The Way Forward: Strategic Diversification

There may come a time in the life of any successful business where growth in output or sales slows or stalls. There are a few options to regenerate growth; however, without a significant and deliberate strategy, the business could remain open to the ravages of increased competition, outdated processes or less interested consumers. Perhaps your market has become saturated or there is a need to spread risk to avoid an unexpected downturn in your core business sector. One way to regenerate growth is to follow a strategic diversification strategy.

There are four widely accepted diversification strategies: horizontal, vertical, concentric and conglomerate. While each is different in execution, they have many commonalities, the most important of which is the need to have a complete understanding of your business and markets so you can determine which strategy is best suited to your business.

There can be no guesswork, business growth must be based on reliable assessment, definitive market research and in-depth analysis. Without this data-driven, evidence-based approach, businesses increase risk. Building new sales and revenue may require diverting essential funds away from your core business; however, rapid diversification to increase untapped markets may suffer due to lack of expertise or entry of an unproven brand may simply never make a noticeable impact.

Let’s take a look at each of the four strategies.

Horizontal diversification is when you create or obtain new products that do not deviate from your core business but do attract new consumers. A successful example of this is Facebook’s acquisition of Instagram. Both Facebook and Instagram targeted social media users, but each targeted a different demographic. By acquiring Instagram, Facebook was able to continue serving its existing users while extending its services to a new demographic.

Conversely, eBay’s takeover of the VoIP company Skype was not successful. eBay thought that better personal communication between buyer and seller would increase efficiency and sales. The reality was that consumers were perfectly happy with the established platform. This mistake cost eBay 65% of its shares and $700 million over four years.

Vertical diversification (known also as vertical integration) involves a company becoming more involved in the business supply chain in its core industry. The benefits include reduced production costs, increased upstream and downstream profit and access to new distribution channels. For example, an automobile company may acquire a tire manufacturer to decrease its costs and provide a new product line. In what is often considered an extremely bold move, furniture supplier IKEA purchased forests in Romania, which ensured a cost-effective source of raw materials.

Concentric diversification may seem like a logical, straightforward way to grow; however, as was stated earlier, growth decisions must be based on reliable data and evidence. In concentric diversification, new products that align with your current core business are introduced to create new markets or attract new customers. An example of this is Coca-Cola adding Chi Ltd., a Nigerian-based juice company, to its portfolio with an initial 40% equity investment and eventually completing the acquisition in 2019 by purchasing the remaining 60%.  Coca-Cola used a concentric strategy to expand its footprint in Africa as well as add to its product portfolio.

Finally, let’s look at conglomerate diversification, which is the most-risky of the four. Conglomerate diversification is where a company generates new products or services that are entirely different or unrelated to their current business. Retail giant Walmart is a good example of this with subsidiaries as diverse as building suppliers in Swaziland to gas stations in the UK.

Richard Branson, highly regarded as one of the world’s most successful entrepreneurs, is another example as Virgin has grown from owning a record label to airlines; however, size does not ensure success. Even big companies make mistakes. His ambitious plan to compete with Coca-Cola and Pepsi by creating Virgin Cola failed. The presence of the two giant competitors meant his access to distribution was limited and his ad spend to compete was far too costly. Before exiting the industry, Virgin Cola had gained only a 3% share of its UK target market.

In conclusion, the goal of every business is to succeed and grow. A few rely on emotion and instinct and have found success. Most, however fail. Prudent companies want to minimize risk while increasing the potential for success. The most effective way to do that is to do your homework: research markets, collect reliable data, gather evidence and use that data to make informed decisions. Risk is rarely non-existent. There are factors outside your control such as pandemics, natural disasters, etc. However, through dutiful study, purposeful planning and adhering to your values, the likelihood of success can be increased.