Understanding the cost of entry test in diversification decisions
The cost of entry test examines whether you have the resources to allow you to effectively diversify into a new industry. If you lack the resources to be able to effectively diversity without putting your existing operations in jeopardy, then the cost of entry test is not passed – the diversification decision may not make sense since the company doesn’t have the resources to effectively achieve the diversification.
Resources that may limit your ability to move into the new industry
One of the most important resources that may limit the ability of companies to effectively diversify is financial resources – the money needed to diversify. Whether it be acquiring another firm or organic growth – moving into a new area can require significant commitments of resources. Often companies take on debt to finance major diversification moves – servicing such debt should not be detrimental to the company.
Another resource important not to overlook is managerial time. Management only have a certain number of hours in the week – moving to operate in multiple areas can spread the firm too thin.
Other resources that the diversification will rely on
Especially if it is intended that the diversification will make use of other internal resources – such as resource and development or manufacturing – it is important to consider the impact that the move will have on these areas of the business. It is important to be aware of other strains that the diversification may place on the company – potentially making it harder to compete within the original business area.
The importance of the cost of entry – both the existing firm and the new diversified area
When considering the cost of entry test, it is important to examine both the existing firm and the diversified area. The company both needs the resources to maintain its current operations and also sufficient resources to achieve the desired growth.