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What Is Diversification in Business? Why It’s Critical

What Is Diversification in Business? Why It’s Critical

Long-term success is just a piece of the American dream. Both business owners and non-business owners chase after it, whether it is through an investment portfolio after throwing in long, hard days in the workplace or through the business itself.

Can long-term success be guaranteed? No, but there are ways to keep the scale in balance through diversification. Investors push for investment portfolios to be diversified in order to mitigate the risk of loss. The same goes for businesses. 

Building diversification in a business only increases the chance of both long-term success and an increase in profits over time. It’s a concept that’s been around for quite some time, encouraging small to large businesses alike across the world to incorporate it into their strategic plan.

The History Behind Diversification in Business

Diversification in business dates back to 1957 when a mathematician and business manager by the name of H. Igor Ansoff published the Ansoff Matrix in the Harvard Business Review. It stands as one of the four strategies to help businesses stay ahead of risk as they start up their businesses.

What Is the Ansoff Matrix?

The Ansoff Matrix includes four basic growth strategies:

  1. Market Penetration - How to drive sales of an existing product or service in an existing market.

  2. Product Development - Marketing new products or services, introducing them into an existing market.

  3. Market Development - Introducing a business’ existing products or services into a new market.

  4. Diversification - Introducing a business into a new market, including new products or services to offer. 

For this article, we will focus on diversification. It’s a risky strategy, but it has proven itself to increase net profits.

What Does It Mean When A Company Diversifies?

When you diversify something, you are adding flavor or variety to it. The same applies when diversification is used in business.

As a business owner, you can focus on a niche market or offer various products and services that operate independently of each other. Both have pros and cons when you lay them out, but diversification can have the upper hand.

Adding diversification to business is a strategic move that balances the plate. 

For example, suppose you have multiple lines of businesses to manage, and one is struggling. In that case, the others are likely to pick up the slack so that you don’t feel the negative effects across the company that economic factors, amongst other things, can quickly cause.

What Is Unrelated Diversification?

When something is unrelated, it is completely different or opposite. Apply it to business diversification, and that’s what you receive, a business offering a product or service through one line of business and something else through another one.

Familiar with the company Amazon? Who isn’t? They started off selling books; that was their specialty. Then, they took an unrelated approach by widening the types of products and services offered. From booksellers to the grocery store, this is just one example of unrelated diversification.

Unrelated diversification doesn’t always occur within one company’s strategic plan. There are usually one or more companies involved, agreeing upon a merger or an acquisition.

What is Related Diversification?

The Company Apple leads the related diversification realm. How: Through its related products and services. Look at the commonalities in the products it offers from the MacBook to the iPhone and iPad. 

Related diversification is a positive way for businesses to share their current resources. There’s no need to recreate the wheel when using this type of diversification; instead, best practices can be applied and adapted. 

Look at related diversification as a better way, since the business is attuned to the process and familiar with lines of the business overall. 

It all depends on the level of risk you are willing to accept to grow and expand.

Methods of Diversification in Business

It would be easy as pie if diversification were a quick step-by-step strategy. But of course, businesses’ do not follow a one-size-fits-all approach, especially when it comes to growth and profitability.

Concentric Diversification

Also known as convergent diversification, concentric diversification is a way businesses reel in new customers by expanding their product line and offering new products or services. 

Why would a business want to introduce something new? That’s simple. If its main source of revenue is beginning to decline, introducing something new may offset the revenue loss.

Products offered under concentric diversification are related to that of the company's focus. For example, soft drink companies produce a product that is sold in stores to the general public. 

To increase sales and customer awareness, some have offered their product to be sold in bulk through restaurant chains, theme parks, etc.  

Horizontal Diversification

When a business decides to offer a product or service unrelated to what is currently sold but may still serve a purpose for their current customer base, horizontal diversification takes the stage. 

There is a risk with all types of diversification, but horizontal diversification assumes the least? Why? Because it strongly weighs on the backs of the business's customers and their level of loyalty. 

So many big named companies have shown horizontal diversification works. Disney, for example, started off with animation and cartoons. As the love of Mickey Mouse grew across the world, it morphed from the screen and into the hospitality industry, retail industry, cruise industry, and more. 

Conglomerate Diversification

A conglomerate is defined as different groups coming together as one, though they remain distinct and act independently of one another.

When conglomerate diversification occurs, a business is expanding, ready to have subsidiaries under its belt. This opens a whole new door, and experience for both the company and its customers. The company no longer needs to rely on just one line of business to survive. 

Take a look at General Electric (GE). Back in 1892, they specialized in lighting. Over time, they’ve expanded and transformed to include household appliances and medical devices unrelated to its core business strategy.

Vertical Diversification

You are either moving up or down (forward or back) when you move vertically. Netflix proves vertical diversification works. Their business plan started through a mail-order video rental, transforming to a personal kiosk they run and manage, and now through a streaming service bringing shows and movies to life at the touch of a button.

Moving backward means that a business decides to supply raw materials towards the production of a product in-house versus through a 3rd party vendor. This type of decision is made when there are potential cost-savings available. Sometimes, it’s cheaper to do it yourself than to outsource.

When moving forwards, a business feels rooted and is ready to distribute its product on its own. This is favorable when a business wants to take control over the sales of its products and services. One way to do so is to open its own branded retail store versus a larger supply chain outlet. 

Sometimes, businesses do not move forward or backward, though. Instead, they remain in a balanced state. 

This state is known as balanced integration. When does this occur? When the business is ready to wear multiple hats, acting as both the product's supplier and the customer. 

Does this happen often? No, it’s a rarity. This type of diversification requires a large investment of both time and money, but - it is possible.

Why Do Businesses Diversify?

Diversification occurs when:

  • A business is ready to bring in more revenue
  • A business wants to reduce the amount of risk it has in the market
  • The original drive of the business is beginning to decline
  • A business is ready to accept the adventure, exploring potential synergies

Diversification can inspire change and boost a business's bottom line. It doesn’t matter if it’s a start-up getting its feet wet for the first time or an established company looking to spread its roots elsewhere - diversification is a revenue-producing strategy well worth exploring and planning for. 

As a business owner, don’t you want to stay ahead of unexpected economic declines amongst other types of business shifts? Building business diversity gives you the added support, the shield you need against these negative events.

The Bottom Line - Differences Support Each Other

Diversification may not be for every business, but it’s a strategy to explore. Yes, it carries risk as it requires strong marketing to see it through to success, but success remains the long-term goal. 

Success through business diversification translates to a larger net profit and a balanced business plan.

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