diversification strategies of developing country firms.pdf

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Journal of International Management5 (1999) 115140

1075-4253/99/$ see front matter 1999 Elsevier Science Inc. All rights reserved.

PII: S1075-4253(99)00009-5

Diversification strategies of developing country firms

Lilach Nachum*

Cambridge University, ESRC Center for Business Research, Sidgwick Avenue, Cambridge CB3 9DE,

United Kingdom

Abstract

Large diversified firms have been a dominant factor in the economies of many developing coun-

tries. Nonetheless, they have received only limited research attention, and consequently our knowl-

edge of the nature and extent of their behaviour is limited. This research sought to contribute to filling

this gap. Analysis of 163 diversification moves undertaken by 44 firms in various developing coun-

tries shows a considerable variation across developing regions and over time in terms of the objectives

that drive the diversification activities and the strategies pursued to implement them. This variation

can largely be attributed to specific characteristics of countries and regions that affect the behaviour offirms. 1999 Elsevier Science Inc. All rights reserved.

Keywords: Developing country firms; Diversification; Strategies

1. Background

The literature on firms diversification has focused almost exclusively on developed coun-

try firms. The main issues addressed by this literature are the identification of the motivesthat drive firms diversification (Dixon, 1994), organisational and technological characteris-tics of diversified firms (Channon, 1973; Rumelt, 1974; Dyas and Thanheiser, 1976; Peningset al., 1994; Chen, 1996; Argyres, 1996), and the impact of the diversification on their per-formance (Montgomery and Wernerfelt, 1988; Wernerfelt and Montgomery, 1988; Nguyenand Devinney, 1994; Markides, 1995; Markides and Williamson, 1996; Tallman and Li,1996). With few exceptions, the theoretical concepts are drawn from the experience of devel-oped country firms, and the studies that sought to test them empirically are based on data col-lected from this population of firms.

The neglect of developing country firms is surprising as these firms are often well diversi-

fied and maintain an influential position in their economies. Furthermore, their diversifica-

* Tel.:

44 1223 335292; fax:

44 1223 335768.

E-mail address:

[email protected] (L. Nachum)


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L. Nachum/Journal of International Management 5 (1999) 115140

tion activities seem to differ fundamentally from those of their developed country counter-parts, and the validity of knowledge based on the latter to the former is thus often limited.

There are several grounds for these differences. First, developing country firms are, on awhole, less advanced in their managerial and technological knowledge compared with devel-oped country firms, and subsequently different diversification options are available to thesetwo groups of firms. Second, most diversification activities of developed country firms havebeen within manufacturing and services, and the focus of the literature that sought to studytheir behaviour has been on diversification within these sectors. Less experience is thus doc-umented regarding the special difficulties and opportunities associated with diversificationfrom commodities, which has been the most typical route of the diversification of developingcountry firms. Third, the macroeconomic conditions faced by developed country firms (e.g.,

growth rate of their economies and competitive pressures) differ from those that developingcountry firms confront, and these differences affect their diversification activities and the setof issues associated with them.

The few studies that have examined the diversification of developing country firms high-light the unique characteristics of their activities and the need for research that will addressthese specific features. These include Amsden (1989, 1998) of South Korean firms; Amsden(1991) of Taiwanese firms; Lim and Teck (1995) of Singapore manufacturing and servicefirms; Batra and Aw (1998) of Taiwanese manufacturing firms; Cho and Park (1998) andChang and Choi (1988) of South Korean cheabols; Ghemawat and Khanna (1998) andKhanna and Palepu (1997, 1998) of Indian and Chilean firms.

The recent financial crises of the Asian countries have attracted much attention to thesefirms. The wide range of the diversification of Asian firms, along with the huge debt theyhave accumulated, were maintained to be a main cause for the crises and their brutality (seefor example, The Economist, 1997a, 1997c, 1998a; Business Week, 1998). The financial cri-ses also have raised doubts regarding the nature of the impact of the large diversified firmson their economies. Diversified firms were regarded as a main vehicle for the industrialisa-tion of developing countries (see Amsden, 1989, 1991, 1998), similar to the role that suchfirms played in the past in the developed countries, when they were industrialising (Chandler1977, 1990). This approach has driven countries to encourage the emergence of large diversi-

fied firms as a way to accelerate their industrialisation. The recent attempts of China and In-dia to transform state-owned firms into large diversified firms, by using South Korea diversi-fied firms (the chaebols) as their main model (The Economist, 1997d, 1997e, 1997f) suggestexamples for such an approach. However, as a reaction to the financial crises, rather than avehicle for growth, large diversified firms are maintained to be the cause of concentration ofpower that has prevented the development of smaller entrepreneurial firms essential for eco-nomic vitality

1

. These developments have made the study of the activities of these firms ofspecial interest and call for an analysis that will allow a better understanding of their behav-iour, which is the purpose of the present study.

1

Such an attitude has been expressed, for example, in recent writings on the Taiwanese economy that has

encouraged the development of small firms and allowed them to fail (Aw et al., 1997; Business Week, 1998a; The

Economist, 1997b) and has indeed escaped many of the consequences of the crisis.


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The study proceeds as follows. In the next section, I outline the context in which the activ-ities of developing country diversified firms take place and some salient characteristics of

their behaviour and highlight the ways in which they differ from their developed countrycounterparts. Section 3 describes the methodology used to gather the data that documenttheir activities. Section 4 brings the main findings that emerge from analysis of data providedby 44 developing country diversified firms that reported on their experience in 163 diversifi-cation moves. It is followed by a statistical examination of the explanatory power of certainsocietal characteristics for the diversification of firms, by using the contextual analysis pro-cedure. The article concludes by summarising the main findings and suggesting directions inwhich future research may make progress.

2. Developing country diversified firms

Diversified firms are a common phenomenon in many developing countries, particularlyin the more advanced ones, such as Argentina, Brazil, India, Malaysia, Mexico, South Af-rica, South Korea, Taiwan, Thailand, and Turkey. Their emergence is considered a responseto several structural characteristics that have led to the development of diversified firms ofdistinguished type and nature (Leff, 1978, 1979; Amsden, 1989, 1998).

A notable characteristic of developing country diversified firms is the wide range of their di-versification activities, which tend to be opportunistic and technologically unrelated and di-rected towards areas where no special technological skills are required. Subsequently, theycomprise many businesses that have no relations to one another whatsoever. While the domi-nant trend among developed country firms during the last two decades has been towards decon-glomeration and corporate focus (Berger and Ofek, 1995; Servaes, 1996; Sadtlet et al., 1997),developing country firms have been growing rapidly and have diversified widely into unrelatedareas (Gereffi, 1990; Prendergast, 1990; Koike, 1993; Amsden and Hikino, 1994; Benavente,1996). South Korean chaebols have taken this approach to an extreme (Ungson et al., 1997).The largest chaebols have been active in well over 100 different unrelated businesses (

The

Economist

, 1997c). Samsung, one of the largest chaebols, has 166 different businesses, and ithas grown tenfold every six years since the 1960s (

The Economist

, 1997a). Other developing

country firms are also well diversified, though the range of their activities may not be as wide

2

.Several closely related reasons explain these diversification patterns. First, many domestic

markets are too small to provide sufficient growth opportunities within a single productgroup, and developing country firms were often unable to compensate for the small size of

2

There are of course examples of deconglomeration and focus among developing country firms, but these are

rare. JCI a South African mining finance house suggests one. The firm was established in its current form after a

restructuring of the well-diversified Johnnies in 199495. Before the restructuring, Johnnies had interests in areas

as diverse as mining, finance, media breweries, and cars. The restructuring was driven by the realisation that there is

little synergy between the various parts of the group. Peter Perkins, an economist in JCI wrote to UNCTAD: . . .

In our experience, diversification in the past has resulted in a lack of managerial focus and a failure to maximise

market ratings, as measured by share prices. The initiatives at JCI Limited since its listing in 1995 have resulted in

a 52% appreciation in the share price compared with a rise of 31% in the share price index of Johannesburg Stock

Exchange mining house. . . . Our advice . . . would be to limit diversification to one commodity group, unless

[there is] a clear rationale for doing otherwise. (correspondence with UNCTAD, 21 April 1997).


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their domestic markets by exports or investment abroad, because they were not competitivein world markets. During the last decade or so there has been a considerable growth of their

international activity (see UNCTAD-DTCI [1997] and UNCTAD [1997a] for documentationof their international activity via FDI and exports, respectively), but diversification into otherareas of economic activities has remained a main route of growth.

Second, wide and unrelated diversification has an obvious appeal in economies subject torisks and to the uncertainties of instability and rapid structural change and is driven, in part,by an effort to alleviate these factors and to avoid the risk inherent in specialising in a narrowproduct range. Diversification is often undertaken as a response to market failures, commonin many developing countries. Such market failures make it costly for firms to acquirethrough the market necessary inputs, such as finance, technology, and management talents

(Khanna and Palepu 1997, 1998). Diversified firms, which can obtain these inputs internally,thus enjoy a considerable advantage.Third, developing country firms have, for the most part, been catching up rather than lead-

ing in the creation of new technology. Rather than developing their own technology, theyhave tended to rely heavily on technology acquired externally. Consequently, they lack aproprietary technology to exploit in closely related areas, which is a dominant reason for fo-cus or diversification into closely related areas (Chandler, 1977, 1990), a situation that hasfacilitated wide diversification into diverse and unrelated areas (Amsden and Hikino, 1994;Benavente, 1996). Furthermore, such diversification is a big gamble, because a firm entersmany new areas in which it does not have any expertise or knowledge. Many developing

country firms have been able to do it successfully because they have bought the technical ex-pertise and thus avoided the risk associated with the development of new technologies.

In the absence of proprietary technology, and the subsequent diversification into unrelatedareas, developing country diversified firms have developed advantages in conglomerationper se (Amsden and Hikino, 1994; Amsden, 1998). They excel in generic skills, originatingfrom the acquisition of foreign technology, which are applicable to many industries, in rapidand cost-effective entry into new industries and in related activities, such as feasibility stud-ies, task force formation, training, new plant design and construction, and operation start-up.Their advantages in these activities have become an invaluable competitive asset and have

allowed them to move into new industries rapidly and at relatively low costs. Once a groupdeveloped project execution capabilities in one industry, top management could transfersuch capabilities from industry to industry. Diversification itself thus became a source ofeconomy of scope, and there were considerable benefits to be gained from diversifying fur-ther, a situation that has further accelerated the expansion of these firms.

An additional notable characteristic of diversified firms in developing countries, whichhas affected the nature of their diversification activities, is their ownership structure. Whilein most developed countries family ownership has long been dropped in favour of ownershipforms that provide financial resources and allow professional management, the majority of

developing country diversified firms are family owned and controlled

3

. By the 1990s, there

3

It should, however, be noted that the family is not always the major shareholder of these firms. Often, the fam-

ily keeps the control and management but not necessarily majority ownership (Hattori, 1984; The Economist

,


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is some conflicting evidence that family ownership was weakening in several developingcountries, but the leading groups have remained family controlled and managed in most of them.

For two main reasons, family businesses attempt to create highly diversified groups, oftenin unrelated areas. First, the owner families seek to diversify their business lines and productsto spread risk (Suehiro, 1993). Evidence suggests that managers who own their firms aremore likely to diversify due to their greater need for risk reduction (see for example, Danis etal., 1997). Second, the generation transition within the business group tends to facilitate di-versification. The tradition in many developing countries (notably the Asian countries) re-quires dividing the firm so that each son gets an equal part in it (Hattori, 1984). To avoid theconsequences of splitting the firm over and over, and at the same time to meet the pressingneed of finding work for the younger generations, firms diversify at accelerated rates, and

into industries completely different from the initial family business.Finally, the recent string of financial crises in Asia has exposed the fact that the wide di-versification of many developing country firms has depended critically on the support ofgovernments and on the cheap money they supplied. Developing country governments haveplayed a dominant role in the emergence and the subsequent growth of diversified firms.Firms have often diversified in response to policy distortions, including ones that are not, ornot explicitly, intended to encourage such outcome (Ghemawat and Khanna 1998). For ex-ample, sales-based rather than value-added taxation of products has played an important rolein encouraging vertical integration. Inward looking trade policies pursued by many develop-ing countries, notably during the 1960s and 1970s, often forced firms based on imported fac-

tors of production to enter new businesses. In addition to this somewhat indirect role, thegovernments of some developing countries have actively and directly encouraged the devel-opment of large diversified firms, by providing selected firms favourable conditions, such asaccess to bank loans at attractive interest rates. These policies allowed firms to expand intonew fields without worrying about rate of return and encouraged their opportunistic selectionof industries towards which their diversification took place.

In the discussion so far, we have ignored differences among firms based in various devel-oping regions as well as within these regions. Such variation is often very large, though it hasreceived only limited research attention, and often can only be supported by anecdotal obser-

vations. For example, whereas the largest Asian diversified firms are very large and well di-versified, their Latin American counterparts are smaller and tend to be less diversified. Scat-tered evidence suggests that diversification in Latin America is less technologicallyunrelated than in Asia. These differences became apparent recently. In response to thechanging competitive situation at home, several leading Latin American diversified firmshave consolidated their business in an attempt to focus on their core activities and have ex-panded geographically. Examples include Mexicos Cemex and Argentinas oil firm YPF,

1997b). For example, the members of the Birla family, the founder of the largest Indian group Birla, owned in the

early 1980s less than 2% of the ordinary shares of the group (Ito, 1984). In spite of such minority shareholding,the family control is not challenged by outsiders for two main reasons. First, when these firms issue equity, it is

usually in the form of nonvoting shares, which do not threaten family control. Second, the family members own

many related firms, which are tied to the group as suppliers, customers, etc., and they help to maintain the fam-

ilys control over the group (Ito, 1984).


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which have recently become multinationals in their core activity. By contrast, Asian con-glomerates, notably South Korea chaebols, have fount it hard to withdraw from their enor-

mous number of businesses even in response to the recent financial crises and the large pres-sure of their governments and the IMF (

Newsweek

, 1997; The Economist

, 1998a).Furthermore, foreign firms have been an integral part of the diversification activities of manyLatin American countries, whereas in most Asian countries as well as in the Middle East, lo-cal private firms are the main industrial actors. Asian firms, notably the chaebols in SouthKorea and the largest Middle East firms, refuse the equity participation of foreign enter-prises. By contrast, Latin American firms, such as Mexicos grupos, have aggressivelysought opportunities for joint ventures (UNCTAD-DTCI, 1997).

There are also considerable differences among firms within regions. For instance, Taiwan

has a predominance of small and medium-sized firms, while South Koreas economy is con-trolled by huge conglomerates, the chaebols. State-owned firms are still quite important inTaiwan but are relatively insignificant in South Korea (Gereffi, 1990). While in most Asiancountries, family control and ownership is the norm, the proportion of corporate firms amongthe large firms in Thailand has been rising substantially over the last decades (due mostly tothe increasing presence of foreign firms). Some of this variation is illustrated and discussedin the empirical analysis that follows.

3. The firms studied and the questionnaire

The study of the diversification activities and strategies of developing country firms wasbased on data collected through a mailed questionnaire that was distributed to a sample of di-versified firms in a range of developing countries. Firms were drawn for the study from thedatabase World global scope: corporate information on the worlds leading companies.This database lists the largest 14,000 firms worldwide, according to (a) sizethe largestfirms in the stock exchanges in their countries, and (b) profitabilitythe firms that yield thehighest earning per share.

To be included in the study, firms had to meet the criteria discussed in the following sections.

1. Firms must operate in more than one area of economic activity and acquire no morethan 90% of their sales from their main product group. The operationality of this crite-rion requires a clear definition of area of economic activity. The ambiguity inherent inthe concept of a product or an industry besets both conceptual definition of areasof economic activity and its measurement. Indeed, there is no generally accepted def-inition or measure of diversification and the definitions used by researchers vary con-siderably. What diversification implies depends on the grouping of commodities de-fined as a single product. In defining diversification, we follow the distinction initiallymade by Rumelt (1974) and adopted by many analyses on diversification (see for ex-

ample, Dyas and Thanheiser, 1976; Argyres, 1996; Chen, 1996; Markides, 1995;Markides and Williamson, 1996; Tallman and Li, 1996). A diversification move istaken to be any entry into a new product activity that requires or implies an appreciableincrease in the available managerial competence within the firm. A 4-digit Standard In-dustrial Classification (SIC) classification is commonly adopted for the actual mea-


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surement and is the one used in the present study. This definition is likely to lead to un-der representation of vertically integrated firms. Because the activities of such firms

are, by definition, within a single product group, they are often classified as single-product firms. Subjective judgements were made in these cases, based on a review ofsecondary sources (such as firms annual reports and qualitative information providedby the database World global scope).

2. The firm must be the core industry/ies from which the firms diversified is a commodityindustry. We have narrowed our observations to firms that diversified from commodi-ties because historically the economies of all the countries classified as developingcountries were based heavily on commodities. Thus, the diversification activities oftheir firms, for the most part, started from commodities. Certain characteristics of com-

modities (such as specific combination of capital and labour, heavy reliance on un-skilled and low-skilled labour) suggest that the diversification activities of commodityfirms may differ from those of firms engaged in manufacturing or services. By focus-ing on this type of diversification, we could remove the heterogeneity related to sec-toral differences and identify the salient characteristics of diversification from this sec-tor. Commodity industries are classified according to the classification of the FederalStatistical Policy and Standards Office of the U.S. Department of Commerce.

3. Firms are headquarters in a developing country. This requirement excludes from thestudy affiliates of foreign firms active in the developing countries. The UN classifica-tion of countries at various levels of economic development was followed for the cate-

gorisation of developing countries. Approximately 300 firms met these criteria andwere selected to be the focus of the empirical work. A questionnaire was mailed tothese firms in spring 1997, in which they were asked to provide information regardingeach of the five most significant diversification moves they have implemented. For themost part, the unit of analysis in the questionnaire (and consequently in the analysisthat follows) was a diversification move, rather than a firm, since different diversifica-tion moves undertaken by a single firm can often vary considerably, in a manner thatmay prevent meaningful generalisations. The questionnaire consisted of four sections.The first was designed to gather information regarding the objectives of different di-

versification moves. It was followed by a section that referred to the planning and theformulation of strategies for competing in the new areas of activity. The third sectionsought to explore the activities pursued to implement the diversification moves, and thefourth asked for firms assessment of the success of the diversification and its impacton their overall performance. This article reports the main findings of the first threesections. In a second article, we address the findings of the last section.

Forty-four firms returned complete questionnaires (14.6% response rate) in which they re-ported on their experience in the implementation of 163 diversification moves

4

. Table 1 pre-sents some characteristics of the sample. A Chi-Square goodness-of-fit test was conducted to

estimate the extent to which the respondents represent the population of the firms approachedwith respect to their size and the intensity of their diversification (measured by the number of

4

Some firms reported on less than five diversification moves, because they had not diversified five times.


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Table 1

Characteristics of the firms surveyed

By Industry

1

n

Size (revenues

in dollars)

Diversificationintensity

(no. of products,

4-digit SIC)

Agriculture products 7 648,817 (1,078,710) 4.428 (1.618)

Mining 5 1,283,721 (2,126,205) 2.000 (1.000)

Oil and gas extraction 4 707,271 (1,142,011) 3.750 (0.500)

Food and tobacco 16 767,356 (1,055,980) 3.687 (1.701)

Textile 2 337,442 (na) 2.000 (na)

Chemicals 3 909,297 (1,280,084) 4.000 (1.000)

Petroleum products 3 185,886 (138,607) 5.000 (2.645)

Primary metal 4 248,658 (330,971) 3.666 (0.577)

Total sample 44 748,634 (1,162,576) 3.690 (1.615)

By region

2

Asia 7 485,521 (1,104,736) 4.142 (2.035)

Middle East 4 na 1.666 (0.577)

Southeast Asia 13 561,969 (916,237) 4.461 (1.560)

Latin America 12 1,316,006 (1,493,821) 3.416 (1.240)

Africa 8 240,627 (394,663) 3.142 (1.345)

Total sample 44 748,634 (1,162,576) 3.690 (1.615)

Values in parentheses represent standard deviation.

1

The core industry from which firms diversified.

2

Classification of countries into regions.

Number of responses from each country appear in parentheses:

Africa

: Egypt (2); South Africa (6).

Asia

: India (4); Pakistan (1); Sri-Lanka (2).

Middle East

: Saudi Arabia (1); United Arab Emirates (3).

Southeast Asia

: Indonesia (2); Hong-Kong (1); Malaysia (7); Taiwan (3).

Latin America

: Argentina (3); Brazil (2); Chile (3); Colombia (1); Mexico (2); Peru (1).

4-digit SIC product groups in which a firm is active). The null hypothesis was rejected in

both cases at the 0.05 level of confidence.A major reason for refusal to complete the questionnaire was that the firms approached

did not consider themselves as diversified firms and therefore felt that the questionnaire isnot applicable to them (see Fig. 1). Another reason for the low response rate (compared withwhat is expected in similar surveys of developed country firms [see Fowler, 1988; Zikmund,1994]) is that most firms approached are family owned, an ownership structure that is reluc-tant to share information.

4. The empirical findings

4.1. Objectives of the diversification

Different objectives drive the diversification activities of firms. This variety reflects thecomplex nature of diversification moves, where multiple objectives may be at work, some-


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times even at a single diversification move. It would be useful to know whether certain diver-sification objectives, or cluster of objectives, predominate, and whether there are some in-

dustrial or geographical patterns in their variation. Such knowledge would suggest degree ofplausibility and importance for the various objectives that underlie firms behaviour. (See Fig. 2)

The analysis in Table 2 shows that the dominating objective for the diversification of thefirms surveyed is the search for growth. Thirty-seven and twenty percent of all diversifica-tion moves were driven by this factor as the first and the second objectives, respectively, farahead of most other objectives. In light of the modest ability of developing country firms togrow via geographic expansion, product diversification is a main route for growth, as ourfindings illustrate. By contrast, very few diversification moves were driven by slow growthof the firms existing activities. The regional analysis, however, shows large differences be-

tween regions in the importance assigned to this objective, differences that seem related tothe growth rates of the economies concerned. Thus, in contrast to the objectives of firms inother regions, the decline of the present activity is the main drive behind the diversificationof Asian and Middle East firms. Indeed, most countries in these regions have been growingslowly over the last decades. Particularly notable in this context are Middle Eastern firms,most of them are heavily engaged in oil and in oil related activities that have been stagnatingduring large parts of the last two decades.

Fig. 1. Firms perception of diversification.


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Diversification to even out cyclical effects of a single industry is regarded by the firms asvery important (this motive was driving 12 and 25% of all diversification moves, as first and

second objectives, respectively). This reflects the unstable and risky economies of many de-veloping countries, a factor discussed above as one of the reasons for the extent and nature ofthe diversification of developing country firms. Such an objective is particularly commonamong firms diversifying from commodities, due to sharp cyclical trends typical to these sec-tors. This objective is most likely to drive diversification into unrelated areas, as expressedfor example by a mining company that acquired interests in the Mexican railroad, after it wasprivatised, . . . to protect ourselves from . . . the cyclical prices of metals (questionnaire).The firm (which did not agree to disclose its name) reported that it searched purposefully foran entirely unrelated field as a target for its diversification to avoid the risk of being focused

on commodities.Competitive pressures provide only a moderate drive for the diversification moves of thefirms surveyed, a finding that reflects the relative low competitive pressures typical to manydeveloping countries (a situation that is changing rapidly in many countries with the liberali-sation and opening up to foreign competition). A main reason for this competitive situation isthe activities of the diversified firms themselves. These firms exercise a degree of marketpower that exceeds by far their counterparts in the developed countries, and the industriesthey control are characterised by tight oligopolistic structures and high concentration. For ex-ample, in 1997, more than 80% of South Koreas GDP was generated by 30 chaebols (

News-

week

, 1997). As much as one third of manufacturing output in most Latin American coun-

tries is under the control of some two dozen large domestic conglomerates (Benavente,1996). The largest 100 Mexican firms in the 1980s accounted for approximately 50% of thecountrys GDP and owned more than 70% of its private capital (Amsden and Hikino, 1994).

Fig. 2. Objectives of diversification of incorporated firms.


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At the end of the 1980s, the top 20 Indian groups accounted for approximately two thirds oftotal private sector industrial assets (Ghemawat and Khanna, 1998). A similar concentration

is typical to most developing countries and it abolishes competitive pressures, which subse-quently have limited impact on the diversification of firms, as our findings show.

The relatively small number of diversification moves driven by the intention to benefitfrom complementarity between various activities and to utilise knowledge gained elsewherein a new activity reflect the tendency of developing country firms to diversify widely into un-related areas (discussed in some length above). However, there are considerable differencesacross regions in this respect, with the diversification moves of Middle East firms driven bythis objective far more than firms of other regions. This pattern reflects the tendency of Mid-dle East oil firms to diversify into oil-related industries, in which their previous knowledge is

often of considerable value.Very few diversification moves were driven by the intention to extend the scope of thefirm within its existing product line, by forward vertical integration. These findings highlightthe low value assigned by developing country firms to proximity to customers, via marketingand distribution, and show how limited impact, if at all, such considerations exercise over

Table 2

Objectives of diversification (shares of all diversification moves

1

)

Objectives

Whole sample

By region

2

Asia

Middle

East

Southeast

Asia

Latin

America Africa1st obj. 2nd obj. 3rd obj.

To a new activity because the

present one is on the decline 0.05 0.02 0.03 0.37 0.42 0.02 0.03 0.04

To a new activity to grow

beyond existing size 0.37 0.20 0.08 0.00 0.25 0.34 0.32 0.54

To even out cyclical effects

of a single industry 0.12 0.25 0.11 0.07 0.00 0.14 0.15 0.11

To follow similar moves

by major competitors 0.01 0.08 0.15 0.00 0.00 0.02 0.03 0.00

To acquire strong market positionin a new market before main

competitors 0.14 0.15 0.12 0.30 0.00 0.10 0.26 0.04

To benefit from complementarity

between two or more activities 0.18 0.11 0.16 0.03 0.33 0.22 0.20 0.12

Rational follow-up to previous

diversifications (e.g., utilise

knowledge gained) 0.08 0.07 0.05 0.18 0.00 0.08 0.00 0.11

To get closer to final consumers 0.02 0.11 0.15 0.00 0.00 0.07 0.00 0.00

To control the distribution of the

intermediate and/or final

products 0.00 0.00 0.12 0.03 0.00 0.00 0.00 0.00Total 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

1

Totals may not add up due to rounding errors.

2

Only the first objective reported for each diversification move.

Differences across the regions are not significant in one-way analysis of variance (ANOVA).


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their expansion. The economic reality faced by developing country firms in the past encour-aged this approach as it gave little incentives to develop branding and marketing. A deeply

unequal income distribution (notably in Latin America but also elsewhere in the developingworld) inhibited the development of consumer markets, and the heavy control of the govern-ment on the economies often meant that proximity to government officials was far more im-portant than proximity to customers. While many of the causes for this reality have changedin most developing countries, their firms still tend to neglect these aspects of their businessactivity (see also ahead). Furthermore, developing country firms have traditionally not beenactive in the consumer goods industries, and when they export their output, they seldom selldirectly to the final consumers, where such skills are in highest need.

4.2. The acquisition of new skills for the diversification

The analysis in Table 3 suggests that there are fundamental differences among the firmssurveyed in terms of their approach to the acquisition of the various skills needed for theirexpansion. Technological skills, and to a lesser extent managerial skills, were acquired forthe majority of the diversification moves, whereas marketing skills were acquired for a farsmaller portion of such moves. Also the mode of acquisition of these skills vary consider-ably. The most important mode to acquire managerial and marketing skills (to the extent thatthe latter are acquired) is via internal development, while technological skills are most likelyto be acquired externally.

As discussed above, developing country firms usually lack a proprietary technology, andhave tended to borrow technology that has already been commercialised by firms from othercountries. For example, no industry was established in South Korea even in the early 1990sfor which foreign technology was unavailable (Amsden and Hikino, 1994). R&D as a formalactivity has been undertaken by relatively few developing country firms, and to the extentthat such activities exist, they have taken the form of adoptive activities that in most caseswould not fall under an internationally accepted definition of R&D activities. In 1996, hightech stocks accounted for only 0.5% of stock market capitalisation in Southeast Asia, com-pared with 5% in Japan and 9% in the US (

The Economist

, 1996a). Our findings support the

tendency of developing country firms to acquire technology externally rather than to developit internally. The main routes for the acquisition of technology are agreements with foreignfirms or the acquisition of external resources, a pattern that is well established by previous

Table 3

Acquisition of new skills for the diversification (shares of all diversification moves)

Acquisition mode

Skills Acquisition

1

Internal

development

Via foreign

partnership

Hire/purchase

external resourcesTechnology 0.853 0.137 0.310 0.551

Management 0.705 0.833 0.166 0.000

Marketing 0.176 0.666 0.333 0.000

1

Shares of diversification moves in which new skills were acquired.


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research (see for example, Dahlman and Frischtak, 1993; Hou and Gee, 1993; Katz and Ber-covich, 1993; Jegathesan, 1997; Ungson et al., 1997; Vonurtas and Safioleas, 1997).

By contrast, when it comes to managerial and marketing skills, the firms surveyed relyheavily on internal resources. A Pakistani firm that did not agree to release its name reporteda clear policy according to which . . . wherever possible, internal [managerial] skills wereused. Only when they were lackingexternal skills were secured (questionnaire). Other re-sponses suggest that firms tend to believe that they have less need to acquire managerialskills and a better ability to develop them internally. A textile Hong Kong firm reported that . . . with all diversifications undertaken by the company, the core management team . . .has had the required skills and expertise . . . such that it was capable to make any prompt ad-

justment necessary . . . and to monitor effectively the day-to-day business (questionnaire).

This attitude towards managerial skills is, to a certain extent at least, an outcome of the ten-dency of developing country firms to be managed by family members, who often regard theacquisition of specific managerial skills as unnecessary.

4.3. The finance of the diversification

The firms surveyed finance the majority of their diversification moves by internal sourcesof finance (Table 4), a pattern that reflects the lack of appropriate domestic sources of exter-nal finance and difficulties in accessing foreign sources. There is, however, considerable re-gional variation in terms of the patterns of finance. Latin American firms rely mainly on in-

ternal sources of finance, a result of relatively undeveloped external sources. By contrast,Middle East firms have access to a more developed financial system both at home, due to awell-developed banking system (notably in some of the Gulf countries), and in the neigh-bouring countries. Indeed, they rely on internal sources of finance less than their counterpartsin other regions. The heavy reliance of Southeast Asian firms on external sources was re-ported also by other studies (Singh, 1995, 1996) and is attributed to the fast growth of thesefirms, whereas their investment demand has far outstripped their internal resources. In addi-tion, more than elsewhere in the developing world, firms in this region have enjoyed prefer-ential access to external sources of finance, made attractive by government subsidies.

To the extent that the firms surveyed use external resources, they rely mainly on thoseavailable in their home country. Under such circumstances, the availability of the latter is vi-tal for their ability to expand and was indeed cited as a major obstacle for the growth of firmsin the poorer developing countries (UNCTAD, 1993). Middle East firms are the exception inthis respect. They are better able to finance their diversification by capital raised abroad dueto strong financial ties between the countries in this region (notably the Gulf countries, towhich most Middle East firms in our sample belong), facilitated by various regional agree-ments. These ties and agreements give firms favourable access to capital outside their homecountry, notably in some of the well-developed stock markets in the region (such as those in

Bahrain, Amman) (Azzam, 1988; Wilson, 1994).With the exception of African firms (most of them are South African), the firms surveyeddisplay a preference for debt over equity capital, both in domestic markets and abroad. Athome this preference reflects the levels of development of the stock markets and the bankingsystems. In spite of considerable progress achieved lately, in many developing countries the


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stock markets remain small in relation to the size of the economies (The Economist, 1997b),providing only limited source of finance. This explains why Latin American firms finance arelatively small share of their diversification moves by finance raised on the stock markets.By contrast, South African firms use the more developed stock market in their country as amajor source to finance their expansion.

The patterns of fund raising have changed considerably over time. The relative importanceof internal finance has diminished consistently (most notably during the last decade) and sev-eral external sources of finance have taken its place. Notably there has been a considerableincrease in raising capital abroad. While foreign sources were not in use until the last decade,

17 and 9% of diversification moves undertaken during the last five years were financed bythese sourcesin the form of debt and equity, respectively. A major reason for these changesis the liberalisation of regulations related to capital raising at home and abroad. Financialmarkets were a main target of the interventionist policies of many developing country gov-ernments. Severe regulations of Latin American countries over their financial markets haveinhibited the development of the capital markets. In most East Asian countries (with the no-table exception of Hong Kong) governments have intervened extensively during the pastthree decades, treating financial institutions as tools of their industrial policy (see for exam-ple, Lee, 1992; Koike, 1993; Glen and Pinto, 1995). Furthermore, in many countries firms

could not borrow money from foreign banks without a special permission from the govern-ment, which thus controlled the allocation of both domestic and foreign capital. The liberali-sation of these rules (which is taking place in most developing countries albeit progressing atdifferent tempos) has changed the options available for firms and their subsequent use of var-ious sources to finance their expansion, as our findings show.

Table 4

Sources of finance for diversification, by region and over time

1

By region By diversification age

2

Financial source Asia

Middle

East

Southeast

Asia

Latin

America Africa

05

years

610

years

1120

years

20

years

Internal funds 0.43 0.21 0.37 0.56 0.50 0.35 0.47 0.55 0.56

Equity capital raised in the home country 0.11 0.07 0.12 0.16 0.26 0.08 0.16 0.15 0.18

Loan capital raised in the home country 0.23 0.25 0.32 0.19 0.20 0.29 0.20 0.15 0.25

Equity capital raised abroad 0.06 0.21 0.04 0.02 0.03 0.09 0.05 0.07 0.00

Loan capital raised abroad 0.12 0.25 0.14 0.04 0.00 0.17 0.09 0.07 0.00

Government support 0.04 0.00 0.00 0.02 0.00 0.02 0.02 0.00 0.00

Concessional finance from international

or regional organisations 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total

3

1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

1

Shares of all diversification moves in each region/age group that were financed by a particular source (finance

of 25% or more of the total funds needed for the diversification).

2

Years since implementation, measured from 1997.

3


Differences are significant at 0.1 across regions and are not significant over time. All test of significance were

conducted adding firm size as a control variable.


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4.4. The implementation of the diversification

Firms can diversify through mergers and/or acquisition or through internal growth, that is,the internal development of new business areas. The factors that affect their choice betweenthese profoundly different expansion modes are both external and internal to firms. Theformer includes forces such as signals and incentives from the capital markets (Markides,1995) or changes in competition laws and antitrust regulation. The latter relate to firmsattitudes towards risk and their expectations regarding the tempo and nature of theirgrowth.

The firms included in our survey display a strong preference for internal development (Ta-ble 5). Diversification via establishment of a new subsidiary or extension of an existing oneare by far the most common modalities used by the firms surveyed to enter into new areas of

activity. Additional support for this pattern is provided also by other studies. Forty-five andtwenty percent of the cases of expansion of South Korea chaebols in the first half of the1980s involved acquiring stocks and establishing new firms, respectively. Merging and ac-quiring management participation and business rights accounted for only 35% of all cases(Amsden, 1989). To a certain extent, the preference of developing country firms for organicgrowth is a result of financial constraints rather than a strategic choice, and it is related tolack of financial resources to acquire other firms, particularly foreign firms. In most devel-oped countries (notably the U.S.), the well-developed stock markets provide a main source tofinance growth by acquisitions. Similar sources are not available for firms in most develop-

ing countries, which leaves them with the option of internal growth as the main one.To the extent that the firms surveyed implemented their diversification moves by acquisi-

tion of other firms, they display a preference for firms in their own countries. Several firmsexplained this tendency by difficulties to merge with foreign firms with considerably differ-ent cultures and values. Pervez, Argentina suggests an example: . . . . the cultural changeneeded to adjust the values of new organisations to our own corporate philosophy, . . . theconfidence factor and the achievement of a culture which surpasses the mere adding of partshas been one of the biggest obstacles [for the acquisition of foreign firms] (questionnaire).Another major reason cited is the high cost of foreign firms. By contrast, most of the jointventure agreements are with foreign firms.

The preference of the firms surveyed for green-field establishment as the main modality toenter into new areas has diminished considerably during the last decades. While more thanhalf of the diversification moves undertaken 20 years ago or more were implemented via theestablishment of new subsidiaries, this modality accounts for only 23% of diversificationmoves implemented in the 1990s. The largest increase during this period was in joint ven-tures with foreign firms, which did not exist two decades ago and became a major way to di-versify in the 1990s. These nonequity agreements have become a wide spreading mechanismamong developing country firms to get access to technology and markets (Vonurtas and Safi-oleas, 1997).

4.5. The impact of government policies on the diversification

Governments have a whole array of policies that can affect the diversification behaviourof firms, ranging from firms preference for product diversification over other routes to


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growth (e.g., geographical diversification) to firms selection of one type of diversificationover others (such as vertical vs. horizontal diversification). Governments can also affect thedirection of diversification, by targeting specific industries.

Previous research on the diversification experience of developing countries suggests thatdiversification is unlikely to succeed if certain macroeconomic indicators are not in place.This has been illustrated by studies of the international organisations on this topic (see for ex-ample, UNCTAD, 1994, 1995a, 1995b, 1997; World Bank, 1990. These studies have soughtto illustrate that the activities of governments in areas such as infrastructure, access to rawmaterial, feasibility of marketing certain products, availability of financial resources are im-portant determinants of the capacity of firms to diversify. Many developing country govern-ments, however, notably those of some Asian and Latin American countries, have played amuch more active and direct role in affecting the nature and direction of the diversification of

their firms. These governments have actively encouraged the development of selected firmsoperating in many unrelated areas, by providing them with favoured conditions, such ascheap capital, access to foreign currency to import scarce materials, subsidised interest rates,tax exemptions, and preferential contracts for government projects. In most Asian and LatinAmerican countries, the larger diversified firms have close relationships with those in power

Table 5

Modalities to implement diversification moves, total and over time (number of diversification moves and shares of

all moves for an age group)

Diversification age

1

(shares)

Modalities

Diversifications

(n)

up to 5

years

610

years

1120

years

20

years

Establishment of new subsidiary to handle

the new area of activity 47 0.23 0.20 0.22 0.54

Extension of existing subsidiary or department

to deal also with the new activities 32 0.24 0.31 0.22 0.18

Acquisition of existing domestic firm to add to

your company to handle the new activity 27 0.18 0.12 0.44 0.09

Acquisition of existing foreign firm to add to

your company to handle the new activity 20 0.12 0.07 0.00 0.09

Joint venture with a domestic firm already

active in the new area/industry 3 0.04 0.03 0.00 0.09

Joint venture with a foreign firm already

active in the new area/industry 25 0.18 0.23 0.11 0.00

Nonequity agreement with a domestic firm

already active in the new area/industry 1 0.00 0.00 0.00 0.00

Nonequity agreement with a foreign firm

already active in the new area/industry 1 0.00 0.03 0.00 0.00

Total

2

156 1.00 1.00 1.00 1.00

1


2

Total does not add up to the total number of diversification moves reported due to missing observations. Total

shares may not add up due to rounding errors.

Differences are not significant in one-way analysis of variance (ANOVA).


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(Amsden, 1991, 1998; Koike, 1993; Ungson et al., 1997). Some have gone as far as to arguethat diversified firms in these countries have emerged mainly because of political connec-

tions (Jones and Sakong, 1980).Nonetheless, the analyses in Tables 6 illustrate that the majority of the firms surveyed con-

sider the policies of their governments to have no impact on their diversification activities,although there is a considerable variation among various policy tools, with some regarded tobe more influential then others. In light of the discussion so far, this is a most surprising find-ing. Several explanations, related to the characteristics of the firms surveyed, might be sug-gested for this finding. First, the support of governments has been confined to selected firmsthat were encouraged to diversify and grow large, but the majority of firms were not as priv-ileged and have diversified without such support. Second, it might be that our sample does

not represent firms from the countries whose governments pursued the most interventionistpolicies (for example, there are no South Korean firms in the sample). However, these expla-nations are partial at best, and if these findings can be verified on a larger sample, they sig-nify a considerable challenge to the common view regarding the impact of developing coun-try governments on the expansion of their firms.

African firms stand out as those that consider the policies of their governments to havemost impact on their diversification activities, but there is considerable variance among vari-ous policies. By contrast, Latin American firms regard government policies as having thesmallest impact on their expansion. Furthermore, firms in this region, far more than firms inany other region, expressed the view that government policies are the most critical obstacle

for the implementation of their diversification plans. An Argentinean petroleum and gascompany that did not agree to disclose its identity wrote: . . . the most serious problems as-sociated with the different diversifications were the constant political interference on the reg-ulation and law framework. . . . this implies a high uncertainty which makes our investmenthighly risky (questionnaire). Compania de Minas Buenaventura, Peru expressed a similarview: . . . political uncertaintylack of stable and rational rules of the game (e.g., inflationrunning at 7,000% a year in 1990)was most disturbing. . . . political, social, and economicscenarios must be stable and stimulating to promote investment (questionnaire).

Firms views of the impact of government policies on their diversification activities have

changed considerably over time. Certain policies were regarded as lacking any impact (or didnot exist) two decades ago, and have become considerably more influential since then. Thiscategory includes policies such as import-related incentives, technology incentives, assis-tance in identifying opportunities for diversification, and providing training for employees.Other policies, such as export and fiscal incentives, have become less influential over time.These developments are likely to reflect actual changes in the approach of many developingcountry governments towards the expansion of their firms and the subsequent tools used tofacilitate or inhibit particular directions of growth. Developing country governments have re-alised that their firms need to acquire certain skills (notably technology) and to upgrade the

capabilities of their labour to grow and diversity, and consequently they have increasinglyprovided assistance in the acquisition of these skills. Furthermore, the governments of mostdeveloping countries have changed considerably their approach towards trade policy over thelast two decades and have modified their policies accordingly. The changes in the perceptionof firms regarding the impact of particular policies over time reflect these developments.


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4.6. The sale of the output of the diversification

Domestic markets are by far the main markets in which the firms surveyed sell the outputof their diversification (Table 7). This implies that their diversification activities are under-taken primarily in response to demand in their home countries, with only limited attention toopportunities elsewhere. Asian firms rely more heavily on their domestic markets, while Af-rican as well as Southeast Asian firms sell smaller parts of the output of their diversificationdomestically. These differences are related to the size of domestic markets (firms based in

large home markets engage in international activity to a lesser extent than their counterpartsin smaller countries, regardless of their level of economic development) and to the ability offirms to compete successfully outside their home country. This ability is often related to pol-icies pursued by the governments of various developing countries, which encouraged the de-velopment of more inward or outward looking firms.

The overwhelming focus on the domestic market has diminished considerably over thelast two decades. Ninety percent of the output of diversification activities implemented 20years ago or more were sold domestically, while this share dropped to approximately 60% inthe last decade. Sales abroad have increased substantially during this period. This change re-

flects the improvement of the international competitiveness of developing country firms.One of the most severe consequences of the protectionist policies pursued by many develop-ing country governments (notably in the 1960s and 1970s, with some particularly slow to lib-eralise them in the coming decades) was that they prevented firms from competing interna-tionally and abolished foreign competition at home. Unable to compete internationally,

Table 6

The influence of government policies on firms diversification activities, by region and over time


1

Government policies Asia

Middle

East

Southeast

Asia

Latin

America Africa

Up to 5

years

610

years

1120

years

20

years

Financial incentives in money 0.80 0.80 .092 0.85 0.60 0.90 0.77 0.50 0.85

Financial incentives in kind 0.77 1.00 0.75 1.00 1.00 0.92 0.85 1.00 1.00

Export-related incentives 0.85 0.63 1.00 1.00 0.66 0.78 1.00 1.00 0.50

Import-related incentives 0.73 0.50 0.61 0.81 1.00 0.68 0.71 0.80 1.00

Fiscal incentives 0.71 0.77 0.66 0.94 0.38 0.74 0.84 0.80 0.50

Technology incentives 0.81 1.00 1.00 1.00 1.00 0.88 1.00 1.00 1.00

Assistance in identifying opportunities

for diversification 0.86 1.00 0.84 1.00 0.27 0.90 0.92 1.00 1.00

Facilities providing training

for employees 0.56 1.00 1.00 1.00 0.83 0.73 1.00 1.00 1.00

Shares of all diversification moves in each cell in which firms perceive the policies of their governments as

lacking any influence.

The impact of government policies were ranked on a scale as follows: 1, highly influential; 2, of moderate influ-

ence; 3, of no influence/does not exist. This is the response reported in the table above, expressed as share of total

responses for each cell.

Differences are significant at the 0.05 and 0.1 levels across regions and over time, respectively.

1



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133

firms expansion was confined to the opportunities provided by the domestic markets, as ourfindings demonstrate. This situation was particularly typical in Latin America (see Fleury

[1995] for description of the Brazilian economy) and in several Asi with the ability to utilizebundling strategies in the mature phase of the life cycle; 6. Longer life cycles removes priceas the primary driver in a companys marketing strategy enabling it to incorporate morevalue-added elements in its marketing and product strategies; 7. Longer life cycles tend toenable a firm to develop more customer focused service strategies; and 8. Longer life cyclesenable a firm to develop more cash cow opportunities for itself by being able to recoup all ofits research and devcreasingly important for them, as our findings demonstrate.

The well-known preference of developing country firms for export over FDI as the mainmodality to serve foreign markets is supported by our findings (with the exception of South-

east Asian firms). Developing country firms exhibit such preference because exports are lessrisky and require less familiarity with foreign markets compared with FDI. The more interna-tionally matured and experienced Southeast Asian firms are able to move parts of their pro-duction overseas and serve foreign markets also through local production facilities (seeUNCTAD-DTCI [1997] for a detailed description of this process). When exporting, the firmssurveyed display a preference for developing over developed country markets. Such prefer-ence is particularly notable in regions in which there are strong regional ties, such as theMiddle East and Latin America, and regional trade agreements facilitate exports to the neigh-bouring countries

5

.

Table 7

Markets in which firms sell the output of their diversification, by region and by industry


1

Markets Asia

Middle

East

Southeast

Asia

Latin

American Africa

Up to 5

years

610

years

1120

years

20

years

Domestic market 0.78 0.65 0.60 0.67 0.48 0.66 0.57 0.77 0.90

Foreign market via affiliate

2

0.07 0.15 0.33 0.05 0.08 0.08 0.16 0.07 0.00

Export to developing countries

3

0.08 0.20 0.03 0.20 0.26 0.17 0.16 0.15 0.10

Export to developed countries 0.07 0.00 0.03 0.07 0.17 0.08 0.11 0.15 0.00

Total

4

1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

Shares of all diversification moves in each region/industry which their output was sold in a particular market

(25% or more of total output).

Differences are significant at the 0.1 level across regions and are not significant over time.

1


2

Includes branch(s), subsidiary(ies), or joint venture(s) established in a foreign market.

3

All countries except Japan, Western European, and North American countries, which form the group of devel-

oped countries.

4


5

The findings do not reflect the heavy reliance of some firms in Latin America, notably Mexican firms, on the

U.S. market for their export, because firms from these countries are under-represented in the sample.


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5. Discussion

The findings of the survey and the discussion that followed point at several directions inwhich specific characteristics of countries/regions affect the intensity and nature of the diver-sification activities of firms. To test more systematically these hypothesised links, we use thecontextual analysis procedure (Cheng, 1994), which establishes a causal link between firmscharacteristics and specific attributes of their environment. The assumption underlying thisprocedure is that the societal context in which firms operate is a potential source of variationamong them. This procedure thus relates firms attributes as the dependent variable to char-acteristics of societal context, such as those pertaining to a countrys economic, legal, andpolitical structures, as predictors. These relationships are tested using cross-national settings.

The discussion thus far suggests several societal characteristics as the most influential on

the diversification activities of firms. These characteristics, the hypothesised impact on di-versification and their operation measures are presented in Table 8. We add two firm-levelpredictors: revenues and profitability (earning per share), that vary across firms. The depen-dent variable is the diversification intensity of individual firms, measured by the share of themain source of revenues in total revenues

6

. The results of a regression analysis estimatingthis model are presented in Table 8.

The findings of the analysis confirm most of our hypotheses regarding the impact of indi-vidual characteristics on the diversification of firms, and overall, the model has strong ex-planatory power for the variance in diversification intensity among them. With the exception

of capital market structure, all other societal characteristics are highly significant and relateto the dependent variable as hypothesised. This implies that the environment in which firmsoperate influence the intensity of their diversification activities. Recently, there has been agrowing interest in this topic, and there are few studies that emphasise this link (notablyKhanna and Palepu, 1997, 1998; Ghemawat and Khanna, 1998). These studies have soughtto illustrate by way of several case studies conducted in India and Chile the impact of thecharacteristics of developing countries on the diversification of firms. In particular they haveemphasised the institutional framework as a major country factor. Our study adds to this lit-erature by extending the scope of the country characteristics examined and by testing moresystematically for their impact.

In contrast to the opinion expressed by the firms surveyed, government incentives werefound to relate significantly and positively to the diversification intensity of firms. This find-ing is in line with arguments stressed by previous research regarding the critical role playedby developing country governments in this process (see Amsden, 1991, 1998; Koike, 1993;Ungson et al., 1997; Ghemawat and Khanna, 1998). These studies have shown, mostly byway of case studies and descriptive analyses, how governments affect, both directly and indi-rectly, the diversification propensity of their firms. The findings of the regression analysisprovide a more solid confirmation for this opinion.

6In the statistical analysis, the dependent variable is expressed as 1 the share of the largest business, to create

a measure that gets higher values the more diversified is the firm.


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L. Nachum/Journal of International Management 5 (1999) 115140 135

The low level of significance of capital market structure implies that the latter is a less im-portant determinant of the intensity of diversification. These findings are in line with thefindings of the survey regarding the mixed approaches to finance and the wide variation inthis respect across regions and countries. Such variation relates to the level of development

Table 8

The link between country characteristics and diversification intensity (hypotheses, operation measures and

regression statistics)

Predictors:

Societal

characteristics

Hypothesised impact on

diversification activity Operation measure(s)1Regression statistics

(t-values)

Domestic market

size

The small size of many developing countries

limits the growth potential within a firms

own industry and facilitates diversification

into other industries as a way to grow

GDP, Billion $ 0.00199 (2.45)*

Capital market

structure

The specific structure of capital markets

create constraints on diversification and a

tendency for internal finance

Domestic credit

provided by the

banking sector, % of

GDP (number of listeddomestic companies)

0.00130 (1.50)**

Risk and

uncertainty

Diversification has often been undertaken to

avoid the risk of relying on a single activity or

industry in economies subject to high

instability

Composite ICRG risk

rating20.01867 (5.51)*

Technological

capabilities

Limited technological capabilities derive

firms to diversify as a way to gain competitive

edge

High tech export, % of

total exports; number

of patent applications

filed by residents

***

Government

incentives

Developing country governments have

encouraged the diversification of firms inboth direct and indirect ways

Subsidies and other

current transfer, as %of total government

expenditure

0.0222 (3.22)*

Firm-level

characteristics

Control variables Revenues (earning per

share)

0.0000 (1.01)

General statistics n 44

Adj. R square: 0.689

Sig. F 0.000

1Regional averages were calculated for each variable. Share data were broken into the raw data to calculate

their averages. For example, the average for high tech export as percentage of total export was calculated as the

ratio between the averages of high tech export and total exports. The data is for 1997. In parentheses, variables ex-

cluded from the final model because they did not yield good statistics results. Intercept was removed as it dimin-

ished the overall explanatory power of the model as well as of individual variables.2The composite ICRG risk rating is an overall index calculated by the International Country Risk Guide

(ICRG). This index is based on 22 indicators of risk, grouped together into three major categories: political, financial,

and economic indicators, and ranges from 0 to 100. The lower the rating, the more risky is the country concerned.

*p-values0.0.

**p-value 0.14.

***Both variables were removed from the regression due to high correlation with the other predictors.

Source of societal data: World Bank (1999).


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136 L. Nachum/Journal of International Management 5 (1999) 115140

of domestic finance options, to regulations related to finance raising domestically andabroad. Consequently, the structure of domestic capital markets affect differently firms in

different regions, a situation that is reflected in the findings of the regression.Previous research has paid limited, if any, attention to the effect of market size on the di-

versification of firms. The argument here is that when firms operate only or mainly domesti-cally, smaller domestic markets facilitate diversification, as they restrict growth optionswithin a single industry. Our findings provide strong support for this link. They also confirmthe strong and negative impact of risk and uncertainty on the diversification of firms.

6. Concluding remarks

This study sought to examine the strategic behaviour of developing country firms thathave diversified from commodities and to identify the salient patterns of their behaviour. Itwas based on responses of 44 developing country firms to a mailed questionnaire in whichthey reported on their experience in 163 diversification moves. The various analyses con-ducted in the article highlight the variety of objectives that drive the expansion of thesefirms, as well as the strategies and modalities undertaken to implement them. To a large ex-tent, this variety could be attributed to specific characteristics of regions, such as the size ofdomestic markets, the existence of regional economic ties, the development of the financialsystem, which influence the particular characteristics of the diversification activities of firms.

Notable among these is the role played by governments in different regions. This role is be-coming more apparent in the longitudinal analyses, which illustrate considerable changes inthe diversification activities of the firms studied over time, many of them are influenced bychanges in government policies, particularly those related to the liberalisation of markets andthe financial systems. Indeed, a regression analysis conducted to test these links more sys-tematically has shown that the societal environment in which firms operate exercise strongimpact on their diversification activities. Most societal characteristics were found to behighly significant, and they explain a large portion of the variance in the intensity of diversi-fication among the firms included in the survey. It remains for future research to explore fur-

ther the behaviour of developing country diversified firms, to reach a better understanding ofthe reasons for their existence, and why they have evolved into such a critical factor in lateindustrialising countries. Large diversified firms were shown to play a dominant role in theindustrialisation of developed countries (Chandler, 1990). Do they have the potential to playa role just as vital in the economic development of the developing countries, and what, ifanything, governments should do to facilitate such developments? Why is it that firms basedin countries at similar levels of development diversify in a considerably different manner,and which of these different routes is more desirable for their home country? A better under-standing of these issues will hopefully allow progress in the development of a theory of di-

versification of developing country firms, as part of a more general theory of the strategic be-haviour of these firms. The recent financial crises in Asia seem to suggest a great need for abetter understanding of such issues.

Another task left for future research is to examine the diversification behaviour of devel-oping country firms that have originated from industries other than commodities. While this


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is the most common route for diversification in most developing countries, it is by no meansthe only one. For example, several of South Koreas largest chaebols have diversified from

service activities (Ungson et al., 1997). The experience of firms diversifying from and withinmanufacturing and services might be different from the experience of firms diversifyingfrom commodities. The latter may exhibit greater tendency for forward vertical diversifica-tion to control the distribution, while they are unlikely to diversify vertically backward. Theyare also more likely, particularly nowadays, to diversify away from commodities and into ar-eas unrelated to their core activity, to even out cyclical trends typical to this sector. Such dif-ferences may affect the configuration of the country attributes that influence the diversifica-tion of firms and require additional research that will address them.

Finally, the small size of the sample limits the validity of the findings, which should there-

fore be taken as no more than an indication for order of magnitude and directions of trends,rather than a solid proof of reality. We have chosen deliberately to cover firms from all de-veloping countries. This choice allowed us to detect differences among them, but often at theinevitable cost of the depth of the analysis for individual regions and countries. It is our mod-est hope that the lessons that emerged from this study provide a justification for this ap-proach.

Acknowledgments

This article is derived from a research originally prepared for the Division of InternationalTrade in Goods, Services and Commodities of UNCTAD. UNCTADs sponsorship of theoriginal research is highly acknowledged. I wish to thank Drs. Sue Tang and Mehmet Arda,UNCTAD, for useful comments on earlier drafts. I would also like to acknowledge most con-structive and illuminating comments of an anonymous referee.

References

Amsden, A., 1989. Asias next giant: South Korea and late industrialisation. Oxford University Press, New York

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