To Diversify or Not to Diversify, That is the Question
There is no disputing it. Diversifying your investment portfolio is an important strategy to protect your personal wealth. Although your overall returns will be tempered, it hedges risk, smooth’s returns, and ensures liquidity. No, the diversification I’m talking about is a set of business strategies that expands your market and therefore your opportunity for growth.
If we get into our time machine and go back to the latter half of the 20th Century, you would see that diversification was the primary strategy for most companies. With few exceptions, those companies ending up losing their way. More than 80% of the Fortune 500 corporations from 50 years ago are gone (lack of innovation also played a role). For a story on how diversification can be taken to an absurd degree, read the History of the American Machine and Foundry (AMF) Corporation, founded in 1900 and now just operating bowling alleys.
Before we get into how and when diversification makes sense, let’s first talk about the risks. There are three main pitfalls you need to consider when going down the path of expanding your service offering. Each of them alone could ruin your business. All three are most certainly lethal.
It becomes a major distraction. If your company is like most, you have limited resources. Resources include people, money, and time – all three are usually in short order. When you embark on a diversification strategy, some of these resources get redirected (even in the case of acquisitions). And guess who gets distracted? Your best people, since you assigned them this important initiative. How will this impact your current business? I know both your employees and customers will miss them.
It cannibalizes existing sales. It’s very common for companies to diversify in a way that causes them to unwittingly steal market share from existing products or services. For example, when a company realizes they are stuck in the high-end of the market and feel the need to offer something at a lower price point to drive volume. The problem is the new product, even when it has a different name, can provide a higher value-price ratio than your existing offering and customers may make the trade-off, go down market, and reduce your total share of wallet.
It damages your brand. I put this last as I believe this could be the greatest risk. You’ve spent years building and honing your reputation. Your customers have come to expect a certain level of quality, service, and price. When the new product/service falls short of expectations, you’ve hurt your brand equity. This could negatively impact a large swath of customers, taking you years to recover.
Now that I’ve sufficiently scared you away from even mentioning the word diversification, let’s talk about when and how it makes sense. When you have become a dominant player in your market and you are enjoying excellent margins with a stellar reputation, diversification could be an exciting opportunity. There are 5 fairly unique diversification strategies that make sense. Remember to start small.
New Geographies. The easiest form of diversification is geographic diversification. If you sell in a region of a country, sell in other regions (Northeast US to Midwest US). If you are in one country, look at the next logical country (US to Canada), and so on and so forth. As I’m sure you know, selling into other countries comes with it’s own set of challenges; however, these are easily overcome with the right people. The Internet has made the world borderless (nearly), so ignore this at your own peril.
Product Line Extensions. This is typically a minor change to a product in the same category that can expand your market. It could be as simple as a new flavor, color, or package size. Coke is the simplest example. Cherry coke was created because people were adding cherry syrup to regular coke. Diet coke for those people that didn’t want the calories. 2 liter bottles for people that wanted to save money by buying in bulk. All of these carry low risk and provide a pivot that expands your market. Who would argue with that rationale? Of course, do the proper market research and testing to ensure you are delivering on your promise.
Add on Services. This is one of my favorites and often overlooked. GE saw they could make more money from financing the equipment than on selling the equipment. GE Capital was born. How about buying insurance for your phone from BestBuy. You would be surprised how lucrative service contracts can be because the cost to service is so low and you have a captive audience (low sales and marketing costs).
Brand Extensions. This is where you leverage your strong brand equity to sell a new product in a similar market. Under Armour provides a classic example. They developed a breathable material and developed casual sportswear for active people. They used athletes to market their product because if it’s good enough for them, it must be good enough for the weekend warrior. Using that same technology, they moved into running shoes, golf shoes, sports accessories…all targeted at the same active consumer.
New Industries. This one is trickier than it sounds. Just because a product or service is used in multiple industries doesn’t mean the price, quality, and volume expectations are the same. This can be as easy as going from the industrial to the consumer sector or as complex as going from serving business offices to serving hospitals, the difference in expectations can be vast. Be smart and find a new industry that requires a small pivot but provides significant upside and small risk. Again, it probably requires you to hire an industry expert, but that is small price to potentially multiply your available market.
Then there are some companies that have taken all of these to the extreme. Think Richard Branson and the Virgin Group. From a small record company in 1970 to more than 400 companies today (including a global commercial airline). That is one powerful brand.
Diversification can provide quick upside without a large investment when done right, or it can challenge the strongest companies. Remember, you don’t have to go it alone. You can partner, white label, or acquire your way into diversification strategies, but that’s for another blog.