Diversification Strategy : Types and Methods

What is a Diversification Strategy?

A diversification strategy is a business strategy where a company expands its business activities into different markets or industries. The primary goal of diversification is to spread risk and create multiple sources of revenue, thus reducing dependence on a single market or product. There are two main types of diversification, related diversification and unrelated diversification. Related diversification occurs when a company expands into related industries or markets. Unrelated diversification means entering industries or markets that aren’t connected to what the company already does. Companies can diversify in different ways, like growing their own projects, buying other businesses, teaming up with others, or making strategic deals. However, the companies need to pick diversification options that match their goals, skills, and how much risk they can handle. To succeed, companies need to study the market well, plan smartly, and put their plans into action effectively.

Geeky Takeaways:

• Diversification mitigates risk by spreading investments across different markets or industries, thereby safeguarding against the adverse impact of market fluctuations in any single sector.
• By creating multiple revenue streams, diversification enhances stability, making the company less vulnerable to the downturns of any specific market segment or product line.
• Diversification helps companies grow by giving them chances to expand into new markets or industries. They can use what they already know to succeed in these new areas.
• Diversification seeks to balance risk and reward by spreading investments across various opportunities.
• Diversification aims to improve overall portfolio performance and stability through strategic expansion.

Types of Diversification Strategies

Diversification Strategies can be of different types:

1. Horizontal Diversification

Horizontal diversification is when a company adds new products or services to reach new customers or markets related to what it already does. Instead of going into completely different industries, it offers things that appeal to its current customers or use similar ways to sell them. This helps the company use its strengths, reputation, and customer relationships to grow and make more money.

For instance, Google diversified its business beyond internet searches into various sectors such as online advertising, cloud storage, hardware manufacturing (e.g., smartphones, tablets), operating systems (e.g., Android), and software solutions (e.g., Google Workspace, Google Maps). While these ventures differ from its core search engine, they all revolve around technology. This strategic move allowed Google to expand its revenue streams and market presence, positioning itself as a leading player in the tech industry.

2. Vertical Diversification

Vertical diversification is a strategy where a company expands its business by entering into different stages of the production or distribution process. This means moving either backward towards raw material production or forward towards distribution and retailing.

An example of vertical diversification is Apple’s integration of its supply chain by manufacturing its own hardware components, such as processors and screens, for its devices like iPhones and iPads. This vertical integration allows Apple to have greater control over the quality, cost, and timing of its products, as well as to differentiate itself from competitors by offering unique features and capabilities. Additionally, it reduces dependency on third-party suppliers and enhances Apple’s ability to innovate and customize its products to meet consumer demands more effectively.

3. Concentric Diversification

Concentric diversification occurs when a company expands its business by adding new products or services that are closely related to its existing offerings. This strategy allows the company to leverage its current expertise, resources, and customer base to enter new markets or offer complementary products.

An example of concentric diversification is Samsung’s expansion from manufacturing electronics like televisions and smartphones into the home appliances market with products such as refrigerators, washing machines, and air conditioners. This move leverages Samsung’s existing expertise in electronics manufacturing and distribution channels while entering a related market segment. By diversifying into home appliances, Samsung can capture additional market share and revenue opportunities while providing customers with a wider range of products under its brand umbrella. This strategy allows Samsung to benefit from economies of scale, cross-selling opportunities, and synergies between its different product lines.

4. Conglomerate Diversification

Conglomerate diversification is a strategy where a company expands into unrelated businesses or industries that have little to no connection to its existing operations. Unlike concentric diversification, which involves entering related markets, conglomerate diversification involves branching out into entirely different sectors. This strategy allows companies to spread their risk across diverse industries and capture opportunities for growth in new markets.

An example of conglomerate diversification is the Tata Group. Tata Group started as a textile manufacturing company but has diversified extensively over the years. Today, it operates in multiple industries including automotive (Tata Motors), steel (Tata Steel), information technology (Tata Consultancy Services), telecommunications (Tata Communications), hospitality (Taj Hotels), and many others. The conglomerate’s diversification strategy allows it to spread its risk across different sectors while leveraging synergies between its various businesses. This approach has helped Tata Group become one of the largest and most respected conglomerates in India and globally.

5. Geographic Diversification

Geographic diversification is when a company expands its business operations into different locations or regions. Instead of only operating in one area, the company sets up shop in multiple places. This strategy helps reduce risks associated with being too dependent on one market and allows the company to tap into new customer bases and opportunities for growth.

An example of geographical diversification is McDonald’s, which has expanded its fast-food restaurant chain operations to numerous countries worldwide. From its origins in the United States, McDonald’s has established a presence in various regions across the globe, including Europe, Asia, Africa, and South America. This geographical diversification allows McDonald’s to tap into diverse consumer markets, adapt its menu offerings to local preferences, and capture opportunities for growth in different regions. Additionally, by expanding internationally, McDonald’s reduces its dependence on any single market and diversifies its revenue streams.

6. Product Diversification

Product diversification is a strategic approach undertaken by companies to broaden their range of offerings beyond their current product or service lineup. This expansion typically involves introducing entirely new products or services that may vary significantly from what the company currently offers. By pursuing product diversification, companies aim to penetrate new markets, attract diverse customer segments, and diminish reliance on any single product or market for revenue generation.

An example of product diversification is Amazon. Amazon.com started as a bookstore online but expanded to sell many other things like electronics, clothes, food, home items, and digital services. This helped Amazon grow into one of the biggest online stores worldwide, meeting different needs and wants of customers. With a wide range of products and services, Amazon became a go-to place for online shopping for many people.

7. Market Diversification

Market diversification is when a company grows by reaching out to new groups of customers or market niches with its current products or services. This strategy means finding and entering markets that are different from the ones the company already serves, whether in terms of location, demographics, or interests.

An example of market diversification is Coca-Cola, which has expanded its product offerings beyond traditional sodas to include a variety of beverages such as juices, bottled water, sports drinks, and teas. By diversifying its product portfolio, Coca-Cola can reach different consumer segments and cater to changing preferences in the beverage market. This strategy allows Coca-Cola to mitigate risks associated with relying solely on one type of product and expand its presence in various beverage categories, increasing its overall market share and revenue opportunities.

Methods of Diversification

1. Internal Development

Internal development is when companies create new products or services within their organization, rather than buying or merging with other businesses. It involves investing time, money, and effort into researching, designing, and producing something new for customers. While it offers control and utilizes existing strengths, success isn’t guaranteed, making it a risky but valuable strategy for growth and innovation.

For instance, If a company manufactures smartphones, internal development might entail brainstorming new features or designs for their upcoming models. They may invest in research to better understand customer preferences and then use that information to develop innovative technology or software.

2. Acquisitions

Acquisitions help companies expand by purchasing other businesses, providing access to new markets, technologies, and products/services. They enable faster growth but demand meticulous planning, integration, and alignment with long-term goals. Despite diversification benefits, acquisitions involve risks such as cultural clashes and financial hurdles if not managed effectively.

For instance, A clear instance of an acquisition as a diversification strategy is when a technology firm, known for its software, buys a smaller company producing hardware devices like smartphones or tablets. This move enables the technology company to expand its product range and enter the hardware market. Consequently, the acquiring company broadens its business reach, taps into new markets, and provides customers with a wider array of products. Through this acquisition, the technology firm can utilize the expertise and resources of the acquired company to strengthen its competitive edge and stimulate growth in the hardware sector.

3. Joint Ventures

Joint ventures involve multiple companies collaborating on a specific project, pooling resources and expertise to achieve shared goals. They enable entry into new markets, risk sharing, and leveraging strengths but require clear agreements and communication. Despite diversification benefits, challenges like conflicts and cultural differences may arise.

For instance, When two pharmaceutical companies team up to develop and market a new drug. Rather than competing independently, they combine their research, development, and manufacturing capabilities to bring a new medication to market. By collaborating, they can share the costs and risks associated with drug development and regulatory approval processes. This joint venture enables both companies to diversify their product portfolios and access new markets while reducing individual financial and operational burdens.

4. Strategic Alliance

Strategic alliances occur when companies collaborate on projects or goals, leveraging their strengths and resources. They enable market entry, technology adoption, and risk sharing but require clear goals, trust, and communication. Despite growth opportunities, challenges like coordination and cultural differences may arise.

For instance, When a software company partners with a hardware manufacturer to develop and market a new line of computers. Instead of competing against each other, the two companies collaborate to combine their expertise: the software company contributes its operating systems and applications, while the hardware manufacturer provides the necessary hardware components. By working together, they create a product that offers seamless integration between software and hardware, providing customers with a more efficient and user-friendly computing experience. This strategic alliance allows both companies to leverage their strengths and resources to enter a new market segment and compete more effectively against other computer manufacturers.

5. Licensing and Franchising

Licensing and franchising enable company expansion without new locations or products. Licensing permits others to use company ideas or logos for a fee, while franchising allows businesses under a brand name to operate, paying for brand use and support. Both methods extend reach and revenue with careful management for brand integrity and legal compliance.

A clear example of licensing is when a toy company lets another company use its popular cartoon characters to make t-shirts. The other company pays the toy company for the rights to use the characters on their products.

As for franchising, suppose when someone wants to open a McDonald’s restaurant, they pay McDonald’s to use its name, recipes, and way of doing things. In return, they get help from McDonald’s to set up and run the restaurant, but they also have to pay fees and follow strict rules set by McDonald’s.

6. Vertical Integration

Vertical integration is a method of diversification where a company expands its operations either backward into the production process or forward into distribution or retailing. In backward integration, a company takes control of its suppliers, while in forward integration, it takes control of its distributors or retailers. This strategy aims to increase efficiency, reduce costs, and gain more control over the supply chain. So, vertical integration is a strategic decision that companies undertake to enhance efficiency, reduce costs, and gain more control over their value chain, but it requires careful consideration of both its benefits and drawbacks.

An example of vertical integration is Disney’s acquisition of Pixar Animation Studios in 2006. Before the acquisition, Disney focused on film distribution, while Pixar specialized in producing animated movies like “Toy Story” and “Finding Nemo.” By acquiring Pixar, Disney gained control over film production. This move allowed Disney to streamline operations, maximize the value of its intellectual property, and strengthen its position in the animation industry.

7. International Expansion

International expansion is a method of diversification where a company expands its operations into foreign markets beyond its domestic boundaries. This strategy involves establishing a presence in new countries through various means such as exporting products, establishing subsidiaries or joint ventures, or setting up franchises. International expansion allows companies to tap into new customer segments, access untapped markets, and diversify their revenue streams. However, it also involves challenges such as cultural differences, regulatory complications, and geopolitical risks.

Starbucks, a coffeehouse chain from the U.S., expanded its presence worldwide by opening stores in various countries like China, India, and Europe. This move helped Starbucks attract more customers and broaden its sources of income. Through strategic alliances and tailoring its offerings to suit local tastes, Starbucks effectively adjusted to different cultural norms and consumer habits in each country. This expansion significantly boosted Starbucks’ growth and cemented its position as a prominent global coffee brand.