Companies Torn Between 'Muneobal' and 'Diversification' [The Trap of Muneobal Expansion]

④If Successful, Diversify; If Not, Overextend
Diversification More Advantageous in Emerging Economies
"Intensified Pursuit by China Makes Survival Difficult for Anju City"

Editor's NoteThe number of affiliated companies under major domestic conglomerates has increased by nearly 1,000 over the past five years. Amid intense controversy over sprawling expansion centered on Kakao since last year, concerns over the profitability and financial soundness of group companies have grown. As global conglomerates also face increasing cases of being split up or collapsing entirely due to indiscriminate sprawling expansion, caution is rising. We examined the actual state of conglomerates' sprawling expansion amid the tension between entering new industries and the controversy over overexpansion.

Despite criticism of sprawling business expansion, companies entering various fields through a 'diversification' strategy are evaluated as one of the strategies to survive in global market competition. Especially for emerging market companies entering most industries as latecomers, those that adopted diversification strategies early in market formation earned higher profits than companies that stuck to single-industry specialization. Although Korea’s economy is driven by companies with advanced technologies, many companies have entered highly competitive technological fields, leading to the diagnosis that a bold diversification strategy for survival is an environment that cannot be abandoned.

Success is Diversification, Failure is Sprawling... A Fine Line

[Image source=AP Yonhap News]

Among global companies, Apple is regarded as the most successful model of diversification strategy. Apple expanded from a personal computer manufacturer to a company operating smartphones, tablet PCs, and now various mobile platform services.

Apple’s platform service revenue has grown significantly every year. In the first quarter of Apple’s 2024 fiscal year (October?December 2023), product revenue was $96.458 billion (approximately 133 trillion KRW), and service revenue was $23.117 billion. While product sales such as iPhones increased by 6% year-on-year, platform service sales like Apple Music and Apple Pay also grew by 11%. This diversification strategy, which creates synergy through business linkage, is regarded as a good example that led to balanced growth across all sectors.

[Image source=Reuters Yonhap News]

On the other hand, LEGO, the world’s largest toy company, experienced failure in diversification due to the drawbacks of sprawling expansion. Since the 1990s, LEGO diversified into areas with little relevance to its core toy business, such as clothing, watches, publishing, media, and games. Subsequently, in 2003, it suffered a massive loss of 1.4 billion Danish kroner (approximately 270 billion KRW). At that time, sales also plummeted to 8.6 billion Danish kroner, a quarter of the previous year’s figure. LEGO then adopted a restructuring strategy to abandon diversification and refocus on the toy business.

"Diversification is More Advantageous in Emerging Economies"… Reasons for Sprawling Expansion

While diversification strategies risk turning into sprawling business expansion, they are a crucial survival strategy for emerging market companies. Unlike developed countries where the effectiveness of diversification is lower, it has supported the rapid growth of conglomerates in emerging markets. Last month, the U.S. economic media Forbes highlighted a study by global consulting firm McKinsey, which analyzed the effectiveness of diversification strategies among over 4,500 companies worldwide from 2002 to 2012. It noted that emerging market companies adopting diversification strategies had higher profitability. The profits of diversified emerging market companies were 3.6% higher than the average of non-diversified companies, while companies specializing in a single industry earned 2.7% less than the average of non-specialized companies.

Conversely, in developed countries, companies that diversified showed a 0.2% lower return than the average, and those specializing in a single industry showed no significant difference from the average. In fact, companies that limited diversification to about three to six fields had returns about 0.2% higher than average.

McKinsey analyzed, "Even if diversification strategies are pursued, it is difficult to expect synergy effects among affiliates in the highly competitive markets of developed countries, but synergy effects can appear in emerging markets." They added, "Diversified companies in emerging markets are often family-owned, making control easier, and starting businesses as affiliates of large conglomerates provides advantages in investment, regulatory response, and talent acquisition, leading to higher profits."

"Intensifying Chinese Competition in All Fields... Diversification is a Struggle for Survival"

[Image source=Reuters Yonhap News]

Experts recognize that Korean companies should be cautious about indiscriminate sprawling expansion, but the reason they must actively diversify into new fields far from their core industries lies in the rapidly narrowing technological gap with competing countries. As the industrial transition expands into new fields such as secondary batteries and generative artificial intelligence (AI), it is better to open survival opportunities through diversification rather than focusing solely on specific industries that could be overtaken at any time.

Ryu Seong-won, head of the Industrial Innovation Team at the Korea Economic Association, said, "The main reason for criticism of sprawling expansion by some companies like Kakao was the infringement on local small businesses. Such expansion requires regulation, but our reality is that companies cannot survive without investing in new businesses aligned with new trends." He added, "Our companies face competition from Chinese firms in all fields that were once considered specialized businesses, such as semiconductors, petrochemicals, and automobiles. Even Samsung Electronics, which emphasized a super-gap, cannot afford to remain complacent in its existing core industries."

Regulatory authorities plan to support companies’ business diversification by shortening review periods and expanding exemption scopes for merger and acquisition (M&A) reviews with low concerns about competition restriction. A Fair Trade Commission official explained, "To smoothly respond to the Fourth Industrial Revolution and digital transformation, we will improve the system to exempt reporting for types of mergers and acquisitions with low competition concerns starting in August. We aim to reduce the reporting burden on companies and enhance the overall speed of reviews."