Pitfalls of Diversifications
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We are aware that diversification has two major objectives: enhancing of core business processes and a business unit. The purpose of diversification basically incorporates new business in order to increase a firms competitive advantage and the advantages are obviously like risk control, increase better portfolios, takes advantage of existing expertise, extended business lines and so on. However, there are some potencial pitfalls along with the diversifications and can impact business.
Firstly, diversified business can erosion current business and weaken core business competencies. The erosions happen when the diversifications are in the same field of the industry or had some competencies in products or brand awareness. For examples, P&G acquired so many brands of cosmetics like Olay, SK II and other brands, most of them are competitors in the field and diversifications weak the brand awareness but increase the erosions of the same business in cosmetic field. Furthermore, the diversifications can hurt the competitive advantages of company and make diversifying firms turn their backs on the present situation of the business. Diversification can spread the firms managerial resource and let managements to devote efforts and time to the newly merged components. Thus, the existing activities, products or services can be put to second priority. Or in the contrast, company could not spread the managerial resources to take care of newly acquired businesses and could not achieve the efficiency of acquisitions. Such as P&G, a large diversifications halt down the P&G competitive advantages in managing too many brands, they could not spread more energies to maintain the acquired brands, the results are these brands have lower awareness, lost original competitive advantages than before, and do not achieve the efficiency of the diversifications. This gives us an example in potential pitfalls of diversifications too.
Secondly, diversifying firms will increase operating costs in order to fulfill the purpose of varying products and achieve market penetration. Sometime argued that diversification is inefficient and costly. It requires a large capital and R&D investment to start operations of the new business. Researches must be conducted beforehand to achieve the feasibility of the new product or new expansions, the expenses are costly and sometime it is sunk costs can affect the expenditures of the firm and impact the bottom line. There is also a possibility to have an investment to restructure a new product line, create the new products and pay for marketing fees of these products. It is also possible to spend too much financial expenses in acquiring new assets, hiring new staffs, training or firing people for the new organization, and may allocate new resources for the new organizations; these increase the human resources expenses too. All above can increase long term debts of companies and can cause company fall into a financial crisis after a large acquisition. If a company failed in acquisitions, it could only become large costs and cannot bring any profits to companies. This pitfall should be highly concerned before the diversifications.
Thirdly, other risks are existed in geographic diversification in foreign direct investment outside the core business of the