What Is a Diversified Company?
Let me explain what a diversified company really is. It's a company that runs multiple unrelated businesses or products. These unrelated businesses need their own management skills, target different customers, and offer different products or services.
One key benefit you'll see is how it protects the business from big ups and downs in any single industry. But remember, this setup makes it harder for stockholders to see huge wins or losses since the focus isn't on just one area.
Important Note on Management
Here's something crucial: the top management teams know how to juggle the appeal of diversifying with the real downsides of growth and its challenges.
How a Diversified Company Works
Companies diversify by starting new businesses themselves, merging with others, or buying firms in different fields or sectors. A big challenge for these companies is keeping a sharp strategic focus to deliver strong returns for shareholders, rather than weakening the company's value with bad acquisitions or expansions.
Conglomerates
Think of conglomerates as a typical diversified company. These are big outfits made up of independent units in various industries. Many are multinational and span multiple sectors.
Each subsidiary operates on its own, separate from the others, but their managers report to the parent company's senior team.
Being in many businesses lets the parent cut risks from one market, lower costs, and use resources more efficiently. Still, if it gets too big, efficiency drops, and the company might divest to fix that.
Key Takeaways
- A diversified company owns or operates in several unrelated business segments.
- Companies may become diversified by entering into new businesses on its own by merging with another company or by acquiring a company operating in another field or service sector.
- Conglomerates are one common form of a diversified company.
- Diversified companies come with their own specific benefits and limitations.
Diversified Companies in Practice
You've probably heard of some big names like General Electric, 3M, Sara Lee, and Motorola as classic diversified companies. In Europe, there's Siemens and Bayer, and in Asia, Hitachi, Toshiba, and Sanyo Electric.
The core idea of diversifying is to spread out financial, operational, or geographic risks. In financial markets, we talk about two risks: firm-specific and systemic or market risk. Theory says only market risk gets rewarded because investors can diversify away the unique risks themselves.
Businesses often diversify internally to adjust their risk-return profiles, since investors set capital costs based on that. But critics argue some companies just grow for growth's sake, calling it diversification when it's really bloat. Bigger firms mean higher pay for execs, more attention, but also entrenchment and sticking to the status quo. What one person sees as smart diversification, another might call unnecessary expansion.
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