Diversification strategy is a marketing strategy that allows the company to identify and develop additional business lines that differ from the current products and services. In the face of growing competition, the production diversification strategy becomes an excellent tool for risk management; Avoid unnecessary focusing efforts on one direction of the company’s work.
With the correct implementation of the diversification strategy helps to maintain the efficiency and profit of the company in times of economic decline, stagnation or a sharp change in the principles of the industry. The strategy can bring clear advantages to the firm and improve business stability but requires a detailed assessment of the company’s internal resources, environmental factors and a thorough knowledge of market trends. In the article, we will talk about the possible types and classifications of corporate diversification strategies, give examples of successful strategies and consider the proper process for developing a strategy for business diversification.
The main essence of the diversification strategy is to divide the assets and capital of one company between different activities in order to reduce the risks of losing future revenues. Diversification can take various forms: in modern practice, four main types of product diversification strategy are singled out: horizontal, vertical, concentric and conglomerate. Let’s look at each type of strategy in more detail.
The strategy of horizontal diversification involves the acquisition or development of such new products that can be sold to current consumers or to the company’s customers. In this strategy, the company relies on the existing sales level and production technology. An example of horizontal diversification is the addition of a new type of cheese to the range of sales of a dairy company. Risks in the horizontal diversification strategy are reduced by increasing the variety of goods. In the event that one type of product will lose its relevance, the company will still have an assortment that allows you to receive a stable income.
The strategy of vertical diversification involves moving the company “up or down” along the production chain. In other words, the company enters the stages preceding its production cycle or moves ahead on subsequent stages of its production cycle. The strategy of vertical diversification reduces the dependence of the company on the decisions of third parties, prevents third parties from receiving superprofits and closes all important processes within one firm.
An example of vertical integration is the situation where a company ceases to sell its goods through individual retailers and opens its own retail and wholesale store. Or the company acquires a supplier of resources and raw materials for the production of its goods. Or the company opens an auxiliary business for the sale of paints and building materials to its main business for the reconstruction of houses, providing the best prices and the process of supplying materials.
The strategy of concentric diversification is also called a diversified diversification strategy. This strategy means the expansion of the product portfolio through products (or business lines) that allow more efficient or full use of existing technologies and company resources. In other words, following the strategy of concentric diversification, the company creates complementary goods or introduces complementary services that facilitate and improve the consumption of the main product. This type of diversification is often used by small companies, and new products created are usually closely related to the core business of the company.
For example, a manufacturer of children’s products can purchase other small toy manufacturers across the country to increase the distribution of their products and gain access to new markets. Another example may be the introduction of a small bakery in the assortment in addition to the finished baking, semi-finished products and a dough for cooking at home. Advantages of the strategy of related diversification are gaining access to ready solutions and experience, reducing competition in the segment (when buying competing products), increasing the efficiency of using available resources.
The strategy of conglomerative diversification is also called a strategy of unrelated diversification and implies the conduct of two absolutely independent lines of business that do not improve each other’s activities. Following the strategy of conglomerate diversification, the company develops completely new lines of business and accesses completely new customers. In fact, this is an investment of the company’s current profit in new, growing and highly profitable industries. Sometimes this kind of diversification in the future allows the company to gain access to new technologies that can improve the current product.
The company resorts to the strategy of conglomerative diversification when it can effectively apply its knowledge and experience to new markets; when it has technologies that allow it to gain competitive advantages in new markets; When new markets and industries have a significantly high potential. An example of such a strategy can be called a situation where a shoe manufacturer enters a new (for himself) market for clothing production (using his knowledge and experience in consumer preferences and behavior).
The main advantages of the unrelated diversification strategy are that the company can find and develop a more profitable business in the future, and also reduce the impact of seasonal sales downturns on the core business. The drawbacks (or risks) of such a strategy of diversification is the need to allocate significant resources for the development of a new line of business and investments that may not pay off with poor managerial work.
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The strategy of international diversification can take one of the two forms described above: to be connected or unrelated. But we are talking about it separately because of the high importance for the company. International diversification is one of the main strategic ways of diversifying the company’s activities. It is transferred to it when the diversification at the national level is fully completed. This process requires high management competencies and a properly structured management structure.
The company should develop a marketing strategy not only for each business but for each country, taking into account the national and regional market characteristics and the model of consumption of the product. Using the right strategy for international diversification, the company can gain significant economies of scale, access to rare and valuable resources, maximize its resources and reduce the risks of stagnation and decline in sales.
Developing a diversification strategy
The strategy of business diversification can become a tool that will significantly increase the income and competitiveness of the company and may lead to failure. How to properly diversify your business? What is the diversification strategy to choose? Our small check-list will help answer these questions. Follow this plan, which will help in developing a diversification strategy, as well as in choosing the right direction for business diversification.
Step One: Analysis of Strengths and Stability of Business
Before moving on to choosing a diversification strategy, pay attention to a detailed analysis of the company’s current operations. Three key things that you must understand:
- What are the strengths of your current business?
- How stable and without problems does your current business work?
- Are there available resources and are they sufficient?
A successful strategy of diversification of production can be built only on the strengths of the current business. Therefore, do not rely on successful examples of competitors, you are not fully informed about their capabilities and resources, and you can make an erroneous decision when choosing the form of diversification. Analyze all internal resources of the company and make a full list of strengths.
The second important point about which we mentioned above is the stability of the current business. Any initiative, any new idea requires the resources and investments that you use in the current business. Therefore, before developing new directions, make sure of stability, profitability, and productivity of current activities. And if you already see flaws, then invest the available resources in their elimination and only then consider options for diversification.
And the last point that you should consider at the first stage is the sufficiency of resources. Any new project requires financial and human resources for its implementation. Make sure that your company has minimal resources to consider and evaluate possible directions for business diversification. Otherwise, either postpone this project or find alternative ways to increase market share (search for subcontractors, joint ventures, affiliate programs, etc.)
Step 2: Finding Directions for Diversification
Ideally, the choice of the market (or market segment) for business diversification should be made on the basis of a serious macroeconomic and industry analysis, which can identify areas with high growth rates and a favorable investment climate. But more often it happens that directions for diversification are determined on the basis of knowledge and experience of the business owner, as well as taking into account personal contacts and connections.
If you are not yet sure which direction to expand your business, you need to find ideas, potential, and viability of which you will be able to appreciate. The easiest way to collect ideas is to brainstorm. Gather a small group of people who understand your business, are experts in narrow fields or have a strategic mindset. Such people include department heads, market experts, young ambitious specialists. Often, interesting ideas are borne by outside experts who have a “blank” view of the market and can look at business in a different way.
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Step 3: Evaluation of directions for diversification
Planning for the company’s diversification is no different from planning a new business. At the stage of evaluating alternative options for sales growth, it is important to study in detail the market, the intensity of competition and about the distribution of key competitors, determine consumer preferences, general trends, and market dynamics. As a result, you get a list of parameters by which you can assess the overall attractiveness of each market and choose the most suitable option for your business. In the end, for each possible direction of diversification, draw the following conclusions:
- Do you really know the long-term prospects and potential of the market, and also understand the business model of key players?
- Do you really know how to effectively sell in a new market and understand the key drivers of sales?
- Do you really have enough resources to enter the market and capture the target market share?
- Do you have a clear plan for financing diversification, including investments in technology, equipment, promotion of goods and improvement of the quality of work with consumers?
- Do you have criteria for assessing the effectiveness of the chosen diversification strategy and a clear work plan for 3-5 years ahead?
- Is diversification really the best strategy for entering a new market and there are no more effective solutions (partnership, cooperation with companies, etc.)
Step 4: Analyze the company’s total portfolio
After you have evaluated all possible directions for diversification, make a verification action and evaluate each direction within the overall product portfolio of the company. The company’s portfolio is a combination of all products and services that the company offers its customers. The position and role of each product, product line, the business line should be clearly fixed. Perhaps the most successful diversification strategy does not fit into your portfolio.