The previous chapter concentrated on the strategic effects of integrating vertically related activities in a single organization. We turn now to consider the consequences of lateral growth, or diversification.

Diversification occurs whenever a firm combines two or more activities which are not vertically related to each other, although they may both use the same inputs or be sold through the same outlets. Diversified companies therefore have more than one product line on offer to potential customers, and would normally be found operating in two or more different industries. The definition of industry which is appropriate for this purpose has long plagued economists and statisticians. Clearly, diversification must imply that the firm is taking on different activities, but just how different is different?

Statistical measurement generally relies on data obtained from the Censuses of Production and classsified in accordance with the Standard Industrial Classification (S.I.C.). Different activities within manufacturing industry may be classified into 15 industrial orders, or into 120 or so “three digit” industries, or if data were available, into an even larger number of product groups. (For further details, see Shaw and Sutton 1976, Chap. 1, or Utton 1977, pp. 97–9).

Clearly a very fine classification scheme identifying a large number of industries might suggest a higher level of diversification than would a coarser classification, because individual firms would appear to offer more product lines in the former case. But the appearance could be misleading.