In Winner-Take-All Markets, Diversification Is a Liability

The business world has long championed flexibility as a corporate advantage. Diversified firms’ ability to redeploy resources efficiently across businesses can give them an important advantage over non-diversified rivals. When one market stumbles, they could shift capital and talent to better-performing areas of the conglomerate—and do the reverse when developing a new market. This flexibility, the thinking goes, creates value that standalone firms cannot match. When Google launched Google Plus, its answer to Facebook, in 2011, the tech giant possessed more resources, technical expertise, and market reach. Facebook, by contrast, was focused on social media. What happened next? Mark Zuckerberg declared all-out war and devoted the next year to crushing Google’s efforts. By 2014, Google had retreated, redeploying its teams to Android and other ventures. Facebook’s focused commitment had defeated Google’s superior resources. A new paper we published in the Academy of Management Review shows that under intense competitive conditions, the very flexibility that appears advantageous may signal weakness to rivals. This can trigger a do-or-die aggressive response that dooms the diversified player. Our findings can help firms, venture capitalists, entrepreneurs, and corporate strategists make the right decision about whether to enter markets—and when not to. The Commitment Paradox The crux of the matter is commitment. When famed Chinese military strategist Sun Tzu advised armies to burn their ships upon landing in enemy territory, the logic was brutal: Eliminating retreat options signals to the enemy that the invading forces will literally fight to death. Non-diversified firms operate under similar constraints. When social media was Facebook’s entire business, co-existence with Google Plus was inconceivable. Google, by contrast, could redeploy its engineers to its search business, Gmail, YouTube, and Android. Both companies knew this, as did the market, a point which media commentaries observed with gusto. This laser-like focus also helps explain how ASML conquered the lithography market from diversified Nikon in the 1990s, going on to become the leading supplier of machines that make advanced semiconductor chips crucial to the AI revolution. Previous research on the topic similarly found that in concentrated chemical markets, single-product firms consistently outlasted diversified competitors. And when Uber battled DiDi in China, Grab in Southeast Asia, and Yandex in Russia, its diversified portfolio became a liability. Local rivals, committed to defending home markets, outspent and outlasted the American giant. DiDi, for one, spent 40 million yuan to attract customers to its ride-hailing service. Cofounder Wang Gang said the company “was prepared to keep bleeding subsidies for a few years” if Uber had not caved and exited China. Uber eventually sold out in all three regions and redeployed its resources to India, the Middle East, and Africa. Where Flexibility Works—and Where It Fails We found that corporate advantage from the ability to redeploy resources grows with competition until a certain threshold, where it falls off a cliff. At low competitive intensity, which tends to characterize industries with high product differentiation like machinery or industrial equipment, the ability to redeploy resources provides modest benefits. Diversified firms can exploit growth opportunities slightly faster than focused rivals. See more HBR charts in Data & Visuals In moderately competitive industries, such as fast-moving consumer goods, the flexibility advantage derived from resource redeployability rises dramatically. Here, diversified players invest aggressively, deterring the focused rival from matching that commitment. This dynamic stems from the diversified firm’s superior expansion capabilities, not its retreat options. But in winner-takes-all markets, the relationship between competitiveness and redeployability flips. Such sectors, which include tech, feature low product differentiation or large investment requirements. Diversified firms that enter these markets often have to confront determined do-or-die incumbents, who invest aggressively to gain or maintain market dominance. This pattern explains otherwise puzzling corporate failures, like those of Google Plus and Uber. It clarifies why diversified firms struggle in commodity markets and certain technology segments despite superior resources. The commitment disadvantage overwhelms the flexibility advantage. Boundary Conditions Matter Apart from the intensity of competition, we investigated three further factors that determine whether diversification is a boon or bane to corporate advantage: uncertainty, resource costs, and synergy. Higher uncertainty about whether investments will lead to profits increases the value of flexibility across the board. When market trajectories are unpredictable, the option to redeploy resources becomes more valuable, though intense competition still eventually erodes this advantage. Resource costs also matter significantly. In markets requiring substantial sunk investments such as technology, high barriers to entry paradoxically favor focused firms by amplifying the credibility of their commitment. Conversely, if resources can be acquired efficiently externally, internal flexibility matters less—and the commitment disadvantage sets in sooner. Finally, synergies—the ability to share resources simultaneously across businesses—operate differently from redeployability. Synergies create value at all competitive intensities because they don’t compromise commitment. A brand or patent used across multiple product lines doesn’t signal potential retreat. Diversified firms combining both synergies and redeployability enjoy the strongest competitive position. Rethinking Corporate Advantage Our findings are relevant to firms of all sizes—certainly large and diversified corporations, which should be careful entering highly competitive winner-takes-all businesses, but also focused companies looking to diversify in other markets. In the same vein, for venture capitalists and entrepreneurs, these winner-take-all markets might be easier to capture than currently thought, although admittedly the bar remains high. Facebook, fighting with their back against the wall, was more credible than Google simply because they did not have any retreat options. That said, our findings are mostly relevant at the corporate strategy level (for example, regarding the decision to enter markets or not). Current frameworks for diversification focus largely on whether a company has synergies with a new industry they want to enter: Can you serve customers better and/or at lower costs than competitors? Based on our research, companies or venture capitalists entering new businesses should ask themselves two more important questions: Can you ramp up your resource/market position faster than competitors? This is particularly important in markets with medium competitive intensity: The rivalry will be fairly strong but not winner-takes-all. In such cases, being able to ramp up faster than competitors is crucial, because once you’ve established a strong market position, this will deter competitors from entering. Can you credibly commit to defend your resource/market position, whatever it takes? This matters in markets with high competitive intensity: There will (likely) be a winner who takes all. By establishing OpenAI as a legally separate entity, Microsoft created credible commitment to AI competition. OpenAI’s engineers cannot easily be redeployed to other Microsoft businesses. The structural separation signals your determination convincingly. More broadly, market characteristics should also guide diversification decisions. Our study found that industries with low product differentiation and high sunk costs, such as transportation (airlines, rail, shipping), mining, and oil and gas, typically favor focused competitors. More differentiated markets, including fast-moving consumer goods and pharmaceuticals, better accommodate diversified players. Industry evolution matters as well. Our study also found that markets often begin with high product differentiation before standardization, imitation, and converging consumer preferences drive increasing competitive intensity. Diversified firms dominating early stages may face mounting pressure as markets mature. Activist investors pushing for companies to be broken up sometimes have a point: the company really may be worth more as separate pieces. . . . Business literature celebrates adaptive organizations, dynamic capabilities, and organizational agility. These qualities undoubtedly matter, but flexibility carries underestimated costs that cannot be solved through better management. Wise is the corporate strategist who understands which competitive conditions favor flexibility and commitment, and has the discipline to choose accordingly, even when that means forgoing attractive opportunities or constraining otherwise valuable capabilities.

In Winner-Take-All Markets, Diversification Is a Liability

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