Summary: Although conventional wisdom suggests that companies should look for growth opportunities close to their core businesses and capabilities, the author…more
One of the most obvious ways to grow a business is to diversify. But somehow, CEOs and their boards shy away from this. Why? The experts have drilled into them that diversification is a very tricky business. It’s a gamble at best, and at worst, it can pull your company apart. “Stick to your knitting!” the saying goes.
However, I have conducted deep research on diversification, and I’ve found that with the right strategy lens, it’s possible to achieve a very predictable outcome. And the result is predictable growth. Here I’ve set out four rules of thumb that will make diversification a winner for your business in its pursuit of growth.
- 1. Focus on the business unit.
Over the decades, a mountain of academic literature has been obsessing over the question of whether related or unrelated diversification works best. The general conclusion is that “related diversification (entering a new industry that has important similarities with a firm’s existing industries) is wiser than unrelated diversification (entering a new industry that lacks such similarities).” The implication is that moderately diversified companies outperform both undiversified and highly diversified companies.
I liken this theory to eating onion: A little bit of onion is good for you but too much can be harmful. Similarly, some leaders even believe there’s an optimal level of diversification.
The problem is that the theory revolves around a corporate viewpoint on diversification. It’s based on evaluating activities and businesses from the top down. This perspective leads CEOs and boards to fret over the relatedness between their businesses — whether they are connected, unrelated, related in what manner, and so forth.
But what if we adopted business-unit perspective instead? As Michael Porter emphasized years ago, competition in the market primarily takes place between business units, so this is the logical angle to take.
If the proposition is true that moderate diversification is better than no diversification or too much, it would follow that business units that are very similar to others in the company wouldn’t perform as well as business units that are moderately similar to others in the company. Moreover, business units that are very different to others also wouldn’t perform as well as business units that are moderately similar to others.
From a business-unit standpoint, therefore, the moderate/related diversification argument starts to look absurd. Relatedness isn’t an issue in a proposed diversification for growth. Business prospects are.
2. Put the units in charge of strategy.
Some leaders are concerned that too much diversification will increase the burden on senior management, which in turn will restrict potential growth. However, this assumes that HQ needs to oversee the growing and varied portfolio of businesses. If senior management were tasked with devising competitive strategies and detailed operational plans across a diverse range of business units, it would undoubtedly create significant pressure.
However, growth-oriented diversified firms avoid this by adopting a different approach. The critical tasks of strategy and operational planning must be delegated to divisional management. They do, what Warren Buffett, CEO of Berkshire Hathaway, calls, “the heavy lifting.” CEOs and senior management simply serve as support personnel to their divisions.
This brings me to my next rule.
3. Appoint the right unit leaders.
Business unit managers must possess the necessary capabilities. Without skilled individuals in these roles, the growth prospects of diversification efforts will be jeopardized, as the managerial burden shifts back to the corporate center of the company. If this situation leads to the corporate headquarters developing strategies and operational plans for the various businesses, it signals trouble for the growth of the company.
Jack Welch was one group CEO who followed this principle. He stated that his role was to assign the best people to the most promising opportunities and then allocate resources optimally. It was not to get involved in the day-to-day operational decisions of specific divisions. Welch concluded that effective division managers or unit heads must possess authenticity, self-awareness, and the ability to inspire others with their genuine leadership — he was effectively looking for all the qualities of a CEO.
Wesfarmers is Australia’s seventh largest company by market capitalization and is famous for its diversification strategy. Michael Chaney, its former CEO, also stresses the crucial role of effective unit heads in the success of the company. They must possess industry knowledge and focus on key financial metrics like return on capital employed. Chaney also emphasized the importance of complementing these “above-the-waterline characteristics” with “below-the-waterline characteristics.” These included emotional intelligence, such as interpersonal sensitivity, broad interests that encompass diverse areas, and the ability to contemplate how significant issues may impact a business.
4. Create a unit growth culture.
To achieve business growth via diversification you not only need to have the right managers, but you also need the right organizational culture. The culture can’t be staid, risk averse and bureaucratic. It must be lively, entrepreneurial, and accepting of risk. In addition to rewarding profit, therefore, unit heads need to be encouraged to take risks in pursuit of profit. They must, essentially be motivated to act like business owners.
A key factor in identifying opportunities is a culture of engaging with and listening to stakeholders. Successful diversifiers prioritize understanding and meeting the needs of their customers, suppliers, and employees. They are willing to embrace radical change and acquire very different businesses in pursuit of this.
Let’s go back to Wesfarmers, which has consistently grown through clever acquisitions and timely divestments across a range of industries. Central to its approach to growth is its culture, which it describes this way. “We provide autonomy and space with freedom to operate, without fear of failure. We’re curious, open minded, and collaborative. And although we’re thought leaders, we’re humble, and willing to share knowledge and learn from one another.” Former CEO Richard Goyder aptly encapsulates the pivotal importance of culture to the company’s trajectory on growth noting that “culture is very hard to build and easy to destroy.”
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Your reluctance to pursue growth via diversification may be deeply ingrained, influenced by the academic literature that consistently favors related diversification over unrelated diversification. Don’t listen to that received wisdom. Entrepreneurs certainly don’t. Like them, your growth focus should be on the opportunities to do something different. Why limit your business to staying more or less the same?
Graham Kenny is CEO of Strategic Factors and author of the book Strategy Discovery. He is a recognized expert in strategy and performance measurement who helps managers, executives, and boards create successful organizations in the private, public, and not-for-profit sectors. He has been a professor of management in universities in the U.S., and Canada.
