The argument dates back to a dinner I was having at a restaurant last week with three of my Austin Power school friends (yes, we all have a combined IQ that just about beats a tubelight’s... when it’s switched off), who were complaining rancidly that whenever we ate out, I always ordered the same old dish time and again. “Man, why’re you so against ordering different dishes? Look at the wide range we’ve ordered,” they all argued. When I tried to throw them off by mumbling something complicated about how core is better than diversified, they all pounced on me clearly highly irritated, and the grouchiest one of them threw me a choker, “If you’re so much in love with the stupid concept of sticking to your so-called ‘core’ dish, choose dude, which friend amongst us do you want? And choose fast...”
Cornered, my life flashed in front of me... Alright, not my life, but at least a few research reports I had read up a few days back on whether focusing on core businesses is more profitable for companies or having diversified streams of operations. Prof. Gert Bruche of The Berlin School of Economics destroyed the happiness of the core lovers when he proved in his working paper titled, Corporate Strategy, Relatedness and Diversification, that diversify ed companies “display a better performance” than single business companies. Another sparkling report by an erstwhile core proponent, McKinsey & Co, titled, Beyond focus: Diversifying for growth, proves how over a period of a decade, the market value CAGR of diversified companies stood 126% higher than of focused companies. There’s more. The report further clarifies how on one hand, while “the focused group tallied an average annual excess Total Returns to Shareholders of 8%,” the “diversified group notched up 13% annual excess TRS and higher median EPS growth…”
Then follows the pumped-up and charged to the core, ‘anticore’ study by Profs. A. M. Pandya & N. V. Rao of Northeastern Illinois University titled, Diversification and Firm Performance: An empirical evaluation, which proves how, “Diversified firms show better performance compared to undiversified firms on both risk and return dimensions. Diversification can improve debt capacity, reduce the chances of bankruptcy by going into new product/ markets, and improve asset deployment and profitability. Diversified firms pool unsystematic risk and reduce the variability of operating cash flow…” Even the iconic Professor Michael E. Porter of Harvard Business School argues in his almost revolutionary book, Competitive Advantage: Creating and Sustaining Superior Performance, “Resource sharing and competence transfers enable the ‘diversified firm’ either to reduce overall operating costs in one or more of its divisions, and/or to better differentiate the products of one or more divisions resulting in a price premium.”
The argument against core focus entities doesn’t change, even when we talk about the Fortune #1 company ExxonMobil. In his paper titled, Risking Shareholder Value, well-acclaimed consultant Mark Mansley of Claros Consulting, while analyzing the oil giant, proclaims and proves definitively, “ExxonMobil has the potential to transform the company into a total energy business, increasing global market share, through [vertical] diversification!” Another sparkling paper titled, Can Diversification Create Value?, by Prof. Tomas Jandik of Sam Walton College of Business, University of Arkansas and A. K. Makhija, Fisher College of Business, Ohio University, proves how for diversified firms, “this ‘failure’ to focus has been rewarded with higher firm values. Diversification can create value by opening up new investment opportunities...” The most celebrated Professor Belen Villalonga of Harvard Business School proves in his paper titled, Diversification: Discount or Premium? that diversify ed firms “trade at a significant average premium relative to comparable portfolios of single business firms.” Slapping worshippers of single business philosophy harder, he finally sums it all in one short line, “I find diversification as a premium!” Further good news to shareholders of diversifying firms comes from the Boston Consulting Group which, while mocking all praises about ‘core competence’, proves in its report titled, Managing for Value: How The World’s Top Diversified Companies Produce Superior Shareholder Returns, how during the years 1996-2005, not only did the majority of diversified companies resoundingly beat the stock market average by hugely significant margins, but also that a majority of the core focused corporations (almost 60% of them) were not even able to beat the average shareholder returns provided by diversified companies. The typical nail in the core coffin is the conclusive remark that, “There is no statistical correlation between ‘focus’ and shareholder value. The more businesses a company has, the greater the flexibility it has to reinvent itself and sustain growth.”
Even demergers ostensibly attempted by companies to focus on core businesses have ended up destroying shareholder value. BCG in its report titled, Conglomerates Report 2002: Breakups Are Not The Only Solution, it proves statistically how 70% of such break-ups to focus on lesser number of businesses in the past ten years, either “destroyed” or “did not create value”! Contrary to narrowing down multibusiness focus, diversifying mergers in the past 55 years have continued to deliver superior returns as compared to single-business deals, as proven in the landmark paper by Professor Mehmet Engin Akbulut and John G. Matsusaka, Marshall School of Business, University of Southern California, a report that analysed 3,667 mergers in the past 55 years.
But research be damned! With many highly annoyed restaurant guests starting to stare, I still had three massively slighted friends who were spewing fi re in front of me ready to put me on the stake, asking me to choose just one of them, and that too during a dinner where I was supposed to foot the huge bill. Cornered, I did the most intelligent thing – I apologized to my friends and accepted my mistake that diversification was better than core. With all the three gluttons guffawing away to glory in the most atrocious manner at their victory, I did the next most intelligent thing. I loudly asked the waiter to get four ‘diversified’ bills instead of one ‘core’ bill. I paid up my quarter part of the bill, wished my friends a loving goodnight, got up and walked away home... to my sweetest ‘core’ wife... Well, that sets me thinking, would one core wife be better or many diversified wives?... Hmm, not in this life honey, not in this life... Sigh...