In an increasingly competitive environment, a diversification strategy is an excellent tool for risk management. With its help, the company has the opportunity to develop additional lines of business that differ from current products and services. Competent implementation of this strategy allows you to maintain and increase the company’s profit and not lose efficiency under challenging times of stagnation, economic downturn, or in the event of a sharp change in the industry. What other advantages does a business diversification strategy have? What are the disadvantages of this marketing strategy? The answers to these important questions can be found below.
Why is a diversification marketing strategy needed?
Constant market changes force businesses to adapt to new conditions. The main advantage of diversification is the ability to reduce risks through the comprehensive development of the business. Thus, an enterprise, for example, begins to simultaneously develop several little-related or unrelated business areas, which allows it to insure against possible drawdowns in some of them.
One of the most notorious business diversification examples is the Virgin Group conglomerate. Under this brand, film companies, real estate agencies, computer game developers, companies providing banking services, and rail transportation services are registered. The lines of the Virgin Group conglomeration business are so different and, in some cases, utterly unrelated to each other that the likelihood of a complete capital loss is minimized. However, it is worth noting that the planning of activities in companies using diversification of products differs significantly from the planning of the activities of a company occupying a specific niche.
Why do companies diversify? A company that has decided to apply diversification suffers less from such factors:
- unexpected losses due to fluctuations in the market
- decrease in demand for products
- geopolitical conflicts
- policy changes within the country of business incorporation.
The major benefit of diversification is the ability of a business to adapt to new conditions and develop competitive advantages quickly. So, during the pandemic, many enterprises were forced to develop the online market, organize delivery services, and update their assortment, adjusting it to the existing realities. Companies that have successfully diversified during that period overcame challenges and even increased profits. This proves that the use of various types of diversification makes business processes stable, predictable, and resistant to crises.
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When does a company need diversification?
A business can use all the advantages of diversification in various periods of its existence – from times of prosperity to times of the threat of complete collapse. The reasons for using a diversification growth strategy may be:
- the accumulated surplus of funds that business owners decide to use to maintain the company’s competitive advantages in their niche
- the desire to increase profits by increasing production
- the desire to strengthen their position in the face of fierce competition
- the desire to reduce business risks through diversification in various areas of activity.
Often, a business uses a market diversification strategy against the backdrop of a change in market conditions, the transformation of a branch into a legal entity, etc. Sometimes the reason for diversification is the usual curiosity of an entrepreneur who wants to try a new business direction. And in some cases, business owners are driven by the fear of exporting because many companies are afraid of entering the international market, choosing instead to create something new within their own country.
Methods and types of diversification strategies
The benefits of business diversification also lie in its variability. The company can choose the appropriate method based on its current situation, the stage of business development, the activity specifics, and the goals set.
There are three main methods of diversification:
- Expansion. The business enters new markets to increase profits. An example of diversification in such a way can be a company that sells decorative cosmetics in its own country and decides to enter the international market. To do this, it creates websites in foreign languages and enters into contracts with transport companies that will deliver goods to other countries.
- Adaptation. This method of diversification is usually resorted to by entrepreneurs who have managed to accumulate certain financial resources. These funds will be used to open a new line of business and expand the product range. If the new products are similar to the company’s main products, this type is also called a related diversification strategy.
- Merging. Sometimes companies decide to merge to reduce the cost of products. Such diversification may take the form of an acquisition or merger between businesses.
You can use several methods of business diversification at once. For example, companies have merged as part of the business acquisition, and also used the expansion method to enter new markets.
Advantages of diversification
Using diversification in strategic management, you can reduce the risk of unexpected business failures. After all, during a period of falling demand for one product, you can profit from the sale of other products without interruption. Thus, alternative directions compensate for losses, allowing the company to stay afloat.
Some other benefits of business diversification:
- The risk of failure when entering new markets is reduced by launching new products in other business fields.
- There is an opportunity to get out of the markets where there is a decrease in profitability as painlessly as possible.
- The company’s resistance to the crisis and market fluctuations increases.
- There are assortment advantages over other companies due to the ability to offer new services or products.
- It becomes possible to create a closed production cycle, which will reduce the dependence of business on other enterprises.
By expanding the business, it is possible to neutralize market fluctuations in seasonal industries, provide financial synergy from general management, and increase the company’s profits. The benefits of a diversification strategy may vary depending on what type of business diversification has been chosen, what goals it pursues, and for what reasons it used this tool.
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Disadvantages of business diversification
In addition to the undeniable advantages of diversification, the strategy also has its drawbacks. So, business expansion usually requires funds, especially if the company plans to develop a new niche. With a simple range expansion, you can use existing equipment for production, slightly adapting it for new products. But to produce products from a different niche, you will need new equipment.
Other disadvantages of business diversification:
- business need for new personnel to enter a new industry
- the likelihood of increasing the load on the main business type since certain business areas may not generate income and even be unprofitable for quite a long time
- the emergence of difficulties in centralizing processes and settlements between different business areas.
It is also worth remembering that business diversification is a long-term project, which implies that it will take some time to get a positive effect. There were many examples when an entrepreneur sacrificed the interests of the main business, extracting funds from it to develop new directions. As a result, chaos began in the company, and the motivation of employees was significantly reduced.
Is it possible to avoid risks during business diversification?
Despite all its advantages, as it turned out, business diversification has some disadvantages. Using these simple rules, you can minimize the likelihood of a negative scenario and increase your profits when using diversification:
- Before starting business diversification, the company is recommended to establish an experimental base or a testing ground for research and spend time preparing and experimenting.
- Diversification analysis should be carried out. Diversification analysis refers to searching and correctly identifying the most profitable new business areas.
- When using unrelated diversification, you will need to gain experience in a specific business area.
- It is recommended to start with related diversification and introduce new directions along the way.
- It is necessary to make a detailed analysis of an existing business to determine the level of the company’s stability and highlight strengths, limitations, and other nuances.
Experts recommend carefully studying the business target audience, undertaking the development of a new project only when it is based on a clear calculation and reasonable benefits, and thinking over a promotion strategy.
In any case, it is worth wisely using all the advantages of diversification and minimizing possible miscalculations through preliminary planning and market analysis. It has been proven that a diversified business is more resilient to a changing economic environment, allows you to receive income from different, often unrelated sources, and allows the company to gain a foothold in the market. To avoid mistakes, companies need to consider not only the industry but also the geographical features of doing business.
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