January 12, 2020
Successful leaders know that if they want their business to grow and prosper long term, they cannot afford to stick with the same old business practices. They must find ways to reach new customers and increase their profits. One strategy for accomplishing this is diversification. Think Amazon. By offering multiple services, businesses can fill seasonal voids, increasing sales and raising profits.
Here’s a quick guide on the best ways to drive growth through diversification.
First, a Tip About Diversification
Diversification is a growth strategy that involves adding products, services and markets to your company’s core business. Putting your corporate eggs in many baskets is one way to minimize risk.
Diversification in business can mean expansion through new product lines or services. You can use this strategy to take advantage of momentum in a new market, or to minimize the risk of your core market shrinking.
Diversify to Reignite Growth
Many businesses experience phenomenal growth in their early years then plateau. The most common reason for the slowdown is that leads stop coming in. Perhaps you’ve reached maximum penetration in your existing market or a new, low-cost competitor has stolen your thunder.
Adding new product lines, or entering a new market is one way to reignite growth. This strategy is known as market diversification. The aim is to open up new markets and new customer groups, thus improving your company’s performance. Depending on your goals and resources a diversification strategy may be internal, external or a combination of both.
Launching a new product after research and development, market analysis and the production or purchase of goods, is called internal diversification. External diversification occurs when a company expands it activities through mergers, acquisitions, alliances with complementary companies or licensing new technologies.
Diversify to Survive
Motives for diversification can be complex but perhaps the most basic is survival. By definition, a company that focuses on a narrow range of products or services will only have access to a finite customer pool. At some point, you’re going to reach maximum penetration and the costs of running your company may outstrip its potential for growth.
Moreover, a one-trick pony business is extremely vulnerable to factors over which it has no or limited control. Rising raw materials prices, new competitors entering the market, changing customer tastes – these events can be catastrophic to your sales and revenue stream. Diversification places your eggs in many baskets. So you’re not defenseless if one area of your business takes a nosedive.
In the case of seasonal businesses, diversification can help stabilize your cash flow throughout the year. For example, an ice cream truck is likely to sell the bulk of its product in the summer. If the business remains committed to selling only ice cream, it would have to sell enough during the summer months to keep the books in balance during the off-season. An alternative would be to diversify into a selling a product that appeals during the fallow months; coffee for example.
Diversify to Prosper
Diversification is not just about survival. It can also be a proactive growth strategy. Adding new products and services to your line can gain you entry to an attractive new industry full of new customers and high sales potential. It can also kick start growth again, especially if you know how to take advantage of momentum in the market.
Try a Horizontal Diversification Strategy
The most straightforward way to diversify is to expand the product range you already offer. This is known as horizontal diversification. Usually, the new products are closely related to the current core business, for example:
– A toothpaste manufacturer adds toothbrushes to its product line.
– A women’s’ fashion shoe manufacturer develops a line of children’s shoes.
– A men’s shirt retailer offers a range of complementary ties, cuff links or even suits.
With horizontal diversification, a business can reduce some of its risk exposure while exploiting certain synergies. Using the example of the shoe manufacturer, the additional cost of producing children’s shoes should be manageable since the tools, equipment and technical skills to manufacture shoes are already in place. Current customers with children and new customers would be your target market.
Consider a Vertical Diversification Strategy
Think about all the steps that are involved in getting a product to market. The process starts with R&D, then prototyping, fundraising, production, marketing, distribution and so on. With vertical diversification, a company that’s already operating in one of these areas expands to another.
It does this by assuming control over an additional production or distribution step. Vertical diversification, also known as vertical integration, can be forward or backward:
– Forward vertical diversification happens when a business moves forward in the supply chain, i.e., closer to the customer. For example, our shoe manufacturer could start its own network of shops, allowing the business to control sales to the end consumer.
– Backward vertical diversification happens when the business moves backwards in the supply chain and becomes its own supplier. For example, the shoe manufacturer could acquire a tannery, thus reducing its reliance on leather suppliers.
By diversifying vertically, a business can leverage its existing competencies. It can also reduce costs and remain true to its value chain — the activities a company performs to bring a product or service to the market. At the same time, it’s reducing its dependency on original suppliers or outside sales people.
Perhaps the best-known example of a successful vertical diversification strategy is Apple. Apple manufactures its own custom chips, screen technologies and touch ID fingerprinting for iPhones and iPads. This is an example of backward vertical integration. At the same time, Apple has achieved forward vertical diversification by opening a chain of retail stores that exclusively sell Apple products.
Implement a Lateral Diversification Strategy
When a company expands into a new industry it does not currently operate in, it is pursuing a strategy of lateral diversification. For example, an airplane engine manufacturer could develop a range of vacuum cleaners for the consumer market. Or, our shoe manufacturer could open a driving school. There is no connection between the new market and the core business.
Generally, it’s much easier for established brands to diversify laterally than for less well-known brands. Customers tend to have more confidence in brand names they’re already familiar with, even if they don’t immediately associate the brand name with its new product or service.An example of this is the Virgin brand. What started out as a brick and mortar record retailer diversified into travel and leisure, entertainment, financial services and now space travel. This kind of extreme diversification worked because of the vision and extraordinary risk tolerance of its founder, Richard Branson.
Strategize Using the Ansoff Matrix
All businesses strive for growth. But the roads they take to get there vary and the vehicles they use can take many different forms. Ansoff’s Product/Market Matrix is the go-to growth strategy planning tool. Developed by mathematician and business manager, Harry Igor Ansoff, the Ansoff matrix provides a framework for formulating growth strategies.
According to its creator, when the goal is to generate growth, two levels of decision-making surface. Should your business penetrate new markets or should it stay in its existing markets? And, would you like to extend your product portfolio or not? Plug these considerations into his four quadrant product/market matrix, and four strategic directions emerge: Market penetration is the strategy of increasing sales of current products to current markets. The objective is to increase the market share of current products. This can be achieved through competitive pricing strategies, discounts, sales promotions and customer loyalty schemes.
Market development is a growth strategy in which a company tries to sell its current products to new markets. For example, selling the product abroad, or offering it online in addition to brick and mortar sales. This strategy is riskier than market penetration because you have to develop traction in the new market. Product development brings new products into existing markets, such as the toothpaste manufacturer creating a line of toothbrushes. This strategy works well for a business that has a solid customer base in which the existing product line is reaching saturation. There’s an emphasis on market research — to pursue a product development strategy, you must be attuned to your customers’ needs.
Diversification is the strategy of bringing completely new products or services to market. Ansoff pointed out that diversification is fundamentally different from the other three strategies. The other strategies can be pursued with the same technical, financial and other resources that you already use for your existing product line. However, diversification requires new skills, a new knowledge base and maybe even new facilities. It’s the most uncertain strategy because you’re moving into areas where you have no experience.
Analyze Using the BCG Matrix
Another useful tool to help you decide whether and how to diversify, is the BCG Matrix. Invented by the Boston Consulting Group, this matrix provides a visual way to look at your products with respect to:
– Their relative market share compared to the competition;
– and the market growth potential for your products.
Plotting a chart with these axes, products fall into one of four categories:
1. Cash Cows are money makers. They generate more revenue for your business than you have to spend marketing them. Ideally, a business carries as many cash cows as possible.
2. Stars generate a lot of revenue but they also consume a lot of marketing dollars because they are growing so fast. Businesses should keep investing in stars until the growth rate flattens and they turn into cash cows.
3. Dogs have a low market share and low growth rate. You could be losing money on them. It’s wise to get rid of them and diversify into other product categories.
4. Question Marks have a high growth rate, but little market share. New product-market combinations that resulted from recent product diversification often fall into this category. Question mark products could turn into stars or dogs. To predict which, it helps to understand which way consumer trends are moving.
Optimally, your business has products in all four categories. This means that you’re offering different products at different stages of their respective life cycles. Dogs are not really needed, but typically, they’re former cash cows. As they wind down, they bear witness to a successful past.
The Bottom Line
Diversification is usually necessary for survival and growth. But it’s not wise to rush in. Ideally, your core business is solidly established before you launch a new product or enter a new market. Inevitably, diversification will chew up management’s time, diverting attention from other parts of your business. And the risks are greater the further you move away from your comfort zone.Plan carefully for the greatest payoff. Use planning tools, such as Ansoff’s Matrix and the BCG Matrix. Do your market research. With the right plan in place, you can use diversification to potentially open up profitable opportunities for your business.
Need help diversifying? Louis Mamo & Company can help. Our Business Consulting division can help you plan and implement a diversification strategy and timeline. Contact us at any time for a private one-on-one discussion.
(Sources: The Houston Chronicle Small Business, Investopedia, Entrepreneur and The Ansoff Matrix)