Diversification as an international business strategy and some thoughts about risk.

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Being a painter in Vietnam is risky business

By Grant Hall.  Founder of League Cultural Diplomacy

This post is part of the Going Global segment of wherewordsfailblog.com

Since quitting my job and returning to the world of being a business owner after more than a decade of working for other people, for inspiration I’ve restarted reading business books including biographies of famous business leaders.

I’ve already written about how Isaacson’s biography of Steve Jobs, and Richard Branson’s autobiography are worthy reads just to see how advanced their concepts of culture were and how they applied these understandings to build world-leading companies.

Something I found particularly interesting about the Jobs bio was how Apple has successfully used diversification as a business strategy.

BusinessDictionary.com defines “diversification” as:

Corporate strategy: Practice under which a firm enters an industry or market different from its core business. Reasons for diversification include (1) reducing risk of relying on only one or few income sources, (2) avoiding cyclical or seasonal fluctuations by producing goods or services with different demand cycles, (3) achieving a higher growth rate, and (4) countering a competitor by invading the competitor’s core industry or market.

Apple has diversified from software and computer technology to digital music marketing, music players and onwards to mobile phones. The ability to do this has been a major factor for their success over the years.

Diversification is a common strategy for businesses seeking to enter new markets.  Entire business models can be built upon diversification strategies (take BHP Billiton for example),but is diversification right for your business?

Scotiabank provides some advice regarding diversification in their Expanding your business globally article:

In theory, diversification is a sound management strategy because it lowers the dependence of your business on a single source of revenue. Running multiple product lines, serving multiple customer segments, or expanding to multiple geographic markets are all examples of diversification [1]

I have some experience with implementing diversification as a business strategy, and my story shows that it’s not only for the Jobs and Bransons of this world.

For seven years I owned and managed the StrungOut Studios in Adelaide, South Australia, a music school by day and a rehearsal studio at night. StrungOut had two large equipped rooms for bands to practice and two smaller rooms for individual music lessons. I made some extra money by selling some basic music equipment (picks and strings), renting out some gear like amps and guitars, and contracting sound engineers to record the bands that rehearsed there. Many of the worst punk bands from Adelaide’s southern music scene of the late 90’s and early 2000’s recorded their best work at StrungOut.

During this time an opportunity arose to purchase an established business called the South Australian Academy of Music (SAAM) which provided music education services to schools in Adelaide. Although the two businesses were related in that they both operated in the music industry, by buying SAAM I extended the reach of my operations and the purchase benefitted both businesses, in much the same way that Businessdictionary.com suggested above. For example, I countered my competitors by invading their core market; a large threat to StrungOut was that potential clients, young music students, would learn their instrument at school instead of at StrungOut, but this threat was largely negated by purchasing SAAM and diversifying into the school based music education market.

The two businesses shared many of the same systems, such as payroll and invoicing, and some of the employees worked for both. Not long after purchasing SAAM, the benefits of owning two complementary businesses was felt; both experiencing strong growth. I sold both businesses in 2003, and SAAM (which I had since rebranded as Learning Music Australia, a successful business that continues to this day), was sold for almost twice its purchase price. Diversifying into the schools sector was a big risk, but it paid off.

To better understand the ins-and-outs of business diversification strategy I recommend this short video (below) which will help clarify some of the terminologies that are frequently used when discussing diversification. The video contrasts the diversification strategies of the Smucker’s Company and General Electric.

But before you jump in the deep end of diversification, it’s worth understanding the risks.

International business thought leader Michael Porter studied and analysed thirty-six years of the ‘diversification histories of 33 large diversified U.S. companies’ [2] that were ‘chosen at random from many broad sections of the economy[3].    Porter says his findings present a ‘sobering picture of the success ratio’[4]of the analysed company’s diversification activities.  Some of his key findings were that

‘on average, corporations divested more than half their acquisitions in new industries and more than 60% of their acquisitions in entirely new fields’[5]

‘the average divestment rate for unrelated acquisitions is ‘a startling 74%’[6]

With the benefit of hindsight, many commentators[7]point out that diversification in the 50’s and 60’s was a business ‘trend’, one that had ‘been driven by beliefs rather than evidence’[8].  Many companies adopted such a ‘belief’ or ‘trend’ driven approach that resulted in a ‘scatter-gun diversification’[9], which caught up with them by the mid-1990’s by which time they had become large, unwieldy and difficult to manage.  This administrative heritage was encountered by many companies who later suffered abnormal write-downs and losses[10].

An expensive story from the Jobs bio, albeit a hilarious one in a business-humour kind of way, highlights the dangers of the potentially unseen risks associated with diversification. Jobs’ biographer tells the tale:

It began in 1978, when Apple Computers, soon after its launch, was sued by Apple Corps for trademark infringement, based on the fact that the Beatles’ former recording label was called Apple. The suit was settled three years later, when Apple Computers paid Apple Corps $ 80,000. The settlement had what seemed back then an innocuous stipulation: The Beatles would not produce any computer equipment and Apple would not market any music products.

The Beatles kept their end of the bargain; none of them ever produced any computers. But Apple ended up wandering into the music business. It got sued again in 1991, when the Mac incorporated the ability to play musical files, then again in 2003, when the iTunes Store was launched. The legal issues were finally resolved in 2007, when Apple made a deal to pay Apple Corps $ 500 million for all worldwide rights to the name, and then licensed back to the Beatles the right to use Apple Corps for their record and business holdings [11].

Ironically, it took many years for Beatles songs to become available on iTunes – something that bothered Jobs until his final years!

The Scotiabank article also makes a couple of points about the inherent risks of diversifying abroad, questioning:

Will you spread your business too thin by going global? Can your business handle the additional pressures (cost, time, workload) associated with entering one or multiple foreign markets? Perhaps the biggest question: will your domestic operations suffer?  …will this expansion prove to be a distraction? Do you have the bandwidth to pull it off? Is your team ready for the challenge? Do you have enough money? It’s a matter of assessing your company’s ability to continue to serve its current customer base while taking on additional customers in other markets[12]

It’s not all doom and gloom though. If you’ve been following the Going Global segment of where words fail, you will know that in each post I try to briefly introduce a new corporate strategy that might assist you in your aim to go global.  In this post I present another Michael Porter strategy, this time for successful diversification (the full text of which can be accessed here).

Despite the aforementioned historically grim data that Porter’s research uncovered in regards to diversification, he says:

‘a company will create shareholder value through diversification to a greater and greater extent as its strategy moves from portfolio management toward sharing activities’[13].

But how does a company move from portfolio management to sharing activities?  Thankfully, Porter provides a Diversification Strategy in which he details a step-by-step ‘action program’ designed to ‘translate the principals of corporate strategy into successful diversification’.  The steps are as follows:

  1. Identify the interrelationships among already existing business units

  2. Select the core businesses that will be the foundation

  3. Create horizontal organisational mechanisms to facilitate interrelationships among the core businesses and lay the groundwork for future related diversification

  4. Pursue diversification opportunities that allow shared activities

  5. Pursue diversification through the transfer of skills if opportunities for sharing activities are limited or exhausted

  6. Pursue strategy of restructuring if this fits the skills of management or no good opportunities exist for forging corporate interrelationships

  7. Pay dividends so that the shareholders can be the portfolio manager [14].

Now if you consider how Apple diversified over the years, you can see how it has done, at various times and to varying degrees, all of the above. Take for example steps 4 and 5; in the Jobs bio we can read about how Apple pursued diversification opportunities that allowed shared activities plus knowledge and skills transfers that brought touch screens to mobile phones:

By 2005 iPod sales were skyrocketing. An astonishing twenty million were sold that year, quadruple the number of the year before. The product was becoming more important to the company’s bottom line, accounting for 45% of the revenue that year, and it was also burnishing the hipness of the company’s image in a way that drove sales of Macs.

That is why Jobs was worried. “He was always obsessing about what could mess us up,” board member Art Levinson recalled. The conclusion he had come to: “The device that can eat our lunch is the cell phone.” As he explained to the board, the digital camera market was being decimated now that phones were equipped with cameras. The same could happen to the iPod, if phone manufacturers started to build music players into them. “Everyone carries a phone, so that could render the iPod unnecessary.”

Their initial approach was to modify the iPod. They tried to use the trackwheel as a way for a user to scroll through phone options and, without a keyboard, try to enter numbers. It was not a natural fit. “We were having a lot of problems using the wheel, especially in getting it to dial phone numbers,” Fadell recalled. “It was cumbersome.” It was fine for scrolling through an address book, but horrible at inputting anything. The team kept trying to convince themselves that users would mainly be calling people who were already in their address book, but they knew that it wouldn’t really work.

At that time there was a second project under way at Apple: a secret effort to build a tablet computer. In 2005 these narratives intersected, and the ideas for the tablet flowed into the planning for the phone. In other words, the idea for the iPad actually came before, and helped to shape, the birth of the iPhone [15].

These days, having sold over 700 million iPhones worldwide, iPhones now account for such a large percentage of Apples revenue that some pundits are saying Apple needs to diversify further, such as Carnette, Caplinger, and Brugger who opine the following in their article The Biggest Risk to Apple Inc.:

Apple is on a great run coming off record Q2 results and eye-popping smartphone sales.

Last quarter demonstrates what I consider to be the biggest risk to Apple long term: an over reliance on iPhone revenues. Last quarter was a microcosm of Apple’s lack of revenue diversification: A whopping 70% of Apple’s $58 billion in Q2 revenues were derived from iPhone sales.

Smartphones are a highly competitive market, one in which Apple dominates. But what happens if competitors – over time – are able to eat into Apple’s iPhone market share?

It’s not just Apple; any company that relies too heavily on one product is at risk. Historically, Apple has been known for its innovation, something it could use a great deal more of to limit the risk associated with its lack of revenue diversification.

In any business venture there is always an inherent level of risk.  There are always more reasons not to do something than there is to do something – but there is no reward without risk.

The Jobs bio discusses some of his ‘personal heroes’ and their shared attitudes towards risk;

‘Martha Graham, Ansel Adams, Richard Feynman, Maria Callas, Frank Lloyd Wright, James Watson, Amelia Earhart… They tended to be creative people who had taken risks, defied failure, and bet their career on doing things in a different way’ [16].

To finish up today, regular readers will know that I’m always talking about how the business, arts and sports worlds can learn more from each other – so let me leave you with a great piece of business advice regarding risk from that well known business champion, Andre Agassi

 

Endnotes, sources and photo credits are listed on the next page.

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