Globalization has led to most business organizations shifting their operations to cover wide geographical areas. With current favorable terms of business operations between countries, it has been possible for businesses to diversify their market by venturing into other markets both locally and internationally (Stiroh & Rumble, 2006, pp. 2131-2161). At times, there arises a time when government or bodies responsible for regulating business operations come up with limitations of geographical diversification for businesses. This move has both positive and negative repercussions on the financial profitability of an organization. This paper aims at analyzing some of these impacts on financial institutions’ profitability.
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Increase in profit margin
Failure to limit geographical diversification for businesses leads to most of the businesses venturing into all potential markets. This leads to an increase in a number of competitors within a single market. As all these competitors compete for a single market, the profit margin for organizations goes down. This is due to them sharing the customers. At times financial organizations try to overcome the competition by lowering the prices charged for their services or using other promotional methods (Berger, Buch, DeLong & DeYoung, 2004, pp. 333-366). This leads to the organization getting limited profit. Limiting geographical diversification for financial institutions results to an institution existing in a specific market assuming the monopoly. Competition in such a market is low and hence the organization is able to increase its profit margin. The business does not require incurring costs associated with services promotion and other advertisements.
Lack of exploitation of economies of scale
Despite the limitation on geographical expansion facilitating in increasing an organization’s profitability, it has been found to be a factor that constrains an organization’s ability to improve its profitability. This is by making it hard for a financial institution to exploit economies of scale (Berger, Saunders, Scalise & Udell, 1998, pp. 187-229). As an institution expands its operations, it starts offering its services to a wide range of customers. This saves it the costs associated with offering services to a limited number of consumers. The cost incurred in offering services to a limited number of customers is distributed in a wide market thus being compensated by high revenue collected from the customers. Limiting the geographical coverage of a financial institution makes it hard for it to exploit economies of scale. This is because it is not capable of accessing a wide market for its services.
Market diversification makes it possible for organizations to tap the opportunity associated with revenue synergy. Gaining access to varied markets helps organizations use their different salespersons to distribute their products or services to these markets (Mercieca, Schaeck & Wolfe, 2007, pp. 1975-1998). This helps the business organization increase its revenue amount hence increasing its profit. Limiting the geographical diversification of a financial institution makes it hard for an organization to effectively use its salespersons in distributing its services. The sales volume for such an institution goes down hence limiting its profitability. Limiting the geographical expansion of an institution also leads to the institution focusing on the distribution and production of limited services. This makes it hard for an organization to raise its profit.
Limitation of geographic diversification for businesses refers to a situation where a business is limited on the range of market coverage. This may have both beneficial and detrimental effects on an organization with respect to its profit. It reduces chances of competing in the market hence making a financial institution increase its sales volume, consequently, raising its profit. On the other hand, the move limits the ability of an organization to buy or produce its services in large quantities (Qian & Li, 2002, pp. 325-335). This makes it not benefit from economies of scale. Limitation of geographical coverage for a financial institution makes it hard for the institution to have revenue synergy.
Berger, A. N., Buch, C. M., DeLong, G. & DeYoung, R. (2004). Exporting financial institutions management via foreign direct investment mergers and acquisitions. Journal of International Money and Finance, 23(3), pp. 333-366.
Berger, A. N., Saunders, A., Scalise, J. M. & Udell, G. F. (1998). The effects of bank mergers and acquisitions on small business lending. Journal of Financial Economics, 50(2), pp. 187-229.
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Mercieca, S., Schaeck, K. & Wolfe, S. (2007). Small European banks: Benefits from diversification? Journal of Banking and Finance, 31(7), pp. 1975-1998.
Qian, G. & Li, J. (2002). Multinationlity, global market and diversification and profitability among the largest US firms. Journal of Business Research, 55(4), pp. 325-335.
Stiroh, K. J. & Rumble, A. (2006). The dark side of diversification: The case of US financial holding companies. Journal of Banking and Finance, 30(8), pp. 2131-2161.