Diversification (strategy)

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Diversification is a form of growth marketing strategy for a company. It seeks to increase profitability through greater sales volume obtained from new products and new markets. Diversification can occur either at the business unit or at the corporate level. At the business unit level, it is most likely to expand into a new segment of an industry in which the business is already in. At the corporate level, it is generally entering a promising business outside of the scope of the existing business unit.

Diversification is part of the four main marketing strategies defined by the Product/Market Ansoff matrix:

Ansoff pointed out that a diversification strategy stands apart from the other three strategies. The first three strategies are usually pursued with the same technical, financial, and merchandising resources used for the original product line, whereas diversification usually requires a company to acquire new skills, new techniques and new facilities. Therefore, diversification is meant to be the riskiest of the four strategies to pursue for a firm.

Note: The notion of diversification depends on the subjective interpretation of “new” market and “new” product, which should reflect the perceptions of customers rather than managers. Indeed, products tend to create or stimulate new markets; new markets promote product innovation.

1 The different types of diversification strategies
2 Rationale of diversification
3 Risks
4 See also
5 References

[edit] The different types of diversification strategies

The strategies of diversification can include internal development of new products or markets, acquisition of a firm, alliance with a complementary company, licensing of new technologies, and distributing or importing a products line manufactured by another firm. Generally, the final strategy involves a combination of these options. This combination is determined in function of available opportunities and consistency with the objectives and the resources of the company.

There are three types of diversification: concentric, horizontal and conglomerate:

[edit] Concentric diversification

The company adds new products or services which have technological or commercial synergies with current products and which will appeal to new customer groups. The objective is therefore to benefit from synergy effects due to the complementarities of activities, and thus to expand the firm’s market by attracting new groups of buyers. Concentric diversification does not lead the company into a completely new world as it operates in familiar territory in one of the two major fields (technology or marketing). Therefore that kind of diversification makes the task easier, although not necessarily successful.

[edit] Horizontal diversification

The company adds new products or services that are technologically or commercially unrelated to current products, but which may appeal to current customers. In a competitive environment, this form of diversification is desirable if the present customers are loyal to the current products and if the new products have a good quality and are well promoted and priced. Moreover, the new products are marketed to the same economic environment as the existing products, which may lead to rigidity and instability. In other words, this strategy tends to increase the firm’s dependence on certain market segments.

[edit] Conglomerate diversification (or lateral diversification)

The company markets new products or services that have no technological or commercial synergies with current products, but which may appeal to new groups of customers. The conglomerate diversification has very little relationship with the firm’s current business. Therefore, the main reasons of adopting such a strategy are first to improve the profitability and the flexibility of the company, and second to get a better reception in capital markets as the company gets bigger. Even if this strategy is very risky, it could also, if successful, provide increased growth and profitability.

[edit] Rationale of diversification

According to Calori and Harvatopoulos (1988), there are two dimensions of rationale for diversification. The first one relates to the nature of the strategic objective: diversification may be defensive or offensive.

Defensive reasons may be spreading the risk of market contraction, or being forced to diversify when current product or current market orientation seems to provide no further opportunities for growth. Offensive reasons may be conquering new positions, taking opportunities that promise greater profitability than expansion opportunities, or using retained cash that exceeds total expansion needs.

The second dimension involves the expected outcomes of diversification: management may expect great economic value (growth, profitability) or first and foremost great coherence and complementarities with their current activities (exploitation of know-how, more efficient use of available resources and capacities). In addition, companies may also explore diversification just to get a valuable comparison between this strategy and expansion.

[edit] Risks

Diversification is the riskiest of the four strategies presented in the Ansoff matrix and requires the most careful investigation. Going into an unknown market with an unfamiliar product offering means a lack of experience in the new skills and techniques required. Therefore, the company puts itself in a great uncertainty. Moreover, diversification might necessitate significant expanding of human and financial resources, which may detracts focus, commitment and sustained investments in the core industries. Therefore a firm should choose this option only when the current product or current market orientation does not offer further opportunities for growth. In order to measure the chances of success, different tests can be done:

The attractiveness test: the industry that has been chosen has to be either attractive or capable of being made attractive.
The cost-of-entry test: the cost of entry must not capitalize all future profits.
The better-off test: the new unit must either gain competitive advantage from its link with the corporation or vice versa.

Because of the high risks explained above, many attempts of companies to diversify led to failure. However, there are a few good examples of successful diversification:

Virgin moved from music producing to travels and mobile phones
Walt Disney moved from producing animated movies to theme parks and vacation properties
Canon diversified from a camera-making company into producing whole new range of office equipment.