Strategies
for Diversification
By H. Igor Ansoff
The Red Queen said, "Now, here, it takes all
the running you can do to keep in the same place. If you want to get somewhere else, you must run
at least twice as fast as that!"All of
this has important implications for diversification,
as suggested by the Brookings study:
"The majority of the companies included among
the IOO largest of our day have attained their positions
within the last two decades. They are companies
that have started new industries or have
transformed old ones to create or meet consumer
preferences. The companies that have not only
grown in absolute terms but have gained an imof
the product missions. Each objective is designed
to improve some aspect of the balance
between the over-aU product-market strategy and
the expected environment. The specific objectives
derived for any given case can be grouped
into three general categories: growth objectives,
such as I, 2, and 3 above, which are designed
to improve the balance under favorable trend
conditions; stability objectives, such as 3 and 4,
designed as protection against unfavorable
trends and foreseeable contingencies; and flexibility
objectives, such as 5, to strengthen the
company against unforeseeable contingencies. A diversification direction which is highly desirable
for one of the objectives is likely to be
less desirable for others. For example:
C If a company is diversifying because its sales
trend shows a declining volume of demand, it
would be unvdse to consider vertical diversification,
since this would be at best a temporary device to
stave off an eventual decline of business. EUR If a company's industry shows every sign of
healthy growth, then vertical and, in particular,
horizontal diversification would be a desirable device
for strengthening the position of the company
in a field in which its knowledge and experience
are concentrated. e If the major concern is stability under a contingent
forecast, chances are that both horizontal
and vertical diversification could not provide a sufficient
stabilizing influence and that lateral action
is called for. e If management's concern is with the narrowness
of the technological base in the face of what
we have called unforeseeable contingencies, then
lateral diversification into new areas of technology
would be clearly indicated. Measured Sales Goals
Management can and should state the objectives
of growth and stability in quantitative
terms as long-range sales objectives. This is illustrated
in EXHIBIT V. The solid lines describe
a hypothetical company's forecasted performance
without diversification under a general
trend, represented by the sales curve marked Si,
and in a contingency, represented by Sa. The
dashed lines show the improved performance as
a result of diversification, with S3 representing
the curve for continuation of normal trends and
S4 representing the curve for a major reverse. Growth. Management's first aim in diversifying
is to improve the growth pattern of the company. The growth objective can be stated thus:
Strategies for Diversification 119
Under trend conditions the growth rate of sales
after diversification should exceed the growth rate
of sales of the original product line by a minimum
specified margin. Or to illustrate in mathematical
shorthand, the objective for the company in EXHIBIT
V would be:
S3 -- Si ^ jO
where the value of the margin p is specified for
each year after diversification. EXHIBIT V. DIVERSIFICATION OBJECTIVES
SALES
VOLUME
T t-Ume
Some companies (particularly in the growth
industries) fix an annual rate of growth which
they wish to attain. Every year this rate of
growth is compared to the actual growth during
the past year. A decision on diversification action
for the coming year is then based upon the
disparity between the objective and the actual
rate of growth. Stability. The second effect desired of diversification
is improvement in company stability
under contingent conditions. Not only should
diversification prevent sales from dropping as
low as they might have before diversification,
but the percentage drop should also be lower. The second sales objective is thus a stability objective. It can be stated as follows:
Under contingent conditions the percentage decline
in sales which may occur without diversification
should exceed the percentage drop in sales
with diversification by an adequate margin, or
algebraically:
Si --^ S2 S3 ^-- S4
Using this equation, it is possible to relate
the sales volumes before and after diversification
to a rough measure of the resulting stability. Let the ratio of the lowest sales during a slump
to the sales which would have occurred in the
same year under trend conditions be called the
stability factor F. Thus, F = 0.3 would mean
that the company sales during a contingency
120 Harvard Business Review
amount to 30% of what is expected under trend
conditions. In EXHIBIT VI the stability factor of
the company before diversification is the value
Fl = S2/S1 and the stability factor after diversification
is F3 = S4/SS, both computed at the
point on the curve where S2 is minimum. Now let us suppose that management is considering
the purchase of a subsidiary. How
large does the subsidiary have to be if the parent
is to improve the stability of the corporation as
a whole by a certain amount? EXHIBIT VI shows
how the question can be answered:
On the horizontal axis we plot the different
possible sales volumes of a smaller firm that might
be secured as a proportion of the parent's volume. Obviously, the greater this proportion, the greater
the impact of the purchase on the parent's stability. On the vertical axis we plot different ratios of
the parent's stabihty before and after diversification
(F3/F1). The assumed stability factor of the parent is
0.3. Let us say that four prospective subsidiaries
have stability factors of i.o, 0.9, 0.75, and 0.6. If they were not considerably higher than 0.3, of
course, there would be no point in acquiring them
(at least for our purposes here). EXHIBIT VI. IMPROVEMENT IN STABILITY FACTOR
AS A RESULT OF DIVERSIFICATION FOR FJ = 0.3
RATIC
. , F
18
11
F
) OF STABILITY fACTORS
J - STAB/J-/TY OF GBP>/i/GBP/?S/F/C4T/OA/
-ST-ABIL/TY BGBPFOR.B D/VBR.S/F/CAT/C
1
OT.
*>>o
.ooo