The Economist's Buttonwood blog has an interesting post on the way firms are using globalization to achieve intra-firm diversification:
Spread your bets, and you will not be exposed to a sudden collapse in a single company, sector of economy. But for equity investors the task is getting harder and harder. International markets seem to be increasingly correlated.
In part, this may be down to the diversification process itself.... But it may also be that companies have diversified themselves. ... So, for example, Canadian companies get 11.5% of their revenues from Europe; UK companies get 20% of their revenues from emerging markets.
Buttonwood theorizes that this may be efficient:
The ability of companies to diversify their sources of production means they can control their costs. That may explain why profit margins are so high. Of course, this does not seem quite such a wonderful thing if you are a worker in the West.
But I wonder. It calls to mind the last great movement for intra-firm diversification; namely, the conglomerate phenomenon.
Around the middle of the 20th Century, the idea grew up that good managers could manage anything. This view was operationalized via conglomerate mergers, in which companies intentionally sought to diversify their product lines and business activities horizontally across a wide array of unrelated businesses. The theory was that a cyclical manufacturer could buy a noncyclical business, making the combined company stronger because some division would always be doing well. Diversification necessarily reduces the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well. To be sure, diversification reduced the conglomerate's exposure to unsystematic risk. But so what? Investors can diversify their portfolios more cheaply than can a company, not least because the investor need not pay a control premium. Management of a conglomerate may be better off, because their employer is subject to less risk, but the empirical evidence is compelling that intra firm diversification reduces shareholder wealth. The self correcting nature of free markets is demonstrated by what happened next: during the 1980s there was a wave of so called "bust up" takeovers in which conglomerates were acquired and broken up into their constituent pieces, which were then sold off. The process resulted in a sort of reverse synergy: the whole was worth less than the sum of its parts.
Granted, diversification across national economies differs from diversification across economic sectors. It may be the case that the former produces synergies and cost savings that the latter does not.
It probably remains the case, however, that investors can diversify their portfolios across borders more cheaply than can firms. There are a plethora of low-cost global and international index mutual funds and ETFs out there.
All of which argues that managers need to make the case that they really are achieving economic profits by diversifying globally instead of simply spreading their bets by putting their eggs in multiple baskets. If the latter is all they're doing, the lesson of the conglomerate era is that they'd be better off leaving it to investors (and that we need an viable market for corporate control to punish those who don't).
