Efficiency of the diversification strategies of the private railway companies in Japan.

Author:Song, Yeon-Jung
Position::Report
 
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INTRODUCTION

In most industrialized countries, governments have supplied public transportation services and are responsible for supervising and managing their quantity and/or quality. However, the issue of efficiency in the transportation system has recently come into question. Public ownership, subsidies, operating deficits, and inefficient operation are the main issues of debate on urban transportation.

Many private railway companies (PRCs hereafter) were established in Europe, North America, and Japan at the turn of the 20th century. While a good number of them have gone bankrupt because of financial difficulties, PRCs in Japan are now also operating passenger railway service and engaging in different kinds of businesses, such as real estate, retail, and taxi and bus service in addition to their core railway business (Shoji, 2001; Mizutani, 2008; Kamata and Yamauchi, 2010). Indeed, the decreasing railway ridership resulting from the decline in the population of productive age (i.e. people aged 15 to 64) is currently making diversification strategies crucial for PRCs. Thus, an increase in the proportion of operating profits coming from diversified businesses becomes important not only in maintaining the sustainability of the entire firm, but also in supporting the core railway business.

Most previous research focuses on categorizing the type of diversification and its relationship with the profitability of PRCs in Japan. However, there is not much research investigating the relationship between diversification strategies and PRC's performance quantitatively. Thus, the purpose of this study is to investigate whether PRCs in Japan operate their businesses effectively, focusing on the relationship between diversification strategies and technical efficiency. The analysis includes only major PRCs operating in large urban areas.

This paper is organized as follows: first of all, I present an overview of diversification strategies of PRCs in Japan. Then, I review the previous theoretical and empirical studies on diversification strategy, performed in strategic management. I also outline empirical analysis of diversification strategies using stochastic frontier analysis and discuss the results. Finally, I suggest some concluding comments.

LITERATURE REVIEW

Relationship between Diversification and Performance

Diversification can be described by the extent of participation in different businesses and the underlying relationships between the various businesses within each firm (Nayyar, 1992). It can also be explained as the set of strategies that consists of choosing the types of businesses the firm will enter, the extent to which the firm will rely on past competences or require the development of new ones, and the total amount of diversity considered as appropriate in favor of a single strategy (Rumelt, 1974). Literature on diversification has covered a wide range of research questions and issues within its broad scope.

With regarding to the motivation for diversification, Ansoff (1957) claims that a firm wants to be compensated for the deterioration of current technology, to diffuse risk, to utilize excess production capacity, to reinvest revenue, and to acquire superb operation abilities. Porter (1980) mentions the effect of cost reduction through accumulation of experience. He insists that the cost reduction is amplified when the firm utilizes its experience in the process of creating a new product which is similar to a firm's current product, or when it fully utilizes accumulated experience to other related businesses. In other words, the firm considers diversifying because it can lighten the burden of additional cost by sharing common factors, such as experience acquired from the previous business for a new, highly similar one. Based on these arguments, Montgomery (1994) synthesizes the three views of the motivation for the firm's diversification, which are the market-power view, the agency view, and the resource view.

In particular, the resource view insists that a firm diversifies in response to excess capacity of productive factors, called resources. The firm also regards the level of profit and the range of diversification as stock of the firm's assets, core competences, or distinctive capabilities. These resources include factors that the firm has purchased in the market, services, and special knowledge accumulated over time. They are heterogeneous for each firm. If these resources are hard to copy for competitors and to be transferred, they work as competitive advantages. Thus, the optimal level of diversification for the firm is determined by these resources, depending on whether they are different from those of another firm or they exist generally all over the industry (Robins and Wiersema, 1995).

Types of diversification are based on the relatedness among the various businesses of the firm. Wrigley (1970) suggests a basic concept first and Rumelt (1974) modifies it to assess the extent of diversification and the nature of relatedness among the businesses of a diversified firm (Nayyar, 1992). He also categorizes the type of diversification into four categories that can each be broken down into subcategories, to arrive at a total of nine categories. The four major categories defined by Rumelt are single, dominant, related and unrelated business, and all but the single business category can be further divided into subcategories. As a result, the nine business categories are the following: 1) single, 2) dominant-vertical, 3) dominant-unrelated, 4) dominantconstrained, 5) dominant-linked, 6) related constrained, 7) related-linked, 8) unrelated business, and 9) conglomerate. Each category is determined by the specialization ratio (SR), related ratio (RR), and vertical ratio (VR), which are the ratios of operating profit for specialized, related, and vertical business, respectively. The firm is likely to choose a type of diversification by considering the types of tangible resources or assets that it possesses. Intangible assets and financial resources are also considered important. Particularly, intangible assets from research activities like R&D are likely to be more connected with the related diversification (Chatterjee and Wernerfelt, 1994).

Previous research supporting the resource view emphasizes a positive effect of diversification on profitability. Much of that also insists that knowledge-based and inimitable resources can achieve the benefits of diversification (Miller, 2006). Especially, Rumelt (1982) shows through empirical analysis that a related-constrained firm has the highest profitability among diversification categories. Palich et al. (2000) also synthesize diversification-performance literature and suggest three points of view for the profitability issue. Figure 1 shows the three types of relationship between diversification and performance.

[FIGURE 1 OMITTED]

The inverted-U model is strongly supported by many studies. It explains how a firm's performance improves as it diversifies to an appropriate level of related business, and it tends to decrease after a critical point (Bettis, 1981; Rumelt, 1982; Lubatkin and Chatterjee, 1994; Markides and Williamson, 1994; Robins and Wiersema, 1995; Palich et al., 2000). It also explains how a firm's performance improves the more it diversifies, from the single business to related businesses of appropriate level of diversification. On the contrary, if a firm diversifies into unrelated business, its performance worsens gradually (Palich et al., 2000). Therefore, properly matching a firm's resources or assets to its products or services may enhance its profitability.

Diversification Strategies of Prcs in...

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