The direction in which a company moves must ensure it has a competitive advantage. In case this is not the case, changing direction by adopting a diversification strategy can be the winning solution. In this guide, you will discover what diversification means and how and when you can (or should) diversify your business strategy to seize new opportunities and ensure sustainable growth.
Diversification: what it is and why it is critical
Before we talk about the diversification strategies you may decide to adopt for your business, it is important to clarify what this concept means right away, starting with its definition as applied to entrepreneurship.
Definition of diversification
Diversification is a technique for constructing and managing an investment portfolio that, in practical terms, involves creating a wide and varied range of sources of risk and potential return, with the aim of reducing overall risk. In this scenario, in fact, any losses incurred in one area can be offset by positive results in another.
A company implements a diversification strategy when, instead of further strengthening its position in the area in which it already operates, it decides to focus on new production and expand into new markets.
Diversification strategies: advantages and disadvantages
To understand when it is appropriate (or, even, necessary) to adopt a diversification strategy, it is useful to analyze the advantages and disadvantages that taking such a choice brings.
First, however, we ask you to reflect on a phrase uttered by entrepreneur Richard Branson, founder of the Virgin Group (we will return to it later in this guide):
“Diversification is a protection against ignorance. It is very reasonable for a world we cannot predict.”
Changes in economic conditions, today more than yesterday, can be unexpected and drastic. Catching the early signs of these changes allows you to act early (before it is too late!) and overcome the challenges associated with an environment that is constantly changing. One of the responses you can put in place is precisely diversification, the main benefit of which, as mentioned, is to reduce the risk associated with a single market or sector.
Diversification proves especially useful when the possibilities for business expansion in the sector in which your company already operates are complicated. The reasons for this can be varied and range from shrinking consumption to the introduction of new regulations and the entry of new competitors.
Diversification also allows you to leverage available but not fully utilized internal resources, taking advantage of new development opportunities. Not only that, it can give you the chance to maximize some fixed costs and improve economies of scale.
Through diversification you can improve your image and increase your business volume by expanding your business into a new industry and leveraging brand recognition.
A diversification strategy, or, rather, excessive diversification can, however, also have disadvantages. Specifically, it can lead to a scattering of resources, economic and otherwise, that could be used more effectively to improve the company’s competitiveness in its core business. Excessive diversification, moreover, may cause you to lose sight of corporate identity.
Diversification strategies: overview
Up to this point we have talked in general terms about diversification, but you should know that there are different types.
The Ansoff matrix, also known as the product-market matrix, shows that diversification consists of implementing a corporate growth strategy that consists of creating new products and targeting new markets. This strategy is characterized by a medium to high level of risk, but is also distinguished by the ambitiousness of the expected results.
Igor Ansoff himself then identifies different types of diversification. In the next few lines you will find out, specifically, what correlated diversification and conglomerate diversification are.
Related Diversification
Related diversification is implemented when an enterprise diversifies its business into areas related or related to its core business. The correlation strategy may be developed in terms of technology, production, sales or marketing, or in all of these areas.
Conglomerate Diversification
Conglomerate diversification, on the other hand, can be considered the most radical and complex diversification to implement: it consists, in fact, in extending the business by devoting itself to totally new productions (i.e., without any kind of affinity with the knowledge already possessed by the company) aimed at a completely different clientele from the one to which the company has been devoted up to that point.
Diversification strategies: practical examples
In the previous lines, we merely defined what correlated diversification and conglomerate diversification are. The time has now come to shed more light on these two strategies through some practical examples of these particular types of diversification.
Example of related diversification
As mentioned, related diversification is to diversify into areas that, in some way, are related to the company’s core business.
The classic example of this is represented by Apple. Let us briefly review its history: in 1984 Apple launched the Macintosh personal computer, achieving success. By the mid-1990s, however, a period of decline had begun for the company, abetted by the explosion on the market of cheaper and less complex Microsoft-branded computers.
The turning point for Apple came, thus, in 2001, when it launched the iPod. In 2003 it was time for the iTunes software, and then, in 2007, the first iPhone came on the market. The smartphones produced by Apple were able to dominate the market, in part because the company was able to rely on resources, design principles, and skills that it already had in its baggage from producing computers.
After the success of the iPod and iPhone, Apple then continued and expanded its diversification strategy, producing tablets, smartwatches, and other innovative products, always related to its initial business.
Example of conglomerate diversification
Conglomerate diversification, on the other hand, consists of the creation of new products (or services) aimed at a totally different market from the one in which the company usually operates.
To cite a practical example, we need to return once again to Richard Branson’s Virgin Group. This world-renowned brand began at the turn of the 1970s as the name of a record store, later also sold by mail order.
In 1972, however, Virgin Records, a small record label that later became world famous, was born. Among the artists put under contract were names of absolute prominence in the international music scene, from the Sex Pistols to Simple Minds, from Phil Collins to the Rolling Stones.
It was in the 1990s, however, that the Virgin Group entered the airline business, with the establishment of Virgin Atlantic Airways (which was later followed by several other airlines). From airplanes to Space the step is “short”: in 2004 Richard Branson founded Virgin Galactic, a company founded with the aim of offering suborbital space flights for the commercial market.
But that’s not all: today the Virgin Group is a diversified group that operates not only in the music industry or in the air (or space) transportation sector, but also in many others, among the most disparate, starting from the physical wellness sector (with the Virgin Active chain of gyms, also present in Italy) to the communications sector (with Virgin Media and Virgin Fibra), passing through the entertainment sector (with Virgin Books and Virgin Film).
How to choose the right diversification strategy
We have almost reached the end of this guide explaining when and how you can turn your company around, but there is one last point to clarify: how do you choose the right diversification strategy for your company?
To answer this question, it is necessary to remember that diversification is among the business management techniques useful in responding effectively to market changes.
In this sense, adaptation and flexibility are prerequisites if you are to avoid failure. Timing, however, is equally crucial: don’t forget that you may be forced to choose your new direction in a very short period of time, and it is important that you can arrive prepared for this appointment.
You need to know, then, that opting for a related diversification strategy makes sense when the strategic correspondences between current and future business take on competitive significance and, in more practical terms, lay concrete foundations for achieving sales performance that exceeds what you have achieved up to that point.
You can choose, instead, a conglomerate diversification strategy when and if you intercept the opportunity to enter new markets that represent interesting business opportunities for the company’s future, in terms of development, growth or even “just” brand visibility. It is, in this case, a decision to be made only after careful consideration. Conglomerate diversification, in fact, as already pointed out, is the riskiest strategy of all, since neither the new product to be launched nor the new market you are about to enter have any affinity with what you have done up to that point. Fear not: in fact, you now have all the tools and resources to tackle this big step as well.
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