A New Playbook for Diversified Companies

A wave of corporate breakups has rippled through industry after industry over the past several years. This has happened in consumer goods, for instance, with Kraft Foods’ spin-off of its North American grocery business; in materials, with Alcoa’s split into separate aluminum and engineering businesses; in technology, with HP’s separation of services and software from printers and PCs; in energy, with Danish industrial conglomerate A.P. Moller-Maersk’s divestiture of its oil businesses; and in health care, with Siemens’ spin-off of its medical technology division. The trend started in the 1980s in the United States and reached Europe in the late 1990s, but it has intensified in recent years, as more vocal investors have pressed for more focused business structures.1

You might wonder if we are finally seeing the long-anticipated demise of the diversified public corporation.2 After all, both finance and strategy scholars, while recognizing that a little diversification can be a good thing, have argued for years that greater amounts of it are detrimental to performance and value creation, particularly when businesses in a portfolio aren’t clearly linked.3 This idea that the relationship between diversification and performance follows an inverted U-shaped curve has become established wisdom in management literature.4 It continues to permeate leading textbooks on corporate strategy.5

Why would companies diversify beyond optimal levels? Because, traditional thinking suggests, managers have enjoyed higher compensation levels and faced fewer takeover risks in large, diversified corporations than in smaller, more specialized companies. So, many observers assume that it was in response to greater capital and product market pressures in more liberalized, well-developed economies that companies de-diversified and focused on one or a narrow range of activities that they know best.6

Though this tidy narrative is intuitively appealing, two aspects of it don’t hold up. First, some companies continue to be highly diversified — and do well. Many private equity groups and conglomerates such as Alphabet or the Mahindra Group are thriving in multiple lines of business. This observation resonates with recent research7 suggesting that the capacity to manage diversification differs more widely between companies than previously thought.