Chapter Listing | Return to 1997 Topical Index


REVIEW OF THE LITERATURE AND HYPOTHESES

The link between diversification strategy and performance has long been a central issue in the strategic management literature (Rumelt, 1974; Ramanujam and Varadajan, 1989; Markides, 1995). The debate centres around the meaning and measurement of Wrigley’s (1970) concepts of “relatedness” and “core skills”. The view that relatedness enhances value seems to have passed into the collective mind of the financial markets, with shares of conglomerates now trading at a discount to the market, in marked contrast with the 1960’s and 1970’s (Lang and Stultz, 1994).

Several strands of the diversification literature have evolved broadly similar diversification classification schemes. The task for this paper is not to classify firms according to their present degree of diversification, as Wrigley (1970) and Rumelt (1974) have done, but to classify the initial direction of diversification, i.e. the first diversification moves of young firms.

Following Lubatkin and O’Neill (1987), three broad diversification strategy types will be recognized here: a) growth into a new non–competing product/market which is related to the firm’s technological or marketing skills base (often termed related diversification); b) growth into a new part of the value chain previously contracted out (commonly known as vertical integration); c) growth into a new product/market which is unrelated to the firm’s present technological or marketing skills base. A fourth option, which we might expect many young firms to take, is to focus on exploiting the existing product/market, i.e. to remain as a single business.  The literature on large firm diversification suggests the following hypotheses:

Hypothesis 1.  Related diversification is a more successful strategy for growth among young growing firms than unrelated diversification.

Hypothesis 2.   Related diversification is a more successful strategy for growth among young growing firms than vertical integration.

Hypothesis 3. Related diversification is a more successful strategy for growth among young growing firms than no diversification.
 
A second topic for the diversification literature is the mode of growth (Amit et al., 1989): should one grow into new business opportunities organically, perhaps by setting up a new internal structure, or should one acquire an existing business? To this a further question can be linked: should one grow existing business areas organically, or through acquisition, or by both means simultaneously? According to Peters (1993), acquisitions often prove safer and faster growth mechanisms than organic growth. Porter (1987) and others disagree. Page and Jones (1990), in a study of 30 fast–growth firms in the UK, found that acquisition and organic growth needed to operate together for best performance. McCann (1991), however found that acquisition was not an important factor in the success of the fastest–growing ventures in his sample of 100 young high technology firms in the US. They relied instead on product innovation through internal R+D to fuel growth. McCann states (p.91): “it would be unusual for the young, relatively inexperienced venture to grow aggressively through acquisitions, especially when its own market potential is still substantial and untapped”. This suggests that success with acquisitions may be a function of both the age and the technology level of the venture. The former is supported by the findings of Siegel et al. (1993) that high growth was associated with a focused strategy in young firms and plans for diversification in more mature firms. The following
 hypotheses arise from this discussion:

Hypothesis 4. Acquisition is a more successful growth mode than organic growth for older firms but not for younger firms.

Hypothesis 5. Acquisition is a more successful growth mode than organic growth for non–high technology firms but not for high technology firms.

Previous studies (Levie, 1995a) have shown that patterns of strategy and performance do not always replicate across national boundaries. Differences in home market size, availability of critical resources, or cultural or legislative differences might cause certain growth patterns to prevail over others. Setting work on strategy and performance in a comparative context is therefore important as a check on the external validity of any emerging patterns. This paper compares similar temporal cohorts of young growing firms in a small nation state (Ireland), a nation which is a region of a larger state (Scotland) and a large nation state (France).

Ideally, such work also needs to be replicated across different time cohorts of firms, since both access to financial resources, the growth of markets, and availability of takeover targets may vary across the business cycle. Comparison with previous cohorts of young growing firms for Ireland and Scotland are made in this paper for this reason.

Top of page | Chapter Listing | Return to 1997 Topical Index


1997 Babson College All Rights Reserved
Last Updated 06/01/98