The question, “What is Diversification and what is the best strategy to take?” is a common question we receive from our clients. Business diversification is the process by which a company or organization employs the diversification business strategy as a means to an end. This occurs when a company tries to enter a new market with a new product or service.
In the uncertain economy in which we operate, there’s always the possibility that your business can become irrelevant. Not overnight, certainly, but consider the fate of first video cassettes and then CDs. And DVD is headed the same way, now that everything is downloadable and stored in the cloud.
Specialization may be one of the keys to a competitive advantage, but depending on a narrow range of products or services can prove risky to the long-term survival and growth.
Reasons to Diversify
There are a number of reasons why a small business could consider diversification as an option:
- To create additional income streams, instead of being reliant on a particular product or service. This is particularly important if anything more than about 35% of your revenue is generated by one offering.
- Establish new challenges and growth opportunities. It’s easy to get so locked into the day-to-day operation of your business that you lose out on good opportunities for expansion.
- Manage revenue to balance seasonal or cyclical products. If your products and services only generate income at certain times of the year, you’re open to having a slump during the off-season – every time it comes around.
- Give existing customers a wider range to choose from. This works well if your products are related enough to appeal to the same target market. For example, if you offer IT support services, you might find benefit in expanding to provide IT training for employees.
- Attract a new market segment of potential customers. If your customer base is small and exclusive, you run the risk of losing half of your income if one goes out of business. By adding new product lines, you can draw a completely new target audience, which decreases your reliance on the select few.
- Implement a focused growth strategy. We wrote about this earlier in July and the importance of planned growth as opposed to random growth. A focused strategy gives you the option to control both the direction and speed of growth and ensure that it happens.
Determine Core Competencies
Before you decide whether to diversify or not, it’s critical to compiling a list of the main strengths and weaknesses of both your business and your employees. This will help you identify whether you have a great opportunity glaring you in the face, or if you’ll need to employ new resources to support your planned new offering.
Identify Pros and Cons of Diversification
Diversification has both benefits and disadvantages. Most of the reasons for diversifying double as benefits, but the disadvantages are equally pervasive:
- It costs money. Whether it’s capital outlay for infrastructure and raw materials, or simply loss of existing income while you step back from providing your existing services to explore the new avenues, you must be able to absorb the cost without repercussion.
- Risk of failure. Yes, this applies to almost everything you do anyway, but the risk increases when you “fund” new ventures with existing ones—even if you aren’t doing so financially.
- Resource readiness. Do you have the necessary resources in terms of human capital, knowledge base, information technology and core competencies (including your own)?
- Competition. A foray into a new market brings new competitors as well as customers. Determine the risk of competition to both your new and existing ventures and whether you’re able to respond to it.
Evaluate “Stick to the Knitting”
This well-known maxim from “In Search of Excellence” has been around for a long time, but it doesn’t necessarily mean doing nothing. It’s a good reminder that before you take the decision on whether or not to diversify, you should strategically evaluate all your options—including the option to not diversify. What if you invested the same time, money and effort that diversification requires into upgrading and improving your existing products and services?
Once you’ve weighed all the options, before you take the final decision it’s a good idea to determine your marketing and operational strategies for the new offering. This will help you to identify any pitfalls in time to change your mind.