The functioning of any, even the most successful business in an unchanged form cannot continue indefinitely. To maintain it, there is a very important technique. It allows you to give stability to the model and significantly reduces the risks of critical losses, the probability of which especially increases with changing circumstances. This technique is business diversification. It is with its help that all investment risks can be reduced to practically zero.
Definition of a concept
What is diversification? In simple words, this concept means nothing more than the distribution of available capital for various deposits. The essence of this process is to reduce investment risks. Indeed, if one investment portfolio brings a minus to the business, then the rest will block it with their pluses, which will ultimately lead to final profit. No wonder there is a saying that you should not put all your eggs in one basket. It allows you to most accurately understand the essence of the diversification process.
The word that designates this concept has Latin roots. It is formed of two parts. The first of these is the word diversus, meaning “different” in translation; and the second - facere - "do."
Business diversification is a change, introducing diversity, expanding the assortment, reorienting to other areas in the context of trade and investment in financial markets. This process is an investment in various assets based on the instability of world markets, showing us steep ups, followed by recessions. That is why investing in one investment portfolio is risky for any business.
In business practice, diversification involves the simultaneous development of various, unrelated technological processes or services. This process is a variety in the use of goods issued by the company, which allows it to function quite effectively, regardless of the demand for a particular product.
Diversification of the business enables firms to stay afloat in the face of difficult economic conditions by covering losses from unprofitable products with profitable types of goods or services. Moreover, this process can take various forms. In modern practice, there are four main types of diversification strategies. It is horizontal and vertical, concentric and conglomerative. Let's consider them in more detail.
Horizontal diversification
The basis of this type of process is the acquisition and development of new products. In this case, we are talking about such goods or services that could be sold to today's consumers or customers of the company. This strategy allows the company to rely on its existing level of sales, as well as on the already implemented production technology.
An example of this type of diversification is the addition of a new type of raw material to the existing assortment list of a dairy company. Risks are minimal. Indeed, horizontal diversification considers only an increase in the variety of goods. If one of the types of already manufactured products becomes unattractive for the buyer, the assortment list will still allow you to get a stable profit.
Vertical integration
The diversification process under this strategy involves the movement of the company either up or down along its production chain. In other words, the company must go to the stages that preceded its current production cycle, or carry out further development. This tactic allows you to reduce the dependence of the business on third parties and prevents the latter from earning superprofits, closing all the main processes within one company.
There are numerous types of vertical diversification. They relate to situations when a company stops selling goods using retailers and opens its own wholesale and retail stores.
Vertical business integration is also observed when acquiring a supplier of raw materials and resources necessary for the production of own goods, as well as when opening an auxiliary business, for example, when selling construction materials, accompanied by offers of services for the reconstruction of houses. Such a strategy will ensure the best prices for customers and facilitate the process of supplying materials to work.
Concentric diversification
This strategy has another name. Sometimes it is spoken of as related diversification. This process involves the expansion of the production portfolio, which is carried out at the expense of business lines or products. This allows you to most fully and efficiently use the resources and technologies at the company's disposal.
The basis for business diversification under such a strategy is to create complementary goods or services that can improve and facilitate the consumption of the main production product. Small companies often go this way. An example of a concentric diversification of a small business is the acquisition of toys by a manufacturer of children's goods. This move allows you to increase the distribution of your product and gain access to new markets.
Another example of concentric diversification is the expansion of the assortment of a small bakery by offering its customers semi-finished products, as well as dough for home-made baking.
This business diversification strategy allows you to access existing experience and turnkey solutions. In addition, it helps to reduce competition in the segment, as well as increase the efficiency of the use of available resources.
Conglomerative diversification
This strategy is also sometimes called differently. Many know it as unrelated diversification. This process is nothing more than the conduct of several completely independent business areas that do not improve each other's activities.
When adopting this strategy, the company gets access to a completely different circle of consumers. In fact, this can be called an investment of the company's current profit in highly profitable industries. Sometimes this type of diversification allows the company in the near future to gain access to the latest technologies, which, ultimately, will improve the quality of the current product.
When does a conglomerate diversification strategy find application? Companies resort to it in cases where they have the opportunity to effectively apply the existing experience and knowledge, as well as in the presence of technologies to obtain undeniable advantages in new market segments.
How is this diversification of business carried out? Examples of the application of such a strategy are currently available in large numbers. This applies to many shoe manufacturers, who, using their experience and knowledge in the preferences of customers, enter a new market for the company, starting to produce clothes and accessories.
The main advantages of unrelated diversification are the prospects for the development of a more profitable business in the future, as well as the reduced impact of seasonal downturns in the sale of primary goods. The disadvantage or risk of such a strategy is the need to allocate significant resources in order to develop a new direction. And this, with poor management work, can result in losses.
International diversification
This strategy can be either connected or unrelated. But, however, it stands out as a separate type of diversification, as it is of high importance for companies.
A similar process is one of the main strategic ways to increase profitability. It is resorted to in cases where diversification at the national level is already fully completed. When implementing such an international strategy, the company will require a high level of managerial competence and a properly structured leadership structure. This is due to the development of a very wide range of issues. They relate to the marketing strategy of the company both for each business and for a single country. At the same time, regional and national characteristics of states, as well as models of the consumed product should be taken into account. With the proper use of such a strategy, the company receives a significant effect on the scale of production, as well as on access to valuable and rare resources. At the same time, she maximally uses her own resources and reduces the risks from a decline in sales and stagnation.
Process need
When is business diversification needed? It often happens that a particular company concentrates its efforts on growth in only one area. This, of course, allows her to achieve a certain perfection. Indeed, the personnel and management of the company acquire significant skills and extensive experience. This state of affairs makes the company competitive, creating additional incentives for further improvement of production. However, for example, substitutes may appear on the market. And this makes the business invade other areas, often without any functional and production links with the previous products.
The key issue of diversification in this case will be the determination of those optimal boundaries and lists of activities that may occur in the strategic plans of the company. For this, the company must go through certain stages of diversification, which are worth considering in more detail.
The study and further assessment of the position of the company
This is the first stage of diversification, which involves clarifying the following:
- the degree of achievement of diversification, expressed through the ratio of the total sales of goods to the sales volume of a particular unit;
- types of diversification;
- the nature of business operations (domestic, multinational or global);
- focus on the actions necessary to create and develop new units or strengthen key existing positions;
- the steps necessary to expand the portfolio and capture new industries, which involve getting rid of unpromising sites, as well as using enhanced competitive advantages in relation to the ratio of investments in various areas.
Development of a business plan for diversification of the enterprise will allow you to correctly answer these and other questions facing the company. In this document, it is important to reflect the following:
- What are the strengths of the business of the company;
- how stable and profitable current production;
- availability of free resources.
It should be borne in mind that the diversification of business companies always begins with maneuvering, built on the strengths of production. That is why you should not take as an example the successful activities of competitors.After all, no one is fully aware of their capabilities and resources. Such gaps in knowledge can cause an erroneous decision when choosing one form or another of diversification. In addition, at this stage, it is worthwhile to conduct a fairly in-depth analysis of the internal resources of the company, while compiling a complete list of all its strengths.
Another important point is the stability that the current business has. After all, any company will require investment. And they should be taken precisely from the current production. That is why, even before the opening of a new direction, it will be necessary to verify the stability, productivity and profitability of the current business.
Another point that is very important for consideration at the first stage is the sufficiency of available funds. They are important for any new project. That is why it is worth making sure that there is at least a minimal source of human and financial resources that will allow us to consider and evaluate all possible areas of business diversification. Otherwise, this project should be postponed or alternative ways should be found to increase the share of its presence in the market (joint ventures, subcontractors, etc.).
Search for destinations
This is the second step that is needed to diversify a business.
It is done on the basis of industry and macroeconomic analysis, which will establish areas with high growth rates and a favorable investment climate. However, most often this stage of business owners are taking into account their personal connections and contacts, using their own knowledge and experience.
Assessment of directions
This is the third step towards business diversification. At this stage, the company must conduct a detailed study of the market, its intensity, development dynamics, trends, as well as existing competition and consumer preferences. As a result of the work, a whole list of parameters appears, considering which you can determine the most attractive areas. This will allow you to choose the most attractive option, as well as draw conclusions:
- about long-term prospects and market potential;
- the availability of the necessary amount of resources to capture a certain market share;
- on sales performance in the selected segment;
- the existence of a clear plan for financing the diversification process, which should include investments in equipment and technologies, as well as in the promotion of goods and improving the quality of work with customers.
It is also important to decide what is the assessment of the effectiveness of the chosen type of strategy, and to describe in the business plan clear stages of work for the future from three to five years.
Company portfolio analysis
After evaluating all possible areas of business diversification, verification actions should be carried out to describe each area in relation to the general product portfolio of the company. This is the fourth, final step of the work done.
A company’s portfolio is a combination of all the products offered to customers. The role and position of each product or product line of a new direction should be clearly fixed in the business plan. This will allow them to fit into the framework of a diversification strategy, which will be the key to success for the company. A similar assessment with a sufficient level of reliability can be carried out using various methods of portfolio analysis (BCG matrix, ADL matrix and others).
Differentiation
In practice, product innovation is not only through diversification. This is facilitated by the process of differentiation. It involves the development and implementation of a new product.
What is differentiation? By this term is understood the introduction of a number of substantially modified products that distinguish them from similar products of competitors.
What is differentiation? This is an improvement in the attractiveness of the product due to its diversity. The main goal of this work is to increase the competitiveness of the company, taking into account the characteristics of the market segment and consumer preferences.
Marketing differentiation can be carried out by concentrating the capabilities of the product by changing the price, packaging or entering the secondary market, as well as by taking into account the product offer put forward by competitors (distribution channels, price, image, etc.).