When you’re looking for new ways to grow you can’t avoid exploring a business diversification strategy. The benefits of a diversification strategy can be significant.
Yet, diversification remains a challenging topic considering the potential pitfalls and risks.
Too little diversification and you’re putting all your eggs in one basket. But too much spreads the company’s resources too thin, limiting growth and possibly creating management and control problems.
What Is Business Diversification?
Business diversification is a growth strategy based on developing new products and entering new markets. It should be a key topic in any serious strategic planning discussion.
There are several forms of diversification, some riskier than others:
Product Development – This is about business growth from launching new products and services for your current markets.
This is the easiest, least risky form of diversification. Your current customers are already familiar with your firm, what you do, and what you stand for. You have credibility in their eyes. If you offer more solutions to their problems they’re likely to buy.
Market Development – Market development involves selling your current products to new markets. Because you’re entering new markets your firm lacks reputation or brand recognition. As a result, this approach is riskier than product development.
You may be the product “expert”, but the new market is not familiar with your firm. It’s going to take significant marketing effort to generate trust and credibility.
Diversification – This approach involves creating new products for new markets. It’s easy to see why this is the riskiest diversification strategy. First of all, your firm will have little experience with the new product. And the new market will not be familiar with your company and its reputation.
Why Should You Consider Diversification?
There are several reasons for a company to diversify, such as:
- Greater profitability from new growth opportunities.
- Lower risk from exposure to a single market. Markets have life cycles of their own. By selecting markets that are in different stages of their life cycle you reduce the risk of a downturn in a single market. This also allow you to manage the impact of being in a dying market.
- Diversification creates more variety and options for products and services for your customers. This can provide a tremendous boost to brand image and profitability.
- Strengthen the competitive position. By diversifying products or services, the firm can protect itself against the competition.
- Managing the exit from a declining market and entering a new, high-growth market.
Business Diversification Is Risky
Although it sounds appealing at first, diversification is not without risk. But diversification doesn’t need to be a roll of the dice.
Yes, it will always involve uncertainty. All major business decisions do. But there is a wealth of good advice about how to approach diversification.
Managers need to take a structured approach to analyze diversification to reduce the risks. An in-depth analysis does not lead to an easy go/no-go decision. But it does help to improve the likelihood of success.
Can You Beat The Competition?
Identifying a company’s unique competitive strengths is important before entering other markets.
The first step is to determine what these strengths or strategic competencies are. A strategic competency needs to meet these requirements:
- A combination of skills, knowledge, experience, tools, methods, resources, etc.
- It’s valuable to the customer
- It differentiates the firm from the competition
- It’s difficult for a competitor to buy, copy, or create a substitute
- It applies to many markets
It is important to think not about what the company does but about what it does better than the competition.
Clarifying strategic assets makes an organization understand how it brings value in a new market.
Which Strategic Competencies Do You Need?
Be careful not to assume that having some of the necessary strategic assets is enough to move forward with diversification. In reality, a company usually must have all of them.
If a company has only a few strategic assets in an industry where most competitors have a better hand, there’s no point in putting money on the table.
Companies considering diversification need to answer these questions:
- Can we create the critical strategic assets, buy them, or make them irrelevant by changing the rules of the game?
- If so, can we do this at a reasonable cost?
Any strategic competencies critical to success must be acquired, one way or another. Otherwise, moving forward into the new market is likely to end in failure.
Which Lessons Can You Learn From Diversification?
Smart managers, like chess players, always think a couple of moves ahead.
Often, companies can apply what was learned from one diversification move to another market. You need to have processes in place to streamline and promote this learning throughout the organization.
Business diversification is never going to be easy. It takes smart players to know when it’s best to raise their bets and when it’s best to fold.
On the one hand, you can be so focused on operations and putting out the proverbial fires that excellent growth opportunities are missed.
On the other hand, too much of an external focus tends to ignore operations and can result in time and money spent on ventures that are likely to fail.