Diversification as a Business Strategy

What businesses can achieve by diversifying. Written by Lori

Strategies intrigue me, and I have found that although I know about generals, I have been exposed to only parts of the big picture, especially with specific terms such as diversification.
This article (first part of the piece) will not be heavy on strategy talks, but to introduce some fundamentals that offer me as well as readers the tool to look into driving reasons behind diversification decisions.

Part 1 of the series

- Brainstorming what diversification is about, Mind Map introduced
- Potential motivations that are driving diversification decisions
- Goals that businesses may have

What are the first thoughts when you see the word “diversification”? To me, key words that come to mind include,

expansion, new products, different industry, revenue source, …

Mind Map by Lori

You can’t develop a strategy for your business without first thinking through mission and goals

Michael D. Watkins

At the discussion of business diversification, I find people can confuse motivation with goals. Though two appear closely connected, motivation needs to be established before goals; in my perspective, it bears similarity to a company’s mission in terms of meaning and hierarchy. A quick look into Disney’s mission statement “entertain, inform and inspire people around the globe through the power of unparalleled storytelling” shows a clear motivation.

Moreover, I like to think of motivation as an origin.

Any of their diversification ambitions, or any goals that Disney set out to do as a mature company, still should be nicely linked back to its origin.

Photo credit: Unsplash

Let’s reflect on Disney’s case later, and start peeling back the layers to why business diversifies.

1. Start with WHY.
   What motivates a business to expand on their core business?

• Stagnant or mature growth: so the businesses may be looking to expand product lines through e.g. horizontal diversification. In the process of capturing market share, the companies may intend to spread the risk across (international) markets.
• Sustainability: referring to ensuring that the business will be competitive long-term, whether through e.g. horizontal, vertical diversification….

Case of vertical diversification
With past experience in supply chain, I want to explore this diversification concept since it is not that unfamiliar in the field . Vertical diversification talks about integration with its backward (input) or forward (output) supply chain. As an example, if a coffee selling business decides to launch an in-house roasting services, it tries to diversify by branching out backwards, to increase control over their input. The diversification has potentials to cut costs, reinvesting with new revenues, and gaining stability

What stands out to me though is it stands as gateway to new distribution opportunities. Think of it this way, the diversified coffee business can acquire new revenue sources through selling the roasted output to where the demand lies, indicating new channel, and immediate information from the network. It can exchange new values with partners within the ecosystem centered by its in-house capability.
Though there may be the increased risk of diluted resources
(I will dive deeper into diversification risks in 2nd & 3rd posts. Scheduled to be published in 2 weeks).

• Pressure from the top: for example when the management receives pressure to explore new opportunities, as suggested by HBR’s “To diversify or not to diversify” article. This type of motivation may not have originated out of a contemplative strategy, least not initially.
  The decision is rather incidental, say when an emerging company comes to the scene, not necessarily a related industry. It appear more because a business “can” do so, and will increase compensations.

2. Following the “WHY”, what are company’s goals with diversification.
Below may include some ideas of my own.

• Increase sales.
• Capture market share and market power: The risk tends to be higher if companies set out to capture new customer bases by introducing new product lines from unrelated industries.
• Satisfy unfulfilled market needs: commonly, companies may set initial goals to increase profits, but may discover unmet demands by customers which can be fulfill with their core competences. Many successful startups seem to operate on this mechanism.
• Preservation of resources: This may not have been on the radar in the strategy discussions, but is a popular topic in the supply chain field. Echoing the motivation about creating sustainable business, this form of diversification can be leveraged to ensure
  - reduced shock in the face of market volatility or even global warming.
  - added advantage may be reduced production costs.

For example, vertical diversification for a beverage company may be acquiring their suppliers (e.g. bottlers, raw materials providers) to integrate their own chain. It helps to present better margin as well as lowered product price. Combined with horizontal or concentric diversifications, it may also help increase overall bargaining power due to aggregate demand.

When I think about it, the larger the corporation, the better investment. since they can leverage upon increased magnitude of aggregate demand due to the complex internal company groups, bringing economy of scale.
I wonder, if at the end of day, diversification is a game best suited for the major industry players.

But strategic decisions is never that simple. As someone who cares about consumers at large, I think another great question to help reach the goal is,

What are the NEEDS or gaps in the market that we can fulfill? What value can we add to the customer segment. Further, what more can we achieve with the new found positioning, within the given strategic scope.

Next Up-
Part 2 of Business Diversification will take you through what we can do with diversification strategies, with real world example of how it is achieved.

References
Demystifying-strategy-by Michael D. Watkins
types of diversification
acrefore-9780190224851-e-14