What is it about?
Sharing common inputs across business lines can potentially generate synergy that justifies related diversification. The pursuit of such synergy through diversification is, however, fundamentally driven by the indivisibility of inputs between firms. Based on a dataset of U.S. equipment manufacturers for the period 1993 to 2003, I find that a firm is more likely to diversify into a new business when its existing business lines can potentially share more inputs with the new business; however, the firm is less likely to diversify into any new business when its existing business lines are complex. Importantly, the firm’s likelihood of diversifying into a new business decreases more with the complexity in the firm’s existing business lines if they share more inputs with the new business.
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Why is it important?
To realize the synergy from related diversification, a firm needs to actively manage the interdependencies between different business lines, which, in turn, increases its coordination costs. The coordination costs may increase faster than synergy and set a limit to related diversification. This is particularly salient when the firm’s existing business lines already have complex interdependencies among them. The results suggest that increasing coordination costs counterbalance the potential synergistic benefits associated with related diversification.
Perspectives
This paper examines whether the pursuit of synergy itself explains limits to related diversification and therefore the choice for unrelated diversification. It argues that to realize the potential synergy, a firm must actively manage the interdependencies between new and existing businesses, which results in coordination costs. Net synergy may decline not because of exogenous opportunity constraints but because of the rising costs of coordinating interdependencies across an increasing array of related business lines. Therefore, while diminishing synergistic benefits limit diversification in general, increasing coordination costs moderate the impact of synergy on the choice of industries and set a limit to related diversification.
Professor Yue Zhou
University of Michigan
Read the Original
This page is a summary of: Synergy, coordination costs, and diversification choices, Strategic Management Journal, September 2010, Wiley,
DOI: 10.1002/smj.889.
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