International Business - Essay Example

? The advantages and disadvantages of international business diversification BY YOU YOUR SCHOOL INFO HERE HERE The advantages and disadvantages of international business diversification "There is no reason to believe that those now at the top will stay there except as they keep abreast in the race of innovation and competition." (Kaplan 1954, p.142). Introduction Most corporations start as smaller organisations that serve regional markets with a singular product or service. Over time, as the business develops and improves resources (capital, human expertise, improved value chain support) the organisation maintains opportunities to expand its business presence in order to capture new revenue growth. There are fundamental risks associated with a business maintaining a singular posture for serving local markets and only specialising in one category or type of product and service. These risks include sudden or unpredictable changes in consumer behaviour and purchasing intention, the ability of the firm to extend the product life cycle of its singular product, or threats of competitive entry into the servicing market. As such, corporations seek diversification strategies to improve business position. A company is considered to be diversified when it runs more than one business unit (Muszynski 2011). The terminology business in the case of diversification include either changing the business structure or launch of new product lines either related or unrelated to the core product that founded the business. The rationale for diversification generally includes stagnation of existing local market or when the market becomes unattractive due to increases in competitive rivalry (Thompson, Strickland and Gamble 2013). Most diversification occurs through the result of acquisitions, such as in the case of the Walt Disney Company that switched from production of animated films to acquisition and operation of resort vacation properties or the Virgin Group that started with music production and diversified to include mobile telephony through acquisition of telecommunications companies (Porter 1987). International diversification maintains many advantages and disadvantages that will either hinder productive business growth and profitability or cause problems in attempting to recapture the diversification costs and labour. This essay describes these benefits and hindrances, referring to further case studies as justification for the arguments provided. The advantages of diversification There are many risks of servicing only a singular market with one product or service that has been attributed to placing all of a firm’s proverbial eggs in a single basket (Thompson, Strickland and Gamble 2013). Virtually every product or service offered by a corporation has an established life cycle, moving from a growth phase to an eventual decline along the life cycle model in which sales and demand begin to decline. The life cycle of the product is determined by a number of factors, including consumer behaviour changes, innovative product releases by competition that outperforms, competitive pricing instances that drive price-sensitive buyers to rival firms, or even new market entrants that increase choice and lower switching costs for consumers to defect to a rival brand. Whatever the case driving life cycle, corporations must be keenly and proactively aware of the ability of their singular product or service in sustaining long-run profit growth. Because of the risks of a stagnating local market, businesses achieve advantages by diversifying the business into a new international market. The most significant advantage is that diversification allows the business to spread risks (Thompson et al. 2013). Risk occurs through a variety of drivers, both internally-related and externally-driven. For a business operating in a single market with a lone product, any changes to demand can impact revenue growth and even complicate many of the value chain elements that support business, including human resources, supply chain and procurement, as well as sales and marketing. According to Michael Porter, a renowned business theorist and practitioner, companies that operate in a single market face threats of competitive rivalry, risks of substitute product availability in the market, as well as buyer and supplier power that can serve to negotiate pricing structures in procurement and product sales (Thompson, Gamble and Strickland 2005). In some instances, again related to Porter’s view of market forces impacting business, serving a local market constrains the business in terms of the supply chain that is required for manufacture or sustainment of products and services. For a manufacturing firm, the costs associated with supply chains that are dominated by only a single supplier or a handful of suppliers remove the price negotiation leverage that could be sustained with a broader supply methodology. This is because when the business is limited to procurement by a limited volume of suppliers, it increases the vendors’ buying power in the market (Porter 2011). Diversification spreads the price risks associated with supply networks that are controlled by limited supplier bases to introduce the business to a more affordable international supply chain, giving the business more advantageous choice and leveraging power for certain procured products. In many developing countries, the local currency is valued significantly lower than the domestic British or Euro currencies, providing cost opportunities in areas of human labour, supply and procurement, or even local marketing when utilising local currencies as payments to various customers or agencies. Country-level conditions often make it advantageous to seek diversification strategies as a means of improving budget and ensuring cost controls throughout the supporting value chain. For instance, the business now offering a new international product may be able to recruit local talent that demands significantly less in terms of wages, thereby providing service excellence for the new international market without the cost burdens in the human resources division. A diversified corporation now has the ability to continue servicing the local market, with a centralised support headquarters, and a fully-functional unit that is able to service a foreign market with much less operating expenses. Yet another advantage of diversification is broadening the scope of control of the executive team of the corporation (Porter 1985). If the business originally operating in and servicing local markets can only sustain a limited volume of support employees and managers, the organisation often operates in a decentralised function in order to foster cultural development, guarantee service excellence, and provide cohesive opportunities for mutual problem-solving solutions. By expanding into a new international market that provides a better cash flow and revenue growth, the business can now be equipped to centralise business functions that improve the span of control between executives and subordinates (Meier and Bohte 2000). The business that serviced only a local market no longer must rely on the talents of only a singular basket of employees and managers now that capital resources have been improved through the internationalisation and diversification effort. Span of control has significant positive implications for some firms that have diversified as the ability to create better performance metrics is made achievable and executives are able to govern the organisation hierarchically to ensure compliance to regulatory frameworks, compliance to established mission-centric service excellence guarantees, or even in the research and development process. All of the improvements in executive-level span of control increases are usually facilitated by better cash flow position and revenue growth. Reductions in overhead costs, manufacturing costs and labour rates are significant advantages of international diversification (Hill, Ireland and Hoskisson 2004). As the business expands into new product categories that drive better capital position, the business is often able to utilise its volume of increased assets and talent experience developed over time to consolidate business functions whilst still servicing more than just a single local market. In some instances, diversification into foreign sales environments provides the business with its own distribution centres or manufacturing capabilities, thus streamlining functions throughout the entire value chain to recognise cost improvements. Wholly-owned business units that now specialise in certain operational functions (such as production) can control costs in the supply chain as the new business unit can now directly serve the parent unit in the domestic environment. This puts less reliance on external vendors for procurement and can also reduce overhead throughout the entire business model. Another advantage of diversification is the ability of the business to respond more quickly to changes occurring in the external market. Komninos (2002) reinforces that it is quite difficult in many business situations to recognise when a product is reaching its decline stage. It is not, in some instances, until the business sees a quantitative drop in demand and loss of sales revenues that the organisation realises the product is no longer considered relevant with its existing domestic markets (Komninos 2002). Company executives that operate in only a local market, especially the SME that maintains few human capital resources, maintains the burden of controlling multiple areas of business simultaneously in an effort to produce productive business results. These areas range from operations, to sales and marketing, to even customer contractual negotiations, thus placing significant labour burden on higher-level managers that attempt to improve business and market position. These busy professionals may not have the resources or time availability to recognise that the product they have invested so much effort into sustaining and branding is reaching a decline period. By diversifying internationally, the improvements achieved through new market revenue growth and the ability to centralise business functions can allow business leaders to develop proactive metric systems to statistically determine predictable and non-predictable demand patterns that are impacting the market relevancy of its existing product. Essentially, what international diversification drives is the ability to be more strategically-centric and develop contingency plans based on market evaluations to ensure the business is flexible and responsive to reductions in product demand in the local market. This is highly important for the organisation, as when a product reaches the decline stage along its life cycle there are many considerations that serve as hindrances to the business. Cash management becomes critical, controlling costly inventories becomes burdensome and unpredictable, as well as considerations of product abandonment timing are transformed into legitimate and higher-order business concerns (Dooley 2005). Companies, especially smaller-sized companies serving local markets, have more cost-related concerns than diversified businesses that have revenue streams from multiple markets that support business development and improvement. Over-abundance of product inventories that have occurred as a product of not recognising market signals that a product is reaching decline and experiencing limited market relevancy impose considerable holding and taxation costs to the business. In fact, some retail organisations are burdened so significantly from a cost perspective as it relates to inventory holding costs that they will piggyback distribution, using existing distribution networks to avoid holding inventory (Heizer and Render 2004). Sony is a prime example of a business that was forced to diversify based on market conditions and life cycle of its products. In the 1980s, Sony had been heralded as a pioneering innovator for release of the Sony Walkman, a competitive innovation maintaining no competition, thereby justifying a predictable long life cycle. By 2012, Sony had experienced two consecutive annual losses of 267.1 billion yen (Hirai 2012). This is due to the fact that Sony had relied on its brand reputation as a pioneering company and did not create contingency plans that would either extend the life cycle of its products or devote investment into more significant research and development for new products. Sony decided to abandon its products that had reached decline, rather than attempting to extend the life cycle through innovative feature upgrades, moving instead into the smartphone industry by 2012. Sony maintained an abundance of outdated products that no longer were relevant to the markets in which its marketed. Sony is a very powerful example of the advantages of diversification as it relates to product life cycle; if the business had been proactive in seeking new product opportunities, it would not have experienced billions of yen in losses but would have, instead, sought to extend the product life cycle on products with a powerful brand reputation. When the business diversifies into a new international market, there are oftentimes (in developed regions) existing distribution systems that allow for piggybacking activities. As it has been established that inventory holding costs are significant overhead concerns for the business, having a presence outside of the domestic market can diversify logistical strategies as a matter of cost control. Essentially, the company still operating in the local domestic market is no longer limited by the distribution infrastructure available when servicing a singular product. These regions with piggybacking opportunities and other distribution options are often in environments where local currencies are significantly lower than the domestic currency, giving many cost advantages whilst also streamlining logistical methodologies. The disadvantages of diversification It was aforesaid that risk-spreading is a very advantageous outcome of diversification. Risk reduction advantages, however, are not sufficient rationale for diversification strategies (Saunders, Strock and Travlos 1990). There are disadvantages when the business seeks international diversification whilst still attending to the local market. When considering the banking industry as a relevant example, international diversification often occurs as a means of capturing market interest in purchasing of diversified investment options; new products developed for a new international market of investors. Publicly-traded banking institutions, such as HSBC or Wells Fargo, often seek international diversification by entering, as one example, the mutual fund market when the business had, historically, exploited local markets for other investment opportunities unrelated to mutual fund provision. In this case, shareholders in the local market can still defect to other banking facilities and capture their own diversified portfolio of investments from competing banks to manage their own risk-reduction needs (Saunders et al. 1990). The banking example illustrates that not all controls associated with the market are contained within the organisational team. For the banking industry, shareholders are able to establish their own risk-reducing activities by simply altering their investment portfolios to represent a strategy to avoid placing all proverbial eggs into a single investment basket. Thus, in some situations, diversification does not control market characteristics, situations in which buyer markets have their own buying and leveraging powers, which could lead to inefficiencies related to the new diversification strategy. Whilst the banking institution may have believed that diversification into a new product category would lead to higher revenues, market capacity to improve their own risk by selecting various investment options from rival banks could lead to business failure in the new international venture. Why is this? In the banking industry, the ability of consumers to defect to other rival brands could prevent the revenue growth required for the business to achieve synergies in the diversification strategy employed. Porter (1987) has identified research-supported acknowledgement that unsatisfactory performance from some diversified businesses that were enabled through acquisition often leads to a large variety of post-acquisition divestitures. This is because the businesses involved in the case study were unprepared for the level of market power held by customers or because the businesses maintained a fundamental lack of market knowledge necessary to service diverse and unique international markets. Some organisations, such as General Electric or other technology companies, face continuous risks of competitive innovation launches that have the ability to change the dynamics of market competition. In today’s industries, it is becoming easier for competition to replicate the product provided by rivals or improve benefits of existing products through the supporting facilitation of technology improvements and global expertise in research and development. There are always risks that a diversified company could experience a disruptive innovation in the new market. Disruptive innovations are value-producing product innovations that maintain the ability to completely displace an established market (Christensen and Raynor 2003). This has occurred with such companies as Blackberry and Apple, a competitive scenario that was once dominated by Blackberry (previously called Research in Motion) that had their entire market share of mobile communications disrupted by the launch of the Apple iPhone. When considering the competitive risks of disruptive innovations, a diversified business that entered an international market to corner the market with an innovative product could experience significant losses in the event that foreign competition is able to outperform the innovative benefits and characteristics of the business’ existing product. This is similar to the aforesaid scenario of competitive rivalry between Apple and Blackberry. Not all companies have the capital resources or internal talent required to respond quickly to a disruptive innovation, thereby when this occurs, the company that diversified is no longer able to sustain market share. This would have significant budget problems on the main business division still servicing the local market that could, in the worst scenario, put the organisation out of business. Blackberry believed that it would always corner the market for its innovative Blackberry smartphones, as during the time of Blackberry’s launch in 2001, there were no competitors maintaining similar products. First movers are known to define the product category on the market and later entrants are typically assessed unfavourably against the pioneer (Agarwal and Gort 2001). However, Apple maintained significant brand loyalty and, upon launch of the iPhone, Blackberry lost nearly all of its common stock value and market share for lack of foresight about disruptive innovation launches. Blackberry, formally named Research in Motion, is a prime example of a case study in which failure to diversify appropriately leads to disruptive innovations; a learning lesson for businesses to consider competitive prowess before diversifying into international market territories. Chaudhuri and Holbrook (2001) describe the marketing-centric viewpoint of brand loyalty, which is in theory the tendency of customers in a market to prefer one company’s brand over a competing product or service. Brand loyalty, for the business operating in the local market that has managed to create a positive market position with target consumers, may be a significant asset for the organisation. Marketing communications and advertisements, as two examples, that are targeted to local consumers may have favour and relevancy that drives brand attachments leading to higher revenue growth. A diversified company operating in a foreign market may not have the cultural competencies in order to create effective advertising campaigns, thereby not providing the same type of loyalty that the business found in the domestic marketplace. Firms that understand cultures are considered to be high-prestige organisations by a variety of investors (Very et al. 1997). The disadvantage, then, in the above-mentioned scenario is that lack of cultural competence about foreign market needs, lifestyles and characteristics could drive failure in the diversification deployment. Palich, Cardinal and Miller (2000) describe the situation with General Electric, a multi-national, diversified organisation, that was able to transfer human capital competencies from the domestic environment to the foreign environment in order to address unique market characteristics and cultures. However, GE maintained the capital resources to make this a reality in order to be responsive to changing market dynamics related to foreign culture. Diversification within a business not maintaining the foundational cross-cultural knowledge for effective promotional strategy then becomes a significant disadvantage. Conclusion As illustrated by the essay, there are actually more advantages than disadvantages in selecting a diversification strategy. Revenue increases, better cash flow position, and cost reduction in a variety of support divisions along the value chain are the most prominent of these advantages. Inclusive in advantages are better scope of control, more efficient and cost-acknowledging logistics opportunities, and even currency valuation in favour of the diversified corporation. 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