W O R L D V I E W

Seen as dinosaurs in tbe West conglomerates can still add value in other contexts.

Why Focused Strategies\la\ lie W 1011" lor"

Emerging Markets

Core competencies and focus arenow tbe mantras of corporate strate-gists in Western economies. Butwhile managers in the West havedismantled many conglomeratesassembled in the 1960s and 1970s,the large, diversified business groupremains the dominant form of enter-prise tbroughout most emergingmarkets. Some groups operate asholding companies with full owner-ship in many enterprises, others arecollections of publicly traded com-panies, but all have some degree ofcentral control.

As emerging markets open up toglobal competition, consultants and.foreign investors are increasinglypressuring these groups to conformto Western practice by scaling backthe scope of their business activities.The conglomerate is the dinosaur oforganizational design, they argue,too unwieldy and slow to compete intoday's fast-paced markets. Alreadya number of executives have decidedto break up their groups in order toshow that they are focusing on onlya few core businesses.

There are reasons to worry aboutthis .trend. Focus is good advice InNew York or London, but somethingimportant gets lost in translationwhen that advice is given to groupsin emerging markets. Western com-panies take for granted a range of

byTarun Khanna and Krishna Palepu

I institutions that support their busi-ness activities, but many of these in-stitutions are absent in other regionsof the world. (See tbe insert "WhatIs an Emerging Market?") Withouteffective securities regulation andventure capital firms, for example,focused companies may be unable toraise adequate financing; and with-out strong educational institutions,they will struggle to hire skilled em-ployees. Communicating with cus-tomers is difficult when the localinfrastructure is poor, and unpre-dictable government behavior canstymie any operation. Although a fo-cused strategy may enable a com-pany to perform a few activitieswell, companies in emerging marketsmust take responsibility for a widerange of functions in order to dobusiness effectively.

As a result, companies must adapttheir strategies to fit their institu-tional context-^ country's product,capital, and labor markets; its regu-latory system; and its mechanismsfor enforcing contracts. Unlike ad-vanced economies, emerging mar-kets suffer from weak institutionsin all or most of tbese areas. (See tbetable "How Institutional ContextDrives Strategy.") It is this differ-ence in institutional context thatexplains the success of large, diver-sified corporations in developing

economies such as Indonesia andIndia and their failure in advancedeconomies such as the United Statesand the United Kingdom.

In our research, we have foundthat highly diversified businessgroups can be particularly well suit-ed to tbe institutional context inmost developing countries. From thechaebols of Korea to the businesshouses of India to tbe grupos of LatinAmerica, conglomerates can add val-ue by imitating the functions of sev-eral institutions that are presentonly in advanced economies. Suc-cessful groups effectively mediatebetween their member companiesand the rest of the economy.

Filling the Institutional VoidsEmerging markets are hardly uni-

form. Nevertheless, they all fallshort to varying degrees in providingthe institutions necessary to supportbasic business operations.

Product Markets. In the case ofproduct markets, buyers and sellersusually suffer from a severe dearth of

Tarun Khanna is an assistant profes-sor and Krishna Palepu a professorat the Harvard Business School inBoston. Massachusetts. This articleis part of a major project the authorsare conducting that investigates cor-porate strategy in emerging markets.

HARVARD BUSINESS REVIEW fuly-August 1997 41

W O R L D V I E W

information for tbree reasons. First,the communications infrastructurein emerging markets is often under-developed. Even as wireless commu-nication spreads throughout theWest, vast stretches in countriessuch as China and India remainwithout telephones. Power short-ages often render the modes of com-munication that do exist ineffective.The postal service is typically ineffi-cient, slow, or unreliable; and theprivate sector rarely provides effi-cient courier services. High rates ofilliteracy make it difficult for mar-keters to communicate effectivelywith customers.

Second, even when informationabout products does get around,tbere are no mechanisms to cor-roborate the claims made by sellers.Independent consumer-informationorganizations are rare, and govern-ment watchdog agencies are of little

use. The few analysts who rate prod-ucts are generally less sophisticatedthan their counterparts in advancedeconomies.

Third, consumers have no redressmechanisms if a product does notdeliver on its promise. Law enforce-ment is often capricious and so slowthat few who assign any value totime would resort to it. Unlike in ad-vanced markets, there are few extra-judicial arbitration mechanisms towhich one can appeal.

As a result of this lack of infor-mation, companies in emergingmarkets face much higher costs inbuilding credible brands than theircounterparts in advanced econ-omies. In turn, established brandswield tremendous power. A con-glomerate with a reputation for qual-ity products and services can use itsgroup name to enter new businesses,even if those businesses are com-

pletely unrelated to its current lines.Croups also have an advantage whenthey do try to build up a brand be-cause they can spread the cost ofmaintaining it across multiple linesof business. Such groups then havea greater incentive not to damagebrand quality in any one businessbecause they will pay the price intheir other businesses as well.

The Korean chaebols are famousthroughout the world for extendingtheir group identity over multipleproduct categories. Samsung, forexample, has used its name for arange of goods from televisions tomicrowave ovens. Groups in Indiaand Malaysia are beginning to followsuit. The business media in India,for example, abound with advertise-ments that promote group identityrather than emphasize tbe productsor services of individual companieswithin a group.

What Is an Emerging Market?

Most analysts define an emerg-ing market according to sucbcharacteristics as size, growthrate, or how recently it has openedup to the global economy In ourview, the most important crite-rion is bow well an economyhelps buyers and sellers come to-gether. Ideally, every economywould provide a range of institu-tions in order to facilitate thefunctioning of markets, but de-veloping countries fall short in anumber of ways.

For tbe purposes of our argu-ment, tbere are three mainsources of market failure:D Information Problems. Buyers-broadly defined not only as con-sumers in product markets hutalso as employers in labor mar-kets and investors in financialmarkets - need reliable informa-tion to assess the goods and ser-vices that they purchase and theinvestments tbat they make.Without adequate information,they are reluctant to do business.

n Misguided Regulations. Whenregulators place political goalsover economic efficiency, theycan distort tbe functioning ofmarkets. Many emerging mar-kets, for example, restrict theability of companies to lay offworkers. These rules do add somestability to society-and in somecases, they may even be intendedto overcome market failures fromother sources. However, the re-sult is that companies are lessable to take advantage of opportu-nities than they are in advancedeconomies.

G Inefficient Judicial Systems.Companies are reluctant to dobusiness without ways of ensur-ing that their partners will holdup their end of the bargain. Con-tracts can facilitate cooperationby aligning the incentives of thedifferent parties. Markets there-fore depend on judicial systemsthat are strong enough to enforcecontracts in a reliable and pre-dictable way.

In advanced economies, com-panies can rely on a variety of out-side institutions that minimizethese sources of market failure. Insucb a context, companies createvalue primarily by focusing ona narrow set of activities. At theopposite extreme, stagnant or de-clining economies usually sufferfrom near-complete market fail-ure because of tbe utter absenceof basic institutions.

Emerging markets, in the mid-dle of this continuum, offer theprospect of substantial growthbecause they bave developed atleast some of the institutions nec-essary to encourage commerce.But institutional voids are stillcommon enough to cause marketfailures; as a result, companies inemerging markets often have toperform these basic functionsthemselves. In our view, that isthe crucial distinction betweendoing business in an emergingmarket and operating in an ad-vanced economy.

42 HARVARD BUSINESS REVIEW fuly-August 1997

Hov^ Institutional Context Drives StrategyInstitutional Dimension United States Japan

Capital market

Labor market

Product market

Government regulation

Contract enforcement

Result

equity-focused; monitoringby disclosure rules and themorkel for corporate control

many business schools andconsulting firms offeringtalent; certified skillsenhance mobility

reliable enforcement ofliability laws; efficientdisseminotion of information;many activist consumers

low; relatively freeof corruption

predictable

diversified groups havemany disadvantages

bank-focused; monitoringby interlocking investmentsond directors

few business scfiools; traininginternal to companies;company-specificdevelopment of talent

reliable enforcement ofliability laws; efficientdissemination of information;some activist consumers

moderate; relatively freeof corruption

predictable

diversified groups havesome advantages

India

underdeveloped, illiquidequity morkets andnotionalized banks; weakmonitoring by bureaucrats

few business schools andlittle training; managementtalent scorce

limited enforcement ofliability laws; littledissemination of information;few octivist consumers

high; corruption common

unpredictable

diversified groups havemany advantages

Capital Markets. Similar prob-lems occur in capital markets be-cause, without access to informa-tion, investors refrain from puttingmoney into unfamiliar ventures.The U.S. capital markets minimizethese problems through institu-tional mechanisms such as reliablefinancial reporting, a dynamic com-munity of analysts, and an aggres-sive, independent financial press.Venture capital firms and other in-termediaries specialize in investi-gating and assessing new opportu-nities. The Securities and ExchangeCommission and other watchdogbodies make it difficult for un-scrupulous entrepreneurs to misleadunsophisticated investors. As a re-sult, investors have a free flow oflargely accurate information aboutcompanies. And they can hold cor-porate managers and directors ac-countable through the threat of se-curities litigation, proxy fights, andhostile takeovers. By reducing risksto investors, these institutions makeit possible for new enterprises toraise capital on approximately equalterms as big, established companies.

Almost all the institutional mech-anisms that make advanced capitalmarkets work so well are either

ahsent or ineffective in emergingmarkets. Having little informationand few safeguards, investors are re-luctant to put money into new en-terprises. In such a context, diversi-fied groups can point to their trackrecord of returns to investors. As aresult, large and well-establishedcompanies have superior access tocapital markets. This advantage isso pronounced that governmentsin India and South Korea, for exam-ple, have attempted to restrict theamount of credit exposure thatbanks are permitted to have in largecompanies.

Conglomerates also can use theirinternally generated capital to growexisting businesses or to enter newones. In fact, their superior ability toraise capital makes groups a primesource of capital for new enterprisesand gives tbem a great advantageover small companies seeking fund-ing. Besides acting as venture capi-talists, groups also act as lend-ing institutions to existing memberenterprises that are otherwise toosmall to obtain capital from finan-cial institutions. And some Indiangroups, especially those in the auto-mohile sector, have set up sub-sidiaries whose primary purpose is

to provide financing to importantsuppliers and customers.

At the same time, conglomeratesare attractive to foreign investorseager to put money into these oftenfast-growing markets. With so fewfinancial analysts and knowledge-able mutual-fund managers avail-able to guide them, outsiders insteadturn to diversified groups and investin a wide range of industries. In-vestors trust groups to evaluate newopportunities and to exercise an au-diting and supervisory function. Thegroups thus become the conduit forlarge amounts of investment in theircapital-starved countries.

Labor Markets. Most emergingmarkets suffer from a scarcity ofwell-trained people. While the Unit-ed States has more than 600 businessschools training thousands of futuremanagers every year, Thailand has ahandful of high-quality businessschools that produce far fewer entry-level managers than the economyneeds. Vocational training facilitiesare also scarce in emerging markets.

Groups can create value by devel-oping promising managers, and theycan spread the fixed costs of profes-sional development over the busi-nesses in the group. Many of the

44 HARVARD BUSINESS REVIEW July-August 1997

W O R L D V I E W

large groups in India, for example,bave internal management-develop-ment programs - of ten witb dedicat-ed facilities. These programs typical-ly are geared toward developing theskills of experienced managers; butsome groups, such as tbe Malaysianconglomerate Sime Darby, ha\'e insti-tuted training programs for all levelsof employees in an attempt to devel-op their buman capital. And some oftbe Korean cbaebols have set up spe-cial programs in collaboration withtop U.S. business schools in order totrain their own people.

Groups also can provide mucbneeded flexibility for labor marketsin general. Governments in emerg-ing markets usually make it diffi-cult for companies to adjust theirworkforces to cbanging economicconditions. Rigid laws often preventcompanies from laying off their em-ployees, and labor unions insist onjob security in tbe absence of gov-ernment-provided unemploymentbenefits. To counteract tbe rigiditiesof the overall labor market, groupscan develop extensive internal labormarkets of their own. Wben onecompany in a group faces declin-ing prospects, its employees canbe transferred to other group com-panies tbat are on the rise - evento companies in otherwise undesir-able locations. India's Aditya Birlagroup, for example, bas acquired areputation for building communitiesaround its manufacturing plants intbe remotest parts of the country.Because the group provides servicessucb as schools, hospitals, andplaces of worship, managers and otb-er trained employees are more will-ing to relocate. The growing compa-nies benefit by receiving a readysource of reliable employees.

Groups are also able to put newtalent to good use. By allocating tal-ent to where it is most needed, con-glomerates bave a head start in be-ginning new activities. The WiproGroup in India successfully movedbeyond computers into financial ser-vices by relocating skilled engineersfirst to computer-leasing servicesthat would make use of their techni-cal know-bow and tben to a broadrange of financial services. In con-trast, unaffiliated companies usually

bave to recruit publicly in order tobuild tbeir operations - a difficultproposition in countries wbere laborvaries widely in quality and lackscertification from respected educa-tional institutions.

Regulation. As multinationalcompanies know all too well, gov-ernments in most emerging marketsoperate very differently from tbosein the West. Not only does tbe stateintervene much more extensively inbusiness operations, but companiesalso bave a hard time predicting theactions of regulatory bodies.

Governments in emerging mar-kets are heavily involved in an intri-cate array of business decisions.Despite tbe elimination of the old"license raj," for example, Indianlaw still requires that companies getpermission for a range of decisions,sucb as exiting businesses, cbangingprices on commodities, and import-ing raw materials. Tbe law estab-lisbes subjective criteria for many ofthese decisions, so Indian bureau-crats have a great deal of discretionin how they apply the rules.

Diversified groups can add valueby acting as intermediaries whentheir individual companies or for-eign partners need to deal with theregulatory bureaucracy. Experienceand connections give conglomeratesan advantage. Tbe larger the com-pany, the easier it is tocarry tbe cost of main-taining governmentrelationships. Indeed,political economistDennis Encarnationfound that India's largegroups maintain "in-dustrial embassies" inNew Delhi to facili-tate interaction witb bureaucrats.Several groups in India also areknown for tbeir ability to managebureaucratic relations at levels alltbe way down to tbe village council.

India and otber countries may bebearing costs for the uncertainty oftbeir regulatory systems. But as longas government officials have somuch discretion, companies oftenend up working with tbem. Intricaterelations between business and gov-ernment actually appear to be thenorm tbroughout tbe developing

world. The major Malaysian politi-cal parties, for example, all haveaffiliated conglomerates. Untilrecently, the ties between govern-ment and industry in South Koreahave been a centerpiece of tbat coun-try's economic program. Even todayin Indonesia, there are groups wbosegreatest assets appear to include ac-cess to bigh government officials.Because political leaders are so eagerto work with companies, managersmust be prepared to deal with thegovernment and tbe bureaucracy,

Bribes and otber corrupt practicesmay be part of working witb the bu-reaucracy. But tbat's not tbe wholestory. In many cases, educatingofficials is more important than ex-changing favors. The Enron Corpo-ration, a large U.S.-based multina-tional, discovered just tbat wben itentered tbe power generation sectorin India. Prepared to invest $2.8 bil-lion, the single largest foreign ven-ture in Indian history, the companyhad to spend four years and about$20 million educating regulators onthe ways international power proj-ects are financed and regulated.Along tbe way, Enron learned itsown lessons about dealing with theIndian bureaucracy and government;tbe project was almost canceledwhen Enron's aggressive deal-mak-ing style put off newly elected offi-

Not every group addsvalue in the same way,and no group can hope tofill every institutional void.

cials in the state where the powerplant was to be built. As Enron'sexecutives now acknowledge, expe-rience witb Indian politics andbureaucracy migbt bave saved thecompany a great deal of trouble.

Contract Enforcement. Despitetbe extensive involvement of gov-ernment in emerging markets, theseeconomies lack effective mecha-nisms to enforce contracts. In ad-vanced economies, companies canwork together under arm's-lengthcontractual arrangements because

46 HARVARD BUSINESS REVIEW July-August 1997

W O R L D V I E W

Hovsf Groups CanInsHtutional Dimension

Capital market

Labor market

Product market

Government regulation

Contract enforcement

Add ValueInstitutions That Groups Imitate

venture capital firm, private equity provider,mutual fund, bank, auditor

management institute/business school,certification agency, head-hunting firm,relocation service

certification agency, regulatory authority,extrajudicial arbitration service

lobbyist

courts, extrajudicial arbitration service

they know tbe courts will protectthem if their partners break theircontracts. Confidence in tbe judicialsystem makes it easier for everyoneto do business. But courts in emerg-ing markets often enforce contractscapriciously or inefficiently,- as aresult, companies are less likely tobe able to resolve disputes throughjudicial channels.

In sucb situations, conglomeratescan leverage reputations establishedby honest dealings in the past. Be-cause the misdeeds of one companyin a group will damage tbe prospectsof tbe others, all tbe group com-panies have credibility when tbeypromise to honor tbeir agreementswith any single partner. They pro-vide a haven where property rigbtsarc respected. As a result, suppliersand customers are more willing towork with them.

This credibility pays off the mostin relationships with companiesseeking to enter emerging markets.Foreign providers of technology or fi-nance need local partners to carryout their strategies, but tbey worryahout being cheated. A reputationfor honesty and reliability thus canbe a source of enormous competitiveadvantage. As Alice Amsden andTakashi Hiklno bave argued, con-glomerates in several emerging mar-kets bave based much of tbeir suc-cess on tbeir ability to access foreigntechnology. And in India, tbe largestand most diversified business groupsreceive a disproportionate sbare of

technology and financial supportfrom advanced economies aroundtbe world. The bead of RPG Enter-prises, India's third largest conglom-erate, considers his group's relationswitb foreign providers-including 16of tbe 500 largest U.S. companies-to be among its greatest assets.

Managing the House of TataIndia's largest conglomerate in

sales and assets exemplifies bowwell-run groups can add value inemerging markets. Spanning mostsectors of tbe Indian economy, tbeTata companies employ close to300,000 people and bad sales ofRupees 289 billion (U.S. $8.6 billion)in tbe fiscal year 1995 to 1996. Oftbe group's 90 companies, more than40 are publicly traded, and tbese ac-count for approximately 8% of thetotal capitalization of tbe country'spublicly traded companies. Tbecompanies are all held together bytbe internationally recognized Tataname and by interlocking invest-ments and directorates.

The Tatas began as a textile millin 1874, but Indian independence in1947 brought antimonopoly legisla-tion and bigb taxes on dividends tbatencouraged the group to diversifyinto a variety of unrelated areas.Wben India began liberalizing itseconomy in 1991, removing the bar-riers to growth within any given sec-tor, the group had a stark choice tomake. Outside experts advised exec-utives to concentrate on a few strong

sectors of economic activity insteadof continuing as an extensively di-versified entity. But the executivesdecided to remain in most of theirexisting businesses.

One reason for staying diversifiedwas the difficulty of exiting busi-nesses because of some remaininglegal restrictions in India as well asthe Tatas' reputation as a benevolentemployer. But the Tatas also be-lieved that tbey could leverage theirsize and wide scope to help theirconstituent companies in a varietyof ways. So tbey decided to diversifyeven further.

Historically, tbe Tata companieshave always come together to fi-nance tbe launch of new enterprises.But initially tbere was no formalstructure for doing so. Then in 1982,tbe group created Tata Industries, aventure capital vehicle funded witha special pool of investment moneydrawn from the member companies.Since tben, Tata Industries hassought to lead the Tata group intoinformation technology, processcontrol, advanced materials, oil-field services, and other areas. Ithas provided seed money for sev-eral successful ventures, includingtwo computer-manufacturing en-terprises-one cosponsored by Hon-eywell and another cosponsored byIBM. Today tbe Tatas are leading theway in building an information-technology industrial park in coop-eration with tbe state of Karnatakaand witb money and expertise froma consortium that includes the gov-ernment of Singapore.

The Tatas were so active in newventures that by 1995 they neededadditional capital. Tbey decided tosell a stake in Tata Industries ata substantial premium to JardineMatheson, itself a diversified com-pany based in Hong Kong. As a re-sult of the sale, Jardine Mathesonended up owning 20% of tbe equityin Tata Industries. Tbe sale gave tbeTatas (and tbe Indian economy) $200million in "patient" capital froma conglomerate that shared theirlong-term approach to investment.Jardine Matbcson, in turn, gainedexposure to sectors across the Indianeconomy without having to super-vise individual companies.

48 HARVARD BUSINESS REVIEW July Aupist 1997

Many of the group's new venturesbenefited from being able to borrowskilled managers from tbe Tatas' ex-isting businesses, Since 1956, TataAdministrative Services [TAS)-anin-bouse training program with anational reputation for excellence ~has aimed to create a cadre of generalmanagers. Entry into TAS is ex-tremely seleetive and primarily re-stricted to graduates of Indian man-agement institutes. Recruits spendtbeir first year on eourses, interac-tive sessions witb Tata exeeutives,and visits to major Tata plantsaround the country. Mentoring andcareer direetion eontinue for at leastfive years, as eandidates are exposedto tbree different line functions intbree industries to gain a generalmanagement perspeetive.

Fully half of tbese trainees remainwitb tbe Tatas over tbe long term, incontrast to some other large Indiangroups tbat have to reinvent them-selves every few years because ofhigb turnover. For tbose who doleave, the exit options are attractive,increasing the appeal of joining theTatas in the first place. In effect, tbegroup provides hoth managementeducation and a certification servicein a country wbere hoth are scarce.

TAS consciously organizes its re-eruits into cohorts according to theyear tbey entered. As reeruits spreadout to tbe different companies witb-in tbe group, tbey maintain lastingties witb tbeir cobort group, andthese networks improve informa-tion flows aeross tbe group. Thebead office, mindful of the resourcesinvested in these graduates, encour-ages group companies to "sacrifice"a talented employee to anotber com-pany if it is in the interest of botb tbemanagers' career development andtbe group. Cross-company teams of"stars" are assembled to resolveknotty problems that individualcompanies are having. The groupnow plans a new initiative, tbe TataGroup Mobility Plan, to improve tbemobility of all skilled managers, in-cluding non-TAS graduates, acrossgroup companies - and witbout anyloss of henefits.

The Tatas are a favorite of foreigntechnology providers tbat are eom-fortable entering India only witb a

reputable party. Tata executives con-sider tbeir reputation for bonestyand integrity to be among theirgreatest assets, and tbat reputationhas led to joint ventures witb Daim-ler Benz and AT&T, as well as anumher of computer companies.Understanding tbe value of its repu-tation, the group is developing an in-ternal eode of conduct and otberelaborate standards regarding theuse of tbe group name. Special feesfrom the memher companies willpay for an internal auditing functionto enforce those standards. To fosteran orientation toward quality amongits companies, Tata also bas set upan internal system of awards akin totbe United States' Baldrige awards.

By keeping and extending tbeir di-versified holdings, the Tatas havemaintained a scale and scope thatgives tbem a bost of advantageswithin India's specific institutionalcontext. And these advantage aremutually reinforcing. Tbe more ac-cess Tata or any group bas to finan-cial capital, tbe more business op-portunities it can offer to talentedemployees-wbieb in turn belps tbegroup improve quality and enhaneeits reputation witb consumers. Con-tinued success in existing lines ofbusiness has made it all tbe easierfor tbe Tatas to enter new lines ofbusiness. The Tatas today have tbelargest market sbares in many sec-tors of the Indian economy, fromsteel to computers to hotels.

The Tatas, in turn, benefit the In-dian economy. When managementconsultants told a Tata executivetbat diversification into unrelatedactivities did not create value, hereplied, "Don't enunciate a tbeorytbat will bring everytbing to a deadhalt. If we don't start tbese busi-nesses, no one else will either, andsoeiety will be worse off."

Ensuring That DiversificationAdds Value

Onee one understands tbe institu-tional context of any given emergingmarket, it is clear why diversifiedhusiness groups have tbe potentialto add value. (See tbe tahle "HowGroups Can Add Value.") Never-theless, groups do not automaticallyrealize tbat potential. Tbey must he

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actively managed to capture theadvantages offered by scale andscope. Our statistical analysis com-paring groups and independent com-panies in India-and a similar analy-sis on South Korean companies thatTarun Khanna conducted withYishay Yafeh - suggests that manygroups add little or no value to theiroperations. The largest and most di-versified groups, however, do add agood deal of value-perhaps becauseonly these groups have the scale andscope to perform the kind of func-tions we have described.

Indeed, many groups have actuallydiminished the value of their mem-ber companies through poor man-agement. Conglomerates in emerg-ing markets, after all, suffer from the

same problems that plague those inthe West: the more activities a busi-ness engages in, the harder it is forthe head office to coordinate, con-trol, and invest properly in them.Unless a group is ready to offer con-crete benefits to its affiliates, com-panies are better off independent.

Group executives should ask in asystematic way whether they areadding enough value to overcomethe costs of complexity and coordi-nation. They should start by assess-ing their conglomerate's strengths.A group that enjoys brand namerecognition in rural markets mightthink of leveraging its name in unre-lated products targeted to the samemarkets. Or a group that enjoys pref-erential access to large amounts of

capital might consider ventures thatrequire substantial investment.

Of course, not every group willbe able to add value in the sameway, and no group can hope tofill every institutional void. Deci-sions to diversify should be basedon the group's strengths, not just ongrowth prospects. Today a number ofgroups are rushing willy-nilly intopower plants and other infrastruc-ture projects all over Asia, and theirtotal-capacity plans already appearto outstrip the likely demand. Butthere are a few exceptions, such asIndia's Satyam Group. This grouphas tried to leverage its reputationfor honest and efficient partnershipswith foreign companies in order towin the better contracts.

What Is the Best Institutional Context?Even if they admit to the ad-

vantages of diversification inemerging markets, some in-vestors or partners may still urgecompanies to concentrate on afew core activities on the groundsthat all markets will eventuallydevelop the West's set of institu-tions. But their advice assumesthat there is one single set of in-stitutions toward which all coun-tries should move. It is unclear,however, whether any one insti-tutional context is obviously su-perior to others.

Consider the financial systemin the United States. That sys-tem, based on atomistic share-holders, ensures great liquidity,which generally reduces the costof funds. Because shareholderscan "vote with their feet" if theydo not like what management isdoing, however, they are less in-clined to expend the effort neededto discipline management. As aresult, corporate governance maysuffer. Similarly, a labor marketin which employees freely movefrom one company to another in-creases the likelihood that, at anygiven time, there will be an effi-cient match between workers'

skills and the opportunities towhich those skills can be applied.But it reduces the likelihood thatworkers will invest in anythingbut the most general skills; as aresult, society does not reap thebenefits of the long-term, com-pany-specific training of workers.

Japan's institutional context re-veals a different resolution tothese trade-offs. Japan's capitalmarket is bank centered, not eq-uity centered. Banks monitormanagers through equity cross-holdings between companies andboard directorships, and the diffi-culty financial institutions havein unloading their shares encour-ages them to keep management inline. (Banks, in fact, are at the cen-ter of Japan's major keiretsu, andthese groups offer some of thesame advantages of conglomera-tion that are present in emergingmarkets.) Japanese managers andworkers get their training largelywithin companies. Managersrarely move around because theirexpertise is geared toward the spe-cific needs of their company andbecause they lack credentialsfrom such external institutions asbusiness schools.

Institutional context also takesa long time to evolve. Becausedifferent aspects of the institu-tional environment have oftenco-evolved into a well-function-ing system, changes along anyone dimension of an institutionalenvironment can have unantici-pated, adverse effects along otherdimensions. Economies aroundthe world today are experiment-ing with moving from one systemto another using either "shocktherapy" or gradual adjustment -there is much debate aboutwhich is the better approach.Deep-seated institutional voidsmight take decades to be filled.The United States is an extremeexample of a country where thereare relatively few such voids.

Even if the institutional con-text of emerging markets evolvesto the point tbat there are no ad-vantages to diversification, exec-utives there should realize thattheir current opportunities willpersist for some time. They aremuch better served by developingcorporate strategies that matchtheir particular contexts insteadof blindly applying the manage-ment mantra of the day.

50 HARVARD BUSINESS REVIEW July-August i 997

Once a group identifies its oppor-tunities, its executives need to in-stall systems to ensure consistentexecution. For example, they mustimpose discipline over field man-agers, who will be tempted to takeadvantage of ready financing to tryto build empires. The most success-ful groups usually have a strong in-ternal auditing system. Sime Darby,the Malaysian conglomerate, bene-fits from a tradition of strict finan-cial controls and planning thatbegan under its original British man-agers. Its recent entry into financialservices by acquiring UMBC bankwas welcomed by the SoutheastAsian stock markets, which saw theconglomerate adding value throughits management discipline to a largebut underperforming company in arapidly growing sector.

Another strategic imperative forgroups is to manage their corporateidentities. Given that much of theirsuccess depends on the trust oftheir customers and partners, diver-sified groups must enforce standardsof reliability and quality. The head ofMahindra & Mabindra, a group oper-ating in automobiles and infrastruc-ture in India, grabs every symbolicopportunity he gets to dramatize theimportance of never compromisingon the product and after-sales ser-vice offered to customers.

When a group's strategy dependson supplying functions that are ab-sent in the institutional context, it isimportant to move with delibera-tion. Mimicking institutions thatare undeveloped in the economy atlarge requires time and effort. Agroup that acts as a venture capitalfirm, for example, needs to developa track record for nurturing busi-nesses in order to become a magnetfor risk capital. It needs to train andretain individuals who are skilled atidentifying deals and who can bringtheir start-up expertise to bear on avariety of situations; it also needs tohave disciplined managers to run itshigh-risk ventures.

Communicating the Strategyto Investors

Even successful conglomeratesstill face resistance from Westerninvestors and partners who believe

that focus is always best. Althoughmany executives may well be tempt-ed to concentrate their operationsin order to win favor with outsideanalysts, a better solution for well-managed groups is to educate in-vestors about tbe logic underpinningthe group's corporate strategy. (Seethe insert "What Is the Best Institu-tional Context?")

Institutional investors are oftenmost worried not about diversifica-tion per se but about the lack ofopenness in internal group opera-tions. Under tbe current structure ofmany conglomerates, investmentanalysts find it difficult to tell whichbusiness segments are creating valuewithin a conglomerate. They fearthat a group executive will shufflefunds from one company to another.Faced with these concerns, man-agers of conglomerates should in-crease the transparency of their op-erations, communicate this changeto investors, and develop a reputa-tion for doing so.

The Indian group Mahindra &Mahindra is doing just that. While itfocuses on automobiles and closelyrelated businesses, the group has setup a holding company to invest in arange of other projects. The automo-bile company has made a onetime,fully documented infusion of capitalto start the holding company so thatthe group will not have to make re-peated transfers of funds for ad-hocline extensions. If and when theholding company's ventures take offand require new capital, the groupwill take the company public ratherthan draw on funds from the auto-mobile company.

If groups are not adding value,they sbould consider focusing. Butthey should not break up simply be-cause their competitors are focusedforeign companies from advancedeconomies. Western companieshave access to advanced technology,cheap financing, and sophisticatedmanagerial know-how. In the ab-sence of institutions providing theseand other functions in emergingmarkets, diversification may be thebest way to match up against thecompetition. ^Reprint'97404To order reprints, see the last page of this issue.

HARVARD BUSINESS REVIEW July August 1997

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