In the present day, particularly because of the ongoing crisis and uncertainty, the list of companies declaring bankruptcy continues to grow: Gold’s Gym, Hertz, Cirque du Soleil, Brooks Brothers, L’Occitane, among many others. In Chile, several more have joined, such as The Coffee Factory, La Casa Blanca, and Bravissimo. We assume that the crisis is causing many CEOs and managers to doubt, for the first time in many years, whether the business they are tasked with defending and growing will guarantee the future of their organization. 

Similarly, all human creations, no matter how perfect, bear the marks of their obsolescence. In other words, companies that are not focused on growth are focused on decline. And although in practice achieving business diversification can be challenging, it is simply necessary for achieving continuous growth when current markets become saturated and to survive. 

Does this reflection surprise you? Or do you perhaps agree with it? 

At Montblanc Consulting, we believe that there are still a large number of companies engaging in a discreet diversification exercise (which undoubtedly improves their organizational resilience). For example, local companies tend to concentrate between 70% and 95% of their revenue in a single business or among a few clients. 

In fact, diversification plans often have a long execution timeline, swayed by available resources or emerging opportunities, and are naturally subject to business strategies linked to the core business. Additionally, since organic diversification does not offer a significant leap in revenue or profitability but rather gradual growth, the attractiveness of diversification quickly fades. 

So, do the changes we have been experiencing recently justify a much riskier diversification approach? 

In recent years, we have seen a proliferation of examples where companies have chosen to open the door to diversification beyond their borders, venturing into new business activities in unfamiliar sectors and markets. 

  • Virgin Group, recognized within the travel and entertainment industries, is a highly diversified organization with over 200 different businesses, ranging from financial services to industrial sectors, warehouses, and luxury products. 
  • Samsung began by trading fish, fruit, and vegetables. It then moved into the chemical industry before eventually shifting to the production and manufacturing of electronic products. 
  • Mitsubishi is one of the most diversified technology companies in the automotive sphere. Originally founded as a shipping company, the company embarked on a process of unrelated diversification, spanning from finance to nuclear energy, as well as chemicals and industrial sectors. 
  • Engie, historically associated with oil and coal, has made bold efforts to pivot its business model toward renewable energies and energy transition services. 
  • Head, known for manufacturing and marketing ski and tennis products, is an example of related diversification that mitigates seasonality through its range of winter sports products (skiing, snowboarding), racquet sports (tennis, squash, badminton, padel), diving, swimming, among others. 

At this point, at Montblanc Consulting, we are convinced that a company diversifies for three main reasons: (i) the search for growth avenues, (ii) a “new way” of hedging a business (Google wants to prepare to be the one to “disrupt Google,” similarly with Amazon with its other related diversifications such as Prime, Cloud Drive, Kindle, Web Services, among others), and (iii) strengthening the value chain, particularly in countries with restrictions, as was the case for Chile with companies like CMPC, Arauco, CCU, among others. 

We see it as feasible for companies to pursue diversification through (a) developing a new business unit within the company, (b) creating a start-up, (c) forming an alliance, (d) making minority investments, (e) forming a joint venture, and (f) acquiring target companies in the selected segment. 

For our clients, it has been very relevant to ask three basic questions: 

  • Does the industry I want to get involved in offer more attractive opportunities with greater benefits than those in my current sector? 
  • Can I consolidate a competitive advantage over the established companies in the industry I want to enter? 
  • How will the management of this new business be? Do I have the skills and capabilities to be successful? 

Each diversification decision requires a thorough financial analysis. But that’s not all. There are three essential tests that must be applied to determine whether diversification will truly create value for shareholders: 

  • The Attractiveness Test: The industry chosen for diversification must be structurally attractive or have the potential to become so. 
  • The Cost of Entry Test: The initial investment should not absorb all future benefits. 
  • The Better-Off Test: The new unit must gain competitive advantages due to its linkage with the other company, or vice versa. If it doesn’t demonstrate this, it might be better to invest in stocks rather than manage it. 

Other reasons for diversification we propose are (i) real reasons (synergies, financial savings, market power, etc.), and (ii) complementary reasons (growth, risk reduction, etc.), which do not create value unless accompanied by some of the real reasons. For example, the use of excess cash, defense against an acquisition, or increasing executive power are not valid reasons. 

Finally, death remains the law of life. Not all organizations are equipped (financially or humanly) to undertake adequate diversification. But it is also true that it may be strategically convenient or necessary, for long-term survival, to take on the risk in the times we are living through. 

For more information on M&A and the solutions we offer at Montblanc Consulting, visit our website: Montblanc Consulting | Executive Consulting 

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