Product diversification is one of the oldest strategies that has been adopted by a number of the worlds’ largest corporations at some time or the other. In this chapter, we explore the extant literature on measures of product diversification and financial performance of firms. We also review the extant empirical literature on the application of the same in firm-level studies and business group studies. While we discuss the range of measures of product diversification and financial performance, respectively, in Sections 3.1 and 3.2, Section 3.3 briefly reviews the empirical work done outside India, both at the firm level and the business group level. Extensive research has been done focusing in the past on the firm-level diversification-performance linkages in the developed countries. Some of these theories and explanations on firm-level literature are applicable to business group-level studies. Hence, we discuss the existing literature from this perspective and apply a few of these concepts of firm-level theories on business groups in Section 3.4. The institutional and other contextual factors affecting both diversification and performance of an organization are taken up in Section 3.5. In Section 3.6, we examine the business group literature in the Indian context.

Measures of diversification strategy

The existing literature on product diversification is perhaps one of the largest bodies of work in business strategy (Chen et al., 1998). Measurement has always been an important issue in product diversification studies. Product diversification was first studied by economists interested in the relationship between product diversification and monopoly (or market) power (Gort, 1962; Arnould, 1969). Primarily, there are two types of measures to differentiate between product diversification categories – continuous and categorical measures. Business diversity is generally captured through the use of ratios to measure the degree of activity in a single business or a group of businesses (Wrigley, 1970; Rumelt, 1974).

Review of continuous measures

Some researchers have used multiple continuous diversification measures. Jacquemin and Berry's (1979) entropy measure best exemplifies such an approach. Hitherto other studies start with multiple measures but subsequently transform them into categorical measures, typically using the median or a points. of discontinuity along the continuous measure as cutoff points.