Foreign competition and business diversification options

Research Summary

We examine reallocation in a firm's business portfolio amid foreign competition in its primary business. We argue that firms will tend to exit unrelated industries and reallocate resources to related ones, reducing option breadth but increasing the value of narrower options due to synergies that contribute to building defensive moats against encroachment by foreign competition. This sequential process is strengthened among firms with greater absorptive capacity who are especially adept at identifying these changes and reallocation opportunities. Data on 2,582 US firms from 1997 to 2019 provide support for these arguments. Our study advances scholarly understanding of real options under uncertainty. It introduces the option of “flight to nearby places,” demonstrating how firms may seek to maintain competitiveness in the face of foreign competition.

Managerial Summary

As firms manage heightened foreign competition in their primary business, research suggests that reallocating resources within corporate portfolios is critical for maintaining competitiveness. In this context, we propose that firms are likely to streamline operations by exiting unrelated industries and reinforcing related ones. This move narrows options but can drive synergies and enhance the efficacy of defensive strategies against foreign competition. Data from 2,582 US firms provide insights for managers, emphasizing the importance of both option breadth and complementarity among options. Considering the challenges of managing increasingly competitive global markets, we show how firms may convert pressures into nearby opportunities to build defensive moats and maintain competitiveness.