Deciding whether or not to diversify poses a big question for businesses of any kind. Do you choose to stay in your lane and put all your effort into one project? Or do you attempt to reap the benefits of entering different markets by introducing new products and services? In our digital age, where customers and their opinions can change quickly and unexpectedly, it’s an important thing to consider.
If a business opts to diversify, then it must be aware of the need to focus on the new venture without neglecting their core business. Offering a broader range of products/services might run the risk of spreading their resources too thinly.
So, there’s a balance to be achieved in diversification. It’s an easy idea in theory, but can be another thing entirely in reality. Luckily, there are ways and means of minimising the risk of diversification that can help business owners decide whether or not to introduce a new product offering.
For businesses looking to sow seeds in new markets, we’ve written up a handy guide that touches on best practice, the risks to consider and some diversification matrixes you can use to make it happen.
At its simplest, product diversification is a strategy employed by a company to increase its profitability and achieve a higher sales volume from new products. It can occur at the business level or at the corporate level, which provides us with the below definitions:
There are four varieties of strategy that businesses can use in their approach to diversification. These are as follows:
Concentric diversification: When a firm adds related products or markets to its offering, creating synergy for the business; an example of such a strategy would be a computer company adding the manufacturing of laptops to their repertoire.
Horizontal diversification: When a firm enters a new business (which can be related or unrelated) at the same stage of production as its current operations. For instance, Avon selling its products through mail order before branching out into selling in retail stores. Despite the change, this is still at the retail stage of the production process.
Vertical diversification: When a company goes back to a previous or, alternatively, the next stage of its production cycle. For instance, a company involved in the reconstruction of houses starts selling construction materials and paints.
Conglomerate diversification: When a business diversifies into an area that is totally unrelated to its current line of business. Considered the riskiest strategy, entering a new market with a new customer base incurs higher research and development costs, along with an increase in advertising costs.
One of the most appealing benefits of diversification is the increase in sales and revenue a new market can provide. This is especially beneficial if a business is strong in a certain marketplace and is finding it difficult to improve profitability and acquire new customers. A new product or service can bring with it a new opportunity for growth.
If a small business is reliant on one or two large clients for their revenue, it leaves them in a vulnerable position should one of these clients leave. As diversification has the potential to tap into a larger customer base, even without significant growth, it can provide an opportunity to cushion the blow from losing a key customer.
Inherent to diversification is the idea that by diversifying your business’ investments, it spreads your risk in a way that if one of your investments loses value, the others won’t necessarily lose money at the same time. This provides a greater balance to your risks.
Put simply, if you invest all your money in one product and it fails, you could lose all your money. However, if you put only 20% of your money in that product, you’d still have 80%of it to work with.
Keep in mind the operational requirements needed to diversify. The need for short-term capital, as well as a multitasking workforce, might leave you spread too thin. Consider the effects it may have on your team, production, finances and marketing and whether or not it is worth the strain it might put on your other offerings.
Even if you are in a strong position to diversify, it might not be worth diluting your brand or confusing your customers by introducing a range of new products or offerings. If you no longer specialise in a certain product or service, it might bring doubt to your position as a leader in your particular field.
Be warned: there is such a thing as excessive diversification, which could create further risks if not handled properly. If you aren’t selective about the process, then the standards surrounding your business can become slack, as attention is spread.
Will you have the time to pay attention to each investment? Even subtle changes in how a business operates can have a major effect – if you don’t have the time to properly take care of your diversified business then it’s a sign you’ve taken things a step too far.
Likewise, if your portfolio is over-stocked, you run the risk of spreading your capital too thinly. At this point, even a great investment will only have a minute influence on the total value of the portfolio. As a result, some of your best ideas can become diluted.
Conduct as much research as possible. Read up on your potential competition, new means of distribution, and the skillset you’ll need in place to realise your product and bring it to market. And be mindful of the timing, too; if your market is performing poorly, then maybe now isn’t the time for a new product.
Say you’ve generated some interest and a potential client wants to work with you. You’re excited and you impulsively quote the lowest price just to get them on board. Here’s where market research is important; if you offer a potential client a price that is much lower than the market average, then you’ve already got yourself off to a bad start. Look at your new competitors and put yourself in a position where you can ask for a higher price when it’s time to do business.
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If you’re seeking capital to diversify, then be aware that the majority of lending terms are built to benefit investors. Before you open communication channels, make sure you know what you’re giving them compared to what they’re giving to you in return.
Here are a few alternative financing options you could consider before assigning cash to a diversification project.
If you’re thinking about beginning a process of diversification, then consider what you have to invest, both in terms of finance and the resources that are available to you. In doing so, you’ll have to look into the initial funds you need to begin diversifying, as well as the ongoing funds that are required to support expansion, hire new employees and provide them with a salary.
Knowing your limits means you’re aware of what needs to be done and how much you’re willing to put into the process of diversification.
Once you’ve identified how you want to diversify, do you have the systems and teams in place to implement the necessary processes? Are you able to deliver them with the expertise you’ve become known for, in a manner that’s in line with your previous approaches?
Conversely, your business doesn’t want to be in a position where you’re playing catch-up. Make sure remain abreast of all industry and competitor developments, and move ahead of the curve. This ‘early adopter’ approach means you’ll be prepared for market trends and shifts should they occur.
Your existing customers may question or be confused by your brand name appearing on new products or in unfamiliar markets. Ensuring that the new offerings still create value for the customer is an important area to focus on. If your service or product can provide your customers with something they can use regularly, it’ll help to strengthen these areas you’re diversifying into and improve their chances of viability.
Perhaps you can tweak your current service in order to sell to a new group of users. If your item is a ‘high-end’ product or service, could you provide a more affordable version?
Identifying the possibilities afforded to your business through diversification is an integral part of the decision-making process. Consider where your business is, and identify the horizontal and vertical movements that can be made.
When it comes to vertical diversification, ask yourself how much further you can do what you’re currently doing. In your particular area, what can you do to improve and provide even more value to your customers? Is there a way to streamline and strengthen your current product or service in order to move to the next stage and appeal to a new group of customers?
When thinking horizontally, weigh up what your competitors are doing that you may not be. When looking at the niche or area you’re working in, are there any related business opportunities or similar areas you can make a move into? Look at what fits with your business and consider how you can make these new areas work for your customers.
Sometimes called the Product/Market Expansion Grid, the Ansoff Matrix shows four strategies you can use to grow: Market Development, Market Penetration, Product Development and Diversification. The idea is that each time you move into a new quadrant, horizontally or vertically, the risk increases.
Diversification is in the matrix’s upper right quadrant and is the riskiest of the four options. Why? It’s because it involves a business developing a new product and targeting new, unfamiliar markets, and it requires a combination of strategies, meaning it’s riskier. In adopting a diversification strategy, a business must have a clear idea about what it expects to gain from the strategy, and must carry out an honest assessment of the risks. However, by achieving the right balance between risk and reward, this kind of strategy can be highly successful.
The Boston Matrix can be used to analyse a business’ portfolio of products to allocate investment across the portfolio. Based on market share and market growth, the Boston Matrix characterises products into one of four different areas:1. Stars: The high-growth products that compete in markets and are comparatively strong against the competition; they need heavy investment to sustain growth. When the growth slows – and they sustain market share – stars will become cash cows.
2. Cash cows: Low growth products with a high market share, these are mature and successful products with little need for investment. However, they need to be managed for continued profit, where they’ll continue to generate the strong cash flows that the company needs for Stars.3. Question Marks: Products with low market share operating in high-growth markets, these have potential but may need large amounts of investment to grow market share at the expense of competitors. As their name suggests, managers have to consider which ones they should invest in, and which should be allowed to fail.4. Dogs: Low market share, low-growth products that may just generate enough cash to break-even but are rarely worth investing in. Usually sold or closed as a result.
This model helps businesses reach the necessary decisions, while its use of market share is an adequate measure of a product’s ability to generate money. However, it is only a picture of a business’ current position and as such has little predictive value.Of course, like all diversification projects, risk and reward is a difficult balancing act to achieve – but can be central to true success.Gazprom Energy is a leading and award-winning business energy supplier, helping thousands of small businesses manage their gas and electricity contracts. To find out more about what we can offer your business, visit the homepage or call us today on 0161 837 3395.
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