Diversification and profitability in Japanese firms: evidence across industries and firm sizes

Corporate diversification is a key yet debated strategy for maintaining growth and profitability in competitive markets. However, there is limited empirical evidence on how firm size and industry features influence this relationship, especially for unlisted SMEs. This study aims to fill that gap by exploring the varied effects of diversification on profitability. We analyze large-scale firm-level panel data—about 430,000 observations—from Japan’s METI Basic Survey (2011–2024), covering a period of notable structural change that offers a unique context for studying strategic adaptation. Using sales-based Shannon entropy, broken down into related and unrelated components, we compare fixed-effects models, which control for unobserved heterogeneity, with cross-sectional analyses that highlight broader structural trends across different capital sizes. Results show a clear contrast: fixed-effects models suggest limited short-term impacts, while cross-sectional data indicate that diversified firms generally achieve higher profitability than specialized firms. Unrelated diversification, in particular, tends to provide better returns, highlighting its role as a crucial survival strategy amid stagnation in core activities. These findings suggest that, in a mature economy, entering new markets is essential for resilience rather than inefficiency. For managers and policymakers, this underscores the value of supporting strategic business portfolio transformations to ensure corporate longevity.