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Why Should Family Businesses Diversify?

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By Enrique Soriano

OVER a long period of time, the literature on corporate diversification has focused almost exclusively on large, publicly held firms. However, within the last few years, there have been some works published , dealing with diversification issues in small and medium sized firms but also in family businesses (Iacobucci & Rosa, 2005). Whereas some authors hold the view that family businesses engage in significantly less diversification than non-family firms, others describe diversification as a prevalent long-term strategy among family businesses.

Following Guillen (2005) and Granovetter (1995), we define a business group as a collection of legally independent firms that are connected by economic links (such as ownership, financial, and commercial) and social ties (such as family, kinship, and friendship) that lead to operational links. This definition distinguishes conglomerates or strategic alliances from buyer groups, in that the latter operate under somewhat unified entrepreneurial guidance, going beyond simple alliances among otherwise independent firms (Yiu, Bruton and Lu. 2005). In our case, the main social tie that links different firms into a business group will be that all those firms are under the control of the same family. The family business group (FBG), is the group of firms under control or managed by a group of people with family ties.

The usual criteria defining family firms, from the management side point of view, is that the institutional values of the firm should be identified with the family. Empirically this implies the involvement of multiple generations in a business group, the ownership of the group and voting control by family members, the effective management of the firm by family members and a large number of family members having board seats.

Examples of big family business groups in the Philippines are the Ayala Group, the Lopez Group, and the Gokongwei Group. Some of the most enduring family businesses started in one industry before growing into diversified companies with many lines of businesses.

Diversification is entering new markets with new products. Sometimes you just need to bust out and try something new like if you’re a tobacco firm, buying a packaged-food company; a cola firm entering the water business; or a chemical company going into the spa supply business.

Many companies appreciate the need to diversify but few use it as a way of relating to their markets. Fundamentally, this strategy is about creating new products with new product life cycles and making the existing ones obsolete. By doing so, firms launch new products that are developed not just for current customers but for new ones, too. To execute this strategy, you usually manage a merger, an acquisition, or a completely new business venture.

Well-known, highly innovative companies which include Intel, Google, DuPont, and all the pharmaceutical companies are into diversification. A company’s diversification strategy can be either related or unrelated to its original business. Related diversification makes more sense than unrelated because the company shares assets, skills, or capabilities. But many successful companies, such as Tyco and GE, continue to buy unrelated businesses.

We may distinguish among related and unrelated diversification, which in turn can be seen as a continuum in between single business units and fully diversified firms. Related diversification means entering in multiple industries that are able to share a common pool of corporate resources and capabilities. These are businesses where sales force, advertising, and distribution activities can be shared, exploiting closely related technologies.

We may safely assume that the family is directly involved in decisions regarding corporate diversification (in contrast with publicly held firms, where managers make these choices). Hence, to concentrate on FBG can be a useful way to analyse if diversification may be a valuable strategy for creating value.

To a family business, diversification is a way to extend their capabilities into new lines of business. The diversification will turn out profitable if the capabilities than were useful into one line of business are indeed also a capability in the new segment.
Diversification, on the other hand, may have two main costs for family business groups:

(i) The need of adding capabilities outside those of the family, be it through the hiring of professional managers, or through partnerships with other shareholders that incorporate the needed new abilities. (ii) An increase in complexity in the family group that may affect negatively its organization. In any case, the incorporation of outsiders to the FBG reduces the firm’s control by the family and may require an increase in monitoring effort.

Why Diversification Matters

Anyone who has invested money has heard about the importance of diversification in a portfolio to hedge against losing too much money when markets retreat. Diversification can be equally important to businesses that may face serious threats during turbulent economic times or when disruptive technologies enter the marketplace and big competitors move in. Although family businesses are known for their nimbleness and ability to react quickly to changing times, diversifying lines of business and expanding products and services can offer additional security when times get tough.