Five years ago, Reliance Industries Ltd (RIL) was a zero-debt company sitting on cash reserves of nearly $20 billion. The core business of the oil-to-plastics company was growing on the back of robust refining margins. Why would such a company go out and stake ₹ 1.34 trillion ($15 billion) on a new business, one in which there are strong incumbents with entrenched positions and in which the average margins are in decline?

It has been six years since RIL started buying spectrum, initially through a 95% stake in Infotel Broadband. Since then the company has been diverting more and more investments in that space with the result that following its launch, it now faces the formidable challenge of garnering 75-80 million subscribers, who spend an average of ₹ 180 a month on mobile bills, over the next 2-3 years to hit break-even.

It isn’t going to be an easy task, made tougher by the fact that there is little evidence to show that such huge diversifications lead to success. In fact, there is overwhelming research to show that most diversifications lead to a dilution in profitability and over time the new businesses themselves become unviable and have to be divested or just shut down. Which is why conglomerates, whose numbers have been on the decline in developed economies, have consistently underperformed the more focused firms and in most mergers and acquisitions, experts apply what is called a “conglomerate discount" to such diversified corporations.

These insights, however, relate to highly developed markets. In developing economies, conglomerates are actually the norm, thanks to their access to capital, their strong networks and the ability to cross fertilize businesses.

All of those conditions hold good for RIL. Coupled with that has been the need for the company to de-risk its existing business which for all its virtues, was germinated nearly 40 years ago. As Mint reported in an earlier story, over the last seven years, RIL shares have been stagnating, even while the CNX 500 index has nearly doubled. It has already made one large diversification, into retail, though it is largely missing from e-commerce, the fastest growing segment of that business.

Its move into telecom is then fraught with some risk. Not that it is such a bad thing. Eventually, all companies have to take risks in business to enhance shareholder value. Those that don’t, run the risk of finding the ground vanishing from beneath their feet, when major disruptions change the business space they are in. It has happened to such marque names as Research in Motion whose Blackberry phones were once the toast of the business world. In India there is the example of Hindustan Motors Ltd, once the dominant auto company in the country, which ceased operations two years back.

Also Read: Reliance Jio sets the cat among the pigeons

Done right, diversifications have been known to pay off. General Electric Co. started by making incandescent lamps and went on to operate in nearly 700 product markets, mostly with great success. Walt Disney Co. has also diversified in similar fashion, from its core animation business into theme parks, cruise lines, resorts, TV broadcasting, and retailing. In India, ITC Ltd is a great example of a conglomerate which started as a cigarettes maker and has since expanded to hotels, paper and packaging, agri-business and lately foods including chocolates and coffee.

On the flip side there’s a company like Unitech once considered among the best builders in north India with a reputation for high-quality residential and commercial construction, whose ill-advised move into telecom has been a disaster for the group. Even global heavyweight Coca-Cola Co. which decided in the early 1980s to get into the wine business by way of acquisitions, quickly found out that lacking in the critical knowledge needed for the business, it had no clear right to win and exited that business.

Of course, just as there is risk in diversifications, companies focused on a single business are equally vulnerable to market risks. In 2002, Ford Motor Co. had to take a $952 million write-down on its stockpile of palladium (which is used in catalytic converters that scrub fumes from car emissions) when prices of the industrial metal in the international market crashed.

Risk, then, is a part and parcel of business and RIL, like many other Indian groups, is trying to mitigate that by having its footprint in businesses at various stages of maturity and growth. Through the 90s, as the winds of liberalization presented opportunities to traditional Indian businesses as well as newbies, there was a scramble for entry in new business areas, with little concern for complementary strengths. Strangely, it was also a period when Indian businessmen claimed to be deeply influenced by the foremost management guru of the era. While in the West, it was the 1982 publication of In Search of Excellence by Tom Peters and Robert Waterman that convinced companies to focus on their strength, and do only what they do best, in India it was management guru C.K. Prahalad who first articulated the idea of core competence of an organization, arguing that companies should stick to their knitting. While many Indian business leaders claimed to have been influenced by his thinking, very few followed his advice. One large conglomerate, in fact, argued that its core competence was making money!

The problem is that even while it launches itself into the telecom space, Reliance Jio needs to create something unique on a sustainable basis. Otherwise even if it does manage to build a competitive advantage, as long as competitors can catch up and imitate its customer offerings, the advantage will be short-lived.

Also Read: Reliance Jio’s entry will impact voice revenues of other telcos: Analysts

Sundeep Khanna is a consulting editor at Mint and oversees the newsroom’s corporate coverage. The Corporate Outsider will look at current issues and trends in the corporate sector every week.

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