A Generalized Index of Diversification: Trends in U.S.

Manufacturing
Author(s): Frank M. Gollop and James L. Monahan
Source: The Review of Economics and Statistics, Vol. 73, No. 2 (May, 1991), pp. 318-330
Published by: The MIT Press
Stable URL: http://www.jstor.org/stable/2109523 .
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 A GENERALIZED INDEX OF DIVERSIFICATION:
TRENDS IN U.S. MANUFACTURING
FrankM. Gollop and JamesL. Monahan*
Abstract-An indexof diversification suitablefor manufactur-
ing plants and firms is defined as a function of product
number,distribution,and dissimilarity.A novel featureof the
index is its continuoustreatmentof product heterogeneity.
Using Censusof Manufacturesdata files, the index is con-
structedfor each establishmentand each enterprisesurveyed
in the 1963-1982censuses.Resultsare reportedat the 2-digit
SIC level. While quantifyingthe upwardtrend in enterprise
diversification,the index revealsan ubiquitousand persistent
declinein establishmentdiversification.Overtime, enterprises
are shifting toward a more diverse portfolioof increasingly
homogeneousplants.Technicaleconomiesof scope appearto
play little role in explainingthe measuredincreasein enter-
prise diversification.
r HE 1901 amalgamationof eight previously
independent iron and steel firms into U.S.
Steel dominatedthe turn-of-the-century business
press. More recently, the company's successful
battle against Mobil for Marathon Oil claimed
1981 business headlines. Analysts are quick to
observethat the shift in U.S. Steel strategyis not
atypical. Philip Morris, for example, acquired
Miller Brewing in 1970, Seven-Up in 1978, and
then in 1985 leveled its sights on General Foods.
U.S. Steel's name change to USX in 1986 barely
raised eyebrows.Diversificationhas replacedhor-
izontal growth.While pure conglomeratemergers
were relativelyrare in the immediatepostwarera,
accountingfor 3.2% of asset acquisitionsin the
1948-53 period, they now accountfor more than
50% of mergeractivity.'
Economists have just begun investigatingthe
properties of multiple-output production. Al-
ready, the notions of scale economies, natural
monopoly, capacity utilization, and productivity
have been revised.2 The applicability of
Receivedfor publicationMarch10, 1988.Revisionaccepted
for publicationJuly 16, 1990.
* Boston College and U.S. Bureau of the Census, respec-
tively.
We wish to thankJ. R. Norsworthy,RobertMcGuckin,and
two anonymousreferees for their helpful commentsthough
we retainfull responsibilityfor any errors.We also gratefully
acknowledgethe U.S. Departmentof Commercefor research
supportunder GrantNo. 3396.The usualcaveatapplies.The
views expressedin this paper do not necessarilyreflect those
of the CensusBureauor the Departmentof Commerce.
1These data are taken from Federal Trade Commission
(1969),p. 673 and FTC (1981),table 20.
2 See Baumol(1977) and Berndtand Fuss (1989).
[ 318 1 Copyright? 1991
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marginal-costpricinghas had to be reinterpreted.3
The prior universalcondemnationof entrybarri-
ers has been questioned.4 In spite of these
provocativetheoreticaladvances,the relative im-
portance of diversificationacross industries and
over time remainsa mystery.There simplyare no
meaningful,publiclyavailablestatisticsmeasuring
the extent of establishment(plant),enterprise,or
industrydiversification.
The Bureau of the Census annually collects
extensive manufacturingdata, but the develop-
ment of its published summarystatistics adopts
the ubiquitouseconomic assumptionof homoge-
neous productmarkets.An establishment'sentire
output is assignedto a particularfour-digitindus-
try on the basis of the plant'sprimaryproduct.As
a result, the Bureau'sprimaryproductspecializa-
tion ratio notwithstanding,published Census of
Manufacturesdata are silent on the extent of
establishment diversificationwithin and across
conventionalindustrylines. Moreover,there cur-
rently exists no measure indicatingthe extent of
enterprise operations across industrylines. This
orientation may be consistent with conventional
economic assumptionsand the historical unim-
portance of diversifiedproduction,but it clearly
masksone of the more importantstructuralphe-
nomena of the postwarperiod.
The primaryobjective of this paper is to de-
velop a generalized index of diversificationand
then, by applyingthe index to establishmentand
enterprisedata currentlycollected by the Census
Bureau,to describethe extent of productdiversi-
fication within U.S. manufacturing.The proper-
ties requiredof a proper diversificationindex are
describedin section I. An index satisfyingthese
requirementsis introducedin section III after the
properties of previously suggested indexes are
discussedbriefly in section II. Trends and inter-
industry differences in manufacturingestablish-
ment and enterprisediversificationare presented
in section IV. Changingpatterns in the source
3See Baumol(1976).
4See Panzarand Willig(1977) and Sharkey(1981).
 A GENERALIZED INDEX OF DIVERSIFICATION 319

components of diversificationare identified as heterogeneitypropertyaddressesproductidentity

well. ratherthan composition.Property(iii) states that
One interesting conclusion is the extent to a firm producingdistantlyrelated products, ce-
which increasingenterprisediversificationis due terisparibus,is more diversifiedthan anotherfirm
to increasing diversificationamong rather than producing products which share technological
within establishments,suggesting that technical and/or marketingsimilarities.7Property(iii) dis-
or within-plant economies of scope offer little tinguishesbetweenwhat the Federal Trade Com-
explanationfor the postwar surge in diversifica- mission labels pure conglomerates and market
tion. The data make clear that the trend within extensionconglomerates.8
establishmentsis for productionto become more, None of the diversificationmeasurespresented
ratherthan less, homogeneous. in the economics literaturesimultaneouslysatis-
fies the criticalnumber,distribution,and hetero-
I. Propertiesof a DiversificationIndex geneityproperties.A brief survey,however,high-
lights guidelinesfor the developmentof an index
There unfortunatelyis no formalmodel of pro- that does.
duction that leads unambiguouslyto a unique
index of diversification.As a result, this paper II. MeasuringDiversification
adopts an axiomatic rather than deductive ap-
proach. Fortunately,the diversificationliterature Gort (1962) generally is credited with having
exhibitsa clear concensus. It posits that a well- made the firstquantitativeexaminationof diversi-
designed index of diversificationshould have the fication in U.S. manufacturing.The familiarpri-
followingfive properties: mary product specializationratio (PPSR) forms
the basis for his most popularlyreferencedmea-
(i) it should vary directlywith the numberof sure:
differentproductsproduced;
n
(ii) it should vary inverselywith the increas-
ingly unequal distribution of products dl1 PPSR =57, ij (1)
j=2
acrossproductlines;
(iii) it should vary directlywith the dissimilar- where typicallydefined at the four-digitlevel,
sj,
ity or heterogeneityof products; is the share of the jth secondary product in
(iv) it shouldhave scope. applyingequallywell establishment,firm,or industryshipments.
to plants, firms,and industries;and The PPSR is a good measure of a producing
(v) if possible, it should be bounded between unit's primaryproductconcentration,but d1 does
zero and unity. not satisfactorilyfulfillthe criticalpropertiesof a
Properties (i) through (iii) form the critical well-defined index of diversification.It is silent
subset.Onlyproperties(ii) and (iii) requireelabo- regarding the number of products. It accounts
ration. The distributionproperty concerns the only for the share distributionbetween the pri-
composition of production. Property (ii) posits mary product and the aggregateof all secondary
that, holdingall else constant,a firmproducingn products.9 Utton (1977) and Goto (1981), how-
products with each having a l/n share of the ever, do offer a heterogeneity claim for d1, argu-
firm'stotal sales is more diversifiedthan another 7The importanceof productheterogeneityas a determinant
firm producingthe identical n productsbut with of diversificationalso has been discussed in the literature.
one representing,say, 90% of firm sales.6 Hold- Both Berry(1971)and Gorecki(1975)acknowledgeits impor-
tance. With various degrees of formalism, Utton (1977),
ing all else constant,weightingproductionactivity Jacquemin and Berry(1979),Pomfretand Shapiro(1980),and
towarda subset of primaryproductsreduces the Goto (1981) explicitlyaccountfor it in their research.
diversifiednature of the enterprise.The firm be- 8A conglomerateformedthroughmarketextensionmerges
comes more dependentupon fewer products.The noncompetingproductswith related marketingchannels or
productionprocesses.
9 Gort (1962) designs an alternativemeasureof diversifica-
SSee the discussionin section 11. tion nE%.2s1, in an attemptto satisfyboth the numberand
6
The importanceof the distributionproperty has been distributionrequirements.Like d1, however,this measureis
recognizedpreviously.See, for example, Berry (1971) and sensitiveto neitherthe distributionnor heterogeneityof sec-
McVey(1972). ondaryproducts.

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 320 THE REVIEW OF ECONOMICS AND STATISTICS

ing that applyingthe index at the aggregatetwo- Jacqueminand Berry(1979) propose the entropy
or three-digitlevel meaningfullymeasures prod- index:
uct dissimilarity.This conclusionfollows, the ar-
gumentcontinues,because this form of d1 would d4- Esi ln(llsi). (5)
register only production activity outside the Like d2, both d3 and d4 are sensitiveto changes
broadly defined industry aggregate housing the in the number and distributionof products. In
primaryfour-digitproduct.Though it lacks some fact, each index can be decomposedinto number
desirablefeatures,but because of the readyavail- and distribution components. Unlike their
ability of PPSR data in Census publications,d1 Herfindahlcounterpart,however,neither d3 nor
remains a popularlyused measure of diversifica- d4 is bounded from above by a constant; 1 <
tion.10 d3 < n and 0 < d4 < ln(n). Another distinctionis
Berry (1971) and McVey (1972) apparentlyin- notable as well. As the simple numberof prod-
dependently propose and apply the Herfindahl ucts increasesor the distributionof productsbe-
index as a measure of corporate diversification. comes more equal, the Herfindahl-basedindex d2
The indexhas the form ESY2, where s1 is the share increases at a decreasingrate, d3 increases at a
of the ith product in total sales. McVey (1972) constantrate, and the entropyindex d4 increases
uses the index directly;Berry(1971) suggeststhe at a decreasingrate in productnumberbut at an
form increasingrate in productdistribution.The char-
d221-Es7.
acterizationsof diversificationby the three in-
(2) dexes are
quite different. In the end, however,
The index does not addressproduct heterogene- none of the three indexes satisfies the hetero-
ity, but it does satisfyboth the numberand distri- geneity property.
bution properties.This can be demonstratedby Pomfret and Shapiro(1980) introducea diver-
addingand subtracting1/n to (2), where n is the sification measure that does attempt to address
numberof distinctfour-digitproducts: the heterogeneityrequirement:
d5 - ESjVijx (6)
d + 1: - - S? ~~~~~(3)
( n) (n2
where i and j represent primaryand secondary
The first term in (3) varies directly with the
industries,respectively,and
numberof products,thereby satisfyingthe num-
ber property.The second term can be interpreted vii = 0 if the producingagent operates in one
as the difference between two Herfindahl in- 4-digit industryonly,
dexes, one based on actual product shares (si) = 1 if j is in the same 3-digit industryas i,
and a second calculatedon assumedequal shares = 2 if j is in the same 2-digit industryas i,
(1/n). The term satisfies the distributionprop- and
erty. It takes a zero value when the n products = 3 if i and j are in different2-digit indus-
are distributedequally.It takes increasinglynega- tries.
tive values as the distributionof productionbe- Except for the case where n = 1, however, the
comes more unequal. index d5 is not necessarilysensitive to variations
Two other indexes have similar properties. in either the number or share distributionof
Utton (1977) constructs a "cumulativediversifi- products.The index is calculatedby simplycom-
cation curve" and introducesan index based on biningproductshares aroundcommondummy
sj
the area above that curve: variablesvi identifyingSIC boundaries.1" Chang-
d32Erisi - 1, (4) ing the number or distributionof products as-
signed to any vij categoryleaves d5 unchanged.
where ri is the shipmentsrankof the ith product None of the existing measures of D compre-
and products are ranked in descending order. hensivelysatisfies the five properties introduced
10The measure appears 11The "concentricindex"introducedby Caves,Porter,and
d, frequentlyin the literature.See,
for example,Rhoades(1973),Gorecki(1974, 1975),Greening Spence (1980)addressesinterproductdistancein nearlyiden-
(1980),and Caves(1981). tical fashion.

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 A GENERALIZED INDEX OF DIVERSIFICATION 321

above, but the cumulativehistoryprovides some lently. As for the Utton index, both derivatives
useful insights. First, most empiricalstudies ap- equal zero. While reasonable people may dis-
plying any of the above indexes treat the output agree as to the most appropriatefunctionalrep-
of each establishment as a homogeneous resentationof diversification,the naturalinclina-
product.12 Regardlessof its productmix, all ship- tion of economists is to posit that the marginal
ments are assigned the plant's primaryproduct contributionto diversificationof a change from
code. The changinginternal product diversifica- one to two or two to three distinct products
tion of establishmentsis masked. The resulting exceeds the marginal contributionof a change
indexes are measuresof industrialdiversification, from producing80 to 81 products.
not product diversification.The latter is pre- The Herfindahl-basedindex d2 exhibits the
ferred. Second, while a number of studies ac- desired negativesecond derivativesin both prod-
knowledge the importance of accounting for uct number and distribution. Furthermore, as
productheterogeneity,those that formallyincor- demonstratedby Davies (1979), for n < 100 the
porate some notion of product dissimilarityuni- Herfindahlindexplaces equalweighton the num-
versallydefine distance between productswholly ber and distributioncomponentsidentifiedin (3),
in terms of SIC codes. The Utton and Goto a desirablepropertygiven the lack of prior infor-
applicationsof d, and the Pomfret and Shapiro mation regardingwhich characteristic(if either)
index d5 are representative.Such indexes, how- should dominate.
ever, registerheterogeneityonly as productscross
SIC borders.As a result, the measured distance III. An Index of Diversification
between chemical and petroleumproductsis as-
sumed equal to the distance between chemical The critical issue is how to generalize the
productsand electricalmachinery.A more mean- Herfindahl-based index d2 to make it sensitiveto
ingful index of diversificationrequiresa distance product heterogeneity. Fortunately,the Herfin-
metric more sensitive to dissimilaritiesamong dahl index already has embedded in it an elemen-
products.Third,and most important,of the basic tary treatment of heterogeneity. Two products
measures described above, the Herfindahl-based are either identical or different.If identical,out-
index appears the most promisingcandidate for put units are simplyaggregatedand given a com-
furthergeneralization.Index d2 fails the hetero- mon product subscript.If different,output bun-
geneity requirementbut otherwise satisfies the dles are given distinctsubscripts.
remainingfour propertiesof a well-designedin- Makingthis bivariatenotion of producthetero-
dex. geneityexplicitis the key to properlygeneralizing
The Utton (d3) and entropy(d4) indexes also d2. An exampleis instructive.Consideran enter-
satisfythe numberand distributionpropertiesbut prise that producesthree differentfive-digitprod-
(1) neither is bounded in the appealingzero-one ucts yi with shares si. The resultingvalue of d2 is
interval and (2) their second derivativesdo not
exhibit wholly desirable properties. The second =
d d=1 - S2
_525 - 2 -2
S_32
derivativesof the entropy index with respect to
the numberof productsand the extent of equality =(1-3)- (si2- (7)
in productdistributionare negative and positive,
respectively.Unless strongargumentsexist to the Contrastthis with the scenariowhere Y2 and y3,
contrary,the derivativesshouldbe signed equiva- perhaps because they fall within the same four-
digit productgroup, are treated as identical:
12
Examples include Berry (1971, 1974), McVey (1972),
Rhoades (1973), Gorecki (1974, 1975), Utton (1977), 2= 1-5S2- (52++ S)
Jacqueminand Berry (1979), Greening(1980), and Pomfret
and Shapiro (1980). Goto (1981) and Gorecki (1980) are
exceptions.Goto considersthe commoditycompositionof the = (1- )-E si2-9 )2S2S3 * (8)
124 largest Japanese firms in the 1963-75 period. Gorecki
tests three mechanicalapproximationsto the distributionof
plant output against actual output vectors in 1970 for 890 The number and distributioncomponentsin (8)
plantsin 155 Canadianfood processingenterprises. still are computedon the basis of the true num-

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322 THE REVIEW OF ECONOMICS AND STATISTICS

ber and distributionof five-digit products but, and

because the modeler has decided that Y2 and y3
are to be treated as identical, the extra term Wij input cost share of the jth input in the
-2S2S3 appearsin (8). Generalizingthe example ith product.

to n productsyields
The input cost shares {Wkj} and {wi} serve as
d2= 1- ES- - E SiSkZik estimatesof the parameters{I,kj} and {/,ij} defin-
i i koi
ing the Cobb-Douglastechnologies Yk = ki
and y1= HlXfii for the kth and i h products,
( n) E(i n2 respectively.Assumingcompetitivemarkets,
E ESiSkZik, (9)
i koi
dln y1 X_plj _
where =
E
wlj,

Zik = if the ith and kth products

{1
are identical
{Oif the ith and kth products
are not identical.
As evidentfrom (7) and (8), the last term in (9)
serves as a correctiveadjustmentto the number
and distributioncomponents;EESiSkZik takes a
non-zerovalue only when it is necessaryto offset
the upward bias resulting whenever two truly
identical product bundles are improperlydistin-
guished (Zik = 1). As such, EESiSkZik contains a
primitivenotion of productheterogeneity.
The problem with this formulationis that a
zero value is assignedto Zik wheneverthe ith and
kth productsare judged to be non-identical,with-
out any regard to how minimal or substantial
their differencesmay be. Note, this is perfectly
acceptable given the limited "corrective"role
EESiSkZik plays in (9). The number and share
distributionof productsshould be sensitive only
to the presence of distinct products, not to the
extent of their dissimilarity.The heterogeneity
propertydescribedin section I, however,requires
much more. The index d'2must be generalizedto
include a continuousmeasureof productdissimi-
laritythat makes an independentcontributionto
the final index of diversification.
The continuousvariable otik providesa mecha-
nism capturingproductdissimilarity:
2= 1 - ESI - E E SiSk(Zik - ik), (10)
i koi
where
= kg i)
(n (11)
input. The
where plj is the price of the jth
distance function ai k therefore quantifies the
difference between the products described by
{f3kj} and {/,ij}* Division by 2 in the formulation
of aoik ensuresthat the variableis boundedin the
zero-one interval.The importanceof the one-half
powerwill be made clear below.
The definition of ai k is based on the simple
premise that two products requiring the same
inputsin : ^arlyidenticalproportionsare likelyto
be less heterogeneous than two productshaving
significantlydissimilarinput requirements.Hold-
ing all else constant, a well-designed index of
diversificationshould identify a plant producing
canned fruit and canned vegetables as less diver-
sified than an establishment producing canned
fruit and the cans themselves. Given the role of
ahk in (10), the measured index d'" would be
higherfor the latter plant.
The heterogeneityvariable aik focuses on one
importantdimensionof dissimilarity.Others cer-
tainlyexist and are encompassedby the notion of
dissimilarityreferenced in property (iii) above.
Lemelin(1982) and MacDonald(1985),for exam-
ple, would define dissimilaritybetween products
in terms of, among other things, different cus-
tomer sets (consumerversusproducergoods) and
the extent of R & D activityas well as production
differences."3

7i k (E andO < ik < 1, 13

The Lemelin (1982) and MacDonald(1985) papers are
not designed to incorporatethese heterogeneitycharacteris-
tics into measuresof diversificationbut use these and other
Wkj input cost share of the jth input in the indicatorsto identifyfactorsinfluencingthe choice of indus-
kth product, tries into which a firmdiversifies.

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 A GENERALIZED INDEX OF DIVERSIFICATION 323

The heterogeneityterm in (10) focuses solely wheneverZik = 1. For Zik = 0, however, ik takes
on productdistancebased on differinginput sets some positivevalue in the zero-one interval,ap-
and attempts to incorporatethis dimension for- proachingunity as the productsbecome increas-
mally into a measure of diversification.This pro- ingly dissimilar.
duction orientationfor otik is consistentwith the It follows that d'"is bounded in the zero-two
model'sultimateapplicationto Censusdatawhich interval. Dividing (10) by 2 bounds d'2 in the
focus on manufacturingactivityat the production desirablezero-one interval:
site.
Three characteristicsof the heterogeneityterm
D 1/241 - -i E ESi Sk(Zik -
Oik)].
EESiSk(Zik - oTik) in (10) are worth noting. First,
ii k0i
the notion of productdistancerepresentedby the (13)
difference [wkj - wi,1 is consistentwith the basic
distance function underlyingthe Herfindahldis-
The index takes a zero value for any entity that
tributionterm E(s2 - 1/n2). The latter is a sim-
producesonly a single product;D = 0 when si =
plified form of (1/2n)EE(si - sk)2. The distribu-
1 and Zik and otik are undefined.In contrast, D
tion term therefore defines product distance in
approachesunity as a producingunit approaches
terms of output shares (si - Sk); the heterogene-
a state of "perfect diversification;"lim D = 1 as
ity term defines product distance in terms of -> 0 and ik
s7 1 for all i, k.
-*
input shares (Wk1 - wij). Second, EESiSk(Zik -
Finally, a simplifying restriction can be im-
aOik) measures the heterogeneity of the firm's
posed. Since the index D is to be applied to the
whole productmix and can be rewrittenin a form
five-digit product data reported to the Census
revealing the heterogeneity contributionarising
Bureau by each manufacturingestablishment,it
througheach product:
is reasonableto assume that productsidentified
E E SiSk(Zik - ik) = EaSi7o (12) by a reportingplant as distinctfive-digitproducts
i k* ii satisfy some minimum,howeverminimal,notion
4 Sk(Zi/ - ik) represents the across of product dissimilarity.It follows that all Zik
where o five-digitproduct pairs take zero values.
product heterogeneityspecific to product i and
Symmetrically,it is reasonableto assume that all
si(oi identifies the contributionof that product's
output units grouped by a respondingestablish-
heterogeneity to overall firm diversification.
ment within a common five-digitcode are suffi-
Third, note that the product shares Sk play an
ciently similarso as to be aggregateddirectlyas
importantrole in the definitionof oi and there-
in (10), therebymakingunnecessaryall corrective
fore Esiaoi. The extent of product heterogeneity
adjustments- 2SiSk Zik where Zik would take a
arising through oa1 in, say, a three-productfirm
unit value. In short, the length of the product
where s1 = 0.5, s2 or 53= 0.49, o-12= 1.0, and
vector reported by establishmentsis accepted,
a13= 0.1 depends on whether 52 or S3 has the
therebyreducing(13) to its final form:
0.49 share. Intuition suggests that the measured
heterogeneityof the firm'sproductmix shouldbe
higher (lower) if s2 equals 0.49 (0.01). Hetero- D = 1/2 1 - ESi E SikoSikY (14)
geneity should be higher (lower) when it is the ii koi
two dominant products that are very dissimilar
(similar).The variablesSk ensure this result. One nice propertyof the index is that it can be
Heterogeneity thus depends importantly on decomposed into unique number, distribution,
both Zik and aik. The discrete variable Zik con- and heterogeneitycomponents:
tinues to play its correctiverole, ensuringthat the
index of diversificationis not upwardbiased by
any disaggregationof a homogeneous output D = 1/2[(1 --) + E - s 2)
bundle into artificiallydistinct product groups.
The continuousvariableaik, in contrast,captures
the extent of dissimilaritybetween any two prod- + E ESiSkTikj (15)
ucts for which Zik = 0. By definition, aoik = 0 i koi

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324 THE REVIEWOF ECONOMICSAND STATISTICS

where all other productpairs:

dH 1
(1 - the number component =-
1/2 1 - -_
, n (N), 0 <N <0.5;
dOik 4SiSkoik'>O
and
1/2Et1 ) thedistribution a2H 1
1/En2-7 component(S), 2
595k61k2< 0.
- 8iSk ik

t1E The importance of the one-half power in the

- 1/2(1 --) < S < 0; and definitionof oik in (10) becomes clear.
nJ
The importantconclusionis that all three com-
the heterogeneity ponents defining D share common curvature
1/2E ESiSko0k component(H),
i k#i properties,ensuringthat the final index exhibits
the usual marginalrate of substitutionproperties
-1/2(1- Es7)<H?<11/2(1- Es). familiarto economists.The even more important
conclusion is that the index D satisfies the five
The three componentsexhibit commonbehav- properties requiredof a meaningfulindex of di-
ior within their relevantranges.The N, S, and H versification. The remainingtask is to structure
its application to Census of Manufactures data.
terms increase, respectively,with increasesin the
number of products, distributionalequality, and
IV. Diversification in U.S. Manufacturing
productdissimilarity.Moreover,each increasesat
a decreasingrate. This can be demonstratedquite An index of diversificationis constructed for
easily. Clearly, each establishmentand each enterprisesurveyed
by the Census of Manufactures in 1963, 1967,
dN 1
-= >0 1972, 1977,and 1982.An establishmentis defined
dn 2n2 as a manufacturingunit producinggoods under
and one ownership and located at a single physical
1
location. An enterprise is an aggregate of all
a2N
=-- <0 establishmentshavingcommonownership.Inter-
plant transferswithin each enterpriseare netted
double counting
since n > 0. The same properties hold for the out not only to protect against
but also to ensure that vertical integrationdoes
distribution term. A change to a more equal
not contaminate the measure of enterprise diver-
productdistributioncan be representedby allow-
sification. All necessary data are taken from the
ing a below averageproductshare Sb (Sb < l/n)
Census of Manufactures full establishment data
to increase at the expense of an above average
product share Sa (Sa > l/n) holding constant all file.
other productshares.As a result, Outputs in each year are distinguishedat the
five-digitproduct class level using common 1972
d9S dSa SIC definitions,a classificationsystem differenti-
- =
Sb
-
Oa Sb + Saa > ating more than 1300 five-digitproduct classes.
dSbaS
This ensures that simple productreclassifications
and have no effect on measured trends in the index
a2s sa D."4 The product share variables si specific to
= -1 + = -2 < 0. each establishmentand enterpriseare measured
aSbd aSb
using value of shipments data stated in current
Finally,considerthe heterogeneityterm. The sum prices."5
of differences in input requirementsdefined in 14
However,the effectsof trulynew productadditions(dele-
(10), E1jlWkj - wij /2 is central to the notion of tions) that are not simplythe result of SIC reclassifications,
productheterogeneity.Consequently,an increase mergers, or splits are properlypermittedto affect the in-
in H can be representedby an increase in this dexes D.
15A complete descriptionof the data base, variablecon-
sum 0 for any productpair (i, k) while, for con- struction,and detailed data sources is availableon request
venience, holding constant the similar sums for fromthe authors.

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 A GENERALIZED INDEX OF DIVERSIFICATION
The definition of product heterogeneity re-
quiresa vector of input cost shares (wij) for each
five-digit product. Ten input categories in the
Census establishmentfiles are distinguished:pro-
duction workers, other labor, fuel, electricity,
purchased services, agriculturalmaterials, min-
eral inputs, nondurablematerials,durablemate-
rials, and capital. The representativeinput mix
for each five-digitproduct is defined as the un-
weighted mean of input cost shares in those es-
tablishmentsmanufacturingonly that product.16
This procedure guarantees product-specific,
Cobb-Douglasinput requirementvectors.
Diversificationindexesare constructedfor each
establishmentand each enterprise and then are
assigned to their appropriate two-digit indus-
tries.'7 Unweighted and shipments-weighted
mean diversificationindexes are calculated for
each industryaggregate.18
Table 1 reportsweightedand unweightedaver-
age diversificationindexes for establishmentsin
each two-digit industry. Consider first the
weightedindexes,the preferredmeasureof diver-
sification within an industry.The 1982 indexes
range from a low of 0.049 in tobacco to 0.428 in
petroleum and coal products. Sixteen of twenty
industries have 1982 indexes below 0.206, the
manufacturingaverage.Decompositionof this av-
erage into its number, distribution,and hetero-
geneity components yields 0.244, - 0.101, and
0.063, respectively.Given the definitionsin (15),
the componentsrevealthat establishmentsin 1982
on averageproduced 1.95 fairly similarproducts
in very unequal (86:14) proportions.On the in-
dex scale of zero to one, individualmanufacturing
plants, with the exception of those producing
petroleum and coal products and chemicals,are
not very diversified.19
16
Increasingthe numberof input categoriesto twenty in-
creases the establishmentand enterprise diversificationin-
dexes, on average,by approximately 0.01 points.
17
The 1963 Census of Manufactures data file contains
296,033 establishmentsand 265,778 enterprises.There are
348,385 establishmentsand 294,397 enterprisesin the 1982
Censusfile.
18 Unweightedand shipments-weighted indexesfor both es-
tablishmentsand enterprisesalso are constructedfor each
4-digitindustryand are availableon requestfromthe authors
or the CensusBureau.
19 The 1982number,distribution,and heterogeneitycompo-
nents take 0.413, -0.122, and 0.137 values, respectively,in
petroleumand coal productsand 0.297, -0.111, and 0.090 movements in the number, distribution,and heterogeneity
values,respectively,in chemicals.
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325
The establishment-basedindexes not only are
small but also have decreased over the 1963-82
period. Seventeen of twenty industries exhibit
decliningdiversification.The three exceptionsare
tobacco (an increase in the number of outputs,
though each new product has a very small share
in production),apparel (a slight increase in the
number of dissimilarproducts),and leather and
leather products (an increase in the number of
products and a move to a more heterogeneous
productmix).20
The ranking of industries, however, has re-
mained relatively unchanged with only two no-
table exceptions:rubberand plasticproducts,and
leather. The formerexperiencedthe most severe
decline. Its rankfell from fourth to eighteenth as
its index declined steadily from 0.280 in 1963 to
0.106 in 1982, the result of the industry'smove to
a more limitednumberof productsand to a more
homogeneous product mix. The latter, leather
and leather products, experienced precisely the
opposite trend, as its rank climbed from nine-
teenth in 1963 to thirteenthin 1982.
The unweightedindexes, also reportedin table
1, generally are small and declining over time.
The importantobservation,however, is that the
unweighted index is smaller than its weighted
counterpart in every instance, suggesting that
large establishments are more diversified than
small ones. The 1982 all-manufacturing weighted
average index is 0.206; the unweighted mean
is only 0.051. The fact that the rate of decline in
the unweighted index over the 1963-82 period
(-37%) far exceeds the correspondingrate for
the weighted index (- 8%) indicatesthat the de-
cline in diversificationis especiallysevere among
the smallestestablishments.
Table 2 presents mean enterprise-basedin-
dexes for each industry.It has the same formatas
table 1, but there the similaritystops. The 1982
weighted indexes range from 0.252 in lumber to
0.589 in petroleum and coal products.Six of the
twenty industries have average enterprise-based
diversificationindexes above 0.50. Four have in-
dexes greater then 0.55. These include paper,
chemicals, petroleum and coal products, and
transportationequipment.The 0.464 all-industry
20
The parentheticalexplanationsare derivedfromobserved
componentsfor each industry'sindex.
326 THE REVIEW OF ECONOMICS AND STATISTICS

TABLE 1.-DIVERSIFICATION INDEXES: ESTABLISHMENTS

Shipments-Weighted Unweighted
1963 1967 1972 1977 1982 1963 1967 1972 1977 1982

Food and Kindred Products .242 .240 .230 .217 .192 .106 .090 .088 .079 .080
Tobacco Manufactures .040 .052 .055 .052 .049 .024 .027 .030 .025 .025
Textile Mill Products .180 .169 .167 .156 .163 .071 .064 .062 .053 .060
Apparel .118 .119 .121 .125 .137 .038 .033 .034 .037 .041
Lumber and Wood Products .147 .130 .120 .132 .141 .054 .029 .030 .040 .044
Furniture and Fixtures .202 .196 .180 .172 .185 .097 .066 .070 .060 .069
Paper and Allied Products .184 .194 .177 .162 .155 .067 .070 .061 .049 .053
Printing and Publishing .250 .237 .226 .230 .201 .155 .077 .072 .074 .064
Chemicals and Allied Products .286 .297 .289 .282 .276 .133 .118 .112 .092 .093
Petroleum and Coal Products .434 .486 .469 .464 .428 .108 .096 .090 .082 .082
Rubber and Plastics Products .280 .244 .195 .176 .106 .080 .072 .056 .058 .034
Leather and Leather Products .079 .072 .142 .128 .142 .041 .035 .054 .051 .053
Stone, Clay and Glass Products .097 .086 .081 .079 .072 .050 .032 .029 .026 .029
Primary Metal Industries .289 .286 .283 .272 .227 .100 .090 .084 .075 .069
Fabricated Metal Products .155 .155 .136 .131 .116 .069 .059 .057 .049 .046
Machinery, except Electrical .223 .229 .228 .217 .191 .060 .049 .045 .039 .040
Electrical Equipment and Supplies .233 .224 .200 .165 .143 .074 .069 .060 .043 .043
Transportation Equipment .200 .206 .161 .163 .188 .073 .064 .052 .044 .045
Instruments and Related Products .227 .212 .217 .186 .169 .052 .047 .048 .038 .038
Miscellaneous Manufacturing .114 .124 .120 .113 .112 .045 .034 .028 .029 .030
All Manufacturing .223 .224 .208 .211 .206 .081 .059 .056 .052 .051

TABLE 2.-DIVERSIFICATION INDEXES: ENTERPRISES

Shipments-Weighted Unweighted
1963 1967 1972 1977 1982 1963 1967 1972 1977 1982

Food and Kindred Products .400 .436 .479 .472 .428 .103 .081 .074 .062 .063
Tobacco Manufactures .355 .410 .464 .477 .532 .041 .049 .063 .060 .074
Textile Mill Products .428 .434 .468 .456 .448 .070 .062 .061 .050 .059
Apparel .182 .224 .287 .266 .290 .040 .033 .035 .037 .040
Lumber and Wood Products .259 .248 .352 .359 .252 .053 .028 .028 .038 .041
Furniture and Fixtures .245 .262 .318 .263 .255 .095 .062 .066 .058 .065
Paper and Allied Products .498 .524 .539 .541 .561 .070 .069 .067 .056 .064
Printing and Publishing .316 .313 .328 .334 .332 .156 .074 .068 .069 .059
Chemicals and Allied Products .491 .598 .590 .584 .563 .128 .102 .095 .070 .076
Petroleum and Coal Products .545 .610 .631 .606 .589 .101 .090 .088 .091 .093
Rubber and Plastics Products .480 .497 .487 .444 .373 .078 .070 .055 .057 .037
Leather and Leather Products .216 .225 .331 .308 .266 .040 .034 .044 .041 .046
Stone, Clay and Glass Products .314 .333 .412 .412 .294 .053 .034 .032 .030 .032
Primary Metal Industries .553 .567 .576 .592 .542 .099 .091 .085 .075 .073
Fabricated Metal Products .296 .346 .347 .355 .276 .069 .058 .056 .050 .048
Machinery, except Electrical .350 .398 .476 .462 .409 .056 .044 .040 .035 .037
Electrical Equipment and Supplies .529 .509 .494 .465 .454 .071 .065 .056 .039 .042
Transportation Equipment .529 .563 .571 .567 .561 .073 .064 .052 .045 .046
Instruments and Related Products .420 .440 .420 .424 .426 .052 .044 .045 .036 .038
Miscellaneous Manufacturing .232 .237 .319 .247 .294 .046 .033 .028 .029 .030
All Manufacturing .430 .462 .486 .488 .464 .080 .055 .051 .048 .047

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 A GENERALIZED INDEX OF DIVERSIFICATION 327

average contrasts with the establishment-based unweighted indexes increased in only two in-
averageof 0.206. stances." The opposite trends in the all-manu-
The number, distribution, and heterogeneity facturing indexes in table 2 are striking. The
componentsshare the limelightin table 2. These underlyingdistributionof enterprise diversifica-
enterprise-basedcontributionsto the all-manu- tion has become bimodal. Enterprise numbers
facturing index 0.464 are 0.390, - 0.083, and and shipmentshave clusteredin opposite tails.
0.157, respectively.The numbercomponentis the An equally important insight arises from a
dominantforce (enterprises,on average,produce comparisonof tables 1 and 2. While 17 of 20
4.5 differentfive-digitproducts),but the hetero- industries had declining establishment-basedin-
geneity contributionhas a magnitude equal on dexes between 1963 and 1982, enterprise-based
averageto more than 40%of the numbercompo- diversificationincreased in 14 of 20 instances.
nent. Its contribution(0.157) to enterprisediver- There appears to be a shift over time in enter-
sificationis two and one-half times its contribu- prise activity.Risingenterprisediversificationand
tion (0.063) to establishmentdiversification.The falling establishment diversificationimply that
contributionof product distributionis significant firmsappearto be movingtowardmore homoge-
as well. Comparedto its establishmentcounter- neous production within establishments while
part (-0.101), the enterprise-baseddistribution holding a more diverse portfolio of establish-
term (-0.083) is smaller in both absolute and ments.
relative values.21Given that the bounds on the Table 3 investigatesfurther the link between
distributionterm in (15) are an increasingfunc- establishmentand enterprisediversification.Since
tion of product number, it follows that product an enterpriseis defined as the sum of its estab-
distributioncontributesrelativelymore to enter- lishments,an enterprise'sdiversificationmust be
prise than to establishmentdiversification.The a functionof diversificationwithin and amongits
presence of an unequal product distributionoff- plants. Consider adding and subtractinga ship-
sets 40%of the numbercontributionin the estab- ments-weightedaverageof diversificationindexes
lishment model but only 22% in the enterprise for an enterprise's establishmentsto the right-
model. Overall, enterprises produce a larger hand side of an identityequatingthe enterprise's
numberof more dissimilarproducts and a more diversificationindex with itself:
equal distributionof productsthan do establish-
ments.
Di I = EaijD est + (Dent EaijDest),i
The enterprisediversificationrankingof indus- I I
tries is remarkablystable over the twenty-year (16)
period. The only outliers are rubber and plastic
products and tobacco. The former's ranking
and
dropped from seventh to twelfth between 1963 where ent and est represent "enterprise"
the
and 1982. The latter's ranking moved from "establishment,"respectively,and aij equals
eleventh to fifth and today, most assuredly, is shipments'share of the jth plant in the ith firm.
highergiven the 1985 acquisitionsof Nabisco and The first term on the right-handside of (16)
General Foods by R.J. Reynolds and Philip reflects the contributionof within-establishment
Morris,respectively. diversificationto overall Dient. Each Dfest is calcu-
mix and
One of the more interesting insights surfaces lated wholly in terms of the product
of the establishment. The
from a comparisonof weighted and unweighted input requirements jth
that differences in prod-
enterprise indexes. Quite clearly, large enter- second term recognizes
are
prises are more diversifiedthan small ones. The uct mix and input combinationsacrossplants
enterpriseindex captured in the enterprise measure Dient but not
1982weightedall-manufacturing
is ten times its unweightedcounterpart.But con- in the individual Dest. The difference between
sum
siderthe trends.Weightedindexesincreasedover Dient and the weighted establishment
the 1963-82 period in 14 of 20 industries,while 22
Three out of four industriesexhibit a decline in enter-
prise diversificationbetween 1977 and 1982. This may be
21
Recall, an increasinglyequal productdistributionreduces more a statisticalartifactthan an indicationof a trend given
the negativedistributionterm in absolutevalue. the poor state of the economyin 1982,the censusyear.

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328 THE REVIEW OF ECONOMICS AND STATISTICS

TABLE 3.-RELATION BETWEEN ESTABLISHMENT AND ENTERPRISE DIVERSIFICATION

Shipments-Weighted Unweighted
Contribution Contribution
Enterprise Diversification Diversification Enterprise Diversification Diversification
Diversi- within among Diversi- within among
fication Establishments Establishments fication Establishments Establishments

All Manufacturing:
1963 .430 .038 .392 .080 .069 .011
1967 .462 .037 .425 .055 .045 .010
1972 .486 .035 .451 .051 .039 .012
1977 .488 .023 .465 .048 .036 .012
1982 .464 .014 .450 .047 .033 .014
Two-Digit Industries, 1982:
Food and Kindred Products .428 .018 .410 .063 .035 .028
Tobacco Manufactures .532 .000 .532 .074 .009 .065
Textile Mill Products .448 .013 .436 .059 .027 .032
Apparel .290 .036 .254 .040 .027 .012
Lumber and Wood Products .252 .049 .203 .041 .034 .007
Furniture and Fixtures .255 .051 .204 .065 .050 .015
Paper and Allied Products .562 .006 .556 .064 .029 .036
Printing and Publishing .332 .045 .288 .059 .050 .009
Chemicals and Allied Products .563 .009 .555 .076 .040 .036
Petroleum and Coal Products .590 .004 .586 .093 .028 .065
Rubber and Plastics Products .373 .016 .357 .037 .022 .015
Leather and Leather Products .266 .033 .233 .046 .027 .019
Stone, Clay and Glass Products .294 .011 .283 .033 .020 .013
Primary Metal Industries .542 .007 .535 .073 .038 .035
Fabricated Metal Products .276 .029 .247 .048 .033 .015
Machinery, except Electrical .409 .016 .393 .037 .026 .011
Electrical Equipment and Supplies .454 .007 .447 .042 .022 .019
Transportation Equipment .561 .003 .559 .046 .028 .019
Instruments and Related Products .426 .009 .418 .038 .022 .016
Miscellaneous Manufacturing .294 .020 .273 .030 .023 .007

Ej ai1D"ft quantifiesthe contributionof diversi- ments. Column3 dominatescolumn2 in all cases.

ficationamong an enterprise'splants.
Both terms in (16) must be greater than or
equal to zero. That this is true for the first term
follows from the constraintsaij 2 0 and Deft ? 0
for all i and j. The same propositionalso holds
for the second term since Dfint Ej ajjDfjt. An
enterprise cannot be less diversified than the
weightedsum of its plants'diversificationindexes.
Summarystatisticsfor two-digitindustriescan
be formedby calculatingshipments-weightedand
unweightedversions of (16) over all enterprises
within each two-digit industry. Results are re-
ported in table 3 for aggregatemanufacturingin
each census year and for each two-digitindustry
in 1982. As before, attentionfocuses on the ship-
ments-weightedresults.
The important conclusion is immediatelyap-
parent. Enterprisediversificationcomes from di-
versification among and not within establish-
The within and among-plantcontributionsto all-
manufacturingdiversificationin 1982 are 0.014
and 0.450, respectively.The latter is more than 32
times the former.Within-establishmentcontribu-
tions in 1982 have the largest absolute and rela-
tive values in the lumber and furniture sectors,
but even here the "within"contributionsare only
a fourth of the corresponding diversification
"among" contributions.At the other extreme,
enterprisesin tobacco derive their diversification
almost wholly from diversificationamong plants.
The within-establishmentcontributionin 1982 is
only 0.00002. The corresponding among-plant
contributionis 0.532.
A comparisonof the weighted and unweighted
columns in table 3 also reveals an interesting
phenomenon. The unweighted within-establish-
ment contributionis greater than its weighted
counterpart in the all-manufacturingsector in

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 A GENERALIZED INDEX OF DIVERSIFICATION
every census year and in 16 of 20 industriesin
1982, in spite of the fact that the weighted diver-
sificationindex exceeds the unweightedindex in
every industry in every year and never by less
than a factor of 4. The measures suggest that
large enterprises,on average,have their individ-
ual plants producinga more homogeneousprod-
uct mix than do much smaller firms, those typi-
cally havingsingle plants. Perhapsthis reflects a
lesser degree of flexibility available to those
smallest firms constrained to operate a single
plant. Whateverthe interpretation,it illustrates
another dimension of importantdifferencesbe-
tween large and small enterprises.23
V. Conclusion
A novel feature of this paper is the formal
incorporationof a continuousmeasureof product
heterogeneity into an index of diversification.
Census data suggest that the heterogeneitycom-
ponent is not unimportant.Incorporatinghetero-
geneity into the diversificationindex for each
manufacturingenterpriseadds, on average,0.157
or more than 50% to the value the indexeswould
have were product heterogeneityignored (0.464
versus 0.307). The variance in the heterogeneity
contributionover time and across industries is
substantial.The heterogeneitycomponentranges
from 0.054 (apparel, 1963) to 0.256 (petroleum
and coal products, 1972). Product heterogeneity
should not and need not be ignored.
Applicationof the diversificationindex to U.S.
manufacturing establishments and enterprises
leads to a number of interesting interpretative
conclusions but one stands out in importance.
Enterprisesappear to be restructuringtheir pro-
duction activity, moving toward more homoge-
neous production within establishments while
holding a more diversifiedportfolio of establish-
ments. While all-manufacturingenterprisediver-
sificationhas increasedover the 1963-82 period,
the contributionof diversificationwithin estab-
23
That the weightedamong-establishment contributionex-
ceeds the unweightedcontributionin table 3 followsautomat-
icallyfromthe dominanceof single-plantfirmsin everyindus-
try. For single-establishment firms,the among-establishment
term (DF"t - Ei aijPD) definitionallyequals zero, a condi-
tion applyingto nearly 80% of enterprisesin 1982. These
firmscollectivelyhave little effect on the weighted analysis.
Each firm, however,whether single- or multi-plant,has an
equalweightin formingthe unweightedmeasures.
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329
lishments has declined markedly, from an all-
manufacturingaverage of 0.038 to 0.014. In
contrast,the contributionto enterprisediversifi-
cation from diversificationamong establishments
has increased from 0.392 to 0.450. By 1982 the
latter contribution to enterprise diversification
was more than 32 times the former.
An importantimplicationfollowsdirectly.Con-
trary to the popular argument, technical
economies of scope appear to play little role in
explaining the measured increase in enterprise
diversification.If such technical economies exist
and are activelypursuedby firms,the economies
most likelywouldbe realizedat the establishment
level, but it is precisely here that diversification
has decreased.Between 1963 and 1982 establish-
ment diversificationhas declined in 17 of 20
industries.On average,establishmentswere pro-
ducing fewer and less dissimilarfive-digitprod-
ucts in 1982 than in 1963. In fact, over this
20-year interval wholly undiversified (D = 0)
plants in 13 of 20 industriesincreasedboth their
proportion of industryestablishmentsand their
share of industryshipments.If anything,at the
establishmentlevel firms appear to be seeking
more conventional scale rather than scope
economies.
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