Diversification strategy

Diversification is a corporate strategy to enter into a new products or product lines, new services or new markets, involving substantially different skills, technology and knowledge. Diversification is one of the four main growth strategies defined by Igor Ansoff in the Ansoff Matrix:[1]

Ansoff pointed out that a diversification strategy stands apart from the other three strategies. Whereas, the first three strategies are usually pursued with the same technical, financial, and merchandising resources used for the original product line, the diversification usually requires a company to acquire new skills and knowledge in product development as well as new insights into market behavior simultaneously. This not only requires the acquisition of new skills and knowledge, but also requires the company to acquire new resources including new technologies and new facilities, which exposes the organisation to higher levels of risk.[2]

A typology 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.

Concentric diversification

This means that there is a technological similarity between the industries, which means that the firm is able to leverage its technical know-how to gain some advantage. For example, a company that manufactures industrial adhesives might decide to diversify into adhesives to be sold via retailers. The technology would be the same but the marketing effort would need to change.

It also seems to increase its market share to launch a new product that helps the particular company to earn profit. For instance, the addition of tomato ketchup and sauce to the existing “Maggi” brand processed items of Food Specialities Ltd. is an example of technological-related concentric diversification.

The company could seek new products that have technological or marketing synergies with existing product lines appealing to a new group of customers. This also helps the company to tap that part of the market which remains untapped, and which presents an opportunity to earn profits.

Horizontal diversification

The company adds new products or services that are often technologically or commercially unrelated to current products but that may appeal to current customers. This strategy tends to increase the firm’s dependence on certain market segments. For example, a company that was making notebooks earlier may also enter the pen market with its new product.

When is horizontal diversification desirable? Horizontal 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 or instability.

Horizontal integration occurs when a firm enters a new business (either related or unrelated) at the same stage of production as its current operations. For example, Avon’s move to market jewellery through its door-to-door sales force involved marketing new products through existing channels of distribution. An alternative form of that Avon has also undertaken is selling its products by mail order (e.g., clothing, plastic products) and through retail stores (e.g.,Tiffany’s). In both cases, Avon is still at the retail stage of the production process.

Conglomerate diversification (or lateral diversification)

Goal 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 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.

Risks

Of the four strategies presented in the Ansoff matrix, Diversification has the highest level of risk 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 detract 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:[5]

  • 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 companies attempting to diversify have led to failure. However, there are a few good examples of successful diversification:

  • Apple moved from PCs to mobile devices
  • Virgin Group moved from music production to travel 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 an entirely new range of office equipment.

References

  1. ^ Ansoff, I.: Strategies for Diversification, Harvard Business Review, Vol. 35 Issue 5,Sep-Oct 1957, pp. 113-124
  2. ^ Ansoff, H.I., Corporate Strategy, Penguin, 1968
  3. ^ Aichner, T. & Coletti, P. (2013). “Customers’ online shopping preferences in mass customization”Journal of Direct, Data and Digital Marketing Practice15 (1): 20–35. doi:10.1057/dddmp.2013.34.
  4. ^ Calori and Harvatopoulos (1988). Diversification: Les Regles de conduite. Harvar-L’expansion. Spring. p. 8–59.
  5. ^ Porter, Michael (1987). “From Competitive Advantage to Corporate Strategy”. Harvard Business Review. May–June (3): 43–59.

3 thoughts on “Diversification strategy

  1. zortilonrel says:

    This is a very good tips especially to those new to blogosphere, brief and accurate information… Thanks for sharing this one. A must read article.

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