Policy Seminars -- Winter 2008
| Speaker: Maggie Zhou -- Michigan University |
| Topic: RELATED DIVERSIFICATION AND STRUCTURAL COMPLEXITY |
| Date/Place/Time: January 31,
2008 / UCLA Anderson School -- Cornell Hall D310 / 10AM-11:30AM |
| Abstract: The diversification literature has largely focused on the degree of applicability of firm resources to a new industry: A firm should diversify into more related industries since synergistic benefits decrease with the distance between the new industry and the firm’s primary industry. This paper focuses on the costs of related diversification and, specifically, the coordination costs that accompany related diversification. It argues that related diversification presents a paradox. While related diversification provides more synergistic benefits, it also creates greater coordination costs than unrelated diversification. Interdependencies in production processes contribute to both synergies and coordination costs. With increasing interdependencies, coordination costs may rise faster than potential synergies and set limits to the related diversification strategy. The theory not only provides an alternative explanation for limits to diversification that is independent of the assumption of diminishing synergistic benefits, but also offers a unique explanation for limits to related diversification. In addition, it suggests an important role for organization structure in extending firm scope in related diversification. Specifically, firms can adopt structures with more coordinating units to increase their coordination capacity. However, tradeoffs in structural design, such as that between specialized information processing and comprehensive decision making, alter firms’ coordination costs and consequently the scope of related diversification. The theory has important implications. It proposes that firms in the same primary industry may differ in the degree to which they expand into related markets because of different coordination costs imposed by interdependencies in their existing production processes and by their organization structure. It also sheds light on several empirical anomalies about firms’ diversification strategies, primarily the lack of consistent evidence that related diversifiers outperform unrelated diversifiers and the prevalence of unrelated diversification strategy among diversified firms. I test and find strong support for the theory using a unique dataset about the business segments and organization structures of U.S. equipment manufacturers from 1993 to 2003. |
| Links to papers: Click here for paper |