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Manager’s essential power-toolbox Is diversification the right strategy for your business?

13 Jan 2014 - {{hitsCtrl.values.hits}}

Companies diversify for a host of reasons. In some cases, it’s a survival strategy. For instance, if your company makes the bulk of its sales at a particular time of year, it makes sense to consider diversification. By extending your portfolio of products or services you can ensure a regular revenue stream from January through to December. In other words, the canny ice cream seller who parks his van in front of the schools during mid-afternoon can become the provider of ‘Kola Kenda’ to office-goers in the mornings.

However, there are a number of other good reasons for diversification:

Poor cash flow – Some organisations are unprofitable even though their competitors may be doing well. Such organisations may seek to move into other industries in the hope of getting better cash flow.
Industry dominance – Once an organisation dominates the industry in which it operates, it must look elsewhere for growth opportunities. This is specially so for those businesses in mature or low-growth markets.
Economies of scale – Some organisations can apply a specific set of competences to a variety of unrelated businesses.
Strong cash flow – Organisations that have strong cash flow may want to invest in other businesses rather than risk further expansion in their own industry.
Opportunism – Various organisations thrive on acquiring businesses that are in some way undervalued. An opportunity to make quick money is perceived by expansion.

A note of caution! History tells us it’s not advisable to consider diversification until your core business is stable and profitable. If you’re still struggling to win orders and build a sales time for the core product, there is a real danger that diversification will take your eye off the ball. The catalyst is often the realization that growth in the core business is either slowing or set to slow, often because the market for a particular product is becoming saturated.

Strategies
You can diversify your business by natural progression. For instance, if you sell men’s shirts, adding ties and cufflinks to the range is an obvious next step. On a bigger stage, the Coca-Cola Company is best known for Coke, but popular as that drink is, it certainly isn’t to everyone’s taste. To maximize market share the company offers a broad range of soft drinks, from orange through to diet versions of Coke itself.

A variation of this theme is the addition of complementary services. For instance, manufacturers can boost revenues by not only acting as suppliers but also providing follow-up services such as maintenance.

Diversification can also take the form of brand extension across an apparently unconnected range of products or companies. For instance, Unilever has a portfolio of over 400 brands consisting of food and beverages, ice cream and home and personal care. This kind of diversification has worked because of the strength of the Unilever brands.

You can also trade under different names. Then you can ring-fence one business from another in terms of public perception and reputation. Perhaps more importantly, by establishing each company as a separate entity you also ring-fence the finances. In that respect, if one business fails it can be wound up in an orderly fashion without necessarily affecting other businesses within the group.

Another popular business diversification strategy is to look backwards and forwards along the supply chain for opportunities to tighten your grip on the market. For instance, in the United Sates, Google has busily acquired the leading web data analysis tools, online advertising companies and the social networks and sites that deliver what they unerringly know their users want.

Related diversification
When expanding into different products or markets using existing capabilities, you can create related diversification by using its capabilities and resources in other settings. A car manufacturer might for instance expand its operations into manufacturing of motorcycles or trucks and use its capabilities and resources to become successful in these markets.

Likewise, a company might create related diversification by integrating into the existing value network. For instance, companies producing steel might go into the mining business, where it might control the supplies, etc. for its main operations. Likewise, clothe manufacturers might create their own brand shops, in which they sell their clothes.

Six guidelines for when related diversification may be an effective strategy are as follows:

When a company’s products are currently in the declining stage of the product’s lifecycle.
When new but related products could be offered at highly competitive prices.
When a company competes in a no-growth or a slow-growth industry.
When adding new but related products would significantly enhance the sales of current products.
When new but related products have seasonal sales levels that counterbalance an organisation’s existing peaks and valleys.
When a company has a strong management team.

Honda Motor Company provides a good example of leveraging a core competency through related diversification. Although Honda is best known for its cars and trucks, the company actually started out in the motorcycle business. Through competing in this business, Honda developed a unique ability to build small and reliable engines. When executives decided to diversify into the automobile industry, Honda was successful in part because it leveraged this ability within its new business. Honda also applied its engine-building skills in the all-terrain vehicle, lawn mower and boat motor industries.

Unrelated diversification
The unrelated diversification is based on the concept that any new business or company, which can be acquired under favourable financial conditions and has the potential for high revenues, is suitable for diversification. This is essentially a financial approach; it is implemented when your research division determines that this unrelated diversification in a completely new field would bring significantly higher revenues compared to the related diversification, on the basis of similar products, services, markets or strategies. For example, in the recent years, many companies entered the construction market despite their significantly different field of main business activity.

Sometimes the unrelated diversification is based on the available expertise and experience of the human resources that can be utilized in completely unrelated fields. For example, if the owner of a trade company is competent in the field of computer design, they can open an Internet store to sell goods and also expand activity by adding web page design services, etc.

Disadvantages
You should also look carefully at your existing business. Is it the right time politically and economically to diversify your business? Do you have the right managers to cope with a diverging strategy? Should you integrate the diversified business into one company or ring-fence the new operation as a business in its own right? And is your company strong enough to be an umbrella brand where your core values resonate across the group?

Diversifying into new products and service lines can provide an effective path to fast growth, as you sell more products to existing customers or establish new markets. If you expand your product range and even if the turnover increases, the increase in costs could result in a slump in profits. If you extend your brand into new markets and there is a danger that it will have no resonance with the newly targeted customers. Thus, it’s vital to weigh up the risks as well as the opportunities.

(Lionel Wijesiri, a corporate director with over 25 years’ senior managerial experience, can be contacted at [email protected])

Features

Manager’s essential power-toolbox Is diversification the right strategy for your business?

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