Question

Multinational enterprises may diversify their operations along vertical, horizontal, and conglomerate lines within the host and source countries. Distinguish among these diversification approaches.

Short answer

Vertical diversification involves expanding operations within different stages of the same industry. Horizontal diversification involves moving into different markets at the same stage of production. Conglomerate diversification involves expanding operations into altogether different, unrelated industries. The choice depends on the firm's strategies, resources, and market opportunities in host or source countries.

Step-by-step solution

Understanding Vertical Diversification

This approach involves expanding operations into different stages of the production or distribution within the same industry. For example, a car manufacturer diversifying into parts manufacturing.

Understanding Horizontal Diversification

Horizontal diversification occurs when a firm extends its operations within the same stage of production or distribution, but into other markets or industries. For example, a car manufacturer diversifying into motorcycle or truck manufacturing.

Understanding Conglomerate Diversification

Conglomerate diversification refers to the expansion of operations into different industries altogether, which are unrelated to the firm’s current industry. An example could be a car manufacturer diversifying into the food industry.

Distinguishing Among the Approaches

In distinguishing these types, it is important to consider the level and type of integration involved. Vertical diversification has to do with integration along the value chain within the same industry, horizontal diversification involves exploring different markets within the same stage of production, and conglomerate diversification involves moving into entirely distinct industries. The type of diversification a company chooses depends on its strategy, resources, and the market opportunities available in the host or source countries.

Key concepts

Vertical Diversification

When a company opts for vertical diversification, it expands by moving either up or down its product's supply chain. This means the company begins to control different stages of production or distribution that are traditionally outside its primary operations.
For example, imagine a car manufacturer. Typically, a car company focuses on assembling cars, but with vertical diversification, it might start producing its own car parts like engines or gearboxes. This strategy can help control production costs and ensure better quality throughout the production process.

• Backward Integration: A company moves upstream, such as when a car manufacturer begins producing its own raw materials.
• Forward Integration: A company moves downstream, like when the same manufacturer starts selling cars directly to consumers, bypassing dealerships.

Through vertical diversification, companies can gain better control over their supply chain and improve profit margins by reducing dependency on external suppliers.

Horizontal Diversification

Horizontal diversification occurs when a company expands its product lines or markets by developing new products that can appeal to their existing customer base.
Think of a company that already dominates the car industry; it may decide to start producing motorcycles or trucks. The products are related, often sharing similar technology or markets, but represent a new type of output.

• Market Expansion: The company may enter new geographical areas with its existing product.
• Product Diversification: Developing a wider variety of products to cater to a broader customer base.

This strategy is beneficial as it allows the company to leverage its existing brand and technological expertise across new avenues, potentially increasing its market share and insulating against losses in any one market segment.

Conglomerate Diversification

Conglomerate diversification takes a company into territories that are completely different from its original business. This form of diversification involves adding new, unrelated product lines or industries, which can be quite different from its main operational base.
Imagine a car manufacturer suddenly branching out into the food industry. This venture is far from its core production activities and may involve building new capabilities from scratch.

• Risk Spreading: By diversifying into unrelated industries, a company can spread risk. A downturn in one industry may be offset by stability or growth in another.
• Resource Utilization: Ideally, the company can leverage financial resources and management expertise from its core business to succeed in new industries.

While conglomerate diversification can open up new revenue streams and minimize risk, it demands careful planning and possibly a steep learning curve to ensure success in unfamiliar industry landscapes.