To what extent is diversification the best strategy to achieve profitable growth?

Novartis, a large multinational pharmaceutical company, recently diversified by buying Alcon, in a £24.8bn deal. Alcon is a producer of eye care products such as contact lenses. Google has diversified by investing £124m in a wind power business. To what extent is diversification the best strategy to achieve profitable growth? Justify your answer with reference to Novartis, Google and/ or other organisations that you know. (40 marks)

Diversification - Practice under which a firm enters an industry or market different from its core business. Growth – The process of improving some measure of an enterprise’s success. Business growth can be achieved either by boosting the top line or revenue of the business with greater product sales or service income, or by increasing the bottom line or profitability of the operation by minimizing costs.

Profitable growth can be achieved in many ways and strategic diversification has definitely played a large role in the growth of many large businesses today. However just like any strategy this all depends on many factors e.g. the type of industry the business is operating in or the risks involved into entering new markets.

Virgin is one example of a company that owes most of its very profitable growth base on mostly un- related diversification; and yes although this type of strategy is very risky, it has big rewards making Virgin $ 21.3 billion (2011) and a value of £5.01 billion in 2008. Starting from only a small record shop in London in 1971, Richard Branson (co-founder of virgin and business tycoon) spent no time growing his empire through strategic diversification from transport, internet broadband, TV and even bridal wear in Manchester.

This shows that, although very un related at times, diversification has been the key element to Virgins overall very profitable growth. On the other hand by diversifying into new markets this has the tendency to fail due to other factors such as other competitors. Trying to diversify into new markets is bound to be hard especially if there are already established companies that dominate those markets and therefore makes it hard to grow due to the high barriers of entry from that industry.

For example In 2004 Branson was set to enter the music industry once again by diversifying into the online music industry through an online music store service just like Apple. He also released his own mp3 called the ‘Pulse’ that was to rival Apple’s Ipod. Unfortunately he closed both products later that year due to the fact that Apple kept releasing new products that made the ‘Pulse’ outdated with Apple’s high brand awareness, Virgin found it difficult to rival a large market leader therefore caused them to retrench and withdraw their product.

This shows that although diversifications seem the best strategy for profitable growth, it does pose many risks especially when entering new unfamiliar markets.

On the other hand there are also many other strategies that can achieve profitable growth such as a takeover or a merger. Orange and T-Mobile were two mobile phone companies that had nearly reached the end of their product life cycle in 2008 due to the rising popularity of other networks offering new USP’s such as 3’s unlimited internet and Vodaphones ‘freebees’ perks. However with the equal merger of the two companies in 2010 and performing under the new refurbished name that is EE (everything everywhere), it is now the largest mobile network operator in the UK, with around 28 million customers.

The synergy between these two companies has not only increased their growth but has also benefited from economies of scale through decreased marketing costs and production costs and therefore has increased their profit margin. This shows that a merger may be a much better strategy to achieve profitable growth although in this case having two mobile phone companies that operate in the same industry is less risky due to the fact that they are able to leach ideas of each other and therefore create a new company that is based on each others success.

However other factors may affect the success of a merger or takeover that can inevitably limit growth and even cause the downfall of a business. In case of Chrysler (Jeep) and Daimler (Mercedes Benz) the clash of two cultures has affected the growth of both popular brands.

Daimlers hierarchical structure functioning in Hofstede’s collectivist culture versus Chrysler’s informal, relaxed approach functioning in a team-working individualistic culture was simply two companies that did not understand each other and instead of growth, this inevitably has reduced Daimler’s value from $47bn to the merged company value of $38bn. This shows that the effectiveness of mergers in achieving profitable growth may entirely depend on both companies relationship in terms of their objectives, communication and culture. Another example of a takeover that was not successful was RBS’ acquisition of ABN-AMRO bank.

Fred Goodwin, one of the leaders of RBS, thought that a takeover of ABN-AMRO bank would further expand their company as it had a lot of attractive businesses that performed in many attractive markets. The problem was that they were blind sighted by the size of ABN-AMRO and only performed light diligence. In 2007 RBS performed the biggest hostile takeover in history and paid £49bn from the banks cash reserves. RBS thought that they would be able to use ABN-AMRO’s books to tap into other European markets just like their takeover with Natwest.

However by the time they acquired ABN-AMRO’s books they noticed that it had a lot of toxic sub prime mortgages (mortgages that people could not pay) which drained RBS’ remaining reserves. Although the takeover doubled the size of RBS due to the downturn in economy, they were unable to manage their daily balance sheets due to their large size and therefore collapse in 2008 announcing a loss of £691m before tax.

This shows that takeovers is definitely a good option only if it assessed properly with proper due diligence and an understanding in the business as it can increase profitable growth instantly. However this was not the case for RBS and instead of doubling in size, it caused their failure of the business and the retrenchment of many of their branches.

In conclusion diversification is definitely a good strategy in achieving profitable growth especially in certain industries where this is necessary and for business to stay competitive in many markets. In the case of Virgin, their successful growth has definitely come from un-related diversification and had made them one of the largest profitable companies in the world. However Virgin shows that not all ventures become successful especially if the business is trying to introduce diversified products within unfamiliar markets.

On the other hand Orange and T-mobile’s profitable growth was due to a merger of two equals and not diversification. This was mainly due to the fact that they were two companies that performed within the same industry and therefore was able to expand using their knowledge of the market.

However this can be very risky especially in the case of Chrysler and Daimler where there was a clash of two cultures and therefore caused them to retrench instead of achieving profitable growth. Finally diversification can definitely help achieve profitable growth however this may entirely depend on the business and the risks involve therefore other strategies such as takeovers and mergers may be a better option.