Executives are always looking for ways to expand their businesses, and diversification is one approach they regularly ask about. The answer is always unambiguous: diversifying, in itself, is neither good nor bad; what matters is whether a company can add value. Although more than 70 percent of large companies around the world already operate in more than two industries, our research finds that creating value through diversification is a lot easier in emerging economies than in developed ones.
In fact, when we compared the returns of more than 4,500 companies around the world1 with their level of diversification,2 we found that in emerging economies, the most diversified companies created the highest excess returns, 3.6 percent, compared with –2.7 percent for pure players (Exhibit 1). By contrast, in developed economies, we uncovered almost no difference in excess TRS for any degree of focus or diversification.
As we so often find, cause and effect are not clear. However, underlying market and ownership structures could play a role. For instance, the fierce competition for capital in developed economies probably ensures that market dynamics allocate resources to the best owners, so diversification without cash synergies across businesses confers little or no advantage. In contrast, many diversified companies in emerging economies are family owned or controlled, which can ensure opportunities to reinvest, better access to local and regional governments or to regulatory insights, and the ability to attract talent (Exhibit 2). That translates into higher revenues, profits, and returns to shareholders.