This paper is based upon the assumption that a firm’s profitability is determined by
its degree of diversification which is, in turn, strongly related to the antecedent decision
to carry out diversification activities. This calls for an empirical approach that
permits the joint analysis of the three interrelated and consecutive stages of the overall
diversification process: diversification decision, degree of diversification and outcome
of diversification. We apply parametric and semi-parametric approaches to
control for sample selection and the endogeneity of the diversification decision in
both static and dynamic models. For the analysis, we use the census dataset on the
whole firm population in Vietnam, as a representative of transition countries. After
controlling for industry fixed-effects, the empirical evidence from the firm-level data
shows that diversification has a curvilinear effect on profitability: it improves firms’
profit up to a point, after which a further increase in diversification is associated
with declining performance. This implies that firms should consider optimal levels
of product diversification when they expand their product offerings beyond their
core business. Other noteworthy findings include the following: (i) the factors thatstimulate firms to diversify do not necessarily encourage them to extend their diversification
strategy; (ii) firms that are endowed with highly technological resources
and innovation investment are likely to successfully exploit diversification as an
engine of growth; and (iii) while industry performance does not have a strong influence
on the profitability of firms, it impacts their diversification decision as well as
the degree of diversification.