Professor, School of Management Studies, conglomerate firms. The second reason confirms the Agency view: as a
Jawaharlal Nehru Technological University,
Hyderabad. consequence of a separation of ownership from control in modern firms, it
drvmprasad@yahoo.com.sg is in the interest of managers to adopt diversification, for it may ensure a
the Indian context are few and far between. In the light of the 14 Mueller, D C, 1977, ‘The Effects Of Conglomerate Mergers : A
Survey Of The Empirical Evidence’, Journal of Banking and Finance,
above mixed results and the impact of liberalisation,
pp. 315-347.
privatisation, globalisation, increasing foreign investments,
1 5 Lewellen, W G , 1971, ‘A Pure Financial Rationale for Conglomerate
geographic diversification strategies and the like, there is much Mergers’, Journal of Finance, Vol. 26, pp. 521-537.
scope for further research in this area of strategic importance. 16 Rumelt, R P, Strategy, Structure and Economic Performance; ———
,1982, ‘Diversification Strategy and Profitability’ , Strategic
Management Journal , Vol. 3, pp. 359-369; Bettis R A, 1981,
References and Notes ‘Performance Differences in Related and Unrelated Diversified
Firms’, Strategic Management Journal , Vol. 2, pp. 379-393; Bettis,
1 Penrose, E, 1959, The Theory of the Growth of the Firm, Blackwell, R A, and W K Hall, 1981, ‘Risk and Industry Effects in Large
Oxford. Diversified Firms’, Academy of Management Proceedings, pp. 17-
20; ———, 1982, ‘Diversification Strategy, Accounting Determined
2 Montgomery, C, 1994, ‘Corporate Diversification’, Journal of
Risk, And Accounting Determined Return’ , Academy Of
Economic Perspectives, Vol. 8, pp. 163-178.
Management Journal, Vol. 25, pp. 254-274; Bettis, R A, and V
3 Steiner, P O, 1975, Mergers: Motives, Effects, Policies, University Mahajan, 1985, ‘Risk Return Performance of Diversified Firm’,
of Michigan Press; Gort, M, 1962, Diversification and Integration Management Science, Vol. 31, pp. 785-799; Christensen, H K, and
in American Industry, Princeton University Press, Princeton, NJ; C A Montgomery, 1981, ‘Corporate Economic Performance:
Berry, C H, 1971, ‘Corporate Growth and Diversification’, Journal Diversification Strategy Vs Market Structure’ , Strategic
of Law and Economics, Vol.14, No.2, pp. 371-383; Kamien, M I, Management Journal, Vol. 2, pp. 322-343; Montgomery, C A,
and N L Schwartz, 1975, ‘Market Structure and Innovation : A 1982, ‘The Measurement of Firm Diversification : Some New
Survey’, Journal of Economic Literature, Vol.13, March, pp. 1-37; Empirical Evidence’, Academy of Management Journal, Vol. 25,
Pitts, R A, and H D Hopkins, ‘Firm Diversity: Conceptualization
pp. 299-307; ———, 1985, ‘Product Market Diversification and
And Measurement’, Academy of Management Review, Vol. 7, 1982,
pp. 620-629; Booz, Allen and Hamilton, 1985, Diversification: A Market Power’, Academy Of Management Journal Vol. 28, No. 4,
Survey Of European Chief Executives, Booz, Allen and Hamilton, pp. 789-798; Palepu, K, 1985, ‘Diversification Strategy, Profit
Inc, New York. Performance and the Entropy Measure’, Strategic Management
Journal, Vol. 6, pp. 239-255; George, Paul, 1985, ‘Financial
4 Rumelt, R P, 1974, Strategy, Structure and Economic Performance, Performance of Diversified Companies in India: A Comparative
Harvard University Press, Cambridge, M A. Study of Diversified and Non-Diversified Companies’, Vikalpa, Vol.
5 Pitts, R A, 1976, ‘Diversification Strategies and Organizational 10, No. 2, pp. 179-189; ———, 1986, ‘Does Diversification Always
Policies of Large Diversified Firms’, Journal of Economics and Improve Financial Performance?’, Vikalpa, Vol. 11, No.2, April-
Business, Vol. 28, pp.181-188. June; Varadrajan, P, and V Ramanujam, 1987, ‘Diversification and
Performance: A Re-examination Using a New Two Dimensional
6 Varanasi, M P, 1997, ‘Diversification Strategy and Financial Conceptualisation of Diversity in Firms’, Academy of Management
Performance of the Indian Private Corporate Sector’, Doctoral Journal , Vol. 30, pp 380-397; Amit, R, and J Livnat, 1988,
Dissertation, Osmania University, Hyderabad, India. ‘Diversification and the Risk Return Trade-Off’, Academy Of
7 Rumelt, R P, Strategy, Structure and Economic Performance. Management Journal, Vol. 31, pp. 154-166; Simmonds, P G, 1990,
‘The Combined Diversification Breadth and Mode Dimensions and
8 Williamson, O E, 1975, Markets and Hierarchies: Analysis and the Performance of Large Diversified Firms’, Strategic Management
Anti-Trust Implications, Free Press, New York. Journal, Vol.11, pp.399-410; Shergill, G S, and R Raman, 1994,
9 Gort, M, 1962, Diversification and Integration in American ‘The Extent and Nature of Diversification in Indian Companies’,
Industry, Princeton University Press, Princeton, NJ. Decision Nos.1 & 2, Jan-June.
10 For example, wheat and straw or mutton and wool are produced 1 7 Rumelt, R P, Strategy, Structure and Economic Performance.
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