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Search, Google+, Android, Google Glass, self-driving cars - the company synonymous with online search, Google, appears to be in a hurry to grow in almost every direction at once. The world's largest software maker (measured by revenues) Microsoft has taken a headlong plunge into a series of new businesses - search engine, game consoles, internet access, touch-screen kiosks…
Almost every company struggles with a diversification at some point. When times are good diversification makes unused cash work hard; when times are bad companies enter new territories to re-invent themselves. Such efforts could represent new growth areas or they could prove to be costly distractions. Inevitably, there will be some bad moves, especially with acquisitions that divert resources from a core mission.
The big question therefore: Should a company stay focused on the competencies that made it the leader or help it be counted among the great, or should it diversify to keep up with, or try and overtake, competitors? Experts say that's one of the trickier questions facing a whole host of companies irrespective of their industry. Indeed, the toughest test for leaders is to determine when to move forward and when to pull back. No management textbook or theory can tell you that.
Of course, there are real-life examples to learn from. Here The Strategist looks at two recent examples - of companies from two very different industries that went through the whole grind of diversification and have now decided to exit a few businesses and concentrate on others where they can claim to have competitive advantage. The first one is a leader in the movie exhibition business, namely PVR, while the second is homegrown PC maker HCL Infosystems.
PVR began its innings in the movie exhibition business by introducing world-class multiplexes in India and went for a 'related' diversification into the high-risk high-return business of film production. It decided to get out of the movie making business post the 2012 release of Hindi movie Shanghai because it doesn't see this as a viable business opportunity for the long term. HCL Infosystems, our second example, said recently that it will phase out its manufacturing business over the next few years to improve margins and increase organisational efficiency. The company will instead focus on strengthening the services and distribution verticals. HCL Infosystems CEO and managing director Harsh Chitale has been quoted in the media saying HCL "will be in PC distribution and in after sales services but will not manufacture HCL branded products in the future".
Though both these companies diversified, both understood the need to pause even as one went back to where it started and the other moved away from it. What's pertinent is that both paused at the right time, mulled over what to do next and acted without delay to avoid any distress to their businesses or people.
Back to basics
The latest initiatives of PVR and HCL, or for that matter, Google and Microsoft, raise some interesting questions. What kinds of expansions are synergistic with the core business, and which are unrelated? Can a company remain nimble enough and defend its current turf? Does it risk a backlash as it moves into new markets? Answering that question effectively forces companies to assess their true competitive advantages.
A recent study by Booz & Co covering more than 6,000 companies in 65 industries finds that the best performance improvement and growth opportunity for a company comes when it rises to the top of the industry that it operates in. According to Evan Hirsh, partner, Booz & Co, also the co-author of The Grass isn't Greener, leaders often try to expand into hot new growth industries looking for accelerated performance they think isn't available in their core business. Such efforts often prove futile because companies fail to leverage existing expertise or assets into new businesses to generate returns. "Companies perform better and produce better shareholder returns when they strengthen the key capabilities that help them win in their core industry. Companies that try to grow into new industries are likely to fail," says the study.
Consider PVR against this backdrop. According to Kamal Gianchandani, group president, PVR, the company spotted a viable business opportunity in the business of film production around the year 2007. Moving into film production meant allocating a fair amount of capital to back good cinema. What the company failed to note was that while the production costs for films had sky-rocketed, returns were tougher to come by.
Since the company was looking at a new revenue stream it went whole hog and made huge investments in its film making business - like hiring a completely new team with the mandate to nurture the production arm. The problem, in hindsight, was that it is tough to achieve scale in the business of film production.
"The business of film production can be a margin game but not one of scale," says Gianchandani. Also, the nature of the business is such that you can't be hands-off. It demands that the leadership team is clued into the process from start to finish - go through scripts, meet film directors and sit with them on story sessions, get into the nitty-gritty of production, attend shoots et al. In other words, understand the rules of a completely new ballgame. "The business was taking up a disproportionate amount of management time. On the other hand, the exhibition business, our mainstay, threw up new opportunities," says Gianchandani.
"Also, we realised the returns on investment were far higher here," he adds.
Film exhibition, the mainstay of PVR, has consistently contributed about 90 per cent to the total revenues of the company. At the end of 2007, the success of films like Taare Zameen Par ensured that the business, in its very first year, would contribute 9 per cent to the total revenues of the company. However, by 2012, when PVR decided to shut its film production arm, the segment's contribution to the total revenues of the company had dwindled to 2 per cent.
According to an August report on PVR by Motilal Oswal the closure of production business is 'a step in the right direction'. The report notes, "Though two of its productions - Taare Zameen Par and Jaane Tu Ya Jaane Na - did well, its Khelein Hum Jee Jaan Sey was a flop at box office. Given the capital intensity and high risks involved, the management decided to reduce its focus on the production business. It has taken full control over PVR Pictures by buying out the 40 per cent stake held by JP Morgan Mauritius Holdings and ICICI Venture's India Advantage Fund for Rs 600 million. PVR used PVR Pictures' cash balance of Rs 400 million to part-finance the deal. PVR Pictures has now become a wholly-owned subsidiary and is focusing on the distribution business."
"Everything is okay if your core business doesn't suffer," says Gianchandani. He adds that the decision to branch into film production didn't really hurt the company because it continued to invest in its bread and butter and exploit the new opportunities therein. "Diversification is about revenue. If you see the growth opportunity is limited out there, save yourself the time and come back to see growth in the core business area," he says.
Onto greener pastures
Experts say diversifications fail due to a variety of reasons - from leaders overestimating their ability to manage new businesses, underestimating costs and competition to a new sector losing sheen (in India, for instance, the telecom sector seems to be trouble thanks to scams and piling of debt in companies).
The reverse, interestingly, is also true. You may want to march into new markets when your original business faces the threat of shrinkage or even extinction. See how HCL Infosystems did to understand when to quit a market. It decided to concentrate and grow the business of services and distribution just when it felt the heat - like most others - in the PC manufacturing business. As things stand, the PC business accounts for about 8 per cent (around Rs 1,000 crore) of HCL Infosystems' overall revenues and has been under pressure for some time now as new categories like tablets and phablets are finding more takers.
To be fair HCL is not the only one; in the last few years, most PC makers in the country have incurred losses due to the fluctuation of the rupee against other currencies, especially the US dollar. In any case, the PC business in India is low margin and more than 90 per cent of the components are imported. Plus between Lenovo, Dell and HP the desktop market was fast slipping away from its grasp.
That said, HCL's wasn't an overnight decision. The transition has been in the works for two years now. As a first step. the company put in place a Central Programme Management Office (CPMO) consisting of a core team headed by Rothin Bhattacharyya, EVP, Marketing, Strategy and Corporate Development, HCL Infosystems, to oversee the overall transition process. Then, from each of the shared functions such as HR, administration, taxation etc, single point of contacts or SPOCs were appointed. They were responsible for completing the required restructuring plan pertaining to their function. From each of the business units, SPOCs were nominated to become responsible for coordinating with the CPMO and functional SPOCs to ensure all the actions for the business unit were carried out comprehensively and in time. The core team in the CPMO interacted with the business leaders and the business SPOCs and updated them on the restructuring process. To make the procedure transparent, a detailed FAQ document on the various facets of the organisation that were being impacted because of the restructuring was shared across the organisation.
The process of restructuring was initiated with a clear plan to carve out the diverse businesses into distinct entities, establish operational and financial delineation and ensure the independence of the different strategic business units. The idea, says Bhattacharyya, is to enable each business to meet its respective requirements and at the same time create an organisation customised to the needs and goals of that particular business. "While there would be now greater independence there would also be accountability for each business… Our large growth focus businesses such as services and distribution will now be able to receive undivided attention," he adds. In his view, PC manufacturing in India (with an import content of almost 90 per cent) has been impacted in the last two years due to the volatility in the exchange rate, a major reason why HCL's focus on manufacturing in the value chain of PCs in India has gone down.
Evidently, the decision to diversify or focus needs profound business logic behind it. As Amandeep Kalsi, director, Protiviti Consulting, points out, the first and biggest lesson from the experiences of the two Indian companies is that diversification needs a systematic and focused approach to the business. "PVR was correct in continuing to see growth potential and opportunity in the movie exhibition business even after it diversified into a completely different business. HCL, on the other hand, was quick to spot growth in diversified businesses to such an extent that the core business getting a hit didn't quite matter," explains Kalsi.
So even as companies grapple with the fundamental focus-versus-diversify dilemma, it is important to understand portfolio diversification and active risk management are essential parts of financial analysis which become even more crucial when competition mounts or when categories shrink and there is an urgent need to scout for new sources of revenue. But the recipe for success is in identifying your strengths and competences and sticking to them.
Expert Take
Here are a few things to keep in mind before you take the plunge:
* Question yourself
Do you want to diversify because everyone else is doing it? Do you sense a profitable business in diversification? What do you want to chase through diversification; scale, profitability, viewers /clients/consumers? Will the diversification be through acquisitions or will it be a start-up? Can the diversification add profitability?
* Understand how to do it
Once you have the clear understanding of why the diversification is happening, do it right by having a leadership team that is completely in sync with what it aspires to do. This is important because if the diversification fails, the leaders (who lead from the front) are well equipped and in sync with the understanding of why it is crucial to come back to the core competency area. Second, prepare yourself with a diversification plan so that the entire organisation is aware of the growth strategies. Only a good, sound and a well-intentioned plan can be executed deliberately for diversifying.
* Failing is not a crime
Not all diversification plans are successful despite the best strategies but it doesn't mean you cannot do damage control. Apart from infusing new leadership team (this should be part of the planning strategy), you can also look at partial exits by roping in investors or partners who understand the business well. If nothing works, it's alright.
* Keep the focus
Keep reassessing your core competency business strength even as you expand and diversify for opportunities (PVR was sharp in noting opportunity in its core business despite being the leader already). However, HCL was equally prudent in noting the failure in its core business and kept up the momentum in other related businesses, which are now its core strength areas. Eventually, it is the focus that is important.
AMANDEEP KALSI
DIRECTOR, PROTIVITI CONSULTING
