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What is a Diversification Strategy__blog

Tips & Guides — 13 Jul 2022

What is a Diversification Strategy?

What is a Diversification Strategy? Everything You Need to Know

Companies of all sizes experience the peaks and valleys of doing business in modern globalized markets. No matter how good of a run you are on, there is always some stiff competition on the horizon. Not to mention that potential disruption and uncertainty are around every corner.

Businesses that achieve success can quickly become tied to their core or flagship products. It makes sense to invest more resources into what has the highest ROI. However, every business will reach a point where being a one-trick pony isn’t good enough.   

As the saying goes, you don’t want to put all of your eggs in one basket. And sure, you can go ahead and spread your eggs into many baskets in perpetuity. But even then, how do you know you are putting them in the right baskets?

What is Diversification?

What growth strategy combines new markets and new products? Diversification. Diversification involves developing new products and services and/or entering completely new markets. This growth strategy hedges against uncertainties like supply issues and stagnant market growth.

Diversification is one of the four main growth strategies defined by Igor Ansoff. In his Ansoff Matrix, he combines these strategies with each type of product-market combination as depicted below.

Diversification

Market penetration – Increase the sales of current products in existing markets through any means necessary. This is an aggressive business strategy to increase market share. Marketing planning involves tactics like lower pricing, discounts, and customer loyalty programs. An example of this growth strategy would be Walmart’s continual price reduction strategy for their entire range of products.

Product development – Involves the creation and testing of new products to bring to existing markets. An example of this would be Apple adding laptops to their original product line of desktop computers.

Market development – A market expansion strategy of offering existing products to completely new customers. An example could be entering a foreign market or moving into a different age demographic via affiliate marketing

Compared to the other three strategies, diversification carries the most risk. This is because it involves a business entering into the great unknown of new markets and new product development. Businesses are unable to leverage existing knowledge and technical skills to lower risks.

How to Diversify

Diversification can mainly be accomplished by three methods.

Internal development

Companies can install a diversification strategy internally. This involves leveraging the existing product development process. Relevant and experienced departments create new products to target new markets. An example of this would be Apple moving from music players like the iPod to smart devices like the iPhone and iPad.  

Partnership with other companies

Companies can look to diversify by forming a partnership with one another. The new market development can be mutually beneficial for both parties.  It saves each business from having to develop new products in-house. And it simultaneously introduces each partner to new market segments.

Partnership with other companies

Using a marketing partnership platform like Affise can help your business expand its reach into new market segments. The platform makes it easy to enter new markets via partners. You can team up with influencers, bloggers, content marketers, and other businesses.

Acquisition of another company

While possibly the largest investment, a simple way for a business to diversify is through acquisitions and mergers. This type of strategy will open new customer segments and instantaneously introduce new products.

Types of Diversification Strategies

How you go about diversification depends on several factors, including the size and nature of your business. Additionally, the goals of any diversification strategy affect exactly which type is best.

Horizontal diversification

When a company diversifies horizontally they are introducing new products or services to their existing customer base. Typically, the new products are somewhat related to those already offered. In this way it will be more likely the new products are useful to a business’s existing market than otherwise.

Horizontal diversification appeals to your established customer base. These are people who already trust and like your brand. But you are diversifying your buying relationships with those customers with the new products. 

An example of horizontal diversification would be Disney buying Pixar Studios. Another example would be an enterprise cellphone system provider adding headsets and earbuds to their product line.  

Vertical diversification

Vertical diversification

Image source: slideshare

When a company expands to another step in the supply chain, it is called vertical diversification. This can involve any step from raw materials to customer-facing sales.

This type of diversification is also known as vertical integration.  It can move backward (higher up the supply chain) or forwards (closer to the point-of-sale). For example, an online gaming site could either decide to get involved in the game writing process or open a chain of gaming stores.

Vertical diversification hedges your bets against unforeseen disruption in the supply chain. You will also lessen dependencies on suppliers, thereby increasing your gross profit margin. 

Concentric diversification

With concentric diversification, a company introduces new products that are closely related to its other products.  A concentric strategy allows you to leverage your existing competencies and technical know-how. This allows you to expand reach in your existing markets, but also to enter new markets.

Concentric diversification is a more cost-efficient way to diversify. However, there is some chance of your new products taking market share from your existing ones. An example of this would be an art and crafts company adding a line of acrylic paints to their existing watercolor paint offerings. Some customers may move from watercolor to acrylic painting. 

Some concentric diversification will have less market share crossover. For instance, when IBM moved from strictly mainframe computers to personal desktops computers. But when they began selling laptops, some of their existing desktop customers may switch to laptop-only.  

Conglomerate diversification

Conglomerate diversification

Image source: wallstreetmojo

Conglomerate diversification is when a business introduces new product-market combinations. This strategy helps companies to reach new target markets with a completely different product or service.   

The potential rewards are higher than concentric diversification, but so are the risks. This is because you are venturing into unknown territory. You are unable to leverage your existing resources and technical knowledge with new products in new markets.  

When going for a new product-market strategy, solutions like Affise BI can help mitigate risks. Your team will better identify market opportunities with predictive analytics. An API integration with AppsFlyer ensures data from all areas of your business is connected in one place for fast and accurate reporting. 

Defensive diversification

A defensive diversification strategy is less “how” and more “why.” It does not provide a template for growth but is a goal-oriented strategy. This type of diversification helps an organization to stay competitive and defend what it already has. 

Defensive diversification is often used by large companies in response to three conditions:

  1. The current market has become saturated.
  2. Their existing products can evolve no more and are in decline.
  3. They are losing market share to their top competitors. 

Offensive diversification

Offensive diversification

Offensive diversification is when a business aims to attack existing markets. The goal is to take market share from its competitors. This is an aggressive strategy that involves a multi-pronged attack. It involves introducing many new products and services to enter new markets.

Offensive diversification requires a lot of strategic planning and resources. When it works, it can realign the big players of any market. An example of an offensive strategy would be Facebook acquiring WhatsApp and Instagram. 

Both were top competitors to Facebook and its features. Now, instead, Facebook has recouped a lost user base. They have also acquired news users that would have otherwise been uninterested.

Importance of Diversification

As we stated earlier, no one wants to bet everything on black. No matter how good business is today, things could quickly change. There are many reasons why your company should diversify.

Increases your revenue 

These days, it seems that the behemoth that is Amazon will not stop until it’s taken over the galaxy. And whether it was the creation of Amazon Web Services, the Kindle Fire e-reader, or Prime Video, the conglomerate continues to diversify. It’s no wonder its revenue increases significantly with each coming year.

Increases your revenue

Image source: sumo

When you diversify your business, you add new products or services and reach a new audience. This can only mean one thing, you’ll get more leads and increase sales volume. Of course, there are always costs involved with developing new products and reaching untapped markets.

But diversification allows you to leverage your existing resources for cost-effective revenue growth. Not to mention, you’ll appeal to new customers via your existing and recognizable brand name. And your loyal customers will already be willing to hear your new marketing messages.

A solution like Affise makes it easy to scale your ecommerce business with demand. By using platform-based partnerships, you will be able to reach your new product-market through diverse advertising channels

Lowers your company’s risks

Time and time again, history repeats itself. If the business world has learned anything by now, it’s to make sure you have several different avenues of revenue generation. It’s worth saying again, don’t put all of your eggs in one basket! 

Today we have highly evolved AI, machine learning, and analytics-based forecasting technologies. But we still can’t predict the future. An electronic data interchange is perfect for reducing paper use and maintaining accurate records. But that won’t stop cataclysmic world events from disrupting and shutting down your supply chain. 

Regional lockdowns and labor strikes can prevent consumers from shopping. Just about anything can happen in modern times. Diversification is an easy and smart way to hedge against the unknown and lower all-cause failure risks to your business.

Remain profitable

Remain profitable

Along with global uncertainty, all markets experience some volatility. Anyone in business or finance knows each industry has its ups and downs. Seasonal consumerism, politics, changing economies, and weather all contribute to unpredictability. 

By diversifying your products and markets, you’ll lessen the overall dips in your business financials. At times, even your best products won’t be selling well. Your new products will carry the company through rough patches and remain profitable.

Maximize your company’s current resources

As companies grow in scale, efficiency becomes more important to continually increase revenue. The most successful large organizations run effective but efficient operations. When you implement diversification as a growth strategy, you’re leveraging existing resources (e.g., competencies, brand, etc.) to get multiple things done.

New product development can be applied to existing products. This can improve them and increase existing market differentiation. For example, a VoIP provider could leverage their communications tech. They could tailor a niche platform for contact center workforce management in addition to their core offerings.

Another opportunity could be increasing brand awareness in new markets. You may find your influence grows in your existing market while chasing a new target audience. Diversification is a must for businesses that want to maximize what they already have.

How to Measure Diversification Success

Any diversification strategy carries some risks. Higher risk means a higher reward. This means any diversification growth strategy requires careful and well-thought-out planning. Luckily, there are simple tests that can help predict the success of your diversification strategy.

Porter’s three tests 

Michael Porter is a well-respected and famous economist who created Porter’s five forces analysis, among other things. For diversification, Porter developed three tests to validate any type of diversification. 

Attractiveness test

The first test asks “how attractive is the new market?” In other words, is the new market going to generate more revenue than the cost of entering it? The current state, lifecycle, and market growth rate all contribute to overall market attractiveness.

The stage the market is in—startup/early, growing, or mature—affects the potential for success. And you should never enter a market if it isn’t a viable long-term option. It will rarely be worth it to diversify for temporary gains. 

Cost of entry test

How much does it cost your business to enter a new market? The cost must be weighed against the potential revenue gains and existing financial resources of your company. But you will want to account for the entry costs as accurately as possible. If the estimates of cost vs gain are close, it’s likely not worth your time and money. 

You and your team will need to conduct extensive market research and analysis. This includes doing your due diligence on any and all available information about the market leaders.

Cost of entry test

The total cost will heavily depend on how strong the market competition is and at what scale they’re already operating. You may find it cheaper to acquire a business already in the new market and adjust your plan accordingly. 

With analytics tools like that offered by Affise, your company will be able to research with improved accuracy. You can identify new ideal customer segments and out-gun the competition. Analysis and statistical reporting will aid better insight-led decisions when entering new markets.

Better off test

The better off test sounds simple enough. Does diversification make the business better off? Well, it depends on if new and sustainable business is generated. Or, at least, on if a competitive advantage is gained.

This could mean growing market share and generating more revenue. But it could also mean clearing the path for a different growth strategy like market penetration or product development.

For example, owning and controlling another step in the supply chain may allow a business to cut costs and out-price the competition. Or gaining entry to a new market might facilitate and expedite the process of new product development.

5 Challenges You Might Encounter

Like any business growth strategy, diversification doesn’t come without its challenges. Here are five to consider while creating your diversification strategy:

More resources required for new ventures

New business or additional business may be costly to acquire. Also, new products and services and new and unknown markets introduce extra layers of complexity. No company should look to diversify unless they are able and willing to incur these upfront costs.

Lack of knowledge and competencies

Whether it’s new products and services or new markets, you and your team are heading into uncharted territory. You’re less adept and prepared for what lies ahead and the cost of failure can be great. To properly manage diversification, you’ll need the right experts, brand partners, or access to the right resources to ensure you get it right from the beginning.

Lack of knowledge and competencies

Slower to react to your existing core market 

You must bear in mind that while your business is implementing diversification, your resources may be spread thin. With the challenges presented by new markets, it will be difficult for your team to be as attentive to your current market. Things can get lost in the shuffle, so everyone needs to communicate and stay on task. 

However, no matter how well this is done, you will likely find your organization less agile to manage changes to your existing markets.

Distraction of managerial attention

Diversification can be a huge project that can nearly monopolize the attention of your leadership. This is because there are many deliverables to be tracked and completed on time. Managers will be aware of what’s at stake and alert to all tasks of a diversification project.

As with any managerial time-suck, this means other important operational tasks may slip through the cracks. Longer planning and implementation means more lack of attention. If it goes on too long, small problems may become crises.

Core business may suffer unintended consequences

When pumping resources into a new market, no matter how unlikely, anything is possible. Relationships between markets can oftentimes be hard to correlate. But the forces of the “magic hand” can work in mysterious ways.

Diversification may affect the way your current customers view your brand.  You may lose out to competitors while your attention is elsewhere. As part of any growth strategy, your diversification program must include built-in checks and balances. This will minimize the possibility of unintended consequences on your core business.

Conclusion

Diversification can lead your business to its next stage of growth. It also acts as an insurance policy against future uncertainty. This is independent of industry. Whether SaaS, manufacturing, or retail, there is a diversification strategy that will fit your business. Startups and small businesses should implement diversification strategies that make sense and plans with a lower chance of failure.

Although riskier than other growth strategies, diversification can level up your business to new heights. You can expect to extend your reach and increase revenue. All you need to do is take the proper steps to mitigate risks. Do your due diligence to research market trends and customer needs. Pick a diversification strategy and get going today.

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Jessica Day

Written by

Jessica Day is the Senior Director for Marketing Strategy at Dialpad, a modern business communications platform that takes every kind of conversation to the next level—turning conversations into opportunities. Jessica is an expert in collaborating with multifunctional teams to execute and optimize marketing efforts, for both company and client campaigns.