Diversification is a form of corporate strategy designed to improve opportunities for growth and profitability. Companies can diversify their business by offering new products to existing customers or entering new markets with existing products or new products. A successful diversification strategy can help a company increase sales and revenue, as well as grow market share.
Introducing new products or modifying existing products can provide new revenue streams and increase overall turnover and profit. Diversifying a product range may also give a company higher margins compared with existing products. Entering new markets where there is little competition can enable a company to set prices that win market share without sacrificing profit margins. However, diversification also incurs development, sales and marketing costs. If those costs exceed the potential revenue and profit gains, diversification can be a disadvantage. Diversification can also divert investment and operating funds away from existing activities, limiting potential growth in those areas.
Diversification also requires additional management and operational resources. A successful diversification can make better use of a company’s existing resources. For example, a company entering new markets with existing products makes more productive use of its sales, marketing and manufacturing resources. However, diversifying into new markets with new products or developing new products for existing markets may require skills that the company does not possess, or it may stretch existing resources. Companies that try to sell to new markets using an existing sales team may find that representatives are unable to provide a consistent level of service across the customer base, leading to potential dissatisfaction and customer losses.
Companies are under scrutiny from many different groups of stakeholders, including customers, suppliers, employees, investors and analysts. A diversification strategy can generate positive perceptions by showing that a company is innovative and ambitious. A successful diversification can help attract new investors, retain employees and build strong relations with industry analysts. On the negative side, diversification may raise concerns among existing customers that the company is less interested in their business, and those customers may look for alternative suppliers. A failed diversification strategy can negatively impact a company’s reputation and damage relationships with investors and analysts, as well as dampen employee morale.
Impact on Risk
Choosing different diversification strategies can either increase or reduce a company’s risk. Entering a new market, for example, can reduce the risk of revenue loss due to a downturn in existing sectors. However, if the new market strategy fails, that can increase the risk of reduced profits, because the company will have incurred additional costs with no incremental revenue gain. A diversification strategy that enables a company to operate in a number of different markets reduces the risk of overall failure. However, the management and resource requirements of operating in multiple markets may mean that companies do not focus on their most profitable sectors.
- dolgachov/iStock/Getty Images