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Amit Garg
Tarun Kochhar

Looking to expand your business? Make sure you follow the three vital rules that will help you diversify along the right track.

WHEN companies grow and become successful, they inevitably face the question of what's next? What new breakthrough products or services are they going to come up with? Plans for second stage growth become the topic of management meetings, board discussions and analyst interviews. Management wants larger empires, employees want new playing fields and shareholders want higher returns.

As companies seek new business opportunities, one of the first questions on the research agenda is "What more can we sell to our existing consumers?" This is a valid and important question. Consumer-centred diversification has been the basis for many successful companies, and is one of the objectives of the CRM industry.

Banks are one of the best examples of this. In addition to basic account management, they now sell us insurance, auto loans, personal loans, housing loans, educational loans, credit and debit cards, etc. The entire strategy is built around the lifetime financial needs of a person. The consumer trusts the brand and is happy to minimise his search efforts by continuing to deal with one bank only.

The key word there is trust. As long as there is no inherent conflict in the business, diversification can provide great upsides. However, the conflicts of diversification are not always apparent. Within the traditional manufacturing sector, this is a well-researched subject. The services sector is less well studied, but poses some interesting challenges. Broadly, there are three issues.

Play fair by existing customer

The first and most important issue is at the customer end. While adding a new service line, one must consider how it impacts the existing service offering. Recent events have displayed how the combination of audit and consulting services is a potential disaster. How can the advisor be responsible for verification? Similarly, Wall Street is working hard at ensuring that its research wing is actually independent of its investment banking arms. The issue is that objectivity in one part of the business is compromised by the presence of the other — typically the one that makes higher profits. Over time, the culture of the organisation comes to be dominated by the richer division, and the consumer is the victim of the conflict.

As a result, the recommendations to the customer often depend upon what is more profitable for the company. In the long term, this aspect is fully understood by the customer and the company becomes vulnerable to focussed companies that do not show this `conflict' in their actions.

Auto finance is a case in point. The dealer's recommendation on a financing scheme is rarely taken at face value by the customer today — for he knows that there are likely to be several other attractive schemes available in the market.

Disaster in diversity?

The second issue is organisational. Adding new services typically means an addition of people. If the kind of people is similar, the addition poses no real problems. However, services businesses are often built on very different cultures — not immediately apparent from the outside. Meshing them together can often cause a lot of internal strife. GE had a failed attempt at investment banking — primarily because the culture was too different. Management consulting and software companies have tried to get together — without much visible success.

IT and and IT-Enabled Services (ITES) may well prove to be another challenge. The kind of educational background, salaries and incentive schemes are entirely different and housing them under the same roof is a recipe for disaster. Comparisons across divisions are inevitable and HR systems tend to graduate towards a mean. The best employees then become soft targets for head-hunters and the company is unable to remain a preferred employer.

Don't forget the investor

The third area of conflict is that felt by investors. This was the subject of intense research during the conglomerate boom in the 60s and 70s. Essentially, investors are uncomfortable with a hotchpotch of business models and cross-subsidisation of divisions. They like to understand the underlying economics and growth position. While investor discomfort does not impact operations per se, it has a distinct long-term impact on capital availability for the company. Given the recent problems over the lack of transparency in corporate accounts, this issue is likely to get revived attention.

Solutions do exist

How does one manage conflict, when the business opportunity is so lucrative? Managed well, a software development company can leverage its client base for building a BPO business or starting a software testing facility. Similarly, an accounting firm is well-positioned to provide investment or business advice to a client. But these opportunities aren't worth much if it creates the seeds of destruction for the company over the long term. Unless a solution can be found.

Fortunately, a solution exists. The common thread in all areas of conflict is that the businesses are housed under the same roof. Structure thus becomes the key variable. Separating the corporate and organisational structure is a powerful way of managing management conflict, employee diversity and neutrality for customers. It also allows investors to invest in clearer business models and provides an opportunity for the businesses to tap the capital markets. A well-structured sales commission structure and transfer of personnel can help capture many of the underlying marketing synergies. Infosys appears to have done just that in the case of Progeon, its BPO subsidiary. Like in many other instances, they may well have shown the way for other services companies diversifying into new business areas. The short-term challenges remain, but long term this is more beneficial to the company.

There is one catch. Separate structures do not allow weak management teams to hide behind the profits of other divisions and cross-subsidisation becomes infeasible.

So it takes some strength and conviction to actually implement this policy. In these turbulent times, that is exactly what investors would like to see more of.

The authors, Amit Garg (amtgrg@yahoo.com) and Tarun Kochhar (straitsmark@yahoo.com), are Bangalore-based Management Consultants.

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