The Performance Effects of Service Diversification by Manufacturing Firms

Abstract

Much diversification research has focused on related versus unrelated diversification and the benefits of each (e.g., Hoskisson and Hitt, 1990; Ramanujam and Veraderajan, 1989). Firms pursuing unrelated diversification attempt to reduce business risk (e.g., Amit and Wernerfelt, 1988) and systematic risk (e.g., Barton, 1988; Montgomery and Singh, 1984), creating a structure where each company in the corporate portfolio has access to internal capital. On the other hand, firms pursuing related diversification attempt to leverage competencies across multiple businesses (Prahalad and Hamel, 1990; Robbins and Wiersema, 1995; Snow and Hrebiniak, 1980). Though the tactics of these two diversification strategies are different, at a general level each is an attempt to exploit market inefficiencies. For example, successful unrelated diversification may occur when strategic business units (SBUs) acquire capital more efficiently from the parent corporation than from the market (e.g., Williamson, 1975). Likewise, successful related diversification may occur when firms leverage resources that competing organizations cannot imitate or duplicate (e.g., Argyres, 1996). In sum, diversification is an attempt to create and capitalize on inefficiencies surrounding certain market transactions. One type of transaction that is characterized by innate market inefficiencies involves the delivery of services. Scholars have identified two aspects that are often associated with the production and delivery of services (e.g., Mills, 1986; Normann, 1984). The first is intangibility (Kotler, 1983). While manufacturing firms produce tangible products, most services cannot be seen or touched. This gives rise to information asymmetry, where customers may have difficulty evaluating the quality of service output. This can reduce a customer's ability to make comparisons among competing services (Chase and Bowen, 1989). Second, customers typically participate in the production of a service (Mills, 1986; Skaggs and Huffman, 2003; Skaggs and Youndt, 2004). In most manufacturing environments, products are produced, inventoried, shipped, and then sold to customers; production and consumption occur at different times and often at different locations. However, the simultaneous nature of production and consumption in services requires customers to interact with the firm in order to receive the service (Chase and Bowen, 1989; Mills, 1986; Normann, 1984). Together, these two unique aspects of services (intangibility and customer involvement in the service production process) have been theorized to create market inefficiencies by constraining competitive forces. For example, Nayyar (1990) suggests that information asymmetry in services acts as a switching cost for customers. Because of the inherent difficulty in making comparisons of service output among competing firms, customers are more likely to stay with their current firm. Furthermore, customer participation in service production can act to limit the scope of the competitive arena, since services typically cannot be produced and then sold elsewhere (Mills, 1986; Normann, 1984). Given that successful diversification involves the creation and/or exploitation of market inefficiencies and that, unlike goods, services have innate characteristics that can create these inefficiencies, it is possible that firms producing both goods and services may have an advantage over those that are strictly manufacturing oriented. However, there is little to no research examining this issue. This is somewhat surprising given the dominance of services in the U.S. economy and the fact that many manufacturers are beginning to add service components. To that end, this study represents an initial investigation into whether, at a general level, diversification into services by manufacturers yields higher and more stable performance. Because this topic has received such little research attention, we view this as an exploratory study. …