To enhance profitability, many companies turn to diversification. By introducing new products, features, or services, businesses can expand their revenue streams and reduce their dependence on a single market or product. However, the success of diversification depends on the specific strategy employed by each company.
Every company is unique, and there is no one-size-fits-all approach to growth in the business world. As such, diversification strategies that a company employs can take on different forms depending on the company’s goals, resources, and competitive landscape. Nevertheless, the ultimate goal of all business diversification strategies is the same: to allocate a company’s resources across multiple areas and minimize potential losses for this or that company.
When to apply strategic diversification?
Experts suggest that a company should not jump to business diversification until it has exhausted all other potential growth opportunities in its primary areas of company operation. This cautious approach allows the company to focus on maximizing its core competencies and strengthening its position in existing markets.
While diversification can be a useful tool for some businesses, it is not always the best option for an individual company. For example, some single-profile companies may choose to remain in a single niche market and focus on improving their products or services to increase their market share. By doing so, the company can become more efficient and effective in its existing market, leading to higher profits and sustained company growth over time.
In such cases, the entire business potential is focused on a single direction, which makes it easier for a company to formulate its mission and strategic vision. However, maintaining a position in the market for a single-profile company requires the following:
- achieving maximum success in its specific niche
- offering a unique and highly demanded product or service
- building a positive reputation and a loyal customer base for the company.
Not every brand can meet these criteria and effectively compete. Despite this, there are some remarkable examples of successful single-profile companies, like Apple and McDonald’s, who have been able to maintain their market leadership through a blend of inventive products, strong branding, and customer loyalty.
Even company giants like Apple and McDonald’s have to keep their fingers on the pulse, as they too are at risk of being left behind due to increased competition, market saturation, the emergence of new products and technologies, and sudden shifts in consumer preferences. To remain successful, any such company must continuously innovate, adapt to changes in the market, and stay connected to customers. Despite their size and market dominance, they should be vigilant and willing to evolve to meet the demands of an ever-changing business landscape.
Diversification can be a wise move for a company in various scenarios:
- when the prevailing business opportunities are substantially limited
- when the company has garnered additional resources that can be allocated toward fresh projects
- when diversification can fortify the company’s standing in its market niche or create fresh prospects for augmenting customer value
- when diversification can bring down production costs for the company
- when the company is grappling with a crisis or is in a problematic phase of its growth trajectory
- when diversification can lessen entry costs and hike up revenue for the company.
If a business owner opts to embrace this strategy, they must ascertain the types of diversification that are most fitting for their company. It’s crucial to meticulously assess the advantages and risks of diversification and verify that it aligns with the comprehensive goals and objectives the company pursues.
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Horizontal diversification strategy
To implement a horizontal strategy, businesses often consider introducing novel products or services that differ from their current offerings. The primary objective of this approach is to capture the interest of existing company customers. However, the new product or service must provide something distinct and innovative, even if it belongs to the same industry and utilizes similar resources as the previous ones.
A dairy company that introduces a line of cheeses with unique characteristics to mitigate the risk of any of its existing products becoming outdated or losing favor with customers may serve as a horizontal diversification example. By diversifying its product range, the company can minimize its risk exposure and remain competitive in an ever-changing market.
Horizontal diversification is an immensely popular strategy for any company in the manufacturing industry, and for good reason:
- One of its most significant advantages is that it can markedly improve the financial stability of a company when executed correctly. By diversifying into multiple industries, a business can distribute its operational risks and costs, leading to higher profits and a more secure bottom line for the company.
- This strategy doesn’t require any additional investment in production capacities, yet can still boost sales. This is because new goods can be produced using existing equipment with no additional company costs, which can be especially beneficial for businesses with limited budgets.
- Horizontal diversification enables companies to leverage their existing distribution channels to introduce new products, which can help a company reduce marketing expenses. As a result, the company can direct resources towards other critical areas, such as innovation and R&D, to stay ahead of the competition and meet the ever-evolving customer needs.
Horizontal diversification is a strategy that can offer a multitude of benefits to businesses, one of which is risk reduction through product variety. By diversifying its product line, a company can not only mitigate the impact of potential losses but also achieve various other objectives:
- increase competitiveness
- expand market positioning
- cater to the needs of the target audience
- increase its market share.
Horizontal diversification is a popular investment approach that involves the inclusion of diverse assets in a single portfolio to minimize risks and maximize returns. In the context of trading, businesses often use this strategy to expand their product range and maintain customer interest by introducing new product lines. By diversifying their offerings, businesses can capitalize on emerging trends and stay competitive in a rapidly evolving market.
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Vertical diversification strategy
Vertical diversification is a strategic move where a company expands either upwards or downwards along its production chain. By adopting this approach, a company can either revert to its previous production cycle or move ahead to the next stages of the cycle. The use of this business strategy provides a company with more autonomy from its suppliers and their decisions and helps consolidate all crucial processes within a single entity, making it more efficient and reliable.
For example, a company can stop collaborating with retail outlets and open a store to sell its products, thereby implementing vertical diversification. A construction company can open a hardware store to reduce costs as part of this strategy. Similarly, a factory can buy out a supplier to obtain raw materials at lower prices.
One successful example of business diversification is the IKEA company, which buys timber and uses it to produce furniture. The company is a great illustration of how vertical diversification can be used to create new opportunities and increase profits.
Vertical diversification is a powerful tool for companies seeking to bolster their supply chains, tap into new sales channels, maximize profits, and streamline production costs. There are 2 primary types of vertical diversification strategies:
- Backward diversification: a company that is nearing the end of its supply chain cycle may explore opportunities to diversify into related markets that are tied to its primary products.
- Forward diversification: a company positioned at the beginning of the supply chain cycle can leverage vertical diversification to expand its processing and production of raw materials, opening up new possibilities for growth and profitability.
General Motors, an American company, is an example of upward vertical forward diversification along the value chain through the production of individual automobile parts. These parts constitute up to 65% of the company’s nominal market value, making it an exemplary case of successful vertical diversification.
Сoncentric diversification strategy
Concentric diversification is a business strategy that expands a company’s product line or business segments by utilizing existing resources and technologies more effectively and extensively. Also known as “related diversification,” this approach involves producing new products or offering new services that complement the consumption of a company’s core product. It is typically implemented by small businesses that align new offerings with their primary business.
Large corporations often utilize concentric strategies by acquiring smaller firms to enhance product sales and gain access to new markets. Such diversification aims to attract new customers and improve the purchasing power of existing ones.
Here’s when this approach is relevant:
- The company’s current product line is losing its appeal.
- New products can be sold at higher prices compared to previous offerings.
- The company lacks the capacity and resources to employ a horizontal diversification strategy.
The risks involved in pursuing this approach are minimal. Under the above scenario, related product types can be combined to reduce costs.
Сonglomerate diversification strategy
Enterprises willing to undergo significant changes can opt for the conglomerate diversification strategy. This approach is often taken by large businesses that acquire smaller firms. The latter used to produce goods that are no longer in demand. However, taking this path can be risky, as launching production of an entirely new product requires operating in an uncharted area, retraining personnel, and more.
The conglomerate diversification strategy, also referred to as unrelated diversification, involves venturing into an area that has no connection to the company’s previous operations. If executed well, this move can grant the enterprise access to a brand-new customer base.
Businesses usually resort to conglomerate diversification if they can leverage expertise and competencies in novel areas and if they have access to cutting-edge technologies that enable them to outcompete others in emerging markets.
As an illustration, consider a footwear manufacturer seeking to broaden its customer base that ventures into clothing production, capitalizing on its know-how as well as experience in understanding consumer preferences and behavior.
Conglomerate diversification offers companies the opportunity to reduce their vulnerability to market fluctuations and find new sources of revenue. By expanding into unrelated industries, a company can reduce its reliance on any one product or market, and take advantage of its existing resources and expertise in new ways. Additionally, diversification can help a company to improve its financial stability by increasing revenue streams and overall profitability. This can in turn improve the company’s ability to obtain financing and invest in future growth opportunities.
Successful implementation of the conglomerate diversification strategy demands a substantial investment of resources since the company ventures into uncharted territory, without any assurance of profitability.
How can you choose the right diversification strategy?
To ensure the success of diversification, it is crucial to determine which strategy to prioritize. This involves taking several steps:
- Analyze the strengths and weaknesses of the business. This step also comes with assessing the company’s level of stability and the availability of sufficient resources.
- Identify potential areas for diversification. After conducting a thorough analysis of the industry and macroeconomic aspects, a promising direction can be identified. Often, the niche is chosen based on the owner’s knowledge and experience in the business.
- Evaluate the potential areas for diversification. Company diversification should be treated as planning for a new business. It is essential to carefully research the market, general trends and dynamics, and consumer preferences. After obtaining a list of parameters, the attractiveness of a particular market can be evaluated, and the most suitable option for the business can be chosen.
- Analyze the overall portfolio of the company. The term “portfolio” refers to the entire range of products and services that the enterprise offers to its consumers.
Each business has unique characteristics, and choosing the right diversification strategy can be a challenging task. While large corporations with extensive resources tend to favor horizontal or conglomerate diversification, these strategies can come with significant risks and high capital investments, which may not be feasible for small businesses. Conversely, small firms often opt for concentric and vertical diversification strategies, which involve expanding into related or upstream/downstream markets to capitalize on existing capabilities and resources.
Each business is unique and requires a tailored diversification strategy. Sometimes bold and unconventional decisions made by business leaders can lead to unexpected success. Thus, a thorough analysis of all business aspects is essential to determine the best course of action for diversification.
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