The risks and rewards of a business diversification strategy
Business diversification is not an easy choice and it’s not always a successful business strategy. As noted in the Harvard Business Review article – To Diversify or Not To Diversify – not all attempts to diversify are successful. It shows the example of Blue Circle Industries, a British company that was once a leading cement producer. Its managers decided that since the company made products related to home building, it should diversify into selling bricks, gas stoves, bath tubs and lawn mowers. These attempts to diversify failed.
In contrast, the Boddington Group was a vertically integrated beer producer that owned a brewery, wholesalers and pubs throughout the UK. The company was a small player and found it challenging to make a profit in a consolidating industry. Its main strategic asset was in retailing and hospitality, especially managing pubs. In its drive to diversify the company sold its brewery and purchased resort hotels, restaurants, nursing homes and health clubs while keeping its substantial portfolio of pubs. The diversification was highly successful.
What was the difference between the two businesses? Blue Circle’s approach to diversification was not focused and didn’t answer the most important questions: What are our strategic assets? How and where can we best use them?
Disney is well-known for its successful diversification, which included moving from film and television production to theme parks, consumer products and real estate development.
Before it fell on difficult times, General Electric was held up as a case study for diversification. After starting out selling light bulbs, over time it has diversified into (and out of) a range of products and services, including consumer electronics and appliances, power generation, aviation, health care, media and entertainment, financial services, and more.
Types of business diversification
There are several types of diversification. Understanding the options will help you choose the best strategy for your business.
This is when a company expands by introducing products or services that are related to its existing ones. For example, large accounting firms have moved from only offering accounting services to offering a range of consulting services, including consulting in management, human resources and information technology. Apple branched out by adding smart watches beyond its smartphones.
The pros of this strategy is that you can use your current skills and infrastructure and increase market share with minimal investment. A simple example is the restaurant that expands its menu to offer a bigger range of cuisines. It already has the infrastructure in place and can increase sales by attracting new customers with an expanded menu.
This is when a company adds a product or service that is technically or commercially not connected to its existing products or services. An example is Canon which moved from producing cameras to offering a range of office equipment, including printers, scanners and copiers. The pros of horizontal diversification are that it can help overcome competition in existing products and expand into new markets.
This is when a business moves up or down the production or supply chain. Examples of this include Netflix expanding from being only a streaming service to film production or an iron mining company moving into steel manufacturing. Depending on which direction you move on the supply chain, vertical diversification can be ‘forward’ (closer to the finished product) or ‘backward’ (further from the finished product).
This type of diversification is beneficial for a business that wants more control over its supply chain to guarantee reliability and cost control. It also enables a business to capture more profit throughout the supply chain.
Diversification isn’t just for big multinationals, though. Sydney business VitrineMedia, a manufacturer and supplier of customised LED signage, are a great example of diversification. Since the backlit LED signs are long-lasting (with a 10-year warranty), there is limited opportunity for repeat business once a signage has been created for a location. In order to diversify, the business launched a print division. This meant it could print custom signs for its signage clients (instead of outsourcing) and offer this service to other businesses. Learn more about Michael’s story in VitrineMedia: Lighting Up the High Street.
This is when a company moves into an area not related to its existing current product or services. An example of conglomerate diversification strategy is Virgin which started in the music business and expanded into air travel and mobile phone services. This can be an effective strategy for a business that has strong brand equity and wants to move into faster growing markets. Its pros include creating a new revenue stream and building new interest in a legacy brand. If the brand is not strong to begin with (as in the Blue Circle Industries case mentioned earlier), conglomerate diversification can be very risky.
Using the Ansoff Matrix to analyse diversification
The Ansoff Matrix (also known as the product/market expansion grid) is a tool you can use to consider growth strategies, including diversification. It consists of four options for diversifying a business.
|Existing products & services||New products & services|
|New markets||Market development||Diversification|
|Existing markets||Market penetration||Product development|
On the left-hand side of the matrix are non-diversification strategies for growth that involve existing products and services. In your business you can market your products or services to existing markets with the goal of penetrating the market to reach all or a large percentage of potential customers. You can also take your existing products or services to new markets.
On the other side of the matrix, we have the diversification strategy where you take new products and services to new markets and the product development strategy where you develop new products or services for existing markets. By our definition mentioned earlier, developing new products or services for existing markets is also a form of diversification (like the large accounting firms that expanded by offering new services to existing customers).
The left-hand side of the matrix should be considered as a valid option for business growth. When considering whether to diversify, it’s important to consider if you have fully saturated your existing market (market penetration) and if there are new markets where you can promote existing products and services. If these growth strategies don’t look promising, diversifying in the new products and/or markets may be your answer.
Funding business diversification
While it can be the path to business growth, many SMEs find it challenging to finance their diversification efforts. Unsecured business loans are one way to fund your diversification plans. Learn more about business loans from Moula and get an estimate of principal and interest repayments with our business loan calculator.