Diversification–Performance Relationship:
A Replication and Extension of Prior Research
Leslie E. Palich
BAYLORUNIVERSITYGary R. Carini
BAYLORUNIVERSITYSamuel L. Seaman
BAYLORUNIVERSITYMost strategic management researchers defend related diversification as ize to multinationals. Despite recent criticisms, our findings suggest that yielding superior performance vis-a`-vis unrelated strategies. However, the relatedness synergy framework may yet apply, although only for empirical results on this subject have sometimes been inconsistent with domestic firms. We recognize the limitations of our study; however, the this position, prompting a search for moderating conditions. Based on a conclusions of this research are more important than ever, because Ameri-theory of international impediments to synergy formation, we attempted to can firms are internationalizing their operations at an increasing rate. J
replicate Bettis and Hall’s (1982) findings using a sample of predominantly BUSN RES 2000. 48.43–54. 2000 Elsevier Science Inc. All rights
domestic Fortune 500 firms. We divided these firms into two groups— reserved. product-related (n5 23) and unrelated (n 547) corporations—and
assessed group differences in performance (5-year average return on assets (ROA) spanning 1985–1989) and risk (the standard deviation of ROA over the same time frame). Parallel to Bettis and Hall, we found
T
he study of diversification and its effects on firmperfor-that differences in ROA were significant (F[1,69]5 4.99,p, 0.05); mance is familiar territory to strategic management
whereas, differences in risk were not (F[1,69]52.03, ns). These findings researchers, representing a mainstay topic in the
litera-provide some support for the international impediments theory. To extend ture (Ramanujam and Varadarajan, 1989). However, theory
Bettis and Hall’s (1982) study, we tested a more inclusive model across from more than three decades of research can generally be
a sample of firms, including multinationals. This expanded diversification– distilled into a guiding paradigm that recommends related performance model was based on a sample including multinational firms diversification strategies over their unrelatedalternatives be-from the Fortune 500, separating these again into product-related (n5 cause of the greater potential for synergy formation between
78) and unrelated (n583) concerns. After including control variables businesses in the former (e.g., Rumelt, 1974; Porter, 1985; (firm size, debt, and global relatedness/unrelatedness) as covariates in Salter and Weinhold, 1979). Although several studies have the model, we used a multivariate analysis of variance (MANCOVA) test supported this notion (e.g., Amit and Livnat, 1988a, 1988b; to look for differences in accounting (ROA and return on sales (ROS)) Lubatkin and Rogers, 1989; Palepu, 1985; Rumelt, 1974, and market (market-to-book value) returns, and accounting (standard 1982; Simmonds, 1990; Varadarajan, 1986; Varadarajan and deviation of ROA and ROS) and market (systematic, unsystematic, and Ramanujam, 1987), results have been far from uniform (cf. total) risk. In this test, group differences were not significant (multivariate Hoskisson and Hitt, 1990), spawning a search for explana-F[8,146]51.654, ns), although size and debt emerged as significant tions. Ilinitch and Zeithaml (1995) report common rationales, covariates. Taken together, these findings support the international impedi- including: (1) the difficulty of achieving in practice synergies ments theory, showing that although domestic product-related firms may that seem plausible “on paper,” and (2) the administrative outperform unrelated diversifiers, these differences do not seem to general- “costs” involved in related diversification that may more than
offset the economic benefits of these strategies.
Bettis and Hall (1982) offer still another explanation, citing
Address correspondence to Dr. Leslie E. Palich, Hankamer School of Business,
Baylor University, Waco, TX 76798-8006. E-mail: [email protected] apparent industry effects that emerged in their own study of
Journal of Business Research 48, 43–54 (2000)
2000 Elsevier Science Inc. All rights reserved. ISSN 0148-2963/00/$–see front matter
related and unrelated diversifiers (see Appendix for a citation synergies (i.e., sharing market, production, and technology-related activities) as well as those that are more intangible history of their research). They found that four of the best
performing firms in the sample were pharmaceutical concerns; (i.e., exchanging general management expertise). This concep-tualization seems logical for portfolios comprised of domestic and because these were all related diversifiers, they skewed
risk and return outcomes across categories. In fact, group businesses, but these relationships may experience significant impediments when attempting to exploit these interrelation-differences in performance measured as return on assets (ROA)
were statistically significant until they removed those four ships across international units. firms from the sample. In contrast, group differences in risk
(the standard deviation of ROA) did not reach significance
Market-Related Impediments
before or after controlling industry effects. Their sample was Many have pointed out that international differences often derived from the Fortune 500, and dependent variables were lead to unique customer preferences, requiring customization computed using data spanning 1973 to 1977. of the marketing mix and function to promote product de-Although the efforts reported above help to explain the mand (e.g., Galbraith and Kay, 1986; Garland, Farmer, and inconsistency of previous diversification findings, we contend Taylor, 1990; Levitt, 1983; Morrison and Roth, 1992). There-that another powerful explanation has not yet been exam- fore, divisions in the same country can more successfully ined—the globalization of business. After developing a frame- combine market-related activities than those in separate coun-work that highlights the impact of globalization on the diversi- tries, making it easier for the former to exploit market-related fication–performance relationship, we test the notion by economies of scale and to improve coordination of marketing means of a replication of Bettis and Hall’s (1982) study using activities between these divisions (Davis, Robinson, Pearce, domestic firms. We then compare these results with those of and Park, 1992). That is to say, it is easier to create market an expanded test using a sample of multinationals. Differences synergies by means of advertising efforts, distribution systems, between these assessments would suggest the dynamics of the service networks, and the like between related businesses that linkage shift when examining global firms. operate within the same country.
Production-Related Impediments
The Challenges of Managing
Domestic firms may find that it is easier to exploit
production-International Operations
related synergies than their international counterparts. Thisadvantage stems mostly from the ability of the former to American firms are expanding quickly to exploit emerging
opportunities for international business, as indicated by their manufacture standardized products without sacrificing con-sumer demand (Davis, Robinson, Pearce, and Park, 1992). tenfold increase in foreign ventures during the 1980s alone
(Gomez-Mejia and Welbourne, 1991). Fueled by several moti- Consequently, the former can achieve economies of scale through centralized facilities, while gaining added efficiencies vations—for example, a search for new markets, additional
sources of inputs, and such efficiencies as economies of scale— from longer production runs and machine specialization. Con-sidering some of Porter’s (1985) observations, physical consol-these enterprises have changed the competitive landscape
through rapid globalization (cf. Grant, 1987; Kim, Hwang, and idation of production facilities enables the firm to combine supplier-related activities (e.g., inbound logistics and materials Burgers, 1993). Several studies have highlighted the economic
benefits of expanding internationally (e.g., Buhner, 1987; Ger- management). As a result, the firm enjoys lower freight costs, because material orders are larger and are shipped to only inger, Beamish, and daCosta, 1989; Grant, Jammine, and
Thomas, 1988), although it also seems that these outcomes one location. Costs for input handling are similarly reduced. This centralization also justifies investment in advanced tech-are by no means automatic or universal (Mitchell, Shavers,
and Yeung, 1992). Nonetheless, we should draw only guarded nology to achieve reliable delivery and to reduce costs from shipping and handling damage.
conclusions from Bettis and Hall’s (1982) study of
diversifica-tion and performance, given that: (1) American firms have In contrast, international firms must offer a more complex array of products to serve disparate country markets, eliminat-internationalized substantially since the time of this research
(i.e., since their 1973 to 1977 time frame); and (2) firms ing opportunities to consolidate production efforts. Therefore, the worldwide product lines of these competitors are likely face unique challenges when they internationalize, thereby
complicating the task of developing synergies between busi- to have fewer shared components and to be manufactured using less sophisticated production equipment, inefficient ness units.
Because the superiority of related diversification is based testing and quality control efforts, and indirect activities (e.g., maintenance, personnel management, etc.) that are far from upon synergy formation, the economic benefits of those
port-folios may not as easily accrue to international firms. Porter world class (cf. Porter, 1985). In other words, international firms may find the production synergies of related units prove (1985) developed a framework that outlines the foundations
Shaw, 1990); whereas, cultural diversity breeds divergent
re-Technology-Related Impediments
actions. Porter (1985) outlines several potential competitive
advan-These cognitive differences also translate into variability in tages that arise from sharing technology development between
managerial practices. For example, managers from different business units. First, because of such efficiencies as learning
parts of the world tend to formulate (Porter, 1990; Schneider curve effects, a merged R&D function reduces product or
and DeMeyer, 1991; Snodgrass and Sekaran, 1989), imple-process design costs. It also allows the firm to shorten design
ment (Hofstede, 1980; Snodgrass and Sekaran, 1989), and time, which provides competitive boost. Second, sharing
tech-control (Gomez-Mejia and Welbourne, 1991; Snodgrass and nology development between units increases the critical mass
Sekaran, 1989) strategies in significantly different ways. In in R&D so that the firm is able to attract more capable
person-addition to problems in harnessing tangible interrelationships nel, which works in favor of product or process design. Finally,
across international operations for the benefit of firm perfor-consolidating the R&D function facilitates the transfer of
tech-mance, the usefulness of business relatedness may be similarly nology between businesses, encouraging early entry into new
blunted by natural impediments arising from cognitive differ-technologies for multiple business units.
ences around the world that naturally hinder the transfer of Nonetheless, international firms with related businesses
managerial expertise. may not be able to employ technologies across those units
because of impediments arising mostly from cultural differ-ences. For example, Heiko (1989) suggests that culture may
Research Questions
have a great deal to do with the development of technology
around the globe. He observes that the Just-In-Time (JIT) In light of the discussion above, we attempt to address two method of inventory management has been immensely suc- research questions that represent both a replication of Bettis cessful in Japan, because the culture there supports it. In other and Hall’s (1982) original study and an extension of that words, Japanese culture provided a rich medium in which
work by examining separately the effects of diversification on JIT efficiently developed (Snodgrass and Sekaran, 1989).
Fur-performance using a sample of firms including multinationals. thermore, many have averred that technology is most easily Because we used measures of diversification that differed transferred between countries of similar culture and
develop-slightly from those of the original study as well as a different ment (Porter, 1990). Stated differently, cultural similarity may
sample of firms and more recent diversification and perfor-promote the exchange, because “Cultural compatibilities . . .
mance data, the first research question can be stated as follows. can act as a bond to technology transfer” (Keller and Chinta,
RQ1: Are Bettis and Hall’s (1982) results robust across 1990, p. 40), a notion that has been supported by empirical
tests using samples of domestic firms? findings (e.g., Davidson and McFetridge, 1985). Although
these dynamics present significant challenges to the formation
What has been faulted as inadequate theory may, in fact, still of technology-based synergies between units in multinationals
be relevant for domestic firms today, even after allowing for (despite their relatedness), they do not present a hurdle for
changes in research methodologies. Replication of Bettis and domestic concerns.
Hall’s results would lend credence to early models of diversifi-cation (cf. Rumelt, 1974).
Cognitive-Based Impediments
On the other hand, we have serious reservations about theResearch suggests that the way individuals think varies greatly external validity of Bettis and Hall’s (1982) findings because from country to country. To illustrate, Hofstede and Bond of the time frame of the study and the nature of their sample (1988, p. 20) relate how a manager’s performance can be firms’ operations during that period. Their study actually ad-evaluated differently, depending upon the observer’s cultural dressed one potential explanation for their significant findings biases. by looking at industry effects (indeed, their results signal that these effects may represent a significant variable in this type In one U.S. corporation we know, the head of a
headquar-of research). Nonetheless, the nature headquar-of business in the Fortune ters staff department complained bitterly to the president
500 has shifted dramatically in the mean time, reflecting a about the noncompliance with certain rules by the East
notable trend toward internationalization. Our observations Asian regional manager, who was an expatriate American.
concerning the impediments to exploiting synergies between “I fully agree,” said the president, “His behavior is stupid
international operations (even those that are related) may and against company policy. I have only one question.
help to explain some of the inconsistencies between early From the time he worked in headquarters, I have known
diversification research and more recent empirical assess-Mr. X to be an intelligent man. How can he be so intelligent
ments. We have stated this matter as a research question. in Los Angeles and so stupid in Hong Kong?”
RQ2: Are Bettis and Hall’s (1982) results robust across Culture conditions perceptions so that people from like
each industry (determined at the four-digit level of SICs). For
Methods
product unrelatedness, the Herfindahl measure was computed We addressed these two research questions using a longitudi- based on the sum of squared proportions ofindustry involve-nal research design. First, we formed a sample of primarily ments relative tototaloperations (i.e., by computing the pro-domestic corporations from the Fortune 500 and examined portion of operations in industry one relative to total opera-group differences between related and unrelated diversifiers tions, squaring that number, and summing that figure with within this category; that is, using their levels of diversification the same computation for all remaining industries). Product att1(January, 1985) to predict their risk and return att2(the relatedness was computed in the same way, except the
mea-immediately following 5-year period, 1985 to 1989). Then, sure was calculated industry-by-industry for the firm’s involve-we examined a more broad sample of firms from the Fortune ment. The firm’s meanwithin-industryspread (i.e., the firm’s 500, one including multinational firms as well. As before, mean concentration within involved industries) represented we compared the risk and return of related and unrelated the product relatedness index. For these measures, propor-diversifiers using data from the same time period. tions were calculated from SIC counts (i.e., industry involve-ment was weighted by the number of times an SIC was
re-Independent Variables
ported across each firm’s profile of foreign and domesticTo address the research questions, it was necessary to assess subsidiaries as profiled in the 1985 volume of Directory of
two independent variables—levels of international and prod- Corporate Affiliationsand its 1985–1986 companion volume, uct diversification. The first of these was necessary to set up International Directory of Corporate Affiliations).
the two central analyses, examining between-group differences
INTERNATIONAL DIVERSIFICATION Our measures of interna-for domestic firms and then, separately, interna-for a sample including
tional diversification were developed to parallel those gener-international firms. We computed a measure of product
diver-ated for product diversification, an approach advocdiver-ated in sification to assess corporate strategy, examining dependent
the literature (Vachani, 1991). That is, to divide firms into performance variables that may be associated with the
make-domestic versus international categories, we created a measure up of each firm’s portfolio of businesses.
using the best known country groupings (see Hofstede, 1980).
PRODUCT DIVERSIFICATION. Research on the impact of prod- Based on Hofstede’s classification, we calculated two separate uct and industry relatedness has been a mainstay topic in Herfindahl-type measures of concentration to capture the strategic management for decades (see Ramanujam and Vara- spread of operations across country clusters as well as the darajan, 1989). Early work in this area treated diversification average level of distribution over countrieswithineach country as a unidimensional construct, assuming a linear (positive) cluster in which the firm operates. We generated the computa-relationship with firm performance as a result of increasing tions above by subsidiary counts fromMoody’s Industrial Man-market power advantages (e.g., Caves, 1981). However, this ual. That is, international involvement in a given nation was research found scant support for the posited linkage (e.g., determined by the number of subsidiaries over which the Beattie, 1980; Rhodes, 1973), prompting some to reconceptu- firm had a controlling interest in that country as reported by alize the nature of diversification to discern unrelated (across Moody’s. Subsidiary counts were used as a proxy for involve-industry) from related (within involve-industry) expansion. ment for two important reasons. First, no public source was In the vanguard of this movement, Rumelt (1974, p. 29) readily available for sales or asset data by country. Second, postulated that business units are related “when a common number of subsidiaries is a better measure than either sales skill, resource, market or purpose applies to each.” From or asset data, because it is not distorted by foreign exchange this conceptual platform, Rumelt proposed his well-known fluctuations, different currency translations, or such interna-multidimensional classification of firms. In fact, Bettis and
tional financial maneuvers as transfer pricing policies (Kim, Hall (1982) examined firms representing part of Rumelt’s
Hwang, and Burgers, 1989). typology—discerning related-linked, related-constrained, and
unrelated firms—as sorted by his methodology, but a more
Dependent Variables
common approach considers only two general categories—
To replicate the tests that Bettis and Hall (1982) performed, related and unrelated diversifiers (cf. Amit and Livnat, 1988b;
we used their measures of risk and return performance; i.e., Barton, 1988; Geringer, Beamish, and daCosta, 1989; Kim,
ROA and the standard deviation of ROA. As Kim et al. (1989, Hwang, and Burgers, 1989; Palepu, 1985). Following this
p. 50) recognize, ROA measures “the relative efficiency with trend, we used Varadarajan’s (1986) approach to index levels
which the firm produces its output and is particularly well-of both related and unrelated diversification. That is, product
suited to reflect the attainment of synergies in business opera-unrelatedness was measured in Herfindahl fashion as the
con-tions.” Furthermore, ROA is widely accepted as a performance centration of the firm’s operations across industries
(deter-indicator and is relatively resistant to the financial manipula-mined at the two-digit level of standard industrial
classifica-tions of management (Gerhart and Milkovich, 1990). tions [SICs]); whereas, product relatedness was computed
susceptible to short-term irregularities and fluctuations. To and ROS were included in the study to present a broader picture of accounting performance.
smooth out aberrant short-term observations and obtain a
more reliable long-term measure of performance, we com- To build on Bettis and Hall’s (1982) assessment, we have included both accountingandmarket measures of firm risk. puted ROA indices for each firm as 5-year averages, similar
to Bettis and Hall (1982); however, we used quarterly data In line with their study, we included measures of “variation of returns” (Chang and Thomas, 1989) for both ROA and (20 observations per measure) from the Compustat database
to provide a more reliable index for risk (i.e., the standard ROS. However, several studies demonstrated that diversifica-tion also has an impact on firm market risk (e.g., Amit and deviation of ROA). These figures were then verified by
com-paring calculations for sample firms using Compustat’s annual Livnat, 1988a, 1988b; Barton, 1988; Lubatkin and O’Neill, 1987; Lubatkin and Rogers, 1989; Montgomery and Singh, files against the study’s computations from corresponding
(an-nualized) quarterly data. Values discrepant by 10% or more 1984). Following Lubatkin and O’Neill’s (1987) procedure, we used the capital assets pricing model to segment market were checked against data fromValueline, and questionable
cases (20 in all) were eliminated from the study. risk into components—systematic, unsystematic, and total risk—to assess the impact of related and unrelated diversifica-tion on each.
Replication Analysis
Other variables can have an impact on risk and return To test the first research question, analyses of variance
(ANO-outcomes for multinational firms, independent of product VAs) were run on a sample of domestic firms (i.e., those that
relatedness. Our study controlled for these effects through were below the mean on both international relatedness and
analytical treatment (Cook and Campbell, 1979). For exam-unrelatedness). Following Bettis and Hall’s (1982) approach,
ple, several studies controlled the effects of firm size (e.g., these analyses used 5-year average ROA and the standard
Buhner, 1987; Chang and Thomas, 1989; Michel and Shaked, deviation of ROA over the same time period to tap firm risk
1986; Shaked, 1986), a factor of concern because of its inde-and return. These firms were then divided into two subsamples
pendent ability to boost performance (e.g., through a lower based on their levels of product relatedness and unrelatedness
cost of capital), while reducing risk (Chang and Thomas, (including only those that were above the mean on one index
1989). Therefore, our study included firm size (net sales) as or the other, and not both or neither). Replication of Bettis
a covariate to assess its effects. Financial leverage can also and Hall’s (1982) results would require two basic findings:
affect returns (e.g., by reducing accounting returns [cf. (1) a significant difference in ROA between product related
Buhner, 1987]), while raising the firm’s risk (Chang and and unrelated firms, with higher performance among the
for-Thomas, 1989). This variable was also included as a covariate mer; and (2) no significant difference between the two on the
(measured by means of equity to invested capital [cf. Barton, standard deviation of ROA.
1988]) to assess its unique impact on the risk and return performance of sample firms. Altogether, we conducted a
Extension Analysis
MANCOVA test to assess the significance of group differences In an effort to address the second research question—
(product-related vs. unrelated firms) across dependent mea-suggesting that product-related and unrelated firms may not
sures of risk and return, while covarying out the effects of differ in risk and return when tested over a sample including
control variables. international concerns—we set up an alternative analysis
sam-pling across the entire Fortune 500. Further, we expanded
Bettis and Hall’s (1982) analysis to include multiple measures
Results
of performance (including ROA as well as return on salesTable 1 presents the means, standard deviations, and correla-[ROS] and a market performance variable, market-to-book
tion coefficients for the variables included in the ANOVA and value [MTB]) and risk (the standard deviation of ROA and
MANCOVA tests for the initial set of firms from which we ROS as well as market risk measures). To account for the
constructed subsamples. For the most part, the numbers in effects of other relevant variables, we also added four control
Table 1 present few surprises. For example, the three measures variables to the model—firm size, debt, global relatedness,
of performance (ROA, ROS, and MTB) are significantly corre-and global unrelatedness.
lated, as has been the case in prior research. Furthermore, The ROS measure was included to supplement the more
most forms of diversification (all except product relatedness) common ROA found in the diversification literature. This
are associated with size, indicating that larger firms tend to increasingly popular measure was used instead of return on
have greater international spread and the most product unre-equity because of its resistance to distortions caused by the
latedness. Finally, debt is the strongest correlate of perfor-equity base of firms. That is, firms that finance acquisitions
mance. As we would anticipate from financial theory (Brig-via cash or debt can increase profits substantially without
ham, 1995), greater leverage is associated with significantly proportionate expansion of the firm’s equity base. ROS escapes
lower accounting and market performance. these debt-equity mix distortions and thereby provides a stable
im-pediments to synergy formation between product-related (vs. unrelated) operations within multinational firms. Although widely assumed to benefit related diversifiers more, efforts to build synergies between units may be blunted by global incompatibilities. Therefore, we replicated Bettis and Hall’s (1982) results using modified measures of product diversifica-tion and a sample of domestic firms. Parallel to the original study, we ran two separate ANOVAs to assess differences between product-related and unrelated firms—one for risk and one for returns. Our results nearly perfectly replicated those of Bettis and Hall (see Table 2). That is, related concerns had higher returns than unrelated firms; whereas, unrelated diversifiers showed greater risk than related firms. Further-more, ROA differences were significant (F[1, 69]54.99,p,
0.05); whereas, ROA-based risk differences were not (F[1, 69] 5 2.03, ns). The similarities between our findings and Bettis and Hall’s results are striking, suggesting the theory of synergies between related operations may be valid for domestic firms.
The second research question asks whether or not Bettis and Hall’s (1982) conclusions would generalize to multina-tional operations. Our results were revealing (see Table 3). A MANCOVA test demonstrated no significant differences between product-related and unrelated diversifiers when as-sessed in a model including accounting and market-based risk and return measures (multivariate F[8, 146] 5 1.654, ns), although size (multivariate F[8, 146]53.17,p,0.01) and debt (multivariate F[8, 146] 5 5.092, p , 0.0001) both demonstrated significant covariation. Taken together, these findings provide consistent support for our theory of interna-tional impediments.
Discussion and Conclusions
Some diversification researchers (cf. Ilinitch and Zeithaml, 1995) have grown skeptical of the conventional logic that suggests related diversifiers should outperform (and even ex-perience lower risk than) unrelated firms because of the
effi-Table 2. Means, Standard Deviations, and Sample Sizes for ANOVA Tests
Variable Mean F-Statistic
ROA
Related diversification 1.44 (0.59) F(1,69)54.99*
n523
Unrelated diversification 0.81 (1.30)
n547 ROA risk
Related diversification 0.67 (0.35) F(1,69)52.03
Table 3. Means, Standard Deviations, and Sample Sizes for MANCOVA Test
Related Unrelated
Diversification Diversification
Variables (n578) (n583) F-statistic
Accounting returns
ROA 1.31 (1.16) 0.84 (1.06) 1.98
ROS 5.10 (4.61) 3.51 (4.73) 1.51
Accounting risk
ROA 0.91 (1.09) 1.15 (1.83) 1.39
ROS 3.57 (5.17) 5.84 (8.74) 2.15
Market returns
MTB 2.08 (1.33) 7.16 (48.83) 0.74
Market risk
Systematic risk 0.99 (0.78) 1.06 (0.77) 2.08
Unsystematic risk 7.83 (2.71) 8.31 (3.12) 4.78***
Total 9.26 (2.43) 9.81 (2.88) 5.61***
Covariates
Size 3.73 (12.40) 5.62 (11.28) 3.06**
Debt 27.82 (20.70) 36.45 (29.40) 5.10***
Global relatedness 0.16 (0.17) 0.18 (0.17) 1.35
Global unrelatedness 0.34 (0.32) 0.35 (0.28) 0.57
F(8,146)51.654
*p,0.05. **p,0.01. ***p,0.001.
ciency of synergy formation among units in the former. Despite and Mahajan, 1985; Montgomery, 1985). Most studies simply considered industry membership (Grant, 1987; Grant, Jam-early support for the synergy framework (e.g., Amit and
Liv-nat, 1988a, 1988b; Lubatkin and Rogers, 1989; Palepu, 1985; mine, and Thomas, 1988) or controlled these effects in the sample screening stage (Michel and Shaked, 1986; Shaked, Rumelt, 1974, 1982; Simmonds, 1990; Varadarajan, 1986;
Varadarajan and Ramanujam, 1987), recent criticisms stem 1986). Overall, these efforts have not added much to our understanding of diversification effects. Indeed, Zajac (1990, from inconsistent findings in diversification research
(Hoskis-son and Hitt, 1990; Ramanujam and Varadarajan, 1989). p. 225) questions the value of controlling for industry effects at all.
However, the trend of inconsistent findings may not result from an invalid theoretical framework so much as from a
Rumelt (1987) has argued convincingly, and shown empiri-shift in the dynamics of relatedness synergies for international
cally in a large sample study, that intra-industry profitabil-firms. This interpretation is supported by the three tests
men-ity differences may be three to five times greater than inter-tioned above. First, Bettis and Hall (1982) found that related
industry differences. In other words, performance studies diversifiers performed better than unrelated firms using data
that automatically use industry-adjusted performance data from the mid-1970s, a time when American firms were far
may be obscuring rather than illuminating profitability dif-more domestic in their operations. Second, our replication of
ferences. Bettis and Hall’s findings using domestic firms lends credence
to this conclusion. Finally, the fact that related and unrelated Given these concerns and Compustat’s limited ability to calcu-late these control variables (Chang and Thomas, 1989), indus-firm performance did not differ significantly when
multina-tional firms were added to the sample further affirms our try variables were not included in the present study. Previous researchers have also questioned the reliability rationale. When examining the relatedness–performance
link-age, we contend that it is essential to account for the impact of some of the data that have been used in this and other investigations. For example, although numerous studies have of international diversification to avoid misinterpretation.
Some limitations of the study deserve mention so that our classified firms using SIC codes, because they are considered to be objective (Dubofsky and Varadarajan, 1987), Montgomery research can be interpreted within its constraints. First of all,
the study does not control industry effects (cf. Bettis and Hall, (1982) revealed that the Office of Management and Budget does not develop all SIC classifications according to a single 1982), which may play a part in diversification–performance
linkages. Research has studied the impact of such industry guiding principle. As a result, inconsistencies are likely to arise. Nonetheless, SIC codes have been used in this study, variables as industry growth rate (Bettis and Mahajan, 1985;
Dess, Ireland, and Hitt, 1990†
parallel classifications using Rumelt’s popular approach
Dowling and McGee, 1994
(Montgomery, 1985).
Dowling and Ruefli, 1992*
The results of this study were also limited by the perfor- Dubofsky and Varadarajan, 1987 mance measures chosen for the study. The findings failed to Duhaime and Thomas, 1983
Fahey and Christensen, 1986*
demonstrate significant differences between product
diversifi-Farjoun, 1998
cation groups for well-accepted measures (ROA and ROS),
Fiegenbaum and Thomas, 1986*
but others could also be considered for such research. For
Fiegenbaum and Thomas, 1988
example, Japanese firms often use market share growth to Fiegenbaum and Thomas, 1990 track performance (Blinder, 1992), and this may become the Fombrun and Shanley, 1990
Goll and Sambharya, 1995
standard for global competition. Perhaps such measures would
Gomez-Mejia, 1992
tap dimensions of performance that are most relevant to
multi-Grant and Jammine, 1988
national firms.
Grant, Jammine, and Thomas, 1988†
Finally, it is important to note that the present study mea- Gupta, 1984
sured diversification at one point in time and then examined Habib and Victor, 1991
Hamilton and Shergill, 1992*
5 years of subsequent performance. Most studies used this
Harrison, Hall, and Nargundkar, 1993
ordering, because theory suggests diversification is the natural
Hill and Hoskisson, 1987
antecedent of performance. However, not all research has
Hitt and Ireland, 1985†*
taken this approach. To illustrate, Varadarajan and Ramanu- Hoskisson, 1987
jam (1987) measured diversification from 1984 data, while Hoskisson, Harrison, and Dubofsky, 1991
Hoskisson and Hitt, 1988
matching this to 5 years of performance data from a 1984
Jemison, 1987
Forbesreport (i.e., the time frame preceding the measurement
Johnson and Thomas, 1987†
strategy). Although most would argue that this is
inappropri-Keats, 1988
ate, we did not explore data timing alternatives. Grant (1987) Keats and Hitt, 1988 found a relationship by regressing performance on diversifica- Kerr and Bettis, 1987
tion strategy after lagging the former by 4 years, suggesting Ketchen, Thomas, and McDaniel, 1996 Kim, Hwang, and Burgers, 1989
that the relationship between diversification and performance
Kim, Hwang, and Burgers, 1993
in this study could have been masked by failing to include a
Koch and Cebula, 1994*
lag period for performance.
Koh and Venkataraman, 1991
Despite these limitations, the results reported above suggest Krishnan, Miller, and Judge 1997 that relatedness theory may still be valid, but only for firms Kusewitt, 1985
Lane, Cannella, and Lubatkin, 1998
with limited international operations. Because global firms
Lubatkin, 1987†
face a number of unique impediments to synergy formation,
Lubatkin and Chatterjee, 1994
the performance benefits that normally accrue to
product-Lubatkin and O’Neill, 1987
related diversifiers may be constrained by the challenges of Lubatkin and Rogers, 1989 international management. In light of the strong trend toward Lubatkin and Shrieves, 1986
Marsh and Swanson, 1984
overseas expansion, the import of these conclusions is greater
McDougall and Round, 1984
than ever. Although the advantages of internationalization are
McGee and Thomas, 1986
clear, the value of diversification strategy for multinational
Michel and Hambrick, 1992
firms is certainly open to debate. Miller and Bromiley, 1990
Miller and Reuer, 1996 Nahavandi, 1994
Appendix.
Nayyar, 1992 Nielsen, 1983
Studies that Cite Bettis and Hall (1982) as
Nielsen, 1984
Evidence of a Diversification–Performance
O’Neill, Saunders, and McCarthy, 1989
Relationshipa
Oviatt and Bauerschmidt, 1991 Paine and Power, 1984† Amit and Livnat, 1988a
Amit and Livant, 1988b Pant and Lachman, 1998*
Ramanujam and Varadarajan, 1989* Amit and Livnat, 1989a
Amit, Livnat, and Zarowin, 1989b Reger, Duhaime, and Strimpert, 1992
Ruefli, 1990 Buhner, 1987†
Capon, Hulber, Farley, and Martin, 1988† Seth, 1990
Silhan and Thomas, 1986 Chang and Thomas, 1989
Chatterjee and Lubatkin, 1990 Simmonds, 1990
Srivastava and Prabhu, 1996 Collins and Ruefli, 1992
Datta, Rajagopalan, and Rasheed, 1991* Stimpert and Duhaime, 1997*
Thomas and Venkataraman, 1988 Cook, T. D., and Campbell, D. T.:Quasiexperimentation: Design and Analysis Issues for Field Settings. Houghton Mifflin, Boston. 1979. Thompson, 1984a
Thompson, 1984b Datta, D. K., Rajagopalan, N., and Rasheed, A. M. A.: Diversification
Vachani, 1991 and Performance: Critical Review and Future Directions.Journal
Varadarajan, 1986* of Management Studies28 (1991): 529–558.
Varadarajan and Ramanujan, 1987†
Davidson, W. H., and McFetridge, D. G.: Key Characteristics in the Venkatraman and Ramanujam, 1986
Choice of International Technology Transfer Mode. Journal of
Walls and Dyer, 1996
International Business Studies16 (1985): 5–21. Woo, 1987†
Davis, P. S., Robinson, R. B., Pearce, J. A., and Park, S. H.: Business Woo, Willard, and Daellenbach, 1992*
Unit Relatedness and Performance: A Look at the Pulp and Paper
aThese studies were orginally identified via theSocial Sciences Citation Index.
Industry.Strategic Management Journal13 (1992): 349–362.
† These studies also pointed out Bettis and Hall’s (1982) conclusions regarding the
importance of controlling industry effects when assessing the diversification– Dess, G. G., Gupta, A., Hennert, J., and Hill, C. W. L.: Conducting
performance relationship. and Integrating Strategy Research at the International, Corporate, * Marks those sources that pointed out the implications of Bettis and Hall’s (1982)
and Business Levels: Issues and Directions.Journal of Management findings of industry effects for the diversification-performance relationship.
21 (1995): 357–393.
Dess, G. G., Ireland, R. D., and Hitt, M. A.: Industry Effects and
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