As long as a single-business company can achieve profitable growth opportunities in its present industry, there is no urgency to pursue diversification. However, a company’s opportunities for growth can become limited if the industry becomes competitively unattractive. Business diversification is about creating added value for shareholders via diversification requires building a multibusiness company in which the whole is greater than the sum of its parts.
Business diversification stands little chance of building shareholder value without passing the following three tests. The industry attractiveness test. The industry must offer an opportunity for profits and return on investment that is equal to or better than the present business. The cost-of-entry test. The cost to enter the target industry must not be so high as to erode the potential for good profitability. The better-off test. Diversifying into a new business must offer potential to perform better together.
The means of entering new industries and lines of business can take any of three forms: acquisition, internal development, or joint ventures with other companies.
Once a company decides to diversify, its first big corporate strategy decision is whether to diversify into related businesses, unrelated businesses, or some mix of both.
Focusing corporate resources on a few core and mostly related businesses avoids the mistake of diversifying so broadly that resources and management attention are stretched too thin.
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