6 Diversification Strategies & How They Work | Simple Examples
If your business has hit a ceiling, and opportunities seem scarce with your current products or market, a diversification strategy could be right for you. The goal is to diversify your business with new forms of income, so that you can boost your profits and protect yourself against volatile economic conditions. It’s a strategy used by companies the world over.
What is diversification?
Diversification is making a business more diverse by selling a new product, selling in a new market, or taking control of supply chain activities like manufacturing. It’s a broad term with four distinct strategies (and two “meta” strategies), each with varying risks and rewards.
From a defensive viewpoint, the goal of diversification is to have a variety of profit-making activities so that your company can continue making money if some of them are failing. For example, an auto manufacturer may decide to start producing electric cars to offset their losses as people become more environmentally-conscious. From an offensive viewpoint, the goal is to broaden your company’s reach with new products or markets, as a way to increase profits. For example, a business that sells laptops may decide to start selling desktop computers, opening up a new revenue stream that could bring more money into the company.
In theory, the more diversified a company is, the better protection it has against economic uncertainty, changes in buying behaviours, shifting of markets, and other business risks. Diversification reduces these risks in the long term, but increases them in the short term because something completely new is being added to the business, like a new product or market. This makes research and planning essential, because it helps to answer any unknowns. Detailed customer research, exceptional market segmentation, and a clear product development strategy are just a few things that may be needed for successful diversification. Essentially, the more solid information you have about the new thing you are adding, the better your chances of diversifying the business and generating more profit.
When you are diversifying, you may need to redirect funds from your core business, which increases risk further. There’s also danger of diluting your core products and stretching resources too wide. But if you pull off the strategy, you could see a large increase in sales and revenue, a share in a new market, and potentially higher margins for your products. As with every other business strategy, if you invest heavily in research, you have a much better chance of being successful.
The benefits of diversification
These are the three key benefits of diversification:
Reduces long-term risk
The more diversified your business is, the bigger your buffer against losses for specific product lines or markets. You have more eggs in more baskets, so if one basket fails, you have others to fall back on.
Can be highly profitable
History is filled with examples of companies who have gotten rich from diversification. General Electric, 3M, and Motorola are just a handful—they all expanded their offerings and reached sky-high profits as a result. Diversification is usually risky, but can have immense rewards.
Broadens business reach
Diversification may help you expand into new markets and customer groups, which broadens your reach and provides more business opportunities. The more customers you can sell to, the greater your potential for profit.
The risks of a diversification strategy
These are the biggest risks of a diversification strategy, which you should heed before jumping in:
Increase short-term risk
Until you’ve successfully made the change and are receiving income, diversifying is risky because you don’t know if it will work. Maybe your new product will tank because your research failed to uncover a key flaw in your plan. Or perhaps you misinterpreted a behaviour for your target market. This is why extensive research and planning is absolutely necessary. The more you know about your customers and markets, the lower your short-term risk, and the better your chances of successfully diversifying.
May require a high investment
Because so much research is required, your staff’s time will be diverted from other activities, and you may need to hire new people. Fresh strategies will need to be created, and you might also need to pay for industry reports to get the information you need to make good decisions. All of this can be very expensive.
Risk of diluting your brand
As you offer more products or services to different customer groups, there’s a risk of diluting your brand’s core offering and putting your existing customers off. They may not like the direction that your company has taken, or the new values that you seem to have adopted. This can result in an exodus, so it’s crucial to ensure that your branding remains strong and consistent throughout the diversification.
The six most common diversification strategies
These are the most common diversification strategies that are practised by businesses:
1. Concentric diversification (convergent diversification)
If a cafe starts selling different types of cookies, they are practising concentric diversification
Concentric diversification is adding a new product to an existing product line. The word concentric means “having a common centre.” A cafe that sells cookies might also start selling brownies—they are similar types of food, and so clearly belong to the same product line. Or the cafe might start selling a different flavour of cookie.
For concentric diversification, the new product can:
- Have a different attribute, like flavour
- Be in a different format, like selling the same piece of music in vinyl format as well as MP3
- Be totally new but clearly related, like selling shoes in addition to t-shirts
- Be similarly distributed, like downloaded through a website
- Use similar technology, like the same software code
- Have a similar usage, like a new mobile phone
A major appeal to this strategy is that you are staying focused on your core product lines, while providing customers with more choices. It’s the least risky route for this reason—the products are similar, the customer segments are the same, and you don’t need to make big changes to your business strategy. You can use your existing staff and infrastructure to create and sell the products too. It can be a fantastic way to boost profits while keeping risk low.
One important thing: because you’re releasing products in the same line, the quality of the new product should match or exceed your existing products. If they don’t, you risk contaminating the entire line because people will group them into the same category.
2. Horizontal diversification
Horizontal diversification is creating a new product line for existing customers. A book publisher may decide to create a writing app for authors, which is an entirely new type of product that fulfils a different need. Or a bond cleaning business may create a removalist service to help people move home before it’s cleaned.
In horizontal diversification, the product must be unrelated to your existing lines. The goal is to appeal to a different need for your target market. The more products or services you offer, the more likely customers are to return to your business, and the more promotion and brand awareness you will achieve—Amazon is an extreme example of this. On the other hand, more products lead to more complexity and less focus on your core offering, which can cause it to become diluted. When introducing a new product line, be sure that your core products aren’t neglected, as you may lose your loyal base of customers.
To execute this strategy, you’ll need to identify additional needs for your current customers. You can do this by surveying them, interviewing them, creating focus groups, analysing their buying behaviour, or completing market research. Once you’ve uncovered an explicit need, you can be innovative and create the new product or service yourself (this can be fun for staff), or consider acquiring a competitor that already sells them.
This diversification strategy is popular because there’s less risk. Additional research is needed to uncover a new customer need, but you should already be intimately familiar with your customers. This lends extra confidence when creating a new product for them, and doesn’t carry the same perils as selling in an entirely new market. It can be a good strategy to take when your current market is saturated and you’re struggling to grow.
If you manufacture the new products yourself, you may also have cheaper production costs because you’re able to buy materials, resources, and other services in bulk. It can be an excellent way to diversify.
3. Conglomerate diversification
Conglomerate diversification is adding new products that are unrelated to existing product lines, and that target new customer groups. Conglomerate basically means “lots of different things.” A local movie theatre might decide to buy a car wash; a computer manufacturer may see an opportunity in home security systems. The new product must be completely different to their core offering and sold in an unfamiliar market.
As you might have guessed, this strategy is by far the riskiest, which is why it’s usually undertaken by larger companies with plenty of capital to lose. These are the big conglomerates of the world like Warner Media, Procter & Gamble, and Disney.
Conglomerate diversification makes a business more complex, harder to manage, and more challenging for teams to collaborate. New skills are required for the business, and people may need to be moved around which can cause resentment and hostile rivalries. Bureaucracy also swells, making decision-making slower and less efficient. On the other hand, new markets can burst with opportunity, and targeting a variety of markets with a number of products means that you have many eggs in many baskets, which reduces risk in the long-term. Economic downturns and erratic buying behaviours are accounted for because you have plenty of backups.
This strategy is often undertaken due to limited opportunities in existing product markets. When your own market is saturated, and there’s no further opportunities for growth, selling in a new market may be the right move. Many companies execute this strategy by acquiring another business, as it’s much easier to buy a successful company than build one from scratch.
4. Vertical diversification (vertical integration)
Taking control of your product’s manufacturing process is an example of vertical diversification
Vertical diversification is taking over some part of the supply chain, like acquiring a supplier or vendor. This helps to simplify operations because there’s fewer parties involved. Everything can become a little more efficient, so there’s lower costs (in theory). Amazon is a successful example of vertical diversification. Jeff Bezos started out selling books from his garage, and has since created high-tech distribution centres and his own delivery network, taking control of two key parts of the supply chain.
Vertical diversification can be broken down into two types:
- Backward integration—going “backwards” in the supply chain by buying a manufacturer or supplier.
- Forward integration—going “forwards” in the supply chain by opening a store to sell products directly, or buying an existing store that does.
The goal of this strategy is to reduce supply chain costs and lower dependence on other companies. Manufacturers, suppliers, distributors, and vendors no longer have any leverage over you. There’s no unexpected delays, price increases, or other issues that can harm your brand. Instead, the supply chain becomes smoother, and you can capture profits both upstream and downstream. On the downside, there’s a higher risk if your target market is uncertain because you’re invested in more of the supply chain. If the market slumps, your expensive manufacturing plant might become useless.
5. Defensive diversification
Defensive diversification refers to companies who diversify to stay competitive. Their market may have become saturated, their products could be in decline, or they could be losing profit for other reasons, which encourages them to pursue defensive diversification to stay afloat. It’s not an actual strategy like the other types of diversification, but a description; a response to losing profit. It helps them to protect their profits and keep their position in the market.
When a company diversifies defensively, they can undertake any of the other strategies listed in this article (aside from offensive diversification, which is its opposite).
6. Offensive diversification
Offensive diversification is when a business diversifies to gain more share of the market from their competitors. They are in a strong position already, but want to increase their profits by taking business from the competition, which may destabilise them.
As with defensive diversification, a variety of strategies can be used to improve market share, including creating new products or targeting different customer segments.