Two Diversification Mantras: Core Competence Or Every Available Opportunity

The Tata Group is an example of the latter school of business thought. Starting as a trading firm, Tata Group founder Jamsetji Tata went on to establish textile mills, steel mills, and the Taj Hotel. Today, the Tata Group is a salt-to-software-to-skies conglomerate of 90-plus companies and businesses with a revenue of US $150 billion and a combined market cap of US $300 billion in 2023.

Apple stands on the other end of the diversification spectrum with its technology products with greater focus on design, software, technology and innovative products. The company recorded US $383 billion in total revenue in 2023 and its market capitalisation is just below US $3 trillion.

The stark contrasts in the business model says a lot about corporate strategy. While the Tatas diversified into unrelated sectors, Apple has stuck to its core competence—computer desktops, laptops, iPhones and services like Apple Pay and iTunes. The key difference here is technology orientation and innovation. Apple has reaped huge benefits in terms of value addition, revenue, and market capitalisation.

The East-West Divide

Western companies are mostly focused on confining themselves to one or two businesses. Barring exceptions like GE and the Virgin Group, Coca-Cola, Kellogg’s, Apple, Ford, General Motors, Nike, Adidas, IKEA, Zara, and Uber have created maximum value with their focus on just one or two areas of business. Coca-Cola calls itself a complete beverage company and sells all types of beverages across the world. For every hour of the day, it has a beverage. Kinley water, Minute Maid fruit juice, Georgia tea and coffee, Sprite, Coke, and several others. Kellogg’s calls itself a breakfast cereals company and sells that in 150 countries.

On the other hand, companies from the East and emerging markets are largely diversified. Companies from South Korea, Japan, India, China, Brazil, and others are diversified. In South Korea, they are known as chaebols. LG, Samsung, and Hyundai are diversified conglomerates. Japanese firms, except SONY, are also diversified. Mitsubishi, Mitsui, Nissan, Nomura, Sumitomo, Toyota, and Mizuho are also known as keiretsus. Similarly in India, the Tata Group, Reliance Industries, Aditya Birla Group, Adani Group, and others are highly diversified.

Why The Different Routes?

What explains the divergence even though a focused approach to business creates more value, profit, and market capitalization? GE has now started focusing on three broad types of business to improve profitability and market capitalization.

Researchers Tarun Khanna and Krishna Palepu of Harvard Business School studied the phenomenon. They have ascribed it to the context in which the businesses operate and explain the divergence in corporate strategy. Diversification is the best strategy in emerging markets, their study says. The firms have responded to the political economy and the market structure prevailing in their countries.

The Tata Group, for example, began operations in the British era but the government of India took the socialist route and placed restrictions on private companies, particularly big business groups. There was the Monopolies and Restrictive Trade Practices (MRTP) Act which limited companies' growth lest they became monopolies. Groups like the Tatas, the Birlas, the Godrejs, and others diversified into different businesses to avoid the statutory limitation. Though Tata Steel was allowed to operate for historical reasons, the steel sector was reserved for only public sector undertakings. Foreign direct investment was also restricted. With no access to larger capital requirements, the companies did the best they could in different sectors. Further, the stock market was not highly developed. The banks were nationalized and the priority for credit was safety, hence the public sector. The big groups didn't get access to all sectors since certain products were reserved for small-scale industries.

The liberalisation of 1991 undid the shackles of the years passed, leading to the growth of business groups. New firms like Reliance and Adani emerged but they also took the diversification strategy to utilise opportunities in different sectors and grow.

Business Climate Holds Key

In their Harvard Business Review article linked above, Khanna and Palepu argue that focus on core competence is good for companies but in emerging markets that advice may not work well. Western companies can rest easy since they can take institutional support for granted. Companies like Apple and Microsoft could raise money from established venture capital funds that may not be fully developed in emerging markets like India and Brazil.

In such markets, the surplus of the big groups is utilised as venture capital funds for new ventures. For instance, Tata Sons can acquire Jaguar Land Rover by selling TCS equity and raising loans.

Without high-quality educational institutions, it is difficult for focused firms to get quality technical and managerial cadre. But in a diversified set-up like the Tatas, they can leverage talent across companies. After the recent Air India acquisition, the Tata Group could move top managers from within the group for Services and Food Quality and get TCS to upgrade software and digitalise operations. This scale of access to talent is not possible for companies like Spice Jet or Akasha Air. On the other hand, Air India has a high probability of success because it is part of the Tata Group's support and commitment.

The divergence in the approach to diversification lies in the institutional context of the firm in which they operate. It defines strategy even though the financially focused approach gives higher return and market capitalization. The group's core competence brings higher value. However, the context forces them to adapt strategy to overcome challenges in product, capital, and labour markets. That explains the routes Apple and the Tata Group have taken and continue to be on.

(The author is a professor of Strategy, IILM Institute for Higher Education, New Delhi. Views expressed are personal)