• PAGE ONE
• INDEX
• HOME

Corporate diversification, again?

Kala Seetharam Sridhar

INDIA INC. seems to have been bitten by the diversification bug. Companies are on over-drive diversifying into related and unrelated areas. For instance Hero group's flagship company Hero Cycles proposing to enter the hospitality business. This company, along with the US-based Carlson Hospitality, has bid for four Delhi properties of ITDC Hotels including Kanishka, Lodhi and Yatri Niwas. Does this trend bode well for India Inc?

This trend of diversification is quite contradictory to the process of consolidation that characterised Corporate India's response to the opening up post 1991 liberalisation. The pre-reform period was characterised by excessive diversification by large i ndustrial houses. This was because the industrial licensing system created monopoly situation for major industrial houses. In the pre-reform period, it was easy for a large business house to obtain a licence for initiating an activity that was far remove d from its core competence. Thus, for instance, the steel-making Tatas ventured into the hotel business, then soap and detergent manufacturing, and insurance business, and now they have a presence in almost every industry.

Second, the immature capital market in the pre-reform period encouraged diversification because of the widespread practice of providing loans only to those with an established record of performance and repayment. Finally, difficulties of exiting an indus try encourages diversification. These factors led to fragmentation and over-diversification by Corporate India in the pre-reform period.

The year 1991 ushered in the liberalisation and with it came delicensing. This meant any firm, small or new, could as easily obtain a licence to start an activity. It was no longer the preserve of the large players. This had the effect of creating compe titive pressures for existing large industrial houses. This started the process of consolidation by various industries through mergers and acquisitions in the post-reform period. As is well-known, consolidation implies larger economies of scale and that, in turn, means lowered costs. Empirical evidence supports this.

A study of the 253 merger that were put through in the country between 1991 and 1997, more than half (53.2 per cent) were horizontal mergers, indicating that these companies were trying to strengthen themselves to undertake more of their core businesses. Such activity was also found to be more concentrated in industry groups such as beverages and financial services where competition was emerging with the entry of multinational firms.

About 20 per cent of the mergers were unrelated mergers.

Recent evidence indicates that the tendency to diversify persists with India Inc. But this second wave is worrying for a number of reasons. The first is the WTO. When the country is entering a milieu of free trade with full integration into the global ec onomy, will Corporate India be able to face up to internal and external competition if it continues to diversify into unrelated areas?

If a company's core competence is in the production of bicycles, why should it enter the hotel segment. Or, in other words, what is common between managing a bicycle business and hotel? Perceived management ability? Although the proposal is for a joint v enture with an established name in the hotel business, it is not clear how a bicycle company can learn to manage a hotel business and survive competition.

Also, as the CII recently noted, many MNCs have a `sales approach,' with their primary interest being access to the market and in not making heavy investments in the country. Thus, they tie up with domestic companies and some thing goes wrong, they break up the relationship.

The second concern with over-diversification is loss of market share or a reduction in concentration ratios at the product (or service) group level. This has the effect of weakening the response of the industry in the face of competition.

Finally, diversification could be the result of difficulty in exiting an industry for a firm in India due to the Industrial Disputes Act that so far made it mandatory for firms employing more than 100 firms to obtain government permission before doing so . The recent Government announcement of a flexible labour policy extending the flexibility of firing to firms employing up to 1,000 persons (without government permission), is helpful.

But it is not clear if the replacement of Sick Industrial Companies Act (SICA) 1985, that permits the existence of loss-making companies, with the NCLT (National Company Law Tribunal) will make exit for an unit any easier or equitable because of the exte nt of cross-subsidisation that it calls for among firms. The new law calls for a 0.001 per cent of total turnover as contribution from about one-seventh of large firms to finance an insolvency fund for loss-making companies.

During a period of global recession, it is understandable if a company diversifies into related areas through backward or forward vertical diversification. For instance, recently a fertiliser and chemicals company stole a march over its rivals by launchi ng ikisan.com, a unique agri-portal targeted at farmers. The same company also plans to have a company in the sunrise bio-tech industry soon.

Such related diversification is a phenomenon that should become part of corporate restructuring. This is because as the literature and experience in other countries indicate, the corporate response at the industry and economy levels may be looked upon as the sum of restructuring that occurs at the level of the individual firms. This also implies that with faster integration with the world economy, the industries that are diversifying will have to face significant consolidation, being confronted with a l arge number of players of widely varying sizes, to take on competition.

The author is Assistant Professor, Business Environment Group IIM-Lucknow