Consider the reasons why firms may want to diversify and provide a critical assessment of the economic validity of their reasons for diversifying. Abstract
Despite the different degree of competitions and the level of development in the market across the various types of industries, most firms are continuously and consistently looking for ways and opportunities to enhance their ability to grow or even to just maintain sustainability and survival in the industry. Firms carry out diversification such as developing new lines and products, joint ventures and acquiring firms in unrelated lines of business, to improve on their corporate efficiency and benefits of the shareholder. For example, if a firm’s business focuses on seasonal products such as selling heating equipment, sales will do well during the autumn and winter months. However, to ensure the firm’s survival and maintain its business during the summer, it will need to carry out diversification such as establishing new product lines (i.e. Air conditioners). Therefore, firms diversify to achieve economies of scales and scope, to economize on transaction costs, improving shareholder’s diversification by reducing risks, as well as identifying undervalued firms. This paper will look at the different advantages and drawbacks of diversification as well as their economic validity. Diversification for Economies of Scales and Scopes
It has been said that when a firm is able to achieve economies of scale, the production levels becomes more efficient as the number of goods being produced increases. With the increase in production levels, firms will then able to lower their average cost per unit as the fixed cost are able to spread out over a large number of goods. For large firms, this will be a great advantage to them as it allows these firms to be able to gain access to a larger market. Furthermore with a lower average cost in production, they will be able to position their products at a more cheaply and affordable pricing in the market, giving firms a competitive advantage as well as it sits greatly for the consumer. A good example of such company would be Wal-Mart WMT. Being a dominant player in the retailing industry as well as the sheer size of the company, Wal-Mart has great efficiencies at keeping costs low as the company has tremendous bargaining power with its suppliers. This allows Wal-Mart to be able to retail their products at a cheaper price as well as having inexpensive distributions. However, it has been said that diversifying for economies of scales has an adverse effect on the smaller to medium size firms as it raises cost instead. It is generally true if the concept is viewed narrowly but small firms nowadays has managed to find ways to create opportunities to achieve economies of scales such as buying services, sharing risks and scaling through technology. Most small firms rather engaged services from a larger company as opposed to doing the job in-house to cut cost. Therefore any organizations servicing these smaller businesses (i.e. payroll services) are view as an “economies of scale” from the perspective of the small firms. Economies of Scopes on the other hand has a similar concept as economies of scales but refers more to firms that are able to lower their average cost by developing and producing or providing two or more products in their businesses. This means that a given level of production cost of each product line by a firm is much lower as compared to the given output level of a single product each produced by a combination of separate firms. An example of a company that uses economies of scope at its advantage would be Daiso. Daiso produced and retail hundreds of products from foods to house cleaning materials which allow them to offer standardization in their product’s pricings. With higher demands and production level as well as a lower average cost achieved through economies of scales, it definitely does help for firms to diversify so as...
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