Diversify to manage risk effectively
Many factors determine the boom in business. Diversification is a strategy commonly adopted by companies to drive sales and profits from new products and / or markets. Depending on what stage your business is in, diversification can offer many benefits, such as protecting your company from large fluctuations in the industry. For example, if your business is only dedicated to the production and export of corn; a pest outbreak affecting corn crops would negatively affect your business.
However, a diversified company with multiple businesses or unrelated revenue streams would be better positioned to handle the crisis because its funds and resources are not fully tied to any one sector.
In addition, diversification also allows your company to explore new markets and opportunities.
Explore new opportunities
There are numerous types of diversification undertaken by companies. Concentric diversification occurs when a company leverages its existing knowledge and ventures into an industry similar to the one it is already in. Horizontal diversification, on the other hand, occurs when a company incorporates products or services that are not related to its current products into its mix, with the aim of attracting current customers. For example, a shampoo manufacturer engaged in horizontal diversification could introduce anti-frizz hair serums to boost sales.
As a real-life case study, Australian company Wesfarmers embarked on horizontal diversification by establishing Kleenheat Gas in the 1950s. Its previous operations included the marketing of wool and wheat and the distribution of oil to remote areas. The Kleenheat Gas company took advantage of another aspect of the energy industry and was successful.
Diversify wisely
Diversification strategies that are meticulously planned and executed have the potential to deliver great results. Some companies may choose to diversify (overseas or locally) for various reasons, including a pessimistic outlook on the stability of the established market and improving the adaptability of your company to times of financial uncertainty and difficulties. Your business may be “forced” to diversify in response to tough economic conditions, or it could be due to new opportunities that arise.
Business diversification varies widely: companies can venture into an industry that has nothing to do with their current specialization or develop a new product line similar to their existing products. Regardless of the type of diversification, it is important for companies to consider several factors:
- Financial planning
- Market research
- Competence
Expanding globally or starting a new product line from scratch is expensive – does your business have the financial capacity to do so? A good tip is to review your accounts and assess how you can improve your business productivity before diversifying.
Thorough market research and analysis are vital to the success of any business venture. The process often reveals important information, such as the profitability and viability of your proposed product or service in the target market and the strengths and weaknesses of your competitors.
Who are your biggest competitors in your target market? Solid market research provides insight into your strongest rivals and enables you to tailor your product or service to give your business a competitive advantage.
On the other hand, embarking on diversification without proper planning can lead to high volatility and little overall profit. It’s easy to spread your capital too much when you diversify without proper financial planning and market research.
Acclaimed investor Warren Buffett said, “Broad diversification is only required when investors don’t understand what they are doing.” Excessive diversification can be inefficient, increase a company’s investment cost, and generate below-average returns. Diversification is certainly not something to be undertaken lightly without due diligence. However, if planning and research are sound and there are opportunities for business growth, new and exciting opportunities may be created.
