Business owners worried about a rapidly evolving economy may want to consider diversification. This is a growth strategy that involves opening up a new market or moving into a new industry sector.
This could entail developing an innovative product for the new industry sector, so it could be an expensive venture to consider. However, businesses with a diverse product offering will often weather economic storms better than a company with just one product or service on sale. When adverse circumstances arise, businesses that only offer one product can be at risk of losing everything. Diversification is a risk-reduction strategy, involving adding products, services, locations, customers, and markets to any business portfolio.
Different diversification strategies
There are a number of different ways to diversify, including the following methods.
Horizontal diversification
This is probably the least risky way to diversify any business, and could even be funded by way of business credit card expenditure. This involves the acquisition or development of new products that will complement core business activities and are likely to appeal to existing customers. For example, an ice cream business may want to add a different style of frozen dessert to its existing product range. The business may require new technology, different skills, or a new marketing approach to carry out this type of diversification.
“Diversifying your business is a great way to ensure that you have multiple sources of revenue and can reduce the risk of your entire business model collapsing when the economy changes. It’s important to take risks, but it’s also important to be smart about how you diversify and make sure you’re taking calculated risks. A business credit card can be a great way to help fund your diversification efforts, but make sure you use it wisely and pay off the balance each month whenever possible.”
– Damian Brychcy, COO and US MD of Capital On Tap
Concentric diversification
With concentric diversification, businesses expand by adding entirely new products that are related to existing products or industries. This is mainly done to appeal to new customers. This type of diversification can be reliant on the existing competencies and strengths of the workforce, as they need to adapt quickly to the emerging challenges posed by the new products.
Conglomerate diversification
Conglomerate diversification is much riskier than concentric or horizontal diversification as it involves the addition of new products or services that are unrelated to the core business. An example would be if a computer manufacturer decided to start making cars. This type of diversification is highly expensive but could provide the biggest payoffs for businesses if successful. It also entails selling to an entirely different customer base, so will involve a great deal of marketing effort and strategy.
Vertical diversification
This entails expanding up or down the production chain of a business product. For example, a computer manufacturer could make moves into the retail sector to market their equipment directly to consumers.
Diversification to international markets
Diversifying a business to expand into international markets can be a natural route for many businesses, especially those with a unique product or service. It involves identifying any barriers to trade and growing the business on a global scale. Many countries have trade agreements across borders, giving businesses access to diverse markets which may be desperately in need of the products on offer. There are a variety of different pathways to global diversification, so it’s important to choose the one that’s right for your business.
How to diversify your business
One of the fastest ways to diversify any business is via a merger or an acquisition. It’s important to do due diligence and consider every aspect and prior to diversifying this way. This type of move can increase management costs significantly and also lead to bureaucratic inefficiencies. The goal of any diversification strategy should be to seek greater profits as a combined business than what was achieved by the individual companies.
If you’re considering diversifying your business, there are a few steps you can take to ensure success.
- Define the strategy to be used: It’s possible to expand by buying competitors or suppliers and increase overall market share. Alternatively, you may want to consider a move into an entirely unrelated industry sector as this will provide a cushion if your existing market fails.
- Draw up an extensive list of your core business competencies: For example, if your competencies are production and sales this will give some ideas as to which sector to diversify into.
- Research the industries in which you plan to diversify: You should be aiming to move into a field that is growing or has the potential to grow. The list of potential industries can be narrowed down even further when you take into consideration your core business competencies and existing customer base.
- List out all available options: Some possibilities to consider include going into a joint venture agreement with another company or buying a company that already has the skill set needed for success.
- Analyze all the above to choose the best possible option: If you’re planning to buy or merge with another company you’ll need to assess all its strengths and weaknesses. Bear in mind that if you’re setting up a totally new business arrangement you may need to provide financial support for several years before it generates revenue.
Advantages of diversification
There are many advantages that can come from diversification, including:
- Increased sales and revenue
- New revenue streams
- Growth in market share
- Ability to achieve higher margins when compared to existing products
- Cushioning to offset any blow associated with changes in the market.
Disadvantages of diversification
The principal disadvantage of diversification is that it involves costs for development, marketing, and sales. Businesses will also need to be prepared to offer added skills, management teams, and operational resources. Where the demands and upfront costs are greater than potential revenue and profit gains, diversification can put the entire business at risk.
Business owners need to consider whether funding diversification will limit any likely growth in core areas of the existing business. It’s also important to think about whether any lack of expertise in the new sector will lead to setbacks or expensive delays.
Businesses that diversify too quickly risk diluting the core products or services offered. This is an important point to bear in mind, as overstretched resources can lead to struggles with providing consistent levels of service and possibly alienate the existing customer base.
“It’s important to weigh the potential risks and rewards of any diversification strategy, and ensure that resources are allocated properly to make it successful. A business should take a measured approach to any diversification plans, and ensure there is capital available to sustain it. Credit cards can be a good way to fund business diversification with a flexible line of credit.”
– David Luck, co-founder and CEO of Capital On Tap
Conclusion
Diversification can bring great rewards but is not without risks. Perhaps the least risky method to choose is to diversify into similar products or services and sell them to a customer base with which you’re already familiar.
However, diversification can also be a good way to maintain the stability of any business and hedge against economic downturns affecting core business products.