zaro

What Are the Different Forms of Diversification Explained?

Published in Business Strategy 5 mins read

Diversification is a strategic business approach that involves expanding a company's operations into new markets, products, or services to reduce risk and enhance growth potential. It's a fundamental strategy for achieving stability and long-term success by not "putting all your eggs in one basket."

Diversification takes various forms, each with distinct characteristics and strategic implications for businesses aiming to expand their horizons.

Understanding the Key Forms of Diversification

Diversification strategies include: concentric, unrelated, geographical, horizontal, and vertical diversification strategies. Each form offers a unique pathway for businesses to grow and manage risk.

1. Concentric Diversification

Concentric diversification, also known as related diversification, entails introducing new products that contain close relation to the existing ones within the industry. This strategy leverages a company's existing technology, marketing channels, or customer base. The new products or services typically complement or enhance the company's current offerings, allowing it to capitalize on its core competencies.

  • Key Characteristics:
    • Synergy: Aims to achieve synergies by sharing resources, technologies, or distribution networks.
    • Relatedness: New products are closely related to existing ones in terms of technology, production processes, or customer needs.
    • Risk Reduction: Less risky than unrelated diversification as the company operates within a familiar domain.
  • Examples:
    • A company manufacturing smartphones starts producing smartwatches or wireless earbuds.
    • A food processing company that produces dairy products introduces new lines of organic yogurts or plant-based milk.
    • A software company specializing in graphic design tools develops new features or companion applications for video editing.

2. Unrelated Diversification

Unrelated diversification, often called conglomerate diversification, involves adding new products or services that are entirely different from a company's current offerings and existing markets. The new ventures have no direct functional or technological relationship with the existing business. This strategy is typically pursued to achieve financial stability through spreading investments across diverse industries, or to acquire undervalued assets.

  • Key Characteristics:
    • No Synergy (Operational): Lacks operational synergy between existing and new businesses, but can offer financial synergy (e.g., stable cash flow from one division supporting another).
    • High Risk/High Reward: Can be high-risk due to lack of expertise in the new industry, but also offers high potential returns if successful.
    • Portfolio Management: Often driven by a desire to create a balanced portfolio of businesses to offset cyclical downturns in any single industry.
  • Examples:
    • A car manufacturing company acquiring a chain of hotels.
    • A textile manufacturer investing in a telecommunications firm.
    • A food and beverage conglomerate purchasing an aerospace engineering company.

3. Geographical Diversification

Geographical diversification involves expanding a company's operations into new geographic regions, markets, or countries. This strategy aims to reduce dependence on a single market, tap into new customer bases, and mitigate risks associated with regional economic downturns or political instability.

  • Key Characteristics:
    • Market Expansion: Access to new customer segments and revenue streams.
    • Risk Spreading: Reduces reliance on a single market, protecting against localized economic shocks.
    • Brand Growth: Enhances brand visibility and global presence.
  • Examples:
    • A retail chain based in one country opens stores in several new international markets.
    • A technology company, successful in North America, launches its services in European and Asian markets.
    • A domestic restaurant franchise expands its operations into new states or provinces.

4. Horizontal Diversification

Horizontal diversification occurs when a company introduces new products or services that are technologically unrelated to its current products, but might appeal to its existing customer base. The new offerings cater to the same customers but fulfill different needs, often complementing their lifestyle or consumption patterns.

  • Key Characteristics:
    • Customer Focus: Leverages existing customer relationships rather than existing technology or production.
    • Cross-Selling Opportunities: Facilitates cross-selling of new products to loyal customers.
    • Market Share: Aims to increase market share within the existing customer demographic.
  • Examples:
    • A company selling high-end laptops starts offering premium headphones or virtual reality headsets to its tech-savvy customers.
    • A coffee shop chain introduces its own line of branded coffee beans, mugs, or brewing equipment for home use.
    • A fashion retailer expands into selling home decor items, targeting customers with similar aesthetic preferences.

5. Vertical Diversification

Vertical diversification involves a company expanding its operations by moving backward or forward along its own supply chain. This can mean taking control of inputs (backward integration) or outputs (forward integration) of its core business.

  • Key Characteristics:
    • Supply Chain Control: Increases control over the production process, from raw materials to final distribution.
    • Cost Reduction: Can lead to cost efficiencies by eliminating middleman markups.
    • Quality Control: Better control over the quality of inputs or the customer experience.
  • Sub-Forms:
    • Backward Vertical Diversification: A company acquires or starts operations that produce the raw materials or components it uses.
      • Example: An automobile manufacturer acquiring a tire company or a steel mill.
      • Example: A bakery buying a flour mill.
    • Forward Vertical Diversification: A company acquires or starts operations that distribute or sell its products directly to customers.
      • Example: A clothing manufacturer opening its own retail stores.
      • Example: A soft drink company acquiring a bottling and distribution network.

Summary of Diversification Forms

Diversification Form Description Relationship to Existing Business Primary Goal Example
Concentric New products closely related to existing ones (technology, market, production). Closely related Achieve synergy, leverage core competencies. Smartphone maker introduces smartwatches.
Unrelated New products/services completely unrelated to existing business. No relation Reduce overall risk, utilize financial resources. Car manufacturer acquires a hotel chain.
Geographical Expanding into new geographic regions or countries with existing offerings. Same products, new location Access new markets, spread market risk. Retail chain opening stores in a new country.
Horizontal New products/services technologically unrelated but appeal to existing customers. Different products, same customer Increase customer spend, broaden product portfolio. Laptop company sells premium headphones.
Vertical Expanding into earlier (backward) or later (forward) stages of the supply chain. Up/down supply chain Control supply chain, reduce costs, ensure quality. Automobile manufacturer buys a tire company (backward).

Each form of diversification offers strategic advantages, and the choice depends on a company's goals, resources, market conditions, and risk tolerance. Successfully implemented, diversification can lead to sustained growth, increased profitability, and enhanced resilience for businesses.