The Bigger, the Better?
Measuring the Financial Health of Media Firms
www.mediajournal.org
by Jaemin Jung, University of West Florida, U.S.A.
Like other businesses, media companies
have a right to pursue profit as a private organization. Whether operating
in radio, local television, network television, cable, newspaper, or magazine,
the essence of business is the logic of
the commercial market (McManus,
1994). Based on this notion, it is natural that media companies have merged
to produce multi-media conglomerates
in their effort to seek more profit. In
fact, a wave of mergers and acquisitions
and the development of new digital
technologies have transformed the media landscape. For example, Walt
Disney purchased Capital Cities/ABC
and its ten television stations, 21 radio
stations, and interest in several cable
networks for $19 billion in 1995
(Albarran & Dimmick, 1996). Subsequent to this acquisition, Time Warner
made another $8.5 billion acquisition
by absorbing Turner Broadcasting Company, a parent company of CNN and
other popular cable networks in 1996.
In 1999, Viacom announced its merger
with CBS. The huge deal combined CBS’
television network, its TV & radio stations, and several internet sites with
Viacom’s well-known cable channels,
movie and television productions, publishing enterprises, theme parks, etc.
With large mergers such as these, the
1990s alone saw well over $300 billion
in major media deals (Croteau &
Hoynes, 2001) that continued into the
new century. On January 10, 2000,
America Online Inc. (AOL) announced
it would buy Time Warner Inc., creating a media giant of unprecedented
size. The $166 billion deal was the biggest corporate merger ever. It was four
times as big as Viacom’s $38 billion acquisition of CBS in 1999.
At present, one media conglomerate or
another owns virtually everything from
production to distribution of all media
products/services, such as newspaper,
magazine, book, broadcasting, cable,
music, movie, and the internet through
diverse business actions. It has always
been assumed that a newspaper article
might be expanded to a magazine article that could become the basis for a
hardcover book, setting the occasion for
a paperback, leading to a TV series and,
finally, a movie. At the same time, the
product might enjoy supporting publicity from its parent company’s news out-
lets. This conceptual advantage, called
“synergy,” has induced the diversification of many media companies.
The continuous diversification activities of media firms can be understood
as a strategy to earn more money. This,
then, begs the question: Does the repeated diversification through mergers and acquisitions result in more
profit expected by the media conglomerates? Some believe that investors who
analyze mergers pay too much attention to short-term earnings gains and
ignore the fact that these gains come
at the expense of long-term prospects.
However, how long is long term? Before
realizing the long-term effect, who provides the money to support these media companies? Eventually, the loss of
media firms might be compensated
with public money as there is a possibility that media companies may increase the price for their products to
make up for the loss from mergers and
acquisitions.
In fact, nearly all major media companies are commercial corporations
whose primary function is creating
Abstract
This study examined the degrees of product diversification of media conglomerates
since the Telecommunications Act of 1996 and tested the impact of product diversification of the firms on their financial health. The strategy of related product diversification enables firms to gain market power and synergy effect, then improves financial performance. Based on that assumption, for a sample of 26 media firms from
1996 to 2002, this study conducted a regression analysis to test the hypotheses. The
results showed two contradictory curvilinear models. First, revenue, EBITDA and sales
growth rates revealed a U-shaped relationship with diversification. That is, performance decreased as firms shifted from concentrated business strategies to related
diversification, but performance increased as firms changed from related diversification to unrelated diversification. On the other hand, financial efficiency variables
measuring management effectiveness or profitability (ROS, ROA and ROE) and stock
market evaluation (earnings per share) showed an inverted U-shape relationship. Thus,
the unrelated diversification led to a decrease in financial efficiency.
Jaemin Jung
([email protected])
is an Assistant Professor in the Department of Communication Arts at the University
of West Florida. His research focuses on the media management and economic issues.
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV : (237 – 250) 237
profits for owners or stockholders. Even
noncommercial and not-for-profit media need to produce profit that can be
used to develop their content and to
operate their organizations. If media
firms are not able to operate profitably,
they will fall into a spiral of decline that
makes it difficult to sustain their operations and offer quality content (Picard,
2002). Therefore, the need of the yardstick measuring the financial performance of media companies is an unavoidable reality. The goal of this study
was to explore the degree of product
diversification of the global media corporations and to examine the impact
on firm financial health. In other
words, this study attempted to explain
the relationship between diversification and financial performance.
Literature Review
Product Diversification
When a firm chooses to diversify its
operations beyond a single industry
and to operate businesses in several industries, it is pursuing a corporate strategy of product diversification (Hitt, Ireland, & Hoskisson, 2001). Through this
strategy, the firm engages in the manufacture and sale of multiple diverse
products. Most firms implement a diversification strategy to enhance the
strategic competitiveness of the entire
company. This position rests upon several assumptions, including those derived from market power theory, internal market efficiency and synergy
arguments (Grant, 1998; McCutcheon,
1991; Scherer, 1980).
Market Power Advantages
Another approach to creating value by
gaining market power is the strategy of
vertical integration, in which a firm
derives a power of reciprocal buying
and selling. Greater diversification in
more factor and product markets increases opportunity for such reciprocity (Grant, 1998). For media industries,
it is possible to integrate the stages in
the vertical supply chain, which includes content creation (gathering
news stories, making television news),
packaging (assembling into a product
like newspaper or television service)
and distribution (delivering to consumers). No single stage is more important
than another. Ultimately, the interdependent relation of different phases in
the supply chain induces media firms
to pursue vertical integration between
the stages (Doyle, 2002).
ate working independently (Hitt, Ireland, & Hoskisson, 2001). The element
of synergy involves developing a single
concept for various media. For example
a children’s story may be packaged as
a comic book, movie, music label, television cartoon, and computer game. By
doing this, media conglomerates can
take advantage of simultaneous revenue streams, thereby generating as
much profit as possible from a single
idea (Croteau & Hoynes, 2001).
Another aspect of synergy involves
cross-promotion. Media conglomerates
have placed more emphasis on the promotion of their own subsidiaries’ products such as television programs or
movies (Jung, 2001, 2002; McAllister,
2000; Williams, 2002). The result is
that conglomerates, with their enormous resources and diverse holdings,
are economically able to develop and
promote projects in ways that smaller
competitors simply cannot match.
Market Efficiencies
The diversified firm has much greater
flexibility in capital formation because
it can access both externally and internally generated resources (Lang & Stulz,
1994; Stulz, 1990). That is, losses can be
funded through cross-subsidization
whereby the firm taps excess revenues
from one product line to support another (Berger & Ofeck, 1995; Meyer,
Milgram, & Roberts, 1992; Scherer,
1980). Thus, diversification can generate efficiencies that are unavailable to
the single-business firm (Gertner,
Schartstein, & Stein, 1994). In a media
situation, diversified media firms can
afford to absorb the cost of an expensive movie flop through cross-subsidizing from other booming business units.
Therefore, diversified media firms can
withstand short-term losses and wait
for the next megahit.
Synergy
Synergy exists when the value created
by business units working together exceeds the value those same units cre-
238 © 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV
Linkage between
Product Diversification
and Performance
Linear Model
Industrial organization considered the
relative performance of diversified and
undiversified firms and proposed that
diversification may be associated with
concomitant increases in performance.
However, empirical research has revealed conflicting results.
Gort (1962) was one of the first to examine the profitability of diversified
firms. He analyzed 111 large U.S. corporations over the years 1947-1957 and
showed that there was no significant
correlation between profitability and
diversification. In a study of 104 U.S.
food-processing firms, Arnould (1969)
also concluded that no significant relationship existed between diversification and profitability. On the other
hand, Carter (1977) presented evidence
that diversified firms outperform their
specialized counterparts. However,
www.mediajournal.org
Diversified firms can exploit market
power advantages that are mostly not
available to their undiversified counterparts (Caves, 1981; Hitt, Ireland, &
Hoskisson, 2001; McCutcheon, 1991;
Scherer, 1980; Sobel, 1984). For example, broadcasters with a large audience share or market share are able to
command a premium in the cost-per-
thousand rates that they charge advertisers (Doyle, 2002).
Markham (1973) found that in all of the
multiple regression models relating
diversification with various firm-specific variables, whenever profitability
entered at a significant level, it entered
with a negative sign.
Lang and Stulz (1994) also showed that
financial market and firm diversification were negatively related throughout the 1980s. In general, firms that
chose to diversify were poor performers
relative to firms that did not.
Beginning with Gort (1962), industrial
economists spawned decades of research based on the premise that diversification and performance are linearly
and positively related. However, they
found no evidence supportive of the
view that diversification provides firms
with a valuable asset.
www.mediajournal.org
Curvilinear Model
Later approaches from the perspective
of strategic management focused specifically on performance differences between related and unrelated diversifiers
showing a more systematic paradigm
(Christensen & Montgomery, 1981;
Palich, Cardinal, & Miller, 2000; Palich,
Carini, & Seaman, 2000; Rumelt, 1974,
1982; Varadarajan & Ramanujam,
1987). The most common theoretical
rationale suggesting the superiority of
related diversification is derived from
economies of scope (Markides &
Williamson, 1996; Seth, 1990). Specifically, related diversifiers generate operational synergies by designing a portfolio of businesses that are mutually
reinforcing. Since they are related in
some way, units are able to share resources or boost revenues by bundling
products, enjoying a positive brand
reputation, etc. (Barney, 1997). While
benefits accrue to diversification, at
some point these efforts are also associated with major costs. For example,
Grant, Jammine and Thomas (1988) recognize the growing strain on top management as it tries to manage an increasingly disparate portfolio of businesses.
Markides (1992) delineates other costs
such as coordination costs and other
diseconomies related to organizational
inefficiencies of conflicting “dominant
logics” between businesses and internal
capital market inefficiencies.
Taken together, these studies indicate
that moderate levels of diversification
yield higher levels of performance than
either limited or extensive diversification. Thus, they provide support for an
inverted-U curvilinear model wherein
performance increases as firms shift
from single business strategies to related diversification, but performance
decreases as firms change from related
diversification to unrelated diversification (Bettis & Hall, 1982; Christensen &
Montgomery, 1981; Geringer, Beamish,
& daCosta, 1989; Geringer, Tallman, &
Olsen, 2000; Grant, Jammine, & Thomas, 1988; Kim, Hwang, & Burgers,
1989; Palepu, 1985; Palich, Cardinal, &
Miller, 2000; Palich, Carini, & Seaman,
2000; Sambharya, 1995; Tallman & Li,
1996).
Diversification in the Media Studies
Compared to fervent research in the
business management area, diversification research in media studies has
rarely been seen in the literature. As an
initial study, Dimmick and Wallschlaeger (1986) researched the level of
diversification of television network
parent companies. The results indicated
that the least diversified parent companies were most active in new media ventures. Albarran and Porco (1990) measured diversification of corporations
involved in pay cable by using the formula developed by Dimmick and
Wallschlaeger (1986). Their results were
consistent with the previous research
that all firms appear to utilize diversification as a means to limit resource dependency and ensure organizational
survival. Both studies dealt with the
concept of product diversification.
In contrast, Picard and Rimmer (1999)
introduced the concept of geographic
diversification as well as product diver-
sification. They sought to determine
whether the degree of diversification
affected the financial performance of
newspaper firms during economic
downturns. They concluded that nonnewspaper diversification reduced the
effects of the recession. The introduction
of multiple measures of performance
such as growth rates and profitability
was another contribution to the diversification literature in media studies.
Because of the enormous size and a
wave of mergers across the media industry, recent studies have attempted
to analyze the structure and performance of media conglomerates. For
example, Albarran and Moellinger
(2002) examined the biggest six media
conglomerates’ structure, conduct,
and performance following the industrial organization model. They focused
more on the common strategies of six
media giants than on the differences.
Powers and Pang (2002) examined the
diversification and performance of
eleven media conglomerates before
and after the Telecommunication Act
of 1996. The study provided an alternative analysis of the premise that media
conglomerates must be harmful to free
speech by arguing that the number of
news outlets has increased since the
Act. Shaver and Shaver (2003) examined the activities of eleven companies
over a ten-year period and concluded
that operating margins were negatively correlated to the degree of business diversity. In other words, greater
margins were realized as companies
became more concentrated within
their core industries rather than diversifying into other areas.
Chan-Olmsted and Chang (2003) reviewed the diversification patterns of
seven leading media companies in
terms of product/international dimension and proposed an analytical framework for examining the factors influencing these strategic choices. They
also explained how the medium-diversifiers yielded the best financial performance. However, because of the lim-
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV 239
ited sample size, it is difficult to generalize the results. According to Peltier’s
study (2002) of the relationship between diversification and financial performance of eleven media conglomerates, there was no positive correlation
between its presence in multiple businesses and economic performance.
However, the study fell short in two regards. First, it needed a larger number
of firms in the sample. Second, the
study only used net margin as performance, whereas multidimensional aspects of economic performance also
should be taken into consideration. In
sum, the attempts to measure financial
performance of media firms’ diversification among media scholars are very
limited, and no conclusion is possible.
Research Questions
and Hypotheses
Although the industrial organization
approach was unsuccessful in supporting the linear linkage between product
diversification and performance, this
study adopts such an approach, as well
as a strategic management approach, to
test the two frameworks. Because the
two approaches adopted different
methods in measuring the degree of
diversification, this study attempted to
measure both the extent (less or more
diversification) and direction (related
or unrelated diversification) of product
diversification. Because of the exploratory nature of this study, it is meaningful to study both perspectives in the
media industry context. Before proposing hypotheses, in order to see the degrees of product diversification, this
study examined the following research
questions.
Another mechanism that is expected to
allow diversified firms to sustain higher
profits is efficiency gains. Diversification deals may generate economies of
scope among the different media industries. Economies of scope occur when
the cost of jointly producing two different products is less than the cost to produce each of them independently
(Gertner, Schrfstein, & Stein, 1994; Lang
& Stulz, 1994). Hence, a single idea, first
materialized in a film for example, may
then be used to publish a CD of the
film’s music, a book of the scenario, a
video game, Web site etc. Disney exploits these kinds of synergies very efficiently. In the same vein, Time Warner’s
television channels, newspapers, and
magazines may promote AOL through
advertising and vice versa.
The above arguments lead to the rationale that the more diversification a
240 © 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV
firm has in its operations, the better its
chances of extracting healthier financial performance increase. Considering
the multiple aspects of financial
health, this study employed both the
financial performance (revenues, sales
growth rates, and EBITDA) indicating
relative power and magnitude of a firm
and the financial efficiency (ROS, ROA,
ROE, and EPS) indicating management
effectiveness/profitability and stock
market evaluation. From the perspective of industrial organization, the first
two hypotheses on the relationship between the extent (total degree) of product diversification and financial health
were proposed as followings.
H1a: A firm’s extent (total degree) of
product diversification is positively related to firm financial
performance.
H1b: A firm’s extent (total degree) of
product diversification is positively related to firm financial efficiency.
As long as product diversification stays
within the scope of a firm’s strategic
resources and capabilities, it will provide increasing profit margins. However, excessively high or unrelated product diversification depresses firm
performance, as costs outstrip returns
to strategic resources (Bengtsson, 2000;
Chen, 1998; Geringer, Tallman, & Olsen,
2000; Jones & Hill, 1988; Prahalad &
Bettis, 1986; Tallman & Li, 1996;
Williamson, 1975). Obviously, a company would be expected to profit from
related diversification by economies of
scale and scope that should generate
more synergistic benefits than in the
case of unrelated diversification that
have no relationship other than becoming part of one overarching system of
corporate control. In general, the resource-based strategic management
strongly argues for strategic relatedness
within a conglomerate when it comes
to diversification strategy (Chatterjie &
Wernerfelt, 1991). Based on strategic
management perspective, an invertedU curvilinear relationship is expected
www.mediajournal.org
RQ 1: What are the degrees of diversification in the extent (total degree)
of product diversification of the
media conglomerates?
RQ 2: What are the degrees of diversification in the direction (related
degree) of product diversification of the media conglomerates?
The argument in the industrial organization literature linking diversification
to profitability revolves around the notion of market power (Caves, 1981;
Markham, 1973). Vertical mergers may
be interpreted as a means to exclude rival firms from the market by reducing
either their supply of raw materials or
their outlets. The reason for choosing
vertical integration is then clearly market foreclosure. In fact, the ownership
of program services by cable MSOs has
historically encountered problems. For
example, MSOs have occasionally discriminated against competing program
services by refusing carriage, charging
higher retail prices for competing services and providing less favorable channel positions. MSOs have also refused to
provide the program services in which
they had an interest to competing distribution outlets such as SMATV operators and MMDS broadcasters (Owen &
Wildman, 1992). Because of its ability
to acquire and exercise market power, a
diversified firm is alleged to be able to
subvert market forces through mechanisms such as cross-subsidization,
predatory pricing, reciprocity in selling
and buying, and barriers to entry.
between the direction (related direction) of product diversification and financial health.
H2a: A firm’s direction (related degree)
of product diversification has an
inverted-U shape relationship
with its financial performance.
H2b: A firm’s direction (related degree)
of product diversification has an
inverted-U shape relationship
with its financial efficiency.
Methods
Sample
In order to test the hypotheses, the top
25 media companies as ranked by the
industry journal Broadcasting & Cable
on the basis of 2001 media revenues
were chosen (see Appendix 1). Although Bertelsmann was not listed on
the list, the firm was added because of
its revenue size and position as one of
most frequently mentioned global media leaders.
www.mediajournal.org
Data for the top 26 media firms were collected over a seven-year (1996-2002) period. The enactment of the Telecommunications Act of 1996 struck down the
walls between the media and telecommunication industry by allowing firms
to cross the boundary. It also removed
the limitation of television and radio
station ownership by a single entity and
raised the ownership cap. Consequently, the law has accelerated a wave
of mergers and acquisitions in the media and telecommunications industry.
Therefore, the year 1996 was selected as
the starting point of the analysis.
182 observations can be pooled by gathering the data for seven years of observation for the top 26 firms. However,
the sample size was more than the estimated number of observations because of ownership change. For example, the AOL-Time Warner merger
took place in 2000. Therefore, the AOL
and Time Warner were treated as different companies before that year. The
diversification and performance data for
two firms were gathered separately and
included as the different samples from
1996 to 1999. For this reason, 16 samples
were added (Time Warner, 1996-1999;
CBS, 1996-1999; Times Mirror, 1996-1999;
Seagram, 1996-1999). On the other hand,
because Vivendi was an environment
business firm before it acquired Seagram
(parent company of Universal Studio and
Polygram) in 2000, the data of Vivendi
from 1996 and 1999 were not included
in the analysis. In case of Discovery, the
researcher failed to collect appropriate
data for the period. In total, 187 samples
were used for the final analysis.
Data Source
The major archival data source for diversification measurement is The Directory of Corporate Affiliations, which
includes more than 180,000 parent
companies, affiliates, subsidiaries, and
divisions in the U.S. and worldwide. Profiled data in the 1996 through 2002 volumes of The Directory of Corporate Affiliations were analyzed. For the
measurement of financial performance, the data were derived from the
firms’ annual reports and 10-K filings.
All financial figures were verified by
comparing those reports with Standard
& Poor’s Compustat financial data.
Measurement
Extent
Previous literature from the industrial
organization studies used objective
measures based on SIC count to capture
the total degree of diversification
(Arnould, 1969; Carter, 1977; Gort,
1962). This study also used the number
of different four-digit Standard Industrial Classification (SIC)1 codes in which
firms operate. Its use was dictated by
the following considerations: (1) It is a
well-accepted classification system and
is frequently used in previous research;
and (2) the analysis presented in this
study can be replicated by others. All
media products/services are categorized
as one of the four-digit SIC codes by industry. For example, if a company runs
businesses in newspaper (2711), magazine (2711) and television broadcasting
station (4833), the extent (total degree)
of the firm’s diversification is three.
Direction
The notion of ‘relatedness’ depends
on how managers define their businesses (Salter & Weinhold, 1979). However, it is impractical to judge the relatedness of transactions based on each
manager’s decision for each transaction. Thus, strategic management scholars has introduced several methods to
measure the direction (related degree)
of diversification based on objective
data, including Rumelt’s category
(1972), Herfindahl type index (Montgomery, 1982), Entropy (Jacquemin &
Berry, 1979; Palepu, 1985), and BSD &
MNSD (Varadarajan & Ramanujam,
1987).
Entropy measure is a frequently used
method to measure the relatedness of
product diversification based on a
firm’s sales volume by product segment. However, it is difficult to find secondary sources that provide reliable
and consistent data by product segment
for media firms. Worse yet, each media
firm provides product segment revenue
in a different way. For example, one
company combines broadcasting, cable,
movie, games, and other segments as
entertainment revenue, while another
company reports its revenue from
broadcasting and cable separately. As a
consequence, it is problematic to apply
the same rule of segment to all companies.
Adopting Jacquemin and Berry’s (1979)
entropy measurement, researchers
used the number of SIC industries instead of sales segment data (Geringer,
Tallman, & Olsen, 2000; Palich, Carini,
& Seaman, 2000; Robins & Wiersema,
1995; Sambharya, 1995). They used a
Herfindahl type measure of product diversification, which takes into account
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV 241
treated as an unrelated business. A detailed list of SIC codes is summarized
in the Appendix 2.
both the number of segments in which
the firm operates and the relative importance of each segment. Following
their approach, this study adopted the
categories of the Standard Industrial
Classification. Based on the classification, two businesses are considered related if they share the same two-digit
SIC code, and vice versa. In other words,
products belonging to different fourdigit SIC industries within the same
two-digit industry group are treated as
related. For example, the first two-digit,
SIC code 27, indicates print media such
as newspaper (2711), magazine (2721)
and book (2731). On the other hand, the
first two-digit, SIC code 48, includes
electronic media such as radio station
(4832), television broadcasting (4833)
and cable television (4841). Therefore,
the integration of two SIC code 27 businesses (e.g., newspaper and magazines)
were treated as a related business, while
the integration of SIC code 48 businesses (e.g., television station or cable
television) and SIC code 27 businesses
(e.g., newspaper or magazine) was
Using this category, the Herfindahl
measure is computed based on the sum
of the squared proportion of industry
involvements relative to total operations. Subtracting that sum from one
provides an index that rises as industry spread (i.e., product unrelatedness)
increases. Following is the equation for
the measurement of unrelated degree
of product diversification:
D = 1-Σ Pi2/(Σpi)2
; where Pi= proportion of operations in
the industry i to total operations.
The following is an example of calculation: Two companies, A and B, involve
businesses of four SIC codes equally.
Company A is involved in four businesses in the same two-digit SIC (2711,
2721, 4831, and 4832) which are print
(27) and broadcasting (48) businesses.
On the other hand, company B has dif-
Figure 1: Mean of SCI codes of product diversification from 1996 to 2002
27.9
18.2
1996
17.1
1997
16.8
1998
17.5
1999
27.6
19.6
2000
2001
2002
Figure 2: Mean of unrelated degree of product diversification from 1996 to 2002
0.633
0.611
0.584
0.594
0.578
0.581
1996
1997
1998
1999
2000
2001
2002
242 © 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV
Financial health
First, financial efficiency is most often
measured in diversification studies by
profit to sales or profit to asset ratios
(Tallman & Li, 1996). Managers and external analysts also frequently use data
such as ROS and ROA as a measure of
management effectiveness. Thus, traditional accounting measures such as
return on sales (ROS), return on assets
(ROA) and return on equity (ROE) were
used in this study to measure firms’ financial efficiency. Changes in stock
prices tend to follow the announcement of figures such as ROS and ROA,
indicating that the reports have important signaling effects (Fama & Miller,
1984). In order to check stock market’s
evaluation, earnings per share (EPS)
were also measured.
Second, considering the multiple
aspects of performance, this study employed another set of variables to measure firms’ relative power and magnitude in financial performance. Total
revenues were adopted to show the
conglomerates’ relative positions in
the market, while sales growth rate
was evaluated to see the growth potential over short-term profitability (ChanOlmsted & Chang, 2003). Earnings
before interests, taxes, depreciations,
and amortizations (EBITDA) were used
to evaluate cash flow. EBITDA is not a
typical performance measure in accordance with generally accepted accounting principles (GAAP). However, because media business is principally
goodwill related, EBITDA will be another appropriate measure for evaluating the media sectors.
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0.581
ferent two-digit SIC businesses (2721,
4833, 7375, and 7812) in four areas,
which are print (27), broadcasting (48),
information service (73), and motion
picture (78). Based on the Herfindahl
calculation, company A has value of .50
and company B has the value of .75.
Therefore, the higher value indicates
that the firm is diversified into more
unrelated direction.
Table 1: Results of regressing financial performance on the direction of product diversification
Revenues
B
Constant
RD
RD2
19565.33
(6012.5)
-147730
(22954)
208996
(21897)
R2
beta
EBITDA
t
B
3.25***
4271.9
(1325.8)
-28167.9
(4975.1)
37945
(4699.8)
-1.223
-6.436***
1.813
9.544***
.579
F-ratio
95.486***
beta
Sales growth rates
t
B
3.22**
2.49
(.603)
-6.69
(2.28)
4.76
(2.17)
-1.19
-5.66**
1.69
8.07***
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-.775
-2.93**
.580
2.19**
.073
61.199***
6.866***
Product diversification was defined in
two different dimensions. First, the extent of diversification was defined as
the total degree of diversification,
which was measured by the total number of Standard Industrial Classification codes in which a firm is involved.
Second, the direction of diversification
was defined as the related degree of
diversification, as calculated by the
Herfindahl formula.
which showed a 37.1% increase. On the
other hand, there was a 6.3 % decrease
in the mean from 1996 to 1997. This
might be due to changes in the structure of Walt Disney. Subsequent to the
acquisition of Capital Cities/ABC by
the Walt Disney in 1996, Disney completed the divestiture of its publishing
assets, including 39 business periodicals and more than 10 daily newspapers. This led to the decrease of the
number of SIC codes involved in the
firms in 1997.
Figure 1 shows the descriptive results
of the extent of product diversification
from 1996 to 2002. Most firms analyzed
in this study are involved in at least ten
businesses, and the mean of the total
number of SIC codes of the sample
firms has changed from 18 in 1996 to
near 28 in 2002. There was not much
variation until 1999. However, it
showed a significant increase in 2001
and 2002, because of the following
mega-mergers: AOL-Time Warner
(2000), Vivendi-Seagram (2002), Clear
Channel-AMFM (1999), Tribune-Times
Mirror (20002), Viacom-CBS (1999), and
Gannett-Central Newspapers (2000). At
the same time, Disney, Bertelsmann,
and Cox Enterprise also diversified
their businesses in recent years in
response to their competitors’ diversification strategies. The percentage
change year by year revealed the most
significant increase from 2000 to 2001,
Figure 2 shows the mean of the direction of product diversification of the
sample firms from 1996 to 2002. The
measurement of direction for product
diversification was based on the relatedness of the diversified businesses.
The scale ranges from zero to one. In
this scale, the larger number means
the firm is more diversified in unrelated businesses. The mean of unrelated diversification increased from
0.581 in 1996 to over 0.60 in 2002. Like
the extent (total degree) of diversification, the unrelated degree of product
diversification also showed increase,
indicating that media firms have expanded into more diverse business sectors over the years. Meredith, for example, which initially started as a
magazine publishing company, now
runs an equivalent number of broadcasting businesses. Moreover, it has expanded its business into integrated
t
4.136***
.413
Standard errors are in parentheses.
RD = direction (related degree) of product diversification
RD2 = square of direction (related degree) of product diversification
Results
beta
* p <.10
** p <.05
*** p <.01
marketing service and interactive media. The Washington Post Company
had businesses mainly in print and
broadcasting in 1996 but has increased
its ownership in the areas of cable television systems, educational services
and interactive media. Similar to the
extent of diversification, the decrease
in 1997 seems to be interpreted as a
result of the Disney divestitures.
A regression analysis was conducted to
estimate the effects of product diversification on media firms’ financial
health. The first two hypotheses (H1a
and H1b) proposed that a firm’s financial health has a positive linear
relationship with the extent (total degree) of diversification. Because this
study employed two sets (financial performance and financial efficiency) of
financial health measures for dependent variable, each set was tested separately.
First, the regression with the financial
performance measures was conducted.
With the total revenue measurement,
Hypothesis 1a was supported by showing a significant positive result in the
regression model (β = .883, R2 = .779,
p < .001). According to the revenue measure, the more product diversification
yielded better performance. H1a was
also supported by the EBITDA variable.
Coefficient of product diversification
showed significance with a positive
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV 243
Table 2: Results of regressing financial efficiency on the direction of product diversification
ROS
B
Constant
RD
RD2
-.057
(.014)
.380
(.396)
-.393
(.377)
beta
ROA
t
B
-.54
.002
(.04)
.192
(.159)
-.251
(.152)
.263
.96
-.284
-1.0
beta
ROE
t
B
.053
-.257
(.483)
1.387
(1.845)
-1.12
(1.76)
.329
1.208
-.448
-1.66**
beta
EPS
t
B
-.532
-1.62
(2.34)
12.91
(8.844)
-11.84
(8.36)
.206
.752
-.173
-.634
beta
-.690
.406
1.46
-.393
-1.42
R2
.006
.026
.004
.013
F-ratio
.553
2.346*
.335
1.066
Standard errors are in parentheses.
RD = direction (related degree) of product diversification
RD2 = square of direction (related degree) of product diversification
sign (β = .86, R2 = .74, p < .001). Thus,
firms pursuing diversification in diverse product markets have succeeded
in achieving better financial performance in terms of operating cash flow.
However, sales growth rates did not
yield a significant relationship.
On the other hand, even though the
results were not statistically significant, the variables (ROS, ROA, ROE, and
EPS) in the set of financial efficiency
measures revealed a negative relationship with the extent of product diversification. Thus, H1b was not supported.
The predictions of Hypotheses 2a and
2b were modeled by resource-based
strategic management, which posits
that related diversifiers have more
Performance = β0 + β 1 (direction of
diversification) + β2 (direction of diversification)2
The expected direction of the coefficient for diversification variable was
positive and the square value of diversification variable was negative. Two sets
of financial health measures were
tested to assess the relationship with
the direction (related degree) of product diversification. Table 1 presents the
results of regression analysis on the effect of direction of diversification on
firms’ financial performance. First, total revenues revealed a curvilinear
model with a high degree of explained
power in R-square. However, it was not
expected that the directions of the coefficient would be found to be contradictory to the predictions. The coefficient of related degree enters with a
negative sign, and that of the square of
related degree enters with a positive
sign. In other words, it was a U-shaped
curvilinear model, not an inverted-U
curvilinear model. When EBITDA was
used as a dependent variable, the results showed the same U-shape relation-
244 © 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV
* p <.10
** p <.05
ship with the direction of product diversification. Sales growth rates showed
less degree of explained power than
revenues and EBITDA. But the relationship to product diversification was also
revealed as a U-shape model. Thus, Hypothesis 2a was not supported. Concentrated media business and the more
unrelated diversifiers are, therefore,
better than medium level diversifiers
with medium degree of relatedness.
This result, however, is contradictory to
the postulations of the relationship between diversification and performance
literature discussed in the previous section.
On the other hand, the remaining four
dependent variables (ROS, ROA, ROE,
and EPS), which indicate the financial
efficiency showed the expected inverted-U shape relationship with the
direction of product diversification.
Table 2 presents the results of the regression analysis. The coefficient of related degree enters with a positive sign,
and that of the square of related degree
enters with a negative sign. By revealing an inverted-U shape, it supported
the notion that related diversifiers are
better than unrelated diversifiers,
which cause high transaction cost and
coordination complexity. This result
suggests that financial efficiency such
as profitability or stock market evaluation increased with the increase in di-
www.mediajournal.org
While main industrial organization
literatures, which measure the extent
(total degree) of diversification, failed to
show a linear relationship between total diversification and performance,
this study supported a linear relationship between variables. It should be
noted, however, that more diversification only contributed to the magnitude
(revenues and EBITDA) of the firms and
did not lead to the increase of management effectiveness and profitability
(ROS, ROA, and ROE) or market investor’s evaluation (EPS).
profit than unrelated diversifiers.
Therefore, it assumed an inverted-U
shape relationship between the direction of diversification and financial
health by proposing the following quadratic model:
t
versification up to a certain point, after
which it began to decline. It should be
noted, however, that only ROA showed
a statistically significant result (p<.05)
and the other three variables (ROA, ROE,
and EPS) failed to yield significant result
in each regression model. Thus, H2a was
partially supported in the regression test.
Discussion and Conclusions
This study suggests that the relationship between product diversification
and performance is more complex than
the linear relationship implied in most
studies of diversification. Directionless
rampant diversification did not contribute to firms’ healthy finance. It only
showed a positive relationship with
overall amount of revenues and EBITDA.
Moreover, the extent of diversification
showed a negative relationship with
management effectiveness measures
such as ROS, ROA, and ROE. The relation-
ship was also revealed as negative in the
measurement of earnings per share.
Regarding the direction (related degree)
of diversification, this study revealed
two contradictory results; the invertedU shape and the U-shape model. Because this study adopted two sets of
variables to measure financial health,
the discrepancy might be due to the selection of dependent variable. The first
set of measures indicating financial efficiency such as management effectiveness/profitability (ROS, ROA, and ROE)
and stock market reaction (earnings per
share) showed the tendency of the expected inverted-U shape (See Figure 3).
The empirical results indicated that
product diversification into related
business operations contributes to better financial efficiency. However, excessive diversification, which leads to a
high degree of unrelated diversification, might decrease financial effi-
Performance
Figure 3: Inverted-U shape Model – Relationship between the direction of diversification and financial efficiency
Product Diversification
www.mediajournal.org
Performance
Figure 4: U-Shaped Model – Relationship between the direction of diversification and financial performance
Product Diversification
ciency. Therefore, the proven invertedU shape model in previous management studies might be applicable to
media firms. The results recognize that
increasing diversification may not be
associated with concomitant increases
in financial health, at least not through
the entire relevant continuum.
Another set of measures (revenues,
EBITDA, and sales growth rates), indicating relative power and the overall financial magnitude in the market, also
showed a curvilinear relationship between the direction of diversification
and financial health. However, it was a
U-shaped curvilinear model (See Figure
4), not the expected inverted-U curvilinear model. In other words, this finding
for media firms does not support previous studies completed by strategic management scholars. Rather, the hypotheses relating direction (related degree)
of diversification yielded a contradictory result. That is, performance decreases as firms shift from concentrated
business strategies to related diversification, but performance increases as
firms change from related diversification to unrelated diversification. The
theoretical framework of diversification in strategic management cannot
account for this contradiction. Therefore, explanation for this discrepancy is
speculative at best.
One possible reason is that although
the diversification strategy pursued by
media firms has been successful in
terms of overall financial size, it does
not seem to contribute to managerial
effectiveness and profitability for the
firms. In line with theoretic interpretation, the firms might enjoy the market power advantage through greater
flexibility in capital formation. Thus,
they maintained a relatively strong position in the market by maintaining
higher cash levels. That is, media firms
are able to generate more cash when
they sell more “different” products to
customers. However, they might not be
successful in creating synergy effects
from diversification. Where is the evi-
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV 245
dence that the company got more efficiency and profitability in aggregating
Time Warner content with AOL distribution? Contrary to the rosy expectation of the new company, it presently
faces a record-high financial failure.
The mantra of synergy does not work
in the media industry at this point, not
only in AOL Time Warner but also in
other media companies as well. Obviously, financial efficiency decreased as
the firms expanded their businesses
into unrelated media sectors.
A slightly different explanation for the
contradictory result is the contribution of the enormous revenue size of
GE and Sony. It might be worked as a
bias in the model and lead to the opposite direction in the proposed hypotheses 2a. It is possible to run statistical
procedures after eliminating two companies in the sample.2 However, because other companies also have nonmedia related business, it is fair to
include GE and Sony’s non-media business sectors and performance as well.
The contradiction can also be accounted
for from the perspective of multi-dimensional aspects of financial health measurement. The three variables (revenue,
EBITDA, and sales growth rates) measuring relative power and financial magnitude were statistically significant with
the opposite direction of the hypotheses. It should be noted, however, that
the performance measurement for financial efficiency such as management
efficiency (ROS, ROA, and ROE) and investors’ reaction (EPS) showed the expected direction of the hypotheses. If
the latter set of variables were a more
critical measure for a firm’s financial
health, the proven inverted-U model
might be applicable to media firms.
Because of its exploratory attempt to
determine the relationship between
product diversification and financial
health, this study has a number of limitations and recommendations for future research. One of the limitations of
this study comes from the measurement of relatedness. This study
used a set of categories, the U.S.
government’s SIC code, which is the
most frequently used in assessing firm
relatedness. According to the classification, newspaper (2711), magazine (2721)
and book (2731) businesses are counted
as related business. On the other hand,
businesses that do not share the same
two-digit SIC code (e.g., SIC code 27, print
and SIC code 48, broadcasting) were
treated as unrelated. The combinations
of related cross-media ownership that
yield the most significant economic efficiencies are those that facilitate sharing of common specialized content or a
common distribution infrastructure
and expertise (George, Joll, & Lynk,
1992; Martin, 1993). A firm publishing
a newspaper might expand its business
into magazine publishing, because it
can utilize its resources and know-how
learned in print media business.
However, unrelated diversification (e.g.,
television stations and newspapers)
does not always give rise to many general economic gains. Because produc-
246 © 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV
tion and distribution techniques are
different for broadcasting and newspapers, relatively few opportunities to
make better use of collective resources
will arise directly from related diversification of these particular sectors of
the media (Doyle, 2002). If economies of
scope are non-existent and financial
profits are generally difficult to
achieve, few economic benefits can be
directly attributable to cross-ownership
of television and newspapers. It should
be noted, however, that both print and
broadcasting businesses are operated in
the ‘media’ industry. Thus, more elaborate consideration regarding the ‘relatedness’ of businesses in the media industry is desirable, instead of relying on
traditional SIC-based measures.
Second, because the primary goal of the
this study was to reveal the relationship
between the diversification of media
firms and performance, it did not take
into account how alternative factors
such as managerial decisions affect performance, to a great extent that diversification strategies per se. Future studies might consider the causal flow of
process from the managerial decision
about the strategies through performance.
Lastly, other variables, such as international diversification and its combined
effect with product diversification, also
should be considered in future studies.
Because media firms diversify their
businesses not only into different product markets but also into international
markets, the result of dual diversification might be different.
Despite these limitations, this study
has taken a useful step in the analysis
of diversification effects on performance. The financial efficiency reflected in management effectiveness
such as return ratios, did not provide
apparent evidence of cross-media synergy effect. Transaction cost theory
suggests that excess product diversification may harm performance (Jones
& Hill, 1988; Williamson, 1975). In
www.mediajournal.org
In conclusion, this study provides partial corroborating evidence that performance is related to product diversification in a nonlinear manner, supporting
the contention that concentrated and
more diversified business firms are better in generating more cash than re-
lated business firms. The highly diversified firms, such as top ranked AOL
Time Warner, Vivendi, Disney, Viacom,
or News Corp., achieved better performance, as measured by cash flow using
EBITDA and total sales. However, related
diversifiers, such as Gannett, Tribune,
Times Mirror, McGraw-Hill, Belo, and
New York Times, yielded better performance in profitability (ROS, ROA and
ROE). At the same time, the results also
showed that unrelated diversification
led to a decrease of stock market evaluation. Market investors believe overly diversified media conglomerates with
non-synergistic asset holdings may have
to restructure, divest, and focus on core
business (Ferrari et al., 2002).
other words, more diversification does
not always seem to be better. Hence, it
is desirable to determine a realistic
business diversification strategy rather
than relying on the traditional concept
of vertical integration or poorly conceived synergy advantage.
From the perspective of the public,
whether the high-profit generating
media conglomerates would invest
that hurts members of the public, who
need fair and high-quality media products and services.
money to provide quality information
and entertainment products is questionable. Even worse, if these same conglomerates are struggling financially
because of their rampant diversification activities, which might lead to excessive debt levels, ultimately it is the
public who will suffer. Big is not necessarily bad, but uncontrollably ambitious growth, which may cause financial difficulty, might create a problem
Acknowledgements
The author would like to thank Dr.
Sylvia Chan-Olmsted at the University
of Florida and three anonymous
reviewers for their valuable comments.
Appendix 1: Top 26 Media companies including Bertelsmann
Rank
Company
Nation
Revenue
(billion)
Ownership
1
2
3
4
5
6
7
8
9
10
11
12
13
AOL Time Warner
Vivendi Universal
Walt Disney
Viacom
Bertelsmann
Comcast
Sony
News Corp.
Hughes Electronics
Cox Enterprises
Clear Channel
Gannett
NBC
U.S.
France
U.S.
U.S.
Germany
U.S.
Japan
Australia
U.S.
U.S.
U.S.
U.S.
U.S.
38.2
31.0
25.3
23.2
19.1
19.1
17.1
13.8
8.3
8.0
7.9
6.3
5.8
PB
PB
PB
PB
PV
PB
PB
PB
PB
PV
PB
PB
PB
Rank
Company
Nation
14
15
16
17
18
19
20
21
22
23
24
25
26
Tribune Co.
McGraw-Hill
Cablevision
Charter
Hearst
Echostar
Adelphia
NYT Co.
Washington Post
Discovery
E. W. Scripps
Belo
Meredith
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
U.S.
PV: Privately held
Source: Broadcasting & Cable (2002, May 13)
Revenue
(billion)
Ownership
5.3
4.7
4.4
4.1
4.1
4.0
3.6
3.0
2.4
1.8
1.5
1.4
1.1
PB
PB
PB
PB
PV
PB
PB
PB
PB
PV
PB
PB
PB
PB: Publicly held
Appendix 2: Standard Industrial Classification codes in media businesses
Sector
SIC
Business
Sector
SIC
Business
Print media
2711 Newspapers
Information service
7371
Computer programming services
2721 Periodical/magazine
7372
Prepackaged software
2731 Book publishing
7373
Computer integrated systems design
2732 Book printing
7375
Information retrieval services
7812
Motion picture/video tape production
7819
Services to motion picture production
2741 Miscellaneous Publishing
Motion picture
www.mediajournal.org
2789 Bookbinding
Communication 3651 Household audio/video equipment
equipment
3652 Prerecorded audio/ tapes/disks
7822
Motion picture/video tape distribution
7829
Services to motion picture distribution
3663 Radio/TV broadcasting equipment
7832
Motion picture theaters
3669 Communications equipment
7841
Video tape rental
7922
Theatrical producers (except motion picture)
7929
Bands, orchestras, actors, and other entertainment
4833 Television broadcasting stations
7941
Professional sports clubs and promoters
4841 Cable/pay television services
7996
Amusement parks
4899 Communications services
7997
Membership sports and recreation clubs
3695 Magnetic/optical recording media
Communications 4832 Radio broadcasting stations
Amusement
and recreation
© 2003 – JMM – The International Journal on Media Management – Vol. 5 – No. IV 247
Endnotes
1 Standard Industrial Classification (SIC) system was developed to facilitate collection of data for economic analysis by the Department of Labor. It employs a set
of reporting standards that have evolved over time based on a variety of considerations ranging from similarities in materials to product-market linkage. Each
industry is assigned as different SIC code. For example, the SIC code of newspaper publishing is 2711, while broadcasting stations have a SIC code of 4833.
2 A regression test was conducted after eliminating two firms. The result obtained similar and only slightly weaker explanation power.
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