Starting any new company can be a daunting prospect. Even more frightening: investing your own money into a risky business concept that could easily fail upon launch.
So how do you hedge your bets to make it a success? Plus, how can you make your business more attractive to investors?
Diversification is the answer.
The key strategy used by start-ups and experienced companies alike, diversifying means spreading your investment. That way, if one line isn’t a hit- you’ll cover your income through the others.
What is Diversification?
Diversification strategy is applied when companies wish to grow. It is the practice of introducing a new product into your supply chain in order to increase profits. These products could be a new segment of the industry your company already occupies, known as business-level diversification. Alternatively, corporate-level diversification occurs if you penetrate a new market.
Growth Strategies
Diversification is one of four different growth strategies popularised by Igor Ansoff. Depending on the industry, size, and ambition of your company, one of these growth strategies is more likely to be a fit than the others. They are:
- Penetration
- Product Development
- Market Development
- Diversification
Penetration refers to entering the market at an incredibly low sale price in order to price out your competitors. Product development refers to the creation and testing of new products within your current market. Market development refers to entering new markets outside of your current industry. But, let’s talk about diversification.
What are the types of diversification strategies?
There are three different types of diversification strategies that are commonly used today. These are:
- Concentric Diversification
- Horizontal Diversification
- Conglomerate Diversification
Concentric Diversification
Concentric diversification refers to the development of new products and services that are similar to the ones you already sell. For example, an orange juice brand releases a new “smooth” orange juice drink alongside it’s hero product, the orange juice “with bits”.
Horizontal Diversification
Horizontal Diversification refers to the development of new products that are somewhat related to your original lines. For example, while your original product was plant pots, you are now selling seeds for many varieties of herbs and flowers.
Conglomerate Diversification
Conglomerate diversification refers to the development of new products that are unrelated to your original lines. For example, your t-shirt company has now decided to start stocking apple products.
Conglomerate diversification is a much riskier strategy than both concentric diversification and horizontal diversification. This is because it requires more outlay in terms of product development and advertising. Plus, due to the goal of penetrating a new industry- this diversification strategy has more likelihood of failure.
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What companies use a diversification strategy?
Companies will use a diversification strategy for three main reasons. Therefore, the companies who are using diversification strategy are those who:
Growth Strategies
Diversification is one of four different growth strategies popularised by Igor Ansoff. Depending on the industry, size, and ambition of your company, one of these growth strategies is more likely to be a fit than the others. They are:
- Need to mitigate market risk
- Need to protect their business from the competition
- Need to increase their profits and variety of products stocked
However, this means that the types of companies using a diversification strategy are usually under pressure. For example, a new competitor is taking a portion of business and you’d like to acquire it.
Alternatively, taking the decision to diversify requires a lot of analysis work, which typically needs to be completed in an extremely tight timeline. Let’s go through some examples of the companies who choose to use a diversification strategy, and their reasoning.
Mitigate Risk
In times of market volatility or downturn, businesses will look to introduce more products into their line. This spreads their investment across multiple channels, so one product can afford to lose sales while the overall company does not suffer to the same degree.
There is a general riskiness measure that helps to analyse how successful the introduction of a new product might be. This has three major points to satisfy:
- The porter’s attractiveness test
- The cost of entry is less than predicted future profits
- The better-off test: do these new products have a synergy or competitive advantage?
Companies that diversify in order to mitigate risk do so because of unsystematic risk. This refers to risk in the specific market, and could be caused by a competitor getting stronger or going out of business, for example.
Competition
When competition is strong, businesses will tend to compare their strategic assets to provide a competitive advantage. Strategic assets refer to the specific resources or capabilities of your company that are scarce or difficult to replicate.
The types of companies who will diversify to protect their company from the competition may merge with such competition. In this case, they take out the competition and begin sharing in the profits. Plus, there are now fewer consumer options which means that pricing is less competitive. This type of diversification may allow businesses to raise their prices.
A different approach to diversification for competitive purposes is to match or outshine your competition with new goods. In this case, you may choose to pair up diversification with a penetration pricing strategy in order to undercut your competition. The idea with this is to create loyal, returning customers who then make larger purchases in the future.
Profits
Finally, businesses may choose to diversify in order to raise profits. Concentric diversification is a popular and proven strategy in this case.
For example, coffee shops will add to their line with food supplements such as sandwiches and pastries. This may be used as an upsell at the till point and increase profits. Risk of diversification remains small as the products are similar to those already proven to sell.
In a similar vein, gyms may choose to add a sauna room or physio room to their premises. This would not require any added space, but could be rented out to add another stream of income, thus diversifying.
Examples of Successful Diversification
One of the most prominent examples of diversification strategy is General Electric. Originally, the company was focused on electrical goods. However, over the years they have acquired and created operations in the aeronautic, rail, power plant, gas, and kitchen appliances industries.
Another company that has benefitted from diversification is Apple. They used horizontal diversification to expand their product range from computers to iPods. This created an interlinked range of products that beautifully complimented each other and created an exclusivity to owning Apple. No doubt, this led to the release of the first iPhone, and well, the rest is history!
Finally, Disney took a risk to diversify with theme parks after building their company first within the tv and film industry. The company’s ability to commercialise animated characters has also led to profit streams in their cruise experience, alongside branded products ranging from clothing to technology.
So, is diversification the right growth strategy for you?
Whether you’re a start-up looking to scale up, or an experienced business owner wanting to explore the possibilities, diversification could be the answer. But, there are other ways to grow your business that shouldn’t be overlooked.
For more information on the opportunities available to businesses, why not check out our recommendations for podcasts or start-up books!