The Economics and Management of Technological Diversification

John Cantwell, Alfonso Gambardella, Ove Granstrand

• Publisher: Routledge
• Year: 2004
• ISBN:
  9781134450480
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Recently, attempts have been made to understand the patterns of corporate technological diversification and their implications in economic and managerial dimensions. This book consolidates these attempts and breaks new ground by examining the patterns of technological diversification, and their relationship with internationalisation, economic perfo

1 Technological and corporate diversification

John Cantwell, Alfonso Gambardella and Ove Granstrand

1 Introduction

1.1 To diversify or specialize? The diversification dilemma

To diversify or not to diversify – that is the question. As such it is and has been perpetually plaguing company managers and strategic advisors supposedly more decision-oriented than Hamlet. Companies have also been surprisingly Hamletian about it, and as with any soul-twisting strategic question, it has led to ambivalence, conflicts, delays, exaggerated responses and not seldom economic tragedy.

With the usual lag behind management practice, scholars (presumably more Hamletian than managers) in many quarters have in recent decades begun to be puzzled and plagued by the question.¹ At the center-stage of their analysis is the link between diversification and economic performance – a link still missing, despite much search and research, using a variety of tools.

1.2 Purpose

The purpose of this book is to provide a research-based view with a new perspective on corporate diversification, focusing on a particular dimension of diversification – namely, technological diversification and its economic and managerial implications.

1.3 Objectives of the book

A major motivation for this book is that while there are many contributions in the literature on the business diversification of firms, only very recently has there been some initial attempt to understand the patterns of corporate technological diversification, and their implications for several economic and managerial dimensions, such as internationalization, business diversification, economic performance etc. This book attempts to fill that gap. Moreover, in doing so, the book provides a systematic analysis of data, case studies, and other relevant material to understand this phenomenon. As a matter of fact, most of the contributing authors have significant experience with large data sets at the firm level on technological diversification and the other strategic dimensions mentioned. While having a clear analytic content, systematic use of (available) data is another important feature of this book.

The main issues that will be treated in the book are:

• technological diversification and product diversification;
• technological diversification and economic performance;
• technological diversification and internationalization;
• technological diversification and strategic alliances;
• cases of technological diversification in specific industries;
• corporate case studies of technological diversification;
• technological diversification and managerial and organizational issues.

1.4 General overview of the topic

Diversification as a general concept for extending activities of some sort into new areas obviously defines a very wide-ranging and pervasive topic. Diversification in this sense applies to various entities – human cells as well as humans, companies as well as industries, regions as well as nations etc. How human stem-cells diversify or differentiate is largely a puzzle (as of the time of writing) providing a hot research topic. How individuals with different competence profiles perform differently along a vector of high (low) specialization – low (high) diversification has always been an issue, for employers and employees alike, and not least for all students. Adam Smith, Frederick Taylor and Henry Ford settled the issue in favor of specialization, at least for manual tasks, while research in recent decades has instead been pointing towards the virtues of a moderate degree of diversification or multi-skilling. One of the earliest pieces of research on individual diversification in R&D is provided by Pelz and Andrews (1966). They found among many things that scientists with a moderate degree of diversification performed best (in a specified sense) while the best-performing engineers were either highly specialized or highly diversified (i.e. generalists). Why this difference occurs between science and engineering is still an unsolved puzzle.

At a regional level, one could observe industrial districts that are highly specialized such as in northern Italy, but others that are highly diversified such as in Silicon Valley; an observation that parallels the findings of Pelz and Andrews for engineers. Research on links between regional industrial diversity and economic performance is of recent origin and not yet conclusive, however. In a study of seven European core regions Cantwell and Iammarino (2001) find that a region like Basel is highly specialized while one like the South-East of the UK is highly diversified, although they have both enjoyed success in their own ways. They show too that trends towards either a reinforcing or a broadening of specialization may equally well occur in the same large area (in this case Europe). A summary indicator of the degree of diversification (DIV) is given by the reciprocal of the coefficient of variation (CV), since CV is a measure of the degree of concentration of an index of specialization across sectors (the CV is the standard deviation divided by the mean of a distribution). Table 1.1 presents the diversification indicators in two time periods for eight European regions, with an increase in DIV indicating a rise in diversification, and a fall representing a more concentrated or narrower focus of specialization. As can be seen from Table 1.1 the South-East of the UK, the Basel region, Île de France and Stockholm-East Central Sweden have narrowed their regional specialization profile, while the profiles of the regions of Baden-Württemberg, Flanders-Brussels and South Netherlands show an increase in diversification.

Box 1.1 Adam Smith on specialization – diversification

Adam Smith reversed the causality of the conventional wisdom of his day that the differentiation of skills and abilities among individuals led to specialization; instead, according to Smith, specialization (the division of labor) led to the development of locally distinctive skills and capabilities (Loasby, 1999). For Smith, specialization led to a greater inventiveness, owing to the more focused problem-solving of workers themselves when concentrating on more narrowly defined tasks, owing to the emergence of specialist machine-makers, and owing to the emergence of specialist thinkers or integrators (which today might be thought of as the R&D function). With the tremendous increase in the use of machinery in production that followed Smith’s day, and more so with the arrival of science-based and then information-based innovation that came later still, it would be fairer to say that technological change has more typically led the division of labor, and led the social organization of production. However, an enduring strength of Smith’s approach is that he saw specialization and the creation of knowledge as co-evolving. The advance of knowledge depends upon a cumulative interaction between the processes of differentiation (the focus associated with specialization) and integration (the new combinations or new applications that result from utilizing a diversification of activity through discovering or exploiting complementarities between different fields).

Table 1.1 Technological diversification indicators for eight European regions for 1969–1977 and 1987–1996

Box 1.2 Should regions or countries diversify or specialize?

A study by Dalum et al. (1999) shows that specialization particularly in high opportunity technological areas has a positive impact on growth, but over the years this impact seems to have decreased. The relationship between specialization and growth has been found to be a complex one, since demand-side and supply-side mechanisms do not necessarily work in the same direction, which creates difficulties for policy makers. Considering that the observed path-dependency of profiles of specialization implies the feasibility of only incremental change, active policy to increase the degree of specialization in some favored areas might not result in an adequately fast response. Furthermore, as Cantwell and Iammarino (2001) have argued, the direction of cumulative change and diversification, depends also on the strategy followed by the MNCs that are active in the respective regions and how they interact with the local environmental conditions for innovation. Therefore the question “Should regions diversify or further specialize?” might rather become one of “Can policy makers influence the pattern of specialization?” and if the answer is no or very little, “Under which circumstances do regions specialize?”

The national level resembles the regional one to some extent in this context. Not surprisingly large nations like the US, India or Japan have a diversified industrial base, but there are diversified small countries as well. Sweden for example, has a highly diversified industry for her size, with a portfolio of industries that are also highly internationalized. The industry structure differs e.g. compared to Japan, in that Sweden has a diversified portfolio of large, weakly diversified MNCs, each with a small portfolio of specialized businesses, while Japan has a diversified portfolio of large, highly diversified MNCs. However, in contrast to regions it is difficult to find nations that are highly specialized, despite years of international trade, influenced by free-trade policies hailing the virtues of comparative advantage and the international division of labor.

The dynamic trends in trade and technological specialization patterns are not quite conclusive either (Laursen, 2000). Measuring the degree of specialization at a national level by the standard deviation of the cross-sectoral distribution of Revealed Symmetric Comparative Advantage (for trade) or of Revealed Symmetric Technological Advantage (for the pattern of technological activity), an increase in the standard deviation represents a rise in the degree of concentration of the index across fields or a narrowing of specialization. Conversely, a fall in the standard deviation of the indicator denotes an increased diversification or a broadening out of specialization. The ratio of the standard deviation around 1990 to the equivalent about 20 years earlier is shown in Table 1.2 for the OECD countries – ratios above one indicate a rise in the standard deviation (higher concentration or more focused specialization), values below one represent a fall (lower concentration or greater diversification). While overall the degree of international trade specialization has slightly decreased over the long term, i.e. a rise in diversification has occurred, the findings for technological specialization do not show the same clear trend, which might be an indication that “countries increasingly specialize according to consumer preferences (for differentiated products within the same industry) rather than specializing in different industries” (Laursen, 2000: 434).

Table 1.2 The development of specialization patterns for the OECD countries

Perhaps some degree of moderate diversity of national industries is a good thing even in a free trade world with various comparative advantages, dispersed around the globe. Thus, Pasinetti (1981) has argued that owing to the stimulus for improvement provided by import competition, and the benefits from learning and applying technologies that are developed elsewhere – which idea can be extended to the potential for inter-industry spillovers – it is better for a country not to become too narrowly specialized.

Finally, at the company level, which is our focus, diversification is a key strategic variable together with a few others like internationalization. In this context, diversification is usually taken to mean extending the company’s portfolio of products or businesses into new product or business areas. (In this sense, diversification includes vertical integration.) Few aspects of strategy have stirred as much controversy as diversification. This is despite its key role in the evolution of companies historically, and its long standing as a phenomenon, actually preceding internationalization.

In fact, in a general sense that will be explained in the following chapters, corporate (or company) diversification together with its converse, divestment or de-diversification, are dual processes that define corporate evolution. It is thus quite natural that strategic decisions about entering and exiting specific areas stir up controversies among company owners and managers from time to time.

Box 1.3 Natural resource-based diversification – the case of Stora Kopparberg

The Scandinavian corporation Stora Kopparberg (later named Stora, and subsequently merged to form Stora-Enso) is claimed to be one of the world’s oldest joint stock limited companies, established as it was by royal charter in 1347. Thus, the company has a long history and it illustrates nicely the diversification dynamics of a natural resource-based company. As of 2003 the company has entirely left its original core business (copper mining) and transformed itself into an integrated forest-product concern, i.e. it is still a natural but now a renewable resource-based company. The firm was founded as a mining company based on a giant deposit of rich copper ore in Falun in mid-Sweden. The extraction of the ore required, among other things, wood for construction, heating and smelting, power for hoisting and logistics, ropes for hoisting and a number of mechanical devices for efficient operations, for instance a water wheel, which in its own day was as important as was the steam engine in a later era. At the same time the composition of ore enabled production of some other metals and byproducts, such as iron sulfur, red paint and vinegar. Needless to say, technical and managerial knowledge and skills from running a host of mining-related operations also provided a wide range of opportunities to enter new businesses. At the same time resource depletion imposed exits.

Thus over the centuries, on the input side the composition and availability of the mined resources, as well as the composition of other inputs needed for efficient mining led the company to diversify outside its core copper business into forestry, water power, iron, paint, food and various other areas. Let us mention just two specific by-product related examples of such “evolutionary business chains”. Ropes for hoisting ore were made of ox hides with ox meat as a by-product from which (still very popular) sausages were made. The copper ore was vitriolic which led the company to successfully produce a special type of red paint (still very popular for painting houses red, which is characteristic of rural Scandinavian villages). On the output side several of the company’s outputs were generic (as with key metals and materials in general) and created broad interfaces with many product areas and customer business chains, which provided opportunities for forward integration (e.g. into copper cannons and coins) or into other related types of diversification (e.g. iron works).

There were also diversification failures. Less commonly at the time, one such failure was R&D-related. A gifted inventor, Christopher Polhem, managed in the early eighteenth century the equivalent of a corporate R&D lab (“Laboratorium Mechanicum”) and made numerous inventions, as well as basic contributions to mechanical technologies and to mechanical science. However, their cost-effectiveness for the company was dubious and their continued implementation eventually came to be opposed by corporate management, providing an early example of the failure of the transfer of technology from corporate R&D to business operations.

Over the centuries the company moved its business base considerably through entries and exits and eventually moved away from its business roots in copper mining. To briefly summarize the main forces behind a 650-year long business history of diversification is difficult but some salient features have been: (a) a dynamic (evolutionary) interaction between business (output) diversification and resource (input) diversification with business diversification being driven by (b) generic applicability of outputs and (c) resource composition of both outputs (requiring mixes of existing and new inputs) and inputs (enabling economically successful mixes of existing and new businesses, e.g. through new knowledge and by-products); (d) resource availability (e.g. abundant but depletable resources, enabling as well as compelling diversification); governed by (e) market, management and institutional factors (e.g. weak competition, corporate wealth, entrepreneurship and regulation).

The nature of controversy in the industrial and financial community relates to whether a diversification strategy or corporate policy conducive to diversification in general pays off or not. Separation of ownership and management has created problems with owners and managers having separate goals (i.e. principal agent problems) and different types of diversification support different goals. As will be dealt with in Chapter 2, diversification into completely unrelated businesses is in a certain sense a superior strategy for risk-reduction, while diversification into related businesses is preferable for sustaining growth. Profitability in turn is influenced by the nature of relatedness, which is a somewhat complex issue in itself, and the magnitude of market transaction costs and management costs. If external financial markets are perceived as more efficient than internal capital markets in companies, investors may then prefer to diversify their portfolio of holdings themselves, investing in an unconnected set of specialized companies, while corporate managers with different preferences and perceptions may want to diversify their portfolio of businesses to boost growth and stabilize earnings, which are in turn conducive to their bonuses, salaries and status. Thus, at a company level, diversification can occur at several related levels – at the investor level as between different firms or at the individual company level or at the divisional and business unit level within large corporations. Diversification processes at different levels may then be at least partially in conflict with one another due to their differing goals.

Sources of diversification controversies go beyond goal conflicts between and among owners and managers, however. It is in the nature of corporate strategies that they easily become perceived in one period as new and innovative, experience some initial successes, become overimitated and carried to extremes, then produce some failures and overreactions to other extremes in another period with some delays from place to place. Diversification as a strategy came into fashion in the 1950s and 1960s in the US for various reasons – the emergence of a new organizational form (M-form), accounting capabilities, information processing capabilities and a general top-management ideology, all enabling management of a more complex set of businesses. In addition growth opportunities were...

Table of contents

• Cover Page
• Routledge studies in the modern world economy
• Title Page
• Copyright Page
• Figures
• Tables
• Contributors
• Preface
• Abbreviations
• 1 Technological and corporate diversification
• Part I: Background
• Part II: Technological diversification, internationalisation and alliances
• Part III: Technological diversification in specific industries
• Part IV: Strategy and management