Diversify your food business with synergy

Creating new products and entering new businesses brings opportunities and threats, but the key to success is synergy, which comes from economies of scope, market power and unrelated diversification.

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Businesses diversify when they launch new products or enter new markets. This can be developed internally to the firm or externally, by buying another company. Diversification can increase sales, build relationships with desirable customers, and open new competitive landscapes. However, diversification always entails risk because it moves away from what is tried and true.

Strategic decisions by Quaker Oats, a grain-based foods company, are an example of the risks and rewards of diversification. In 1983, it diversified into the sports drink business by buying the Gatorade brand for $230M, as explored in the article, “Pepsi Bought Quaker. Now What?” for Forbes. Quaker Oats followed this up in 1993 by buying Snapple for $1.7B. According to James F. Peltz in the article, “Quaker-Snapple: $1.4 Billion Is Down the Drain,” for the LA Times, Snapple was resold just 27 months later, at a $1.4B loss. Gatorade, meanwhile, grew to $2B a year in sales by 2001. Why the divergent fates? It’s a matter of synergy.

Synergy in business refers to a company being more valuable than its individual parts. It’s the proverbial reasoning of two plus two equaling five. Quaker Oat’s acquisition of Gatorade made both businesses individually more profitable because they were part of the same business unit. Synergy comes from economies of scope, market power and unrelated diversification. Let’s explore these types of diversification before returning to the Quaker Oats example.

Economies of scope

Economies of scope emerge when a business shares activities and core competencies efficiently across its operations. According to the “Strategic Management: Text and Cases, 10th Edition” textbook by Dess et al, a prime example of shared core competency is 3M. The firm, known for products like Post-it® Notes, has deep expertise in adhesive technologies. 3M innovates products from this core competence to sustainably compete in widely different industries like construction, telecommunications and automotive. All their products tie to an unbeatable advantage in adhesives.

Economies of scope also emerge from shared activities. This synergy emerges when manufacturing, distribution or sales are shared more efficiently across business units. Let’s take a hypothetical sauce company that bought a rival as an example. The firm cuts costs by producing all sauce in one kitchen using the same equipment. It distributes all products to the same stores at once and its sales team manages the same grocery accounts. Therefore, operating costs for this collective sauce company are lower than if each company were separate. All their products share activities, increasing synergy.   

Market power

Market power emerges when a business can use its size to increase efficiencies and reduce costs. This can come from pooled negotiating power. ConAgra, for example, is a diversified food processer that creates products like Slim Jim and Orville Redenbacher. According to Dess et al, the firm lowers packaging costs for individual brands by pooling all purchases together. ConAgra derives cost savings from bulk purchasing and increased negotiating power.  

Market power also comes from vertical integration. This is when a business becomes its own supplier or its own retailer. Kroger, for example, has moved up in its supply chain by producing its own milk on its own farms. According to Rob Dongoski in an article for Ernst & Young, 40% of the milk sales at Kroger is produced in house and sold under a private label brand. This vertical integration cuts out wholesalers and creates efficiencies to save the firm money.

Unrelated diversification

Unrelated diversification, unlike above examples, doesn’t derive synergy from horizontal relationships between business units. Synergy here comes from the vertical relationships between the corporate office and business units. The corporate office creates synergy by improving strategy or restructuring a business unit. Corporations are largely the only entities that engage in this type of diversification. One example of this diversification is the Clorox Company. According to Dess et al, the company bought Burt’s Bees for $942M in 2007. Clorox can increase profitability there through its operational expertise, market relationships with mass retailers and via more efficient resource allocation.

Quaker Oats–Snapple example

Now that we’ve learned about multiple ways of diversification, let’s return to our example and explore why the Snapple acquisition may have failed. Limited economies of scope are one reason. Gatorade is in the sports drink segment, while Snapple is in the alternative beverage space. Customers and usage occasions are quite different. According to Dess et al, Quaker Oats struggled to apply their core competence in marketing strategy to the Snapple brand. Shared activities were limited as well. Gatorade was bought largely in bulk at grocery stores. Snapple, however, was generally bought individually at gas stations and convenience stores. Snapple never took well to sales in grocery stores, which decreased synergy in the shared activities of distribution and in-store marketing.

Quaker Oats was helped by market power. Snapple benefited to some extent from lower ingredient and packaging costs through bulk purchasing. However, the market changed to offset this benefit. Soft drink category sales slowed. At the same time, rivals like Coca Cola and Pepsi launched more competing products.

In this example, we saw a large corporation buy two comparable companies over a similar timeframe. One was a huge success, the other a big failure. This is not particularly surprising. In fact, according to Dess et al, big, well-known U.S. companies often sell more of their acquisitions than they retain. These case studies are potent reminders that any diversification must align with strategy and be implemented carefully to be successful.

MSU Product Center

Diversifying a food business brings rewards and potential challenges. In making this strategic decision, consider partnering with Michigan State University (MSU) Extension’s Product Center. The MSU Product Center is an organization that brings together on-campus expertise in the sectors of food, agriculture, and natural resources to help entrepreneurs define and launch innovative products. Field-based innovation counselors advise entrepreneurs on business planning, regulatory requirements, and product development needs. To access business development assistance, select the request counseling tab on the MSU Product Center website or call 517-432-8750.

Reference to commercial products or trade names does not imply endorsement by Michigan State University Extension or bias against those not mentioned. Information presented here does not supersede the product directions.

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