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BCG says diversification is back in vogue.


Boston and Leipzig: The diversified company, long out of fashion and derided by commentators for lack of focus and lack of value, may in fact be the best business model for tough economic times, according to a new report by The Boston Consulting Group (BCG) and HHL — Leipzig Graduate School of Management. The report, entitled The Power of Diversified Companies During Crises, is available here.

Diversified companies actually perform as well as focused companies and also have a measurable financial advantage, according to the report. More critically, top diversified companies turn this financial edge into a competitive advantage that enables them to outperform their peers and recover rapidly from crises. These findings are based on an analysis of more than 1,100 diversified and focused companies conducted jointly by BCG and HHL — Leipzig Graduate School of Management.

"Diversification is a compelling strategy--it represents the time-tested idea that it's best not to put all your eggs in one basket," said Dieter Heuskel, a Düsseldorf-based senior partner at BCG and a co-author of the report. "But in recent years, conventional wisdom has held that focus produces superior financial and operational performance, and the markets have agreed, penalizing diversified companies with the conglomerate discount. Our analysis shows that the discount has declined, and in many cases, it is unwarranted. The best diversified companies perform better for investors and operationally, and their business model is demonstrably more resilient in hard times."

Diversified Companies Had a Superior Risk Profile during the Financial Crisis

  • During the financial downturn, diversified companies had significantly less volatile--or less risky--total shareholder returns (TSRs) than their focused counterparts.
  • This risk advantage was reflected in solid global credit ratings and narrower credit-default-swap spreads. These factors enabled diversified companies to get easier and cheaper access to capital, particularly at the height of the crisis.

Financial Markets Have Begun to Recognize and Reward the Superior Financial Performance of Diversified Companies

  • Investors use the conglomerate discount to compare the valuation of a diversified company with the valuation of a portfolio of focused companies that operate the same lines of business; the discount reflects a lower valuation for the diversified company. From 2005 through 2009, the conglomerate discount in Western Europe and North America shrank to -6.0 percent and -7.2 percent, respectively. In the Asia-Pacific region, a very small conglomerate discount was transformed into a conglomerate premium.
  • Detailed regression analysis shows that the decline in the conglomerate discount is directly correlated with the onset of the financial crisis. In other words, financial markets have recognized and rewarded diversified companies for their superior risk profile and their easier and cheaper access to capital.

The Top Diversified Companies Turned Their Financial Advantage into a Competitive Edge

  • The financial crisis magnified the differences between strong and weak diversified companies. The performance gap between companies that outperformed in the crisis and those that underperformed widened from 16 percent in the period from January 2006 through December 2007, to 52 percent by the end of 2009. The gap continued to grow to 73 percent as the recovery got under way in 2010.
  • By the end of 2010, the top 50 percent of diversified companies had recovered their crisis losses and achieved a median TSR of 11 percent since the end of 2007. By comparison, the diversified underperformers were still far from recovered, with a median TSR of -34 percent.

How to Do It: These Four Lessons Show How the Top Diversified Companies Outperformed Their Peers

The top diversified performers set themselves apart by following four key strategies that take advantage of the greater stability that diversification provides. Other diversified companies can apply these lessons in order to become outperformers.

  • Use the financial stability provided by diversification to avoid crisis overreactions, such as mass layoffs.
  • Invest in the future while peers are financially constrained. This enabled the top companies to ensure a faster rebound from the crisis and secure an ongoing competitive edge in capital-intensive areas such as research and development.
  • Pursue mergers and acquisitions while prices are low and competitors are short on cash.
  • Leverage the diversity of the company's portfolio to shift capital into higher-growth, higher-return businesses.

"There is strength in diversification--and this study bears it out," said Harald Rubner, a Cologne-based senior partner at BCG and a co-author of the report. "Focus has its advantages, but in hard times, the ability of a diversified company to pursue its strongest opportunities, while sustaining those that are temporarily weak, provides a lasting competitive advantage."

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