Diversification Strategy: Overview, Examples, Types, Pros & Cons

Diversification strategies
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Founders, investors, and executives often consider executing a growth strategy, such as diversification, when a business hits a certain stage in its evolution. Diversification is one of the four key growth strategies defined by Igor Ansoff in 1957. For the most part, it allows businesses to consider new markets or goods to expand their scope and sales.

Igor Ansoff, who was he?

Igor Ansoff was a prominent businessman and mathematician who is recognized as the “Father of Strategic Management.” 

His recognition is a result of his role in establishing strategic management as a separate discipline in the 1950s. According to Ansoff, there are only four specific growth options open to a business. He believed that a company could expand through increased market penetration, market growth, or product development; including diversification as a corporate strategy.

Description of a diversification strategy

Diversification strategy is characterized by introducing new products in new markets.  But, what exactly is a diversification strategy, and what makes it a good business growth strategy?

In this article, we examine various examples of this strategy, determine when and why it could be a good growth strategy to adopt, and demonstrate the effect it can have on a business.

What is the concept of diversification strategy?

As we all know, a diversification strategy is a corporate expansion strategy devised by corporations. They are particularly the best fit for those manufacturing new goods in new markets. The concept tells us what diversification strategy is, but it doesn’t tell us why it’s a good fit or how to execute it.

Let’s go through that asap…

Why do companies diversify?

Companies diversify for a variety of reasons, the first of which is to increase profitability. Businesses use diversification to help them reach into markets and sectors they haven’t previously explored. This is accomplished by introducing new goods, services, or features that would cater to these new markets’ consumers.

Businesses will pursue new avenues for revenue by widening their scope and appeal. This has the potential to greatly increase profits.

Diversification is done for a number of purposes, not the least of which is to increase profitability. It, for example, can help a business reduce the risk of a market downturn. It could also improve brand reputation, and serve as a defensive mechanism against fierce competition.

On the other hand, this isn’t without its drawbacks. It is not only the riskiest but also the most difficult of Ansoff’s four growth strategies.

Dangers of a Diversification strategy

Diversification strategy, unlike market penetration strategy, is considered high risk. This assertion is not only due to the inherent risks of creating new goods but also due to the company’s lack of experience operating in the new market. When an organization diversifies, it is deliberately putting itself in a place of great risk.

It further necessitates the substantial expansion of human and financial capital. However, chances are, taking this route may have a negative impact on resource distribution in core industries.

As a result, it is advisable that an organization follow a diversification strategy only when the current product or sector no longer provides opportunities for development. Before deciding to seek diversification, businesses must carefully analyze the risks and determine the probability of achieving a successful outcome.

 Types of Diversification strategies

In the world of business, there is no such thing as a “one-size-fits-all” growth plan. Diversification can take several  forms depending on the path a company wants to go, and it can be related or unrelated to the current product or service offering.

#1. Horizontal diversification

Horizontal diversification is when the business chooses to incorporate goods or services that are unrelated to what you currently sell but can satisfy the needs of your existing customers.

Since you’re mainly dealing with familiar customers and market segments, horizontal diversification is usually the riskiest diversification strategy. If you’re the CEO of Dunder Mifflin Paper Company, it might make sense to branch out into printer manufacturing. This is a completely different product, but it has the ability to draw a large number of your current customers. (And, hopefully, those printers won’t catch fire thanks to excellent quality control.)

#2. Concentric diversification

Concentric diversification occurs when a business enters a new market with a new product. Basically, a product that is technologically close to its existing products. For the most part, this allows them to gain an edge by exploiting factors like industry expertise, technical know-how, and often even existing manufacturing processes. If sales of one product are decreasing, this type of diversification strategy will help offset the loss of revenue by increasing sales of other goods.

A computer manufacturer that diversified from clunky desktop PCs to laptop development is an example of concentric diversification. This would allow them to take advantage of the new wave of computer users who were looking for more portable solutions right away.

#3. Conglomerate diversification

Conglomerate diversification is when you want to expand into completely new markets with unrelated goods in order to meet entirely new consumer bases. A conglomerate is a single corporate entity that owns and operates several businesses in completely different industries. A conglomerate is a holding corporation that owns all of the individual companies. It becomes one after successfully adopting a conglomerate diversification strategy.

Tata Group, which was founded in 1868 and diversified from its modest origins as a hotel company into a global multinational encompassing 100 individual companies, is an example of conglomerate diversification. Chemicals, steel, automotive, engineering, telecommunications, information systems, and consumables are among the industries where it now employs around 706,000 individuals.

#4. Vertical diversification

Vertical diversification, also known as vertical integration, happens when a business moves up or down the supply chain by integrating two or more previously separate stages of development. This usually means that the corporation wishes to take over some or all of the functions associated with the manufacture and delivery of their main product, such as raw material procurement, manufacturing procedures, assembly, distribution, and sale.

Vertical diversification, for example, may mean going into producing the goods you currently sell if you’re a retailer. While this will help you save money by bringing all of your company’s needs in-house, the drawback is that it will limit your company’s versatility and potential opportunities for horizontal diversification.

Vertical diversification can be classified into two types based on the direction in which you move through the supply chain.

  1. Forward diversification
    If you’re at the start of a supply chain in terms of business positioning, you can plan to take care of operations further down the line as well. A mining business, for example, might decide to expand into the processing and production of its raw product.
  2. Backward diversification
    If you’re getting close to the end of a supply chain, consider diversifying into the markets that feed into your commodity. Netflix, for example, started as a video distribution site but has since moved on to producing its own content.

Examples of diversification strategies

The following are real-life examples of implementing diversification strategies. The companies below literally show how this type of strategy can be either effective or stale. It’s, however, important to note that its effectiveness is solely dependent on the business and timing.

#1. Moz.com

It began as SEOmoz, a blog and online community where experts and marketers could share their theories, analysis, and findings.

The founders realized there was a need (and a gap) in their industry after a few years of successfully operating this platform. They started developing their own SEO platform and marketing it as a subscription-based solution after securing an initial round of funding. Moz is now one of the most popular SEO resources on the market, with a market capitalization of around $45 million — something that would not have been possible if they had remained purely an online group.

#2. HubSpot

The inbound marketing behemoth HubSpot started as a software solution for small companies with 1-10 employees looking for a more efficient way to handle their content and customers.

Hubspot diversified its software to appeal to enterprise-level needs as their popularity and demand increased. This resulted in a sales increase from $255,000 ARR in 2007 to $15.6 million in 2010. In 2014, the company further went public with an initial public offering (IPO), raising an unprecedented $125 million and establishing a market cap of about $880 million.

#3. Mailchimp

Email software provider Mailchimp revealed in early 2019 that it was diversifying its offering and entering the lucrative CRM market. Although this was great news for existing customers because they now had access to a product with more features (without having to go shopping for them elsewhere), the steep price rises of 15-20% sparked an online backlash, dampening consumer excitement for the latest all-in-one marketing platform. Many loyal customers left as a result of this. In conclusion, diversification can be a goldmine in terms of scope and revenue, but it is not without danger. Companies should prioritize other growth initiatives first, and diversification should be considered only when their existing product or sector no longer provides room for expansion. A well-thought-out diversification strategy will help the company develop and evolve with careful preparation, consideration of consumer needs, and a keen sense of current market trends.

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