Advantages And Disadvantages Of A Corporation Diversifying Internationally - Essay Example

? Advantages and disadvantages of a corporation diversifying internationally Introduction Diversification is the process of investing assets across a wide range of classes in differing proportions depending on an investor’s goals’, risk tolerance and time horizon. Although diversification does not guarantee the best performance or eradicate risks of investment losses, it helps in alleviating speculation usually involved in investing. Diversification may be used to refer to the variation between businesses within a company. This variation may be by products and/ or services. Diversification meaning varies across businesses, as what stands as diversification in one organization may not have significance in another. Thus, the definition of diversification is subjective. Nonetheless, business diversification may be in the dimension of cost leadership, production of commodity products, new product development, market leadership, strong brand names, high value added products, niche markets served, customers shared, advertisement emphasis, customer service emphasis and product design. Other dimensions may be emphasis on research and development, raw materials used, quality emphasis, distribution networks, company size. International diversification entails diversifying an investment portfolio across diverse geographic regions in order to lessen the overall peril and enhance returns on the portfolio. Corporations embrace international diversification by locating their operations in diverse nations and regions so as to reduce operational and business peril. There are three types of international diversification that is, related diversification, unrelated diversification and single product strategy. Single product strategy entails the pursuit of manufacturing a single good or service, and selling it in a distinct geographic marketplace (Susman, 2007, p 345). Related diversification happens when a firm adds to its current line of production or markets. Related diversification enables a company to capitalize its strengths and abilities in more than one business (Caper & Kotabe, 2003, p 350). McDonald’s uses synergy as it diversifies into other food and restaurant businesses. Unrelated diversification is a company level tactic founded on a multibusiness model with the aim of increasing profitability through the use of common organizational capabilities to augment the performance of all the company’s business units. Firms that pursue this mode of diversification strategy are referred to as conglomerates, implying business organizations that function in numerous diverse industries. Advantages of international diversification Diversification and profit stability The assertions associating diversification on profit stability revolve around the portfolio concept, which holds that investing in diversified stock with non related profits may lower the precariousness of a corporation’s total gains. The idea of portfolio relates to product diversification, which may lower the variance of a company’s total profits. The reason is that the unpredictability of various profit schemes merged is nearly always less than the unpredictability of every profit stream independently, on condition that the profit streams are negatively related. Researches establish that product diversifiers actually enjoy higher profits than non diversifiers. The degree of risk reduction through unrelated diversification may exceed that which may be attained through related diversification. The reason is that unrelated diversification could lower industry specific systematic risk because it entails diversification across numerous industries. On the other hand, related diversification may not lower industry specific systematic risk happening within an industry. Industry specific systematic risks are the risks universal to all businesses in a certain industry (Kim, Hwang & Burgers, 1989, p 47). Rugman observed the same view, that geographical diversification through direct overseas investments evens out a firm’s profits. This result from existence of divergences in goods and factor markets across geographic areas, evening out an organization entire returns (Kim, Hwang & Burgers, 1989, p 46) Recent research on global diversification has established a positive correlation involving profitability and international market operations intensity. The economic scholars explained global marketplaces as a monopolistic or oligopolistic reaction to market limitations. Dubin established that the need to benefit from proprietary parent skills, which are extremely developed but underutilized, is one of the elements of systematic significance of global acquisitions (Kim, Hwang & Burgers, 1989, p 46). An example of a corporation undertaking diversification for profit stability is the Nokia Corporation. In the 1865-1960, nokia was a in the communication business as a paper manufacturer and later into electronics. Its president understood that the industry in which Nokia was operating was dying in terms of profit stability. As a result, the company diversified into digital technology, which the president termed it as the future for corporation in a bid to increase earning stability (IE business school, 2002, p 9). Spreading risks Companies operating internationally need to control and balance the overall risks to which they are exposed by constantly reconfiguring their portfolio of overseas auxiliaries in reaction to environmental changes. Conventional studies established that one subsidiary is invested for every two overseas auxiliaries added to a multinational network ((Brigham & Houston, 2009, p 246). In terms of dynamic asset distribution, maintaining a troubled subsidiary operating in a country experiencing massive economic difficulties creates more troublesome risk than eliminating the auxiliary. For instance, multinationals of Japanese origin faced rapidly reduced demand in countries stricken by the economic crisis of Asia in 1990s. The goodwill attached to real assets in the troubled countries was negative or close to zero. Therefore, it would have been rational to divest the assets. This phenomenon of Japanese multinational (Toyota) best explains that when a corporation is highly geographically diversified, it enjoys more diversification merits from other non troubled auxiliaries than its operations in predicament stricken nations (Tongli, Ping & Chiu, 2005, p 67). Thus, a company has some incentives to keep subsidiaries in economic struggling nations. In theory, when corporations diversify, the risk of the whole portfolio ought to be less than the weighted total of the risks contributed by every auxiliary (Tallman, 2007, p 23). The risk portion that disappears in the process of constructing the portfolio is known as diversifiable risk, whilst the risk that remains is referred to as non diversifiable risk. As such, the most cost efficient mode for corporations is to configure their worldwide portfolio so that they diversify away diversifiable risks (Brigham & Houston, 2009, pg 250). Toyota is a real example of a corporation that enjoys this advantage. In 2011, Toyota experienced double tragedy caused by the Japan’s earthquake, and the flooding of Toyota plant in Thailand. In spite of this, Toyota was resilient in maintaining its profitability due to its presence in many countries. Thus, the risks of troubled operations in Japan and Thailand were evened out. The ever changing consumer needs among its customers is putting pressure on coca cola to invest in new ventures. Growth Firms diversify their operational globally in order to take advantage of growth opportunities in foreign countries. The extent of the relation between global diversification and industry globalization in a corporation’s hub business industry may vary with the nature of rivalry conditions in a corporation’s home market. In particular, a company that has its central business positioned in an industry characterized by intense levels of import competition may face a stronger competitive setting as companies contest for resources and competitive position. As such, the increase in a company’s global diversification stimulated by rising industry globalization is likely to increase. The reason is that companies may see inadequate prospects for growth within the domestic markets, and as international markets augment, the firm may look for supplementary growth in international markets. Additionally, foreign based may enjoy advantages resulting from location differences in terms of cost reduction, and a firm may seek to reap such advantages by taking its dealings abroad. Therefore, the higher the rivalry in a company’s main business, the larger the effect of industry globalization in energizing company’s management to advance global diversification (Wiersema & Bowen, 2008, p 118). Avon is a perfect example of a firm enjoying growth resulting from international diversification. Most of Avon’s sales (70%) are derived from international markets, outside its headquarters in North America. Growth is the key reason why Avon has put much emphasis on international diversification. The company forecast a dawdling potential for growth in the United States market since there is nearly no remaining untapped market for its cosmetic products. The reason is that the United States beauty market is highly cutthroat. As such, Avon prefers to put emphasis on less competitive markets, as domestic sales chiefly depends on women population growth in its domestic markets. The corporation asserts that even if there was a sizeable unexploited market in United States, it cannot result in more sales because; about five percent of the global populace lives in United States. The likeliness of growth goals to propel diversification is probably to be particularly strong for corporations operating in slow growth industries (Pettigrew, Thomas& Whittington, 2001, pg 89). Procter and gamble has enjoyed growth from international diversification, currently operating in more than 180 countries, and a portfolio of more than 78 brands. This has resulted in the growth of the company’s stock price and total earnings since 2007, in spite of the great recession in the mature economies (Maxfield, 2012, para 5). Economies of scale International diversification results in Economies of scale in terms of scope and learning, as well as sharing of core capabilities among diverse business segments and international markets. Organizations with greater capabilities and are well developed at domestic markets can capitalize on these capabilities in international markets. Hymer holds that the higher the engagement of a company in global markets, the higher the exploitation of visible and invisible resources that are anticipated to result in higher performance (Capar & Kotabe, 2003, p 346). This assertion is founded on the knowledge based or resource based perspective of a company in strategic management. Firms operating across national borders have the opportunity to incorporate their tasks across countries by averaging the product, trimming down production, or/ and distributing their resources more competently and effectively. Additionally, firms operating in different countries can achieve competitive advantage by capitalizing imperfections existing in the market through cross border transactions and transfer pricing, which may result in more bargaining power with large organizational size. McDonalds’ corporation enjoys a competitive advantage resulting from international operations. McDonald’s is an unmatched leader in the area of quick service and fast food offering. The corporation has more than 31,000 outlets and a global presence in more than 118 countries, more than $ 1.5 billion in cash laden balance sheet, as well as a market capitalization that dwarfs rivalry, making it almost impossible to compete with. McDonalds’ is not only large in size, but its intensive international and geographic diversification and economies of scale fill the corporation with numerous competitive merits. Economies of scale results in cost savings for the company. The economies of scale enable McDonald’s to carry out research and development activities on new products that result in higher profit margins. The new products help the corporation keep its competitors at bay by offering comparable products at lower prices (Marguez, 2009, para 2). Disadvantages of international diversification Competition Firms operating in international countries face stiff competition from domestic firms or other foreign firms that have presence in the country a firm ventures. In most instances, competition by multinationals compels domestic players to be more competitive at a global arena. In order to be globally competitive, domestic firms opt to strategically involve foreign competitors in global markets. Additionally, the environment usually changes swiftly and impulsively over time. When new technology distorts country boundaries, it may destroy the source of a company’s competitive merit (Costanzo & MacKay, 2009, p 514). In the contemporary world, businesses are more and more affected by the dealings of global rivals due to the concept of globalization. Swift internet connections advanced by companies allow the contracting of communication time bringing together sellers and purchasers on opposite sides in a fraction of a second. For instance, Apple’s iPhone had become a direct rival to Nintendo in 2009 for playing games on small cellular phone devices. When such a critical technological change happens in a company’s core capabilities, the gains it had previously made from transferring or leveraging distinctive capabilities disappear. The company is left with a collection of businesses that have all become poor players in their relevant industries, since they are not based on the new technology. Nintendo was the market leader in manufacturing of gaming consoles for children in the 1980s till 1994 when Sony ventured into the market with its Playstation. The market responded well to Sony’s Playstation, outdoing Nintendo. Nintendo was further hit a blow by competition when the giant Microsoft ventured into the Playstation making game in 2001 with its Xbox brand. Nintendo was completely overwhelmed by competition for Playstation in 2005 after Xbox dominated the market. Further, the company was dealt a blow when Sony made investments in development of high definition television (HDTV) that quickly spread and opened possibilities for development of visually appealing games to gratify augmenting demands for gamers (Rusetski, 2012, p 198) Increase in transaction costs International diversification results in increase in transaction costs for management. Geographical dispersion exceedingly increases managerial information processing demands and transaction costs. Geographical spreading further increases distribution, management and coordination costs. Additionally, a firm needs to have the capacity to integrate coordination, management and distribution knowledge efficiently, when it is involved in diverse markets in a continuing business as an engagement in a diversity markets may obstruct the speed of an organization’s learning (Toyne & Nigh, 1997, p 511). Transaction cost economics asserts than an increase in corporate scope entails an evaluation of the relative costs of negotiating, monitoring, and enforcing agreements related to carrying out internal transactions (chain of command) and externally (marketwise). Higher levels of diversification require extra costs of coordination and control over an organization’s functions in a manner that the organization is consistently trading off the financial benefits related to a corporate strategy alongside the technical costs of implementing the diversification strategy. Given that expansion by a corporation into new geographic markets or new product will necessitate higher control and coordination by the corporation’s management, then past choices to enlarge the organization’s business portfolio by diversification will increase the costs of successive efforts to enlarge internationally. Furthermore, as firms venture into new geographic markets, there have to be a new management to oversee operations in the new subsidiary. In other words, there will be dilution of control, which results in extra costs, as the new venture will require expatriates and other support staff. Coca cola has faced numerous transaction costs in its bid to enter china markets, which is brought about by market imperfections, (Mok, Dai & Yeung, 2002, p 39). Samsung had become one of the most innovative global makers of electronics in 2007 with its research divisions: telecommunications, semiconductors, flat screen and digital media. Due to its varied products that require researchers, engineers, marketers, the company incurs high costs in its pursuit of diversification strategy. The corporation was forced to restructure its business divisions in 2008 due to global recession, in a bid to lower its structure of costs and increase its technical edge. The corporation further restructured in 2009 to reduce transaction costs and speed up product development (Hill & Jones, 2012, p 374,). Dilution and cost of control Diversification is an intricate growth strategy. The top level managers have to have the ability to identify beneficial opportunities to enter new countries and to implement the strategies required to make diversification profitable. Over time, a company’s executive management usually changes; where able executives leave the organization, retire and/ or step down. When such able managers leave the organization, they leave take their visions with them. A company’s new leader may lack the requisite competence to needed to pursue diversification successfully over time. Therefore, the cost structure eradicates the gains that diversification may have produced. There are several aspects that are essential for implementing international diversification. A firm going international must have the capacities to execute activities such as product adaptation and advertising. Nonetheless, there exist impending complicating factors that limit a firm’s ability to carry out these activities successfully. Porter held that greater geographical dispersion increases management, coordination and distribution costs (Toyne & Nigh, 1997, P 509). Unilever Company has faced numerous challenges as a result of wide diversification. Its path to grow strategy saw the company split into two separate units to operate globally. These are: the home and personal care ad foods. As a result, Unilever further decentralized its control over subsidiaries which further dilutes control. The company is suffering from management fatigue as a result of the wide diversification, as well as excess of bureaucracy. In addition to that, Unilever faces the managerial challenge of confusion in terms of responsibility and accountability (Blackford, 2012, p 135). Political, legal and cultural challenges in different countries One of the main challenges for international diversification is the political and legal rules governing a country that a multinational wishes to venture in. diversification through acquisition is mainly affected by political and legal requirements of the diverse nations in an organization has controlling interests. Changes in political fronts create a challenge for international diversification, as uncertainties exist as citizens of democratic nations decide the political directions their nation will take. Organizations need to have a well defined purpose before venturing in overseas operations. Culture plays a critical role in determining whether a firm can last in an international market. Buyers in different cultures have varying attitudes and perceptions toward the same product. For instance, Murdock Rupert was denied control of 25 percent and above of any corporation with broadcasting license in United States for being a non US citizen. This forced him to become a United States citizen in 1985 in order to attain 25 percent and above control (Reed, 2012, para 1-3). Wal-Mart was a victim of political and cultural challenges in its bid to venture in international markets. Its entry into United Kingdom and china was successful, which may be attributed to political influences and cultural differences. However, Wal-Mart entry into Germany was not fruitful, due to German culture, oligopoly marketing environment, powerful trade union and hostile legislation (Landler & Barbaro, 2006, para 3). Additionally, other dimensions of culture like religion causes strife at national and international levels (Hill & Jones, 2012, P 123). Religious wars may greatly disrupt business operations. For instance, the Indian war in Kashmir region as a result of conflicts between Muslims and Hindus may hinder business operations. Christian-Muslim war in Indonesia and Nigeria can also affect business operations in those regions. Understanding cultural differences becomes increasingly essential as international diversification. Hofstede asserted that international businesses encounter multiple challenges, and none is more demoralizing than attaining a comprehension of unfamiliar cultures (Hofstede, 1996, p 75). Conclusion In conclusion, several advantages accrue from firms engaging in international diversification. These include the stability of profitability, spreading of risks and significant growth. Corporations like Procter and gamble have enjoyed growth resulting from international diversification. International diversification benefits corporations to having economies of scale. McDonald’s is one of the fast food chains that has a global presence, and enjoys a competitive merit from diversification. The corporation is able to invest a great deal in R &D to develop new products that are offered to the market at competitive prices. However, global diversification results in challenges like competition. Competition results in severe challenge as it force a company out of business. For instance, Nintendo was forced out of Playstation market to Sony and Microsoft, and political and cultural differences that saw Wal-Mart exit its Germany retail operations. However, the merits and gains of international diversification outweigh the demerits, especially after an organization has reached its optimum to enjoy economies of scale. As such, it is beneficial for firms to pursue diversification, particularly related diversification. Bibliography: Blackford, M.G. (2012). Rise of Modern Business: Great Britain, the United States, Germany, Japan, and China. North Carolina: UNC Press Books. Brigham, F.E & Houston F.J. (2009) Fundamentals of Financial Management. Connecticut: Cengage Learning. Caper, N. & Kotabe, M. (2003) The relationship between international diversification and performance in service firms. Journal of International Business Studies, 23(1), 345-355. Chandra. (2008) Investment Analysis 3/E. USA: Tata McGraw-Hill Education. Costanzo, L.A & MacKay R.B. (2009) Handbook of Research on Strategy and Foresight. UK: Edward Elgar Publishing. Costanzo, L.A. & MacKay, R.B. (2009) Handbook of Research on Strategy and Foresight. UK: Edward Elgar Publishing. Griffin. R.W. (2012) Fundamentals of Management. Connecticut: Cengage Learning. Hill,C.L & Jones, G.R (2012) Strategic Management: An Integrated Approach. Connecticut: Cengage Learning. Hofstede, G. (1996). Cultures and organizations: Software of the mind: Intercultural cooperation and its importance for survival. New York: McGraw Hill. IE business school (2007). Diversification strategy. Accessed on 23 February 2013 from: http://openmultimedia.ie.edu/OpenProducts/diversificacion_i/diversificacion_i/Curso.pdf. Kim, W.C, Hwang, P. & Burgers P.W. (1989) Global diversification strategy and corporate profit performance.  Journal of Strategic Management Journal .10(1), 45-57. Landler, M. & Barbaro, M. (2006) Wal-Mart Finds That Its Formula Doesn’t Fit Every Culture. Accessed on 18 February, 2013 from: http://www.nytimes.com/2006/08/02/business/worldbusiness/02walmart.html?pagewante d=all&_r=0. Marquez, H.R. (2009) buy, sell or hold: let McDonald’s transform the golden arches to golden gains. Accessed on 10 February 2013 from: http://moneymorning.com/2009/02/23/mcdonalds-corp/ Maxfield J. (2012) I huge reason to buy Procter and gamble’s stock. Accessed on 10 February, 2012 from: http://www.dailyfinance.com/2012/05/20/1-huge-reason-to-buy-procter- gambles-stock/. Mingtao S. (2007) Technology Base of mobile cellular operators in Germany and China. Nadiya Parfan: Univerlagtuberlin Mok, V. Dai X. & Yeung G. (2002) an internationalization approach to joint ventures: the case of coca cola in china. Asia pacific business review. 9(1), 39-58 Pettigrew, M.A, Thomas, H, & Whittington, R. (2001). Handbook of Strategy and Management. NY: Sage. Reed, I. (2012) Rupert Murdoch, the power of corporate media chains over governments, and why Canadians must take heed. Accessed on 22 February from: http://niagaraatlarge.com/2012/06/25/rupert-murdoch-the-power-of-corporate-media- chains-over-governments-and-why-canadians-must-take-heed/ Ricky W. Griffin. (2012). Management. Connecticut: Cengage Learning. Rusetski, A. (2012) the whole new world: Nintendo’s targeting choice. Journal of business case studies. 8(2), 197-200. Susman G.I. (2007) Small and Medium-Sized Enterprises and the Global Economy.UK: Edward Elgar Publishing. Tallman, S.B. (2007) A New Generation in International Strategic Management. UK: Edward Elgar Publishing. Tongli, L., Ping, J., & Chiu, W.K. (2005) International Diversification and Performance: Evidence from Singapore. Asia Pacific Journal of Management, 65(2), 65-88. Toyne, B. & Nigh. D.W. (1997) International Business: An Emerging Vision, Volume 1. South Carolina: Univ of South Carolina Press. Wiersema, F.M & Bowen, H.P. (2008) Corporate Diversification: The Impact of Foreign Competition, Industry Globalization, and Product Diversification. Strategic Management Journal, 42(2), 115-132. Read More