Diversification Strategy Explained

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Businesses use different strategies to ensure they remain profitable and insure them from risks. Some of them entail venturing into new markets, increasing their product offering, or reducing prices. Luckily some of these strategies have been well documented and studied over the years. Businesses today can learn from how the early ones implemented them before applying them in their models.

In this piece, we’re going to break down one popular business strategy called the diversification strategy. We will explain what it means to diversify and some of the different ways to do it for your business. Read on;

What is Diversification Strategy?

One of the proven ways of reducing risk in any investment is diversifying your portfolio. At its core, this is what it is all about, regardless of how you apply it. A single investment relies too much on one thing, and if it goes down, the whole investment follows it as well. Think of it as not putting all your eggs in one basket.

Diversification strategy for business is no different. It is the process of generating multiple profit opportunities in one company. This is implemented by providing goods and services to different sets of consumers or having various commodities altogether. Some companies diversify by investing in multiple niches, and it all depends on the level of the value chain this strategy is applied to.

Types of Diversification Strategies

Horizontal Diversification

This strategy involves introducing new products and services to your existing portfolio to expand market share in an existing or new market. It can be implemented by coming up with new products or acquiring a company that offers new products and services and then listing them under your business.

The two types of horizontal diversification include;

Concentric approach

The company adds new products to existing markets that will serve the same customers through similar distribution systems. This specific approach is called market-related concentric diversification. An example is a company that sells shoes to customers and starts selling clothes to the same people using the same distribution lines.

In another instance, the company adds new products to existing ones utilizing the same technology. It is referred to as technology-related concentric diversification. An example is when Samsung started selling smartwatches to customers who used their phones.

Concentric diversification allows firms to leverage their brand, customer base, resources, and existing distribution channels to introduce new products. It aims to get more revenue from the existing customer base while also bringing back those who might have been swayed by other products from competitors.

Companies prefer it because it balances sales if one product is on the decline. It increases cashflows and makes use of surpluses in the new markets.

Conglomerate Approach

This is an unrelated approach which implies that the business adds different products to its current portfolio. It is essentially venturing into new technologies, markets, and products that the firm had not stepped into. Here, the business must get products that they are not known for and appeal to consumers who had no interest in the company.

One advantage of this approach is the potential of high ROI and a new revenue stream for the business, but only if it’s successful.

An example is a technology company venturing into insurance and financial management.

One of the reasons firms take up this approach is to set them up for growth and increase the possibility of venturing into international markets. It increases managerial expertise since they will have to bring new people to run the different production lines.

Pros of Horizontal Diversification

  • Potential cost savings
  • The quality improvement due to standardized offerings
  • Optimized operations
  • Increased human resources
  • Better control over pricing

Cons of Horizontal Diversification

  • External risks
  • Potential loss of customer loyalty

Vertical Diversification

This is where a business looks for opportunities to expand by moving along its production line. The company looks to take control over multiple steps involved in creating a product or service. It entails bringing some of the previously outsourced processes in-house. A normal production process starts with acquiring raw materials and ends with the product being bought by the customer.

The two forms of vertical diversification include;

Backward integration

This is where a business moves backward along the production line. An example is Amazon, which was a bookstore, launching its own publishing house through Kindle.

Forward integration

Here, the company moves closer to the customer-facing end of the production line, most notably by taking control of the distribution and supply of its products. An example is a clothing manufacturer that chooses to open stores to sell its products. It helps businesses to eliminate the middle person to improve profitability.

Pros of Vertical Diversification

  • Reduce reliance on suppliers
  • Economies of scale
  • Increased competitive advantage

Cons of Vertical Diversification

  • Initial costs are high
  • Removes focus on core business due to introduction of another critical function

Defensive Diversification

This strategy is keener on the “why” as opposed to the “how.” It is a more conservative approach that acknowledges the existence of competition in any market. The business here takes up a defensive diversification approach to defend its market share and status quo. It involves measures meant to discourage competitors from aggressively trying to take up your position in the market and protect profitability and market position. It also helps to maintain customer confidence and makes it hard for competitors.

Pros of Defensive Diversification

  • Helps retain market share
  • Maintains reputation
  • Stamps market leadership

Cons of Defensive Diversification

  • External factors can render defensive measures futile

Offensive Diversification

This is the opposite of defensive diversification, and it is a more aggressive approach meant to take up market leadership from a competitor. It is used by companies that want to grow market share through diversifying their product line, even at the expense of other players in that niche. It can involve direct or indirect action aimed at the competition to lay the foundation for further growth.

A good example is the Apple vs. Samsung market wars aiming to eat into each other’s market share.

Pros of Offensive Diversification

  • Destabilizes industry leaders
  • Increases market share
  • Increases sales

Cons of Offensive Diversification

  • Possibility of setbacks from industry leaders

Benefits of Diversification Strategies

Diversification is not a silver bullet, as multiple companies have tried it and failed. However, it offers an excellent opportunity for expansion and is a strategy worth checking out for any company looking to grow. Some of the most successful companies today got to the elite level thanks to diversification.

Some benefits of a well-implemented diversification strategy include;

Increased Revenue

One obvious benefit of diversification is increased sales and revenue. This is why it is touted as one of the best ways companies can grow. The business introduces a new revenue line onto the existing one by launching a new product or service. It is hard to increase profitability in an otherwise saturated market, and businesses can only do it through diversifying.

Risk Mitigation

Diversifying protects your company from risks that affect how customers take up your products or services. Overreliance on one product is not advisable since a government policy, entry of a new player in that niche, or market changes can bring the business down on its knees if the uptake is not as expected. The dynamic market shifts have shown us wonders over the years when companies deemed giants went down due to a technological change.

Kodak, a household in the photography industry, went down due to the introduction of smartphones and digital forms of photography. With a diverse offering, huge impacts on one product or service can be cushioned by other products, which gives you time to improve and tweak the affected ones while still maintaining steady revenue streams.

Brand Awareness

Customers get acquitted to your brand if you participate more in addressing pain points in their lives. Companies like Samsung that produce refrigerators, smartphones, television sets, sound systems, and HVAC systems are household brands since many people interact with their products in their day-to-day activities. This is key to building a solid brand and enhancing customer loyalty. They can always look for products from your company due to their experience with another product from your diversified line. Once brand loyalty is cemented, it is easier to diversify further and even charge a premium for some products.

Good Defensive Strategy

Diversification is an excellent way to cement your business as the industry leader and counter any moves by the competition to eat into your market share. When a company faces stiff competition, introducing a new product helps increase options available to customers and gain a stable hold on the market.

Gets the Best out of Existing Resources

Increasing products and services can help a business milk more from its existing resources. A good example is a technology company that can ride on existing technologies to introduce a new service to customers without going over and beyond to invest in the new one. Some resources, like talent, can be underutilized, and diversifying the business portfolio helps increase their productivity.

Risks of Diversification

Changed Focus

Some businesses focus a lot on one product, and diversifying might make them lose sight of what they must develop the new one. This can lead to reduced quality of the products or services or poor customer experience. Businesses diversifying should be careful not to lose what they already have while trying to get another product or service into the market. A bird at hand is better than two in the bush!

Strained Operations

While trying to get the best from existing resources, it is easy to strain operations. This is particularly evident with human resources, who might not have the capacity to handle the workflows needed to support two products to the expected standards. When diversifying, analyze the impact it will have on your resources and plan to bring in more, as it is equally essential to maintain existing ones.

Overhead Costs

Some forms of diversification, such as vertical and involving introducing a different product or service, can be capital intensive. Think of it as setting up an entirely new business model under your existing one and picture the work and resources it will take to build everything up. If the business does not have enough finances to support the diversification plan, it can compromise on quality, eventually affecting the product or service getting to customers.

Brand Specialization

Some brands are recognized because of specialization. Apple is known for producing top-tier phones, and diversification into low-end and budget smartphones won’t do the company’s brand any good. Customers love certain companies because they specialize, and diversifying can convince them you are no longer the top choice in that niche because you do not specialize. Companies that enjoy the benefits of specialization can find it hard to diversify, as it can bring more harm than good.

Frequently Asked Questions

Question: How do I diversify my business?

Answer: The first step is to do some due diligence to establish whether the move to diversify will benefit the business. From here, pick the method you want to take and ensure that the new offerings create value for the customer. It helps if you are an expert in the industry you are diversifying into, making things easier for you. Lastly, leverage your strengths and have the right people to lead this change, and the chances of success will be high.

Question: What is a focus strategy?

Answer: This is the strategy of developing, marketing, and selling goods or services to a niche market. It is in some way the opposite of diversification as it centers on the improvement of existing products or services to cement the business’ position as the preferred choice to the niche market. An example is Rolls Royce that only makes luxury cars.

Question: Why can diversification fail?

Answer: One reason why a diversification strategy can fail is when it is all wrong from the start. Note that it is a huge move that can have a ripple effect across the whole company, and if it’s flawed, the consequences can be cut across. Companies must analyze carefully what distinct resources they can move in the new markets to give them a competitive edge.

Bottomline

Diversification is a great way to grow your business, but only if you get it right. Most companies use it today, thanks to globalization which has expanded markets. A key to succeeding in this approach is strengthening your core, which is the main product and service you offer. This is the support system that the new products and services will feed on, and it can protect you from any upcoming challenges with the diversified line. Do not be quick to implement this strategy and do extensive analysis to ascertain that customers will get value. Remember, the buck starts and stops with the customer, and if there is nothing in it for them, it might not be the right step to take.

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