Entrepreneurs may agree that your end goal goes far beyond earning an extra coin. The ability to generate wealth and growth is usually the driving force behind most start-ups. A successful business requires investing your money, time, and a mix of the right business strategies to help you navigate through the tough economic times.
It takes a lot more to sustain a successful business for years. One way this can be achieved is through business diversification.
What is Business Diversification?
As the name suggests, it is a business growth strategy that involves venturing into new markets/business – one that your business does not currently operate in – while creating a new product for that new market.
Igor Ansoff, credited as the founding father of this strategy, is well known for his significant role in establishing strategic management as its own discipline back in the 1950s. Diversification is one of the four main growth strategies outlined by Ansoff.
Why do Businesses Diversify?
1. Increase profitability:
One of the most appealing objectives of diversification is the increase in sales and revenue a new market can provide. When the profitability of a business is in secular decline, a new core makes sense. Businesses use diversification to help them expand into markets or industries that they have not currently explored. This is achieved by introducing new products, services, or features that will appeal to the new customers in the new markets. In this way, businesses can increase their profits.
2. Create competitive advantage:
Diversification strategies can influence the competitive balance in an industry. Disadvantaged locations or customers have available revenue waiting for someone to tap into. If your business does not diversify to fill this gap then competitors are bound to do so. If you get in first, you can increase your customer base and establish yourself as the top provider.
3. Stabilizing influence:
Furthermore, diversifying helps businesses build stability. Focusing on a single product increases risk volatility in revenue and resources as demand rises and falls, whereas business diversification ensures that you have more predictability.
4. Avoid downturns:
A conventional reason to diversify is to avoid the ripple effects of an industry’s or sector’s downturn. Numerous single businesses could not survive a lengthy decline in their industry. Being diversified protects the business against unpredictable changes. For instance, a forex trader can do this by shorting stocks on Robinhood.
When is it Right to Diversify Your Business?
Successful entrepreneurs suggest that it is not advisable to consider diversification until your core business is stable and profitable. If you are still struggling to get loyal customers and build a sales time for the core product, there is a danger that diversification will take your eye off the ball.
Therefore, businesses are encouraged to pursue diversification strategies when their current market demonstrates slow or stagnant future opportunities for growth.
Additionally, by considering the points below, you are likely to be in a better position to decide whether the opportunity to diversify is right for your business.
1. Conduct market and product research:
Review all the facts and fully understand all the consequences first. It is advisable to ensure you perform your due diligence since moving to unfamiliar territory without proper knowledge and experience can be challenging.
2. Consider the expertise and resources needed:
A key element in helping you decide whether to expand your business is assessing the skills and resources needed to successfully implement this.
3. Analyze financial demands:
Many entrepreneurs believe in taking more significant risks in achieving higher returns and hence step into diversification. For a smoother ride, a thorough analysis of the financial aspects of the diversification strategy is required. To minimize risks, the cost of entry should not capitalize on all future profits
4. Evaluate strategic assets:
It is crucial for your business to identify its unique and irrefutable competitive strengths before attempting to expand. Diversification involves analyzing what your business does better than its competitors
These refer to how businesses choose to diversify. Different diversification strategies are used to expand firms’ operations as described below.
1. Horizontal diversification
It is a growth strategy that entails the provision of new and unrelated products or services to existing customers. The end goal is usually to expand market share, either in a new segment or your business’s existing market. It can be done through innovating or licensing new products, a merger, or the acquisition of another company.
There are two types of horizontal diversification – concentric and conglomerate.
- Concentric diversification involves introducing new products or services to your product/service line that are closely linked to your existing products or services. In essence, you are expanding your market share within the market your business already operates in. Concentric diversification allows you to leverage your existing brand recognition, customer base, loyalty, resources, and distribution channels. A good example would be if a smartphone company began selling watches.
- Conglomerate diversification: Unlike the previous sub-category, this category entails the introduction of new products or services that have no relation to your business’s current offering. Therefore, it involves entering a completely new market and appealing to customers that may have had zero interest in your business previously. The benefits include high ROI and high growth due to the addition of an entirely new revenue stream. An example of a conglomerate diversification would be a clothing company branching into toys.
2. Vertical diversification
In this strategy, the company expands its product line through a forward or backward integration of products within its existing supply chain. This strategy is suitable for businesses seeking to strengthen and enhance their supply chain, capture upstream or downstream profits, cut production costs, access more distribution channels, and gain more revenue.
For instance, a company that manufacturers and sells cars could diversify its business vertically by selling tires.
3. Defensive diversification
As the name suggests, it is often a response to losing profits and market share, and an effort to defend its position. It is an appropriate strategy for businesses that need to remain competitive as a result of a saturated market segment.
4. Offensive diversification
This diversification strategy occurs when a business is aggressively seeking to increase its profits and market share through expanding its product or service line to enter new markets and capture more customers.
While defensive diversification is practiced to remain in business, offensive diversification is often a strategy for successful businesses to grow further.
Business diversification may not be for everyone and every business, but it is a strategy worth considering for businesses pursuing growth opportunities. It allows for more variety of options for products and services and if well implemented could provide a tremendous boost to your brand image and business profitability.