What is a diversification strategy?

In recent years, an increasing number of companies have turned to diversify their management. To promote a diversification strategy, it is necessary to understand the advantages and disadvantages as well as basic knowledge. In this article, we will explain the patterns, advantages, and disadvantages of diversification strategies. Acquire correct knowledge and succeed in business diversification.

Table of contents

What is a diversification strategy?

A diversification strategy in a company is an effort to develop new businesses in related fields by utilizing the resources it possesses. It is one of the “growth matrix” strategies advocated by business scholar Igor Ansov, who is known as the father of strategic management.

Points to note and points to proceed with diversification

When diversifying, it is necessary to be careful not to neglect existing businesses. If we lose the strength to continue existing businesses by focusing too much on new businesses, the management of the entire organization may deteriorate. New businesses, which have few precedents compared to existing ones, inevitably run the risk of stalling, so it is important to diversify while leaving sufficient margin in the main business.

Therefore, it is better to start a new business with a small investment. Risk can be minimized by assessing the company’s aptitude, market, etc., starting with a business that can be done with the minimum resources, and gradually expanding the scale according to the timing.

It is also important to aim for synergies with existing businesses when it comes to new businesses. If it is a business that can make use of existing know-how, even if it is a new industry, it is possible to gain market competitiveness that other companies do not have. Furthermore, if we can apply the know-how newly obtained from new businesses to existing businesses, it can be an opportunity to lead to breakthroughs in all of our businesses.

Reasons why diversification strategies are attracting attention

Consumer needs are diversifying in response to changes in economic conditions and times both in Japan and overseas. To meet the diversifying needs of consumers, it is important to seek out new products and services rather than sticking to existing businesses.

Today, the environment surrounding a company that runs a business is by no means a good one. There are many competitors in one business field, and we have entered an era in which it is not possible to achieve the desired results by focusing on a single business. Under these circumstances, a diversification strategy is required for companies to secure stable earnings and achieve growth.

Classification of diversification strategies

Diversification strategies include horizontal and vertical, centralized, and conglomerate types. Each of them has its characteristics and strategies, so it is necessary to choose the method that suits the business you want to launch.

Horizontal diversification strategy

A horizontal diversification strategy refers to a strategy that utilizes existing production technology to introduce new products and services into markets that are similar to existing businesses. For example, a construction firm that used to build new homes might start remodeling, or an automobile manufacturer that used to manufacture trucks might start producing sports cars.

The advantage of the horizontal type is that you can make full use of your company’s resources. There is almost no need to invest in new equipment, and financial risks can be reduced. In addition, if the market is similar to the existing business, the risk of failure can be reduced because accumulated know-how can be utilized.

Vertical diversification strategy

It is a strategy to provide new products and services to markets similar to existing businesses by using new technologies that do not exist in existing production technologies. For example, a futon/mat maker produces bed stands, and a computer maker produces desks for computers.

The advantage is that it is easy to approach existing customers and business partners because it targets markets similar to existing businesses. In the example of a personal computer manufacturer, there is also the advantage of being able to provide one-stop services to customers by handling not only terminals but also desks and chairs.

On the other hand, there will be areas that cannot be handled with conventional production technology, so it will be necessary to invest accordingly in acquiring new production equipment and know-how.

Centralized diversification strategy

A centralized diversification strategy is a strategy to introduce products and services that can be produced with in-house resources and technologies into industries that have little connection with conventional businesses. Examples include providing camera lenses as parts for medical equipment, and food manufacturers entering the biotechnology business.

The advantage is that we can utilize the know-how and technology that we have accumulated so far. If things go well, you can expect to earn more than your existing business, and the gap between your business and your existing business may attract attention.

While resource consumption is low, there are various risks depending on the situation, such as the difference in the required quality and the need to develop sales channels from scratch due to entering a field different from existing businesses. First of all, it is important to properly research the demand before entering.

Conglomerate type diversification

Conglomerate-type diversification is a case of entering an unknown world that is completely unrelated to the company’s technology or existing business. For example, a restaurant may enter the house cleaning business, or a construction company may open a cafe.

The appeal of the conglomerate model is that it expands business possibilities. There is also the possibility that the new business will be a big hit and the revenue will increase significantly.

On the other hand, it requires a high initial investment because it cannot make use of the know-how that has been accumulated so far, and there is also a big risk of failure. You may not even look at it and all your investment costs may be wasted. It is necessary to work after understanding that it is a high-risk high return.

Advantages and disadvantages of a diversification strategy

Many companies are embarking on diversification strategies because they can expect various benefits. However, the diversification strategy indeed has disadvantages, so let’s understand it correctly.

Benefits of a diversification strategy

The benefit of a diversification strategy is risk diversification. If you are only working on one business, changes in circumstances and deterioration in earnings will have a direct impact on management. If you have multiple businesses, you can avoid this risk by securing multiple revenue streams. As a result of entering a similar market or a new market, even if the entire organization can secure the same level of profit as before, stable management can solidify the foundation of the organization.

Synergy effects can also be expected, which is an advantage of the diversification strategy. If synergies with existing businesses arise from the development of new technologies and know-how, such as vertical diversification strategies, we can expect a significant improvement in profitability.

Disadvantages of the Diversification Strategy

A disadvantage of a diversification strategy is the risk involved in investing. Depending on how you approach it, you can keep costs down, but when it comes to creating a new business or entering an unknown market, it is necessary to allocate appropriate costs and resources. There is no guarantee that the new business will succeed, so please understand that there is a risk that the invested funds will be wasted.

Also, it is necessary to be careful that there is a possibility that it will become inefficient management. For example, even a company that had a systematic management system in place will need a new management system that matches it when it comes to expanding multiple businesses. Management that could be consolidated into one becomes complicated, and inefficient organizational management may deteriorate business performance.

In addition, there is also the risk of a decline in brand value, depending on the content of the new business. For example, if a company that has established its branding as a high-end manufacturer suddenly starts operating a restaurant that sells at cheap prices, it may damage its high-end image. As a result, existing customers may leave, and in addition to declining revenues, it may become difficult to acquire new customers.

Summary

A diversification strategy is effective for continuing to grow as a company and stabilizing earnings. Securing multiple sources of revenue leads to organizational stability, and synergies with existing businesses can also be expected.
After understanding the types of diversification strategies and their advantages and disadvantages, aim to develop a business that suits your company.