Economics of Industry- Diversification

Economics of Industry

Diversification

Introduction

“Do not put all your eggs in the same basket.”

Many large firms have expended their business to some new areas rather than keep it in the old one—they decided to produce for numerous markets. For example, Tesco has diversified its business to personal finance, while Philips has products in consumer electronics, health care products, and lighting. By diversified through business areas, firms intended to reduce costs and improve market effectiveness by exploiting economics of scale and scope. (Besanko et al 2010)

This essay will mainly discuss the reasons why most of the big firms choose to diversify, the effects of diversification. Also, both potential benefit and potential cost will be identified. Then, after the example of successful and unsuccessful diversifications, the conclusion will be given.

The reasons of diversification

There are two main reasons why the firms will diversify. First, diversify to benefit the firm’s owners by increasing the efficiency of the firm. Second, if the firm’s owners are not directly involved in making the decision to diversify, it might be the managers’ preferences to do it. (Besanko et al 2010)

Economics of scale /scope

Supported by Thomas Brush, if a merger is motivated by scale economics, the market share of the merged firm should increase immediately following the merger. Brush did a large research contains mergers in 356 manufacturing industries. (Brush, T. H. 1996) He learned that when the mergers are associated with operational synergies, there will be an expectation of positive changes in market share. Furthermore, the gains expected from mergers were always substantial. Just like Google bought Motorola Mobility Inc. in May 2012. Although it took more than 12.5 billion, the return is significant. Google got to get more than 170 thousand patents owned by Motorola. That gives Google android system huge competitive advantage, and increase in...