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 their 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 happens when a firm adds related products or markets to its offering. This is done to achieve a strategic fit that creates synergy for the business; an example of such a strategy would be a computer company adding the manufacturing of laptops to their repertoire.
This strategy occurs when a firm enters a new business (which can be related or unrelated) at the same stage of production as its current operations. Take, 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.
This strategy takes place 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.
When a business diversifies into an area that is totally unrelated to its current line of business, this is conglomerate diversification. It’s considered the riskiest strategy as 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.
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.
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.
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:
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.
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