What is a diversification strategy, its types, and why is it important?

Overview

If you’re a business owner, whether your business is doing well or not so well, you’re likely seeking growth. While there are many ways to grow business, a common way that companies achieve growth that you may want to consider is diversification.

Diversification is a strategy for growth through branching out into a new market segment, allowing your business to expand its presence and occupy a totally new space. This is achieved through expanding (or diversifying) your product or service offering to target new customers and grow profits.

There isn’t just one type of diversification; there are several different ways to diversify and grow your company. Below, I’ll walk you through different types of diversification strategies and illustrate the advantages and disadvantages of each for your company.

Types of diversification strategies

There are six established types of diversification strategies:

Horizontal diversification
Vertical diversification
Concentric diversification
Conglomerate diversification
Defensive diversification
Offensive diversification

1. Horizontal Diversification

To diversify your company horizontally means introducing brand new products or services to your current offering in order to expand market share, either in a new market segment or your company’s existing market.

This can be done through: –

innovating or licensing new products,
a merger, or acquisition of another company.

There are two types of horizontal diversification – concentric and conglomerate – which we’ll dive into later on.

The new business venture formed through horizontal diversification is designed to appeal to the company’s existing customer base, while also attracting new customers to the brand.

Some well-known examples of horizontal diversification include:

Disney acquiring Pixar
Facebook acquiring Instagram

2. Vertical Diversification

Vertical diversification also referred to as vertical integration, entails a growth strategy where the company expands its product line through a forward or backward integration of products within its existing supply chain.

For instance,

a company that manufactures and sells cars could diversify its business by selling tires.
A painting company that provides painting services could begin selling paint. As seen in both of these examples, vertical integration converts the company’s inputs into outputs.

Both of the above examples illustrate backward integration.

An example of forward integration would be a toy manufacturer acquiring or opening a toy store. With forward integration, companies capitalize on the later stages of the supply chain than the company’s current business, while backward integration utilizes earlier stages.

Vertical diversification has a number of benefits, including:

strengthening and enhancing your business’s supply chain,
capturing upstream or downstream profits,
cutting production costs,
accessing new distribution channels and
gaining more revenue.

Some high-profile examples of vertical diversification are:

Ikea purchasing forests in order to supply its own raw materials
Amazon integrating into hardware to produce its own Kindle Fire tablets

3. Concentric Diversification

Concentric diversification, a type of horizontal diversification, involves introducing new products or services to your product/service line that are closely related to your existing products or service.

Therefore, you are expanding your market share within the market your company already operates in.

Concentric diversification allows you to leverage your existing brand recognition, customer base, and loyalty, resources, and distribution channels. This type of diversification aims at generating additional revenue from your existing customers, while also attracting new customers who may have been interested in your other products but are more swayed by your newer products.

An example of concentric diversification would be if a smartphone company began selling smartwatches (i.e., Apple, Samsung), or if a furniture company began selling home décor.

4. Conglomerate Diversification

Also, a type of horizontal diversification, a conglomerate diversification strategy, means to introduce brand new products or services that have no relation to your business’s current product offering, therefore entering a completely new market and appealing to customers that may have had zero interest in your business previously.

The benefits of conglomerate diversification are high ROI and high growth due to the addition of an entirely new revenue stream in a totally separate market.

An example of conglomerate diversification would be a clothing company branching out into toys.

5. Defensive Diversification

Defensive and offensive diversification are terms that have more to do with why a company wants to diversify, rather than how.

Defensive diversification refers to companies who diversify in order to remain competitive, as their market segment has become saturated, their existing products have matured and are in decline, or they’re losing out to their competitors.

As the word ‘defensive’ suggests, this strategy is a response to losing profits and market share, and an effort to defend its status and position.

6. Offensive Diversification

Offensive diversification, on the other hand, occurs when a company is aggressively seeking to grow its profits and market share through diversifying its product or service line in order to enter new markets and capture more customers.

While defensive diversification is a means to stay in business, offensive diversification is a means for a successful, thriving company to grow even further.

Why diversification is important

Diversification may not be for everyone and every business, but it’s a business strategy that is definitely worth considering for any company looking to grow.

Diversification has been used by some of the most successful companies around the globe, including Apple, Google, Starbucks, and more.

Here are the main reasons to consider diversification:

Diversification allows businesses to significantly increase their revenue by leveraging their existing resources, brand recognition, and customer base.
Diversifying your business, rather than investing in a single product or market, lowers your company’s risks.
Diversification allows you to remain profitable during industry ups and downs, as a society, the economy, and consumerism fluctuate.
Diversification allows you to maximize your company’s current resources, which may be underutilized.

Conclusion

Diversification is just one of many different ways to create growth for your business. If well thought out and done right, it can pay off substantially for a company and cement a position as a highly competitive market player.

However, a diversification strategy that hasn’t been thought through can be a disastrous and costly mistake for a business. So, make sure you analyze both the potential risks and benefits, as well as determine which type of diversification would be best for your business before you consider implementing this strategy.