Diversification: Determining Interorganizational Dependence

Diversification is similar to merger in our analysis of organization-environment interaction. The subject, primarily studied by economists, has not been viewed in the broader context of an organizational response to resource interdependence. One of the most comprehensive examinations of diversification was Gort’s (1962) study for the National Bureau of Economic Research. Gort examined diversification achieved through product additions and abandonments for various time periods up until 1954, looking at differences among large corporations and among industries. He concluded that the factor most able to account for variations in diversification activity was technology. Technological intensity was measured as the ratio of technical personnel to total employees and, also, as the rate of change in productivity. Industries that were very technological diversified more and were more often entered by diversifying companies. Companies did not primarily diversify into industries that were countercyclical to eliminate some of< the variations resulting from the business cycle affecting their own industries. And, while companies did tend to diversify into growing industries, the growth was primarily due to technological change., Diversified companies were not more or less profitable than other, firms.

While Gort’s study indicates that technological intensity is related to diversification, there are few theoretically useful cues given to interpret these results. The one position consistently used to explain economic activity—profit maximization—is inconsistent with the data. One can make sense out of Gort’s results by assuming that diversification is a strategy used for avoiding constraining resource dependence. Technologically intense manufacturing organizations, firms which employ numerous technical skills to produce high-technology goods tend also, though not invariably to be firms which sell much of their output to the government. Diversification, then, may represent an attempt to reduce the dependence on single customers or concentrated sales markets. In other words, the correlation between technological intensity and diversification may be spurious, as both may be related to selling to the government or to other dominant customers.

Diversification can be viewed as another organizational response to the environment. It is a strategy for avoiding interdependence. Diversification buffers the organization against the potential effects of dependence by putting the organization into another set of relation-ships that are presumably different. Diversification is a way of avoid-big the domination that comes from asymmetric exchanges when it is not possible to absorb or in some other way gain increased control over the powerful external exchange partner. Diversification is most likely to be used when exchanges are very concentrated and when capital or statutory constraints limit the use of merger or other strategies for managing interorganizational relationships.

If diversification is a response to organizational interdependence, then the extent of diversification should be related to the proportion of resources exchanged with one or a few dominant organizations. One organization which can create significant problematic interdependence for other organizations is the government, particularly the federal gov-emment. Since priorities change and the government is frequently the only buyer for output, selling to the government presents an uncertain situation. Moreover, the government can not be acquired, and the use of cooptation and joint ventures is also not possible. We would, there- fore, hypothesize that firms or industries which sell a larger proportion of their output to the government would be more likely to use diversi-fication as a means of coping with interdependence.

To test this possibility as an explanation for Gort’s (1962) results, i we used Gort’s measure of diversification for 13 manufacturing indus-tries and correlated it with the proportion of business these industries ? did with the federal government, as estimated from the input-output fi tables. The correlation was .58, statistically significant even with this small sample, suggesting that industries diversify more, the more they sell to the government. A similar analysis was conducted to examine the proportion of business which industries conducted outside their primary activity, which can be used as another measure of diversifica-tion. The industry’s proportion of sales to the government was cor-related .55 with the extent to which it engaged in business outside its primary activity. Both analyses suggest that industries doing more business with the government tend to diversify more and to have less of their activity concentrated in one industry group.

The merger data displayed previously in Tables 6.1 and 6.2 can also be examined using this perspective on diversification. Although all industries tended to follow patterns of resource exchange in choosing merger partners, this varied from industry to industry. The magnitude of the correlations between merger and resource exchange measures can be used as an estimate of the extent to which organizations made acquisitions among the set of firms with which they engaged in resource exchanges. When the correlation between mergers and exchange is low, it suggests firms may have selected mergers outside their exchange set for purposes of diversification. Following our preceding argument about doing business with the government as a stimulus to diversification, we should find that lower correlations between merger and resource exchange patterns are exhibited for industries that do more business with the federal government. The industries which transacted more with the government had, in fact, lower correlations between mergers and resource exchanges, suggesting that a pattern of diversification was more likely to be pursued.

1. Diversification by Israeli Firms

The general finding that industries diversify more, the more business they do with a single dominant output market can be examined also with the data Aharoni (1971) collected from Israeli manufacturing firms. When we considered these data in Chapter Three, we found that firms doing business with the government tended to be more constrained in their decision making, the higher the proportion of sales made to the government. If diversification represents an attempt to avoid such loss of autonomy, we would expect to observe diversificar tion among firms doing more business with the Israeli government.

A more general perspective would argue that firms would seek to 1 sell relatively less to any market to which they currently sell a great deal. The greater the current percentage of sales to a class of cus-tomers, the less the firm should desire to sell to that same customer class. Aharoni asked each Israeli manager he interviewed what per-centage his firm now sold and what percentage he would like it to sell to each of the following customer types: (1) retailers, (2) wholesalers,, (3) other manufacturers, (4) Shekem (military commissary), (5) defense, and (6) foreign customers. To estimate how much managers would like to reduce their sales to each customer class, we can subtract the percentage desired from the percentage currently sold to each class. The larger this difference, the more the manager would like to reduce sales to that class of customer. If the desired percentage is. greater than the current percentage, it would suggest the manager, would like to increase sales to some customer with which it is nowdoing little business. The correlation of this difference with the amount currently sold to each customer class would indicate whether firms desire to decrease their sales more when they are more dependent on a particular class of customers. These correlations are presented in Table 6.4. As seen in that table, the correlations are all positive and all but one are statistically significant (p < .001). The greater the proportion of sales currently being made to a given customer class, the more the managers desired to reduce their firm’s business to that class.

The magnitude of the relationship between the proportion of current business and desired reductions varies for the six customer classes. The correlation is highest for business conducted with the Shekem (.34) and for business with wholesalers (.34), and is lowest for business with foreign customers (.01). The pattern of results is consistent with our argument that firms seek to avoid constraining dependence when it is most uncertain and problematic. The Shekem represents a concentrated purchasing organization. Unlike the case of defense, however, the Shekem can be supplied by a larger number of firms. Moreover, in the case of defense suppliers, the government is more dependent on the small number of possible suppliers for this Critical resource than it is on a larger number of suppliers who can furnish supplies. A similar interpretation can be applied to the differ-ence in correlations between wholesale and retail organizations. Wholesalers represent a more concentrated customer class than do retailers, and therefore, firms are more interested in reducing their dependence on this class of customer.

Firms which sold their output to foreign customers were not as mterested in changing this position. This apparent anomaly may be due to the Israeli government’s policy of actively encouraging exports to earn foreign exchange. Export incentives, favorable treatment by the ministries, and strong normative values all reinforced the desirability of selling abroad. Because of these factors, interdependence with foreign customers was more acceptable.

Another way of examining these data is to note the percentage of sales desired compared with current sales. In all cases except foreign sales, the preferred mean proportion of sales is less than the actual mean. The average percentage by which the 141 Israeli managers wanted sales decreased to government markets was 21.8 percent, much more than to any other market. The desired reduction to other organi- zations, excluding foreign customers, was 9.2 percent. For foreign customers, an increase of 3.5 percent was desired. The managers were most dissatisfied with selling to the most concentrated market and i were most satisfied with selling to that market in which they earned,, normative rewards and other incentives.

2. United States government Contractors and Diversification

Hunt and Hunt (1971) examined the pattern of relations existing between major contractors and the Department of Defense (DOD) and the National Aeronautics and Space Administration. They observed a great deal of stability in the contractual relationships. Their analysis of the top 50 contractors from 1959 to 1968 indicated a tendency among DOD contractors to reduce their share of business with the DOD during the period. No such tendency was evident among NASA contractors. The difference between NASA and DOD contractors is explainable by the difference in the size of the two markets and their consequent impact on organizations, as well as with the fact that production for the Viet Nam War was declining. From data compiled by Leon Reed for the Council on Economic Priorities, an analysis of the top 100 DOD contractors from 1962 to 1971 suggests that contractors who experienced the greatest rises in sales during the: escalation of the Viet Nam War (1964-1968) were more likely than other contractors to be diversified, as measured by their proportion of sales to DOD and by the number of consumer products. The effect of the growth and subsequent decline in spending on defense were felt most by those firms which were least diversified, particularly the aircraft manufacturers. Other contractors, such as Bendix, acquire additional lines of business in an attempt to reduce reliance on government procurement. Bendix proudly reported its diversification every year, noting in its annual reports its decreasing reliance on government busi-ness.

The various studies suggest that diversification represents an explicit attempt to avoid uncertainty and the control by others who control critical resource exchanges. Product and industry diversification, mergers outside the firm’s own industry, reductions in sales and the expression of a desire to reduce sales all suggest firms’ attempts to move away from relationships in which they are at a relative power disadvantage. Such a result is well predicted by Blau’s (1964) discussion of the consequences of power differences emerging in social relationships.

There are other mechanisms of diversification not discussed here, including product development and diversified marketing strategies. Decisions to market different products for different market segments represent not only attempts to achieve profits but also attempts to diversify dependence and increase stability and certainty. Another form of diversification involves the succession of goals—the tendency for organizations to redefine their stated goals to fit new contingencies in the environment. The restructuring of goals permits the organization to take on new tasks or activities, lessening dependence on old en- vironments and activities.

Source: Pfeffer Jeffrey, Salancik Gerald (2003), The External Control of Organizations: A Resource Dependence Perspective, Stanford Business Books; 1st edition

Leave a Reply

Your email address will not be published. Required fields are marked *