Diversification ought to be considered when
a. a company has run out of ways to build more resource strengths in its present business.
b. diversifying into closely-related businesses opens new avenues for reducing costs.
c. a company faces an uphill battle in creating a more cost-efficient value chain.
d. a company’s profits are being squeezed and it is unable to boost earnings per share.
e. a company lacks sustainable competitive advantage in its present business.
The correct answer and explanation is :
The correct answer is:
b. Diversifying into closely related businesses opens new avenues for reducing costs.
Explanation:
Diversification is a strategic move companies undertake to enter new industries or markets to achieve growth and long-term stability. The primary goal of diversification is to spread risk, create synergies, and enhance competitive advantage. The best time to consider diversification is when expanding into related businesses allows for cost reductions, operational efficiencies, and improved market positioning.
Diversifying into closely related businesses offers several advantages:
- Cost Reduction through Synergies: Companies can leverage shared resources, technologies, and supply chains to reduce costs. For example, a car manufacturer entering the electric vehicle (EV) industry can use existing production infrastructure, suppliers, and distribution channels.
- Economies of Scope: Businesses can spread fixed costs across multiple product lines, making operations more cost-efficient.
- Revenue Growth Opportunities: Entering related markets enables companies to cross-sell products or expand their customer base, increasing overall revenue.
- Competitive Advantage Enhancement: A diversified business portfolio reduces dependence on a single industry, making the company more resilient to market fluctuations.
Other options, such as lacking sustainable competitive advantage (option e) or facing profit pressure (option d), might push companies toward diversification. However, these factors alone do not justify diversification unless the move aligns with the company’s strengths and market opportunities.
A well-executed diversification strategy ensures that companies can maximize operational efficiency and maintain a strong competitive position in the long run.
Here is an illustration of business diversification, showing a company branching into multiple related industries, emphasizing synergy, cost reduction, and market expansion.