Dynamics between brand diversification and segment diversification on firm value

Abstract

Developing a thick portfolio of multiple brands across different levels of services is unique to the lodging industry. Therefore, consideration of brand diversification necessitates thoughts of segment diversification to the lodging portfolio development. Although various diversification strategies have investigated in relation to a firm’s performance, segment diversification has received insufficient attention. This article aims to shed light on that. This article finds evidence that brand diversification increases lodging firm value more significantly when segment is diversified at the same time. When a company diversifies brands within a focused lodging segment, increase in firm value was insignificant.

Keywords

brand diversification firm performance firm value segment

Introduction

This article finds evidence that brand diversification increases a firm’s value when accompanied with lodging segment diversification. When a lodging company diversifies brand within the same lodging segment, the firm’s value doesn’t significantly increase. Significant value increase occurs only when a firm diversifies brands across various lodging segments.

Developing a thick portfolio of multiple brands across different levels of services is unique to the lodging industry (Kang and Lee, 2014), yet the degree of simultaneous diversification between brand diversification and segment diversification varies. For example, let’s assume an owner—a business entity—has two Hilton Garden Inns in its lodging portfolio. When it adds a new property in its lodging portfolio, the business entity may choose to add Hilton Garden Inn, the same brand (no brand/segment diversification), add Holiday Inn Express, a new brand yet in a lodging segment that they have operated (brand segmentation without segment diversification), or Hilton, a new brand in a new lodging segment (brand and segment diversification).

Therefore, consideration of brand diversification necessitates thoughts of segment diversification to the lodging portfolio development. Although various diversification strategies have investigated in relation to a firm’s performance (e.g. moderating effect of brand diversification and geographic diversification on lodging firm’s value (Kang and Lee, 2014); effect of related and unrelated diversification on restaurant firm’s value (Park and Jang, 2013); effect of product diversification on casino firm’s performance (Kang et al., 2012)), segment diversification has received insufficient attention. This article aims to shed light on that. An exception is Lee et al.’s (2011) study which found curvilinear relationship between hotels’ segment diversification and companies’ risk-adjusted performance. Yet it had limited number of observations available and focused only on segmentation diversification. The current study extends the literature by investigating synergetic effect between segmentation diversification and brand diversification.

Due to its portfolio characteristics and limited data availability of publicly traded traditional lodging companies, this article examined hotel real estate investment trusts (REITs) as a laboratory to examine the synergic effect of brand diversification and segment diversification on firm value. REITs were developed to be the mutual fund in the real estate industry, allowing people to invest small amounts of money in large real estate projects managed by experts. REITs also reduce liquidity risk inherent in most real estate investments as those are traded in stock markets (Beals and Arabia, 1998).

Drawing on the Markowitz’s (1952) financial portfolio theory, which posits that an efficient combination of securities yields the maximum return on a given level of risk, this study hypothesizes synergic effect of segment diversification on the relationship between brand diversification and firm value. The idea of the theory is that the risk in a portfolio of diverse individual stocks is smaller than the risk in holding any one of the individual stocks, and it’s possible to construct optimal portfolios that offer the maximum possible expected return for a given level of risk. And to form an efficient portfolio, the risks of the stocks in the portfolio should not be directly related. In the portfolio of lodging properties context, diversifying segment along with brand makes risks in each brand be less related to each other; therefore, expected return goes up. Diversifying brand within same segment may not effectively lead to higher return since risks in various brands tend to be related if those are in the same segment. Therefore, simultaneous diversification of brand diversification and segment diversification would be likely to form a more efficient combination of lodging portfolios than brand diversification limited in one segment. Graphically, the hypothesis is given in Figure 1.

Figure 1.

Graphical representation of the hypothesis.

Method

Data

This study used panel data of 28 hotel REITs’ data from 1996 to 2015. Due to the merger of two big lodging companies, Marriott and Starwood in 2016, the data range until 2015. Two data sources were used to collect data: (1) Compustat for financial data and (2) 10-Ks for hand collection of brand diversification and segmentation diversification information. Once list of brands is identified for each hotel REITs’ firm year, each brand is matched to STR’s, formerly known as Smith Travel Research, annual Chain Scales document to identify segmentation. The STR document lists brand names under each lodging segment, which includes luxury, upper upscale, upscale, upper midscale, midscale, and economy. The categorization is based on the previous year’s annual global average daily rate, and STR updates the information annually (STR, 2017). For geographical diversification, a control variable, each property’s location is identified at a state level. A total of 250 observations are used for the analysis.

Model specifications

The firm value is modeled as a function of degree of brand diversification, degree of segmentation diversification, and interaction of the two diversifications:

FV = α_{0} + α_{1} DOBD + α_{2} DOSD + α_{3} MDOBS + α_{4} DOGD + α_{5} LogSIZE + α_{6} LEV + α_{8} INT + ε

where FV refers to a firm’s value measured by Tobin’s Q, which is calculated as (MVE + PS + DEBT)/TA, where MVE is the market capitalization, PS is a firm’s preferred stock liquidating value, DEBT is the value of the firm’s short-term liabilities net of short-term assets, plus the book value of the long-term debt, and TA is the book value of the firm’s total assets (Chung and Pruitt, 1994). DOBD refers to the degree of brand diversification measured by the 1 − Herfindahl index $(\sum S_{B}^{2})$ ; DOSD refers to the degree of segment diversification measured by the 1-Herfindahl index $(\sum S_{S}^{2})$ ; MDOBS is the interaction term between DOBD and DOSD; DOGD refers to the degree of geographic diversification measured by the 1-Herfindahl index $(\sum S_{G}^{2})$ ; LogSIZE refers to a REIT’s size measured by the natural log of total assets; LEV refers to capital structure measured by debt-to-equity ratio; INT refers to the internationalization measured by a dummy, where 0 signifies no international expansion and 1 signifies international expansion; and ε represents an error term.

To measure degrees of brand, segment, and geographic diversification, this study used the 1-Herfindahl index. The Herfindahl index has been widely utilized by other studies in measuring degree of diversification (e.g. Denis et al., 2002). The Herfindahl index can be measured by the sum of squares of S_i, calculated using the following equation

\sum S_{i}^{2} = S_{1}^{2} + S_{2}^{2} + S_{3}^{2} + \dots \dots + S_{i - 2}^{2} + S_{i - 1}^{2} + S_{i}^{2}

where S_i is the share of each brand. Value 1 means that a property portfolio is composed of only one hotel brand, and a lower index value indicates a higher degree of brand diversification. In the interest of intuitive understanding, this article used the 1-Herfindahl index, where the closer the mean to 1, the more likely hotel REITs were more diversified, and vice versa (e.g. Kang et al., 2012). Segmentation diversification and geographic diversification were measured in the same way. This article used STR’s lodging segment category (luxury, upper upscale, upscale, upper midscale, midscale, and economy) for the analysis.

Results and findings

Table 1 summarizes the variables included in the model. Correlation of 74% between brand diversification and segment diversification shows that REITs companies, in general, tend to expand to other segment when they add new brand, but the degree varies by company and by year.

Table 1.

Variables used in the analyses.

	Variable	Measurement	Mean	SD	1	2	3	4	5	6	7
1	FV	Tobin’s Q	0.98	0.23
2	DOBD	Degree of brand diversification	0.68	0.24	−0.05
3	DOSD	Degree of segment diversification	0.41	0.20	−0.15*	0.74**
4	DOBD × DOSD	Interaction between DOBD and DOSD	—	—	0.02	−0.79**	−0.48**
5	DOGD	Degree of geographic diversification	0.84	0.13	0.05	0.48**	0.52**	−0.52**
6	Size (in millions)	Total assets	2,750.60	23.94	0.17**	0.44**	0.28**	−0.36**	0.58**
7	Leverage	Ratio of debt to equity	1.39	0.04	0.07	−0.54**	−0.34**	0.48**	−0.41**	−0.41**
8	International	1 if it has international unit, 0 otherwise	1.31	0.00	0.23**	0.12	0.05	−0.14*	0.21**	0.49**	0.03

Note: SD: standard deviation.

*p < 0.05; **p < 0.01.

Table 2 reports main results. The model was analyzed using the fixed-effects estimation with clustered robust standard errors based on the results of Breusch–Pagan test and Hausman test. The analysis controls for unobserved heterogeneity of individual REITs companies and time (year) effects and potential data correlations among the observations. To examine the main effect of brand diversification and segment diversification, a separate analysis without the interaction term was conducted, and the results are included in Table 2 as well. The main effect model was analyzed using the fixed-effects estimation with clustered robust standard errors based on the aforementioned tests.

Table 2.

Main results.

Q
Variables	Cons	Brand diversification	Segment diversification		Geographic diversification	Size	Leverage	Int’l
Coefficient	0.77*	0.36	−0.47*		0.53	0.02	0.04*	0.03
t-Value	3.08	1.55	−2.64		1.84	0.54	2.69*	1.05
N	250
R ²	9.02%
Variables	Cons	Brand diversification	Segment diversification	Brand Diversification × Segment Diversification	Geographic diversification	Size	Leverage	Int’l
Coefficient	0.79*	0.86	−0.54*	1.57*	0.37	0.01	0.04*	0.01
t-Value	2.57	1.89	−2.20	2.67	0.96	0.16	2.12	0.23
N	250
R ²	12.81%

*p < 0.05.

The coefficient estimate of brand diversification in the main effect model (0.36) is positive yet insignificant. The result shows that diversifying brand does not significantly increase a firm’s value. At the same time, the significant and negative coefficient estimate of segment diversification in the main effect model (−0.47) shows that, everything being the same, diversifying segmentation would result in decreased firm’s value.

The coefficient of the brand diversification in the interaction model (0.86) is positive yet still insignificant. The result shows that even if a lodging portfolio has multiple brands, if all the brands are in the same lodging category (when DOSD = 0, meaning no segment diversification), its positive impact on a firm’s value was insignificant. On the other hand, the coefficient estimate of the interaction term, Brand Diversification × Segment Diversification, was positive and significant (1.57). It means that when a lodging portfolio diversifies brands across different lodging segmentations, it significantly increases a firm’s value.

Brand diversification and segment diversification can be simultaneously adopted if a portfolio adds a brand in other lodging segment, but not always—a portfolio can add a brand within the lodging segment they already have accumulated. The results indicate that hotel REITs can significantly increase its value if they diversify their portfolios simultaneously by brand and segmentation than taking a purely brand diversification approach without segment diversification.

Discussion

Brands have been regarded as key, intangible assets that enable firms to establish identities through their significant influence on customers’ perceptions (Ailawadi et al., 2001; Capron and Hulland, 1999; Jiang et al., 2002). Many firms operate multiple brands; the degree to which a firm serves markets by operating different kinds of brands is called brand diversification (Bahadir et al., 2008). The resulting financial benefits from brand diversification include revenue stability, risk spreading, economy of scale, and market power increase (Lu and Beamish, 2004). In addition, by extending brand portfolios, a firm can use an already well-known brand name to enjoy a leverage effect (Jiang et al., 2002).

Over recent decades, the lodging industry has significantly increased number of brands in their portfolios, which has resulted in richer selection of brands per each lodging segment for lodging companies and lodging REITs. A firm operating multiple brands can meet the fickle and diverse needs of consumers (Lancaster, 1990; Park et al., 1986), and the financial portfolio theory implies that the strategy will work more efficiently when the brands meet the diverse spectrum of consumers over multiple market segments.

Despite the lodging industry’s unique brand diversification strategy, which offers multiple brands in the same market segment or across different market segments (Kang and Lee, 2014), the multifaceted aspect has not gained its needed attention. This article fills the gap by finding the synergic effect of brand and segmentation diversification in increasing hotel REITs’ values.

The findings are important for several reasons. First, as lodging companies actively diversify by brands and segments, the environment in which hotel REITs can adopt diversification strategies is ready. For example, Marriott International has 19 brands as of December 31, 2015, while it had 10 brands in 1997 (Marriott International, Inc, 1998, 2016). Over 18 years, its number of brands has almost doubled. Choice Hotels International also carries 11 existing brands as of December 31, 2015, while the company had 7 brands in 1997 (Choice Hotels International, Inc, 1998, 2016). Over the same years, its number of brands increased over 57%.

Second, although the option of brand and segment diversification is viable among hotel REITs, this study found that diversifying only by brand within the same segment does not significantly increase hotel REITs’ values. The firms’ values are significantly increased when brand diversification and segment diversification are simultaneously applied. When a hotel REIT adds a new brand in the segment that is absent in their portfolio, it captures broader spectrum of customers, thereby enabling the REIT to achieve higher value. In addition, a hotel REIT with past experience handling diverse brands can learn how to deal with cooperation, motivation, and competition among different segments. With this learning, a hotel REIT can establish the managerial capabilities needed to reduce growing operational or managerial risks associated with diversification.

In some cases, communication to diverse lodging segments may not be necessarily the key reason for the development of a broad brand portfolio. There are differences among brands, and target market could be different among the brands in the same segment. Therefore, some companies may manage various brands within the same segments to best utilize their expertise in managing a certain type of lodging properties. Nevertheless, guests oftentimes find switching hotel brands easy, especially limited-service guests (Tanford et al., 2012), which imply that developing a brand with truly distinctive target market is very challenging and uncommon.

This study is not without limitation. Although some brands are better serving the ever-changing needs of customers than some others and a particular brand may address the needs of a particular segment, differentiating those qualities among brand was beyond the scope of this study. Future research may explore such aspect.

Footnotes

Declaration of conflicting interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) received no financial support for the research, authorship, and/or publication of this article.

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