Three years after the launch of the iPhone, Dell introduced its first smartphone, Aero, as an attempt to compete with Apple. Both companies embraced change, but while one of these diversification strategies worked, one did not. Dell’s Aero flopped immediately after its release.
Diversification can be complicated for businesses across industries and sizes. Companies can only benefit from diversification if they can identify each strategy’s scope for potential success.
What is Business Diversification?
When a company wants to diversify, it means it plans to enter a market or industry in which the business doesn’t operate and additionally creates a new product for that market. They usually do this for two major reasons:
- Preservation of capital, if the product is valuable enough
- Interest on new markets as the business continues developing
The Walt Disney Company is a perfect example. What started as an animation studio is now an entertainment powerhouse that offers people films, vacation destinations, music, merchandise and even cruise ship packages. How did Disney diversify so much? They focused on leaving a footprint in integrated market segments and creating “synergies that work together,” says Dr. Scott Benjamin, Assistant Professor in Florida Tech’s Master of Business Administration program.
“There is a massive control of market there. They need to diversify to create synergies that work together. Their mission statement is controlling the experience of entertainment worldwide.”
Is Diversification a Good Strategy?
Despite Disney’s success, business diversification is risky for any company. Whatever positive predictions analysts may report can’t tell if the new product or service will be successful. The process of diversification requires not only new skills and knowledge, but also new resources like technologies and facilities that expose companies to higher levels of risks.
But if the expansion is successful, there’s a chance they could increase profits. This type of strategy isn’t exclusive to large corporations. Once diversification is adopted, it usually works. According to a report by the Business Development Bank of Canada (BDC), diversified mid-sized firms are generally top performers in the areas of products and services, geography and the number of costumers. Big and small companies equally experience strong financial returns.
The report highlights that “diversification has little to do with a firm’s age. Rather, it appears to depend on the mindset of the entrepreneur.”
4 Types of Business Diversification Strategies
When a business owner or leader of a company chooses to diversify, they must figure out what strategy best fits their needs. Four specific strategies have been adopted by companies across the world.
A strategy in which a company develops or adds new products to its existing product lines to enter a new market.
- Why it works: Concentric strategies enable synergies. The introduction of a new bottled drink within a food company can help gain profit from an untapped market.
Subsidiaries of a multi-industry corporation run their businesses independently of the other divisions, but management reports to leaders of the parent company (e.g., Walt Disney’s wide variety of market operations).
- Why it works: As a McKinsey report points out, conglomerates have the advantage of being mature in the market. High performing conglomerates make sure to purchase companies that are undervalued by the market – and whose performance they can improve. Additionally, conglomerates allow their subsidiaries to be self-supporting, which cuts the major corporation’s need for integrating functions.
3. Horizontal Integration
Acquisition of a business that operates at some level of the value chain in a similar or different industry. This strategy also includes the addition of a new unrelated product or service that could appeal to current customers (e.g., Quality Inn’s purchase of similar value hotels or a notebook company’s choice to start selling pens).
- Why it works: If a company’s customer base is loyal, a new product or service will be a valuable addition to the business.
4. Vertical Integration
A firm expands by controlling its suppliers, distributors or retail locations.
- Why it works: Companies that diversify vertically can achieve “economies of scale,” or savings in costs gained by increased levels of production. Some businesses do this by introducing technologies that improve operations. Another result from verticality is the geographical expansion for supply-distribution purposes.
Examples of Diversified Companies
This company may very well be a prime example of vertical integration. It has its store brands, it owns the manufacturing, controls the distribution and is the retailer itself. Since Target cuts out the middleman, it offers its name product at a low price.
Walmart also succeeds in cutting costs and balancing production. Everything from its warehouse model, store location, to its distribution process is designed to be generally cheaper, so the production costs never overshadow its profits.
General Electric (GE) began as a merger between two electric companies in 1892, and now operates in various segments: Lighting, healthcare, aviation, renewable energy, oil and gas, etc.
Although the firm still manufactures light bulbs and refrigerators, its range of business extended to the point of once owning the television network NBC. Considered one of the world’s most diversified companies, GE reported annual revenue of $121 billion in 2018.
Strategies for Small and Mid-Sized Businesses
Based on the survey of nearly 1,000 businesses, the BDC report was able to showcase a broad scope of observations. MIT’S Sloan Management Review shares similar advice when it comes to diversifying a business:
- Highlight the business core strengths: Questions that companies should be asking themselves before they diversify include: Can existing assets be used for other things without adding costs? Does our diversification strategy ensure that the business will capitalize on existing skills?
- Address weaknesses: Companies should also consider the risk factors and whether they’re ready for adversities. They should ask themselves: What if during the process, we lose our biggest client? Can we protect ourselves from big risks?
- Ensure that financial resources sustain operations: Before diversification, companies must make sure that existing operations aren’t compromised. Business leaders should consider the least expensive and complicated options, and think carefully about time, money and any other resources involved.