What is conglomerate diversification?
Conglomerate diversification involves diversification into unrelated areas, is very common in India. Despite the popularity, conglomerate diversification is considered to be a highly controversial investment strategy. The following are the different aspects of conglomerate diversification:
Pros and cons of conglomerate diversification
The protagonists of conglomerate diversification argue that it helps a company in reducing its overall risk exposure. As the business are characterized by cyclicality it is desired that there are at least two to three distinct lines of business in a firm’s portfolio. This is one of the sayings that “don’t put all your eggs in the same basket”. The risk – reduction benefit of conglomerate diversification shows the behavior of ROI (return on investment, which is simply profit divided by investment) for
- business A
- business B (whose ROI is perfectly negatively correlated with that of business A)
- a portfolio consisting of A and B with equal weightages for them.
An advantage claimed for conglomerate diversification is that it expands opportunities for growth. If the opportunities in the existing business are limited because of some kind of fullness, it is natural to look at other business where growth opportunities exist. Such opportunities are more in newly emerging industries and hence there can be a justification to diversify into fields which may be very different from the firm’s existing business. While the prospects of succeeding in the new line of business are often uncertain, the immense potential acts as irresistible attraction. It naturally appeals firms which have strong growth – orientation. Such firms constantly look for opportunities to broaden their options in a dynamic industrial environment.
Even though it is a good device for reducing risk exposure and broadening growth possibilities, conglomerate diversification more often tends to reduce average profitability.
International experience in conglomerate diversification
Compulsions for conglomerate diversification in India
Guidelines for conglomerate diversification