When a company reaches a certain point in its evolution, founders, investors, and executives often think about planning and implementing a growth strategy, such as diversification.
Diversification strategy is one of the four main strategies for growth identified by Igor Ansoff in 1957, which enables companies to look at other markets they could tap into, or new products they could launch to increase their reach and revenue.
Who was Igor Ansoff?
Igor Ansoff was an applied mathematician and extremely successful business manager who is known as the father of strategic management for his significant role in originating and recognizing strategic management as its own discipline back in the 1950’s. Ansoff proposed that there were only four basic growth alternatives available to a business. He claimed that as a corporate strategy, a business can grow through increased market penetration, market development, product development, or diversification.
The Ansoff Matrix
These four growth strategies were identified by Ansoff using a 2×2 matrix (now known as the Ansoff Matrix) and was made up of new or existing products on one axis and new and existing markets on the other. The Ansoff matrix is a widely used strategic planning tool that provides a simple, yet effective framework to help companies plan and implement an effective growth strategy.
The Ansoff Matrix
Diversification strategy definition
As the image above clearly shows, diversification strategy is defined by adding new products in new markets. But, what is diversification strategy really and what specifically makes it an ideal business growth strategy?
We take a look at the different examples of this particular strategy, identify when and why it may be an ideal growth strategy to implement, and show the potential impact it can have on a business.
What is diversification strategy?
Diversification strategy, as we already know, is a business growth strategy identified by a company developing new products in new markets. That definition tells us what diversification strategy is, but it doesn’t provide any valuable insight into why it’s an ideal business growth strategy for some companies or how it’s implemented.
Why do companies diversify?
First and foremost, companies diversify to achieve greater profitability. Diversification is used by businesses to help them expand into markets and industries that they haven’t currently explored. This is achieved by adding new products, services, or features that will appeal to the customers in these new markets.
By expanding their reach and appeal, businesses are able to explore new avenues for sales, and in turn, have the potential to vastly increase their profits.
In addition to achieving higher profitability, companies choose to diversify for a variety of other reasons. For instance, diversification can also allow a company to minimize the risk of an industry downturn, it can boost brand image, and it can also be used as a defense mechanism to protect a company from strong competition.
On the other hand, diversification strategy is not without its downsides. Out of the four growth strategies proposed by Ansoff, diversification is not only the riskiest but also the most complex.
The risks of diversification strategy
Unlike market penetration strategy, diversification strategy is considered high risk not only because of the inherent risks associated with developing new products, but also because of the business’s lack of experience working within the new market. When a company chooses to diversify, they knowingly put themselves in a position of great uncertainty.
Additionally, diversification often requires significant expansion of human and financial resources, which can sometimes have a detrimental effect on the allocation of resources in the core industries.
For these reasons, it is recommended that a company should only pursue a diversification strategy when the current product or current market no longer offers opportunities for further growth. It’s critical for companies to thoroughly evaluate the risks and assess the likelihood of achieving a profitable outcome before deciding to pursue diversification.
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Different types of diversification strategy
In the world of business, there’s no “one strategy fits all” solution for growth. Diversification can present itself in a variety of different forms depending on the direction a business wishes to move in, and can either be related or unrelated to the current business offering.
If your company decides to add products or services that are unrelated to what you offer currently, but may meet some more needs of your existing customers, this is known as horizontal diversification.
Horizontal diversification is typically the diversification strategy with the least amount of risk involved, as you’re working mostly within familiar customer and market segments. Say you’re the CEO of the Dunder Mifflin Paper Company — it might make complete sense to move into the production of printers. This is a different product altogether, but it has the potential to attract many of your existing customers. (And with excellent quality control, hopefully those printers won’t catch on fire.)
Concentric diversification occurs when a company enters a new market with a new product that is technologically similar to their current products and therefore are able to gain some advantage by leveraging things like industry experience, technical know-how, and sometimes even manufacturing processes already in place. Concentric diversification can be beneficial if sales are declining for one product, as loss in revenue can be offset by a rise in sales from other products.
An example of concentric diversification would be a computer manufacturer who diversified from clunky desktop PCs into laptop production. This would allow them to immediately take advantage of the new wave of computer users who demanded more portable solutions.
If you’re looking to diversify into completely new markets with unrelated products to reach brand new customer bases, this is known as conglomerate diversification. The term conglomerate refers to a single corporate group operating multiple business entities within entirely different industries. The parent company that owns all of the individual entities is known as a conglomerate, and it became one by successfully implementing a conglomerate diversification strategy.
An example of conglomerate diversification would be Tata Group, which was founded in 1868 and diversified from its humble beginnings as a hotel company into a global multinational encompassing 100 individual companies. It now employs 706,000 people across a variety of sectors such as chemicals, steel, automotive, engineering, telecommunications, information systems, and consumables.
Vertical diversification is also known as vertical integration, and occurs when a company moves up or down the supply chain by combining two or more stages of production normally operated by separate companies. This typically means the company decides to start taking over some or all of the functions related to the production and distribution of their core product, such as the purchase of raw material, manufacturing processes, assembly, distribution and sale.
For example, If you’re a retailer, vertical diversification might mean moving into manufacturing the products you currently sell. While this can help lower costs by covering all the needs of your business “in house”, the downside is that it can reduce the flexibility of your business and reduce the opportunity for horizontal diversification in the future.
There are two forms of vertical diversification, which are identified by the direction you move in the supply chain.
1. Forward diversification
If you’re at the beginning of a supply chain in terms of your business positioning, you might decide you want to control operations further along the chain as well. An example of this could be a mining company that decides it wants to expand into processing and development of its raw product.
2. Backward diversification
If you’re closer to the end of a supply chain, you can think about how to diversify into the markets that funnel into your product. For example, Netflix began as a media distribution platform, but now manufactures its own content.
Diversification strategy examples
Moz.com: this popular SEO tool started out as SEOmoz — a blog and online community where experts and marketers could share their theories, research, and results.
After a few years of running this site successfully, the founders realized there was a demand (and a gap) in their industry. Once an initial round of funding was secured, they began to develop their own SEO software and market it as a subscription-based solution. Today, Moz is one of the leading SEO tools on the market, valued at around $45 million dollars — something that wouldn’t have been possible if they’d remained solely as an online community.
HubSpot: inbound marketing giant HubSpot began as a software solution targeting small businesses with 1-10 employees who needed a more streamlined way to manage their content and customers.
As their popularity and demand grew, Hubspot diversified its software to cater for enterprise-level needs. This saw it rise from $255,000 ARR in 2007 to a whopping $15.6 million in revenue by 2010. The company went public with its IPO in 2014, raising an impressive $125 million and cementing the company’s market value at around $880 million.
Mailchimp: In early 2019, email software provider Mailchimp announced that they were diversifying their product and expanding into the lucrative CRM market. While this was big news for current users in that they now had access to a product with increased functionality (without having to go product shopping elsewhere), the hefty price increases of 15-20% caused an online uproar that dampened user enthusiasm around the new all-in-one marketing platform. This caused many existing customers to exit.
In summary, a diversification strategy can be a goldmine in terms of reach and revenue, but it comes with an element of risk. Companies should look to pursue other growth strategies first, and only consider diversification once their current product or current market no longer offers opportunities for further growth. With careful planning, analysis of customer needs, and a keen sense of current marketplace trends, a well thought out diversification strategy can be just what you need to help your business grow and evolve.
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