When and Why Companies Should Diversify: A Growth Theory Examination

In the growth theory of a company or organization, there is a maturity and a declining stage. As the company gets huge publicity in the maturity stage, other companies who introduce better products may appear increasing competition and affecting the sales of a company.

As a company reaches the declining stage, all its products in the market have been used or other companies have introduced new and better products as compared to theirs. As a result, their products lack the initial appeal it had to the public and customers. Therefore, at a time when a company is losing its market publicity, it can invest into other businesses or products.

Diversification, Tammy, Bizjak and Lemmon (1740) define as the ability of a company to incorporate another service or product as one of its investments. On the other hand, Alstete (226) asserts that diversification is a business strategy an organization uses to maintain its position or increase its productivity in the market segment. Additionally, diversification is used in improving the market and total sales of a company despite the market trends. The aim of the essay is to discuss the theory of when and why companies should diversify.

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The essay is divided into five sections under the importance of the diversification process, the risks, strategies of diversification, which includes the motivation (why), the time (when) to diversify, and the conclusion.

Benefits of Diversification

Diversification is a strategic process that a company uses in increasing its publicity and the ability to make sales and good returns from the market. Therefore, important issues are pre-determined before the company diversifies. These include the benefits of diversification and the risks that the company will be exposed to when it diversifies.

According to Vik and McElwee (390), a company only diversifies after they have determined what it is going to benefit from the action. The diversification process is meant to open up a way for the company to realize huge profits from its sales in a market that does not favor its products.

On the other hand, diversification is a strategy that aims to expose the company to a new market with new experiences. Therefore, the company gets to start from the growth phase of its products, which is a sure way of getting a large turn up of customers. However, the positive results of diversification in the markets are not the same for all the companies. Each company has to conduct a market survey that presents the target groups and the needs of the consumers, which ensures that the products introduced will have a lucrative return for the company.

Diversification is also used as a strategy that a company uses in reaching its long-term financial goals while reducing the risks that might lead to the death of the organization. Diversification opens up new opportunities to increase the sales of a company to the market. The introduction of a new product promises high returns since it is in demand by the consumers.

According to ACS (98), the long-term objective of a company is to provide its customers and consumers with the best products at all times. Similarly, the company operates with the objective of ensuring that quality and efficiency is given to their customers. Similarly, a company operates with the objective of developing and environment of trust with their customers.

Diversification is also a strategy that a company uses in managing its risks and the challenges in the markets from the original products they deal. Therefore, another product manufactured by the company is introduced, which with a positive approach to the market helps generate income for the company.

Even with the negative returns from their original product, a company still has an income generated from the other product. Economic downturns and unhealthy competition from other competitors increase the losses that a company may accrue. Therefore, it can increase or maintain its market position by investing into another product.

De Silva, Uyarra and Oakey (23) state that, diversification increases a company's ability to handle new situations and markets. The experience and skills in these new markets and dealing with the new customers is beneficial in the development of an organization and its expansion.

The new avenue of business helps to develop the relation of the company with the market segments and have well-informed market information of their customers. Each market has its unique stimuli that it increases to the company. Potential Risks of Diversification

Despite the positive influence of diversification in a company, there are risks involved for the company. When a company decides to diversify, it has to weigh the negative influences that the process might cause to the company. Diversification is an ideal process for a company to increase its returns, but it also limits the returns that the company realizes at the end of a fiscal term.

Investing in two or three different products portends to bring more returns as compared to a single investment. However, when one of the investments takes off and the others do not, the company does not get to earn the total profits at once. Similarly, the company pays for the different investments in terms of taxes and levies, which accumulates to huge amounts.

Comparing the same with a single investment, a company had the advantage of paying a relatively low amount in a single investment as compare to when they are more than one.

On the other hand, the diversification process, however, does not guarantee the number of diversification that a company can be involved. Therefore, with the allowance to invest as much as possible, a company may lose its grip on the different market trends owing to the high number of investors and managerial tasks involved. The high the number of investments that a company is involved in, the thinner its portfolio becomes.

The market appeal of the company reduces as other companies get to invest in the same product that has led to an economic downturn. As a result, a company becomes unable to maintain its market position, leading to its decline and finally exit from the market. Therefore, companies should determine their strengths and weaknesses in diversifying their activities in the market segments. Strategies

With the benefits and the potential risks of diversification, a company is left with the decision to make on the best strategy to use in the determination of the ideal system to approach the process.

In the strategy used, two critical issues are given consideration to ensure that the diversification process is successful. The motivation (why) or the driving factors towards diversification comes first and, which helps in determining the success of the company in increasing their investment or introducing a new product. The other factor to consider is time, (when), which also is, used in determining if the investment a company goes into will bring positive or negative results.

According to Johnson, Whittington and Scholes (11), the diversification process is a decision that a company has to take keen interest in implementing. Considering the internal and external factors, the company has to make a conclusive decision of the effects of their decision and if it will provide the alternative for the company.

The decision to diversify for a company portends the ability of the company to reduce the risk of failure, decrease the pricing pressures, and increase competitiveness in its market segment. However, the motivation to diversify includes the underinvestment problem for a company, agency costs, need to grow, and the tax shield for the company.

Underinvestment, Campa and Kedia (798) asserts that is the increased inability of a company to benefit from its investments fully. The external investments of a company may bring low returns at the end of the fiscal term of operation. As a result, the firm starts running at losses with the shareholders of the company forced to undergo the changes. Similarly, it becomes hard for the company to maintain its position in the market, albeit the quality of the products sold.

On the other hand, the company may be facing a tough competitor, whose products are an advancement of their, which means that the customer shift is going to occur towards the competitor's products. Therefore, it becomes the mandate of the manager of the company to invest in another good or another company that portends increased returns. Anderson, Bates and Bizjak (7) conclude that, more diversified organizations have the ability to create a high internal capital allowing them to evade the external forces that affects the operation of the company directly. As a result, the company reduces the underinvestment problem.

Secondly, high agency costs are also a reason for the diversification of companies. Ineffective management of an organization results in the monetary benefits realized by the manager at the expense of the shareholders. When a company diversifies, the manager has room to reduce the non-diversifiable employment risk, which allows him to earn from each section the company has invested.

The collective earnings are a boost to their development both in the company and in their personal lives. Moreover, diversification increases the managers' compensation, power, and prestige owing to the increased responsibilities that is created. the diversification also makes the manager essential in the management and general operation of the company. Therefore, before the employees, he is respected and before the stakeholders, he has a high regard owing to the responsibilities that he takes. Therefore, a manager can opt to diversify even with the negative values that the process will have to the company.

Thirdly, the need to grow is also another way a company can diversify. The future of every company is always bright. The ability to expand, address many customers, become the best in the market, or be among the market trendsetters, is among the aspirations of a company.

However, the normal growth curve and the theory of business systems shows that the trend is not always straight for all companies, which means that the markets and the consumers who are always shifting require new products from time to time. Their needs determine the investments of the company, which means that with the changes, the company also changes. Therefore, it will be easier for the company to invest in other goods with the intention of surviving in the market and in maintaining its publicity among the other companies.

Lastly, a company may decide to diversify to increase its tax shield. The merge of two companies might entail no great costs for the two companies, which means that each will benefit from the process equally. The resulting cash flows from their activities will be less volatile leading to the company's increased debt capacity. With the high debt capacity, a company increases its debt shield.

On the other hand, another issue to consider is the time a company decides to diversify. The time that a company decides to diversify directly affects the returns that the company expects from the additional investment it makes. Geringer, Tallman and Olsen (53) mention that the timing of a company's decisions is influential in the profits it makes in the markets.

The starting phase of a company is related to the high number of risks that a company may face prompting the manager to seek an alternative trade. However, in the start- up phase, the company is still unstable, which means that even the other investment may not be as lucrative as the already existing business venture. Similarly, the growth stage requires high investment and commitment to the company. As a result, the company can only concentrate on the already established business venture.

In the maturity stage, the company can formulate the business venture that might increase its market shares and improve on its publicity in the market owing to the inevitable stage of decline that follows. However, even in the maturity stage, the company does not diversify but forms all the necessary opinions and ideas to diversify (Helfat and Eisenhardt 1219).

All the ideas, companies, and products in the market that promise a positive return in the markets are considered the possible investments that a company can invest. Consequently, when the company reaches the company reaches the decline stage, it starts the diversification process. However, the diversification process is done in the early stages of the decline phase of the business to help maintain the public figure of the company before the public gets wind of the economic downturn facing the organization. Conclusion

Diversification refers to the strategic process of a company to increase its sales in the market. Through diversifying, a company gets to increase its returns, promote its functionality, and boost its operation in the markets. The diversification process involves the ability to make changes in the company products or introduce a new product to boost the returns of the company.

Similarly, an organization can diversify through investing in other companies, which have products with high market returns. The diversification, however, is done with the consideration factors of the motivations and the time, summed up as the why and when. Evaluating these two factors gives a company a glimpse of what they expect to gain from the diversification process and the challenges to experience. Similarly, the company also gets to devise systems to use in avoiding the occurrence of these challenges to realize full potential from the diversification.

However, in the diversification process, the company gains to benefit in increasing its functionality, but also suffers from other external influences that affects the public image of the company. Therefore, the why and when factors should be given considerations.

References

1. ACS, Z. J. "How is Entrepreneurship Good for Economic Growth?" Innovation (2006): 97-106.
2. Alstete, J. W. "On Becoming an Entrepreneur: An Evolving Typology." International Journal of Entrepreneurial Behaviour and Research 8 (2002): 222-234.
3. Anderson, R. C., et al. "Corporate Governance and firm Diversification." Financial Management 29 (2000): 5-22.
4. Campa, Jose Manuel and Simi Kedia. "Explainingthe Diversification Discount." Journal of Finance 57 (2002): 1731-1762.
5. De Silva, L. R., E. Uyarra and R. Oakey. "Academic Entrepreneurship in a Resource
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8. Japanese Multinational Firms." Strategic Management Journal 21 (2000): 51-80. Helfat, C. E. and K. M. Eisenhardt. "Intertemporal Economies of Scope, Organizational Modularity, and the Dynamics of Diversification." Strategic Management Journal 25 (2004): 1217-1232.
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11. Vik, J. and G. McElwee. "Diversification and the Entrepreneurial Motivations of Farmers in Norway." Journal of Small Business Management 49 (2011): 390-410.

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