Diversification does not always mean big bucks

by Vivek Kaul & Nikhil Lohade

“Coffee isn’t my cup of tea,” Samuel Goldwyn once remarked. Ganesh Sharma might not agree with this. He liked having his freshly brewed filter coffee, first thing in the morning, with his business newspapers.
The newspapers today talked about a leading business family getting into a new area of business. “This step, in the long-term, will lead to increasing shareholder value,” the chairman had remarked. Sharma could see history repeating itself. The family- owned business enterprises (FOBEs) in India have always lacked focus. Most of them are heavily diversified. The managing agency system that prevailed during the Raj days is responsible for this disease. In a managing agency system, a single management is responsible for various businesses like cement, tea and so on. A typical British company in India was usually a managing agency, which raised money in England and invested it in a large number of businesses in India. This agency became a model for Indian businessmen.

As Gurucharan Das points out in his book, India Unbound, “Since a businessman did not decide what he should produce and depended on what licences were available, there was a made scramble for these, and business houses ended up producing all kinds of unrelated products.” Further, as the new generations get involved, the male scions want independent businesses. This leads to an FOBE diversifying into unrelated areas to some extent as well. But the main reason for diversification, then and now, remains the addiction of Indian business with size.
As Debashis Basu points out in his book, Face Value, “So the moment they were through with planning for one project, they were ready with another. And the moment they achieved a respectable size in one business, they wanted to become big in another.”

In most cases, companies try and get into a new business when the markets are booming. This is a time when raising money for a new business is relatively easy. Thus, companies plan a big leap from the current operations, which rarely pays off. Further, companies rarely have several successful businesses under one umbrella. If one business does well, another pulls down the profits. A good example is Grasim. Grasim is into four major areas — viscose staple fibre (VSF), sponge iron, cement and chemicals. Grasim’s results for the quarter ending December 2005 were similar to the quarter ending September 2005. The bad performance of the company’s sponge iron and VSF divisions hit group profits.

Stockmarket data seems to suggest that it rewards companies which have a certain business focus. The 10th Motilal Oswal Wealth Creation study for 2000-05 clearly indicates that during the period, of the top wealth creating companies, diversified companies formed only 3%. This has largely been the trend since the survey was first carried out in 1992-97. As the study points out, “The participation of diversified companies in wealth creation remains limited”.
Another example is the recent demerger of RIL. One reason why the stockmarket was positive about it was the fact that the demerger will bring greater focus to the residual entities.
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