What companies use a diversification strategy?
Companies will use a diversification strategy for three main reasons. Therefore, the companies who are using diversification strategy are those who:
- Need to mitigate market risk
- Need to protect their business from the competition
- Need to increase their profits and variety of products stocked
However, this means that the types of companies using a diversification strategy are usually under pressure. For example, a new competitor is taking a portion of business and you’d like to acquire it.
Alternatively, taking the decision to diversify requires a lot of analysis work, which typically needs to be completed in an extremely tight timeline. Let’s go through some examples of the companies who choose to use a diversification strategy, and their reasoning.
Mitigate Risk
In times of market volatility or downturn, businesses will look to introduce more products into their line. This spreads their investment across multiple channels, so one product can afford to lose sales while the overall company does not suffer to the same degree.
There is a general riskiness measure that helps to analyse how successful the introduction of a new product might be. This has three major points to satisfy:
- The porter’s attractiveness test
- The cost of entry is less than predicted future profits
- The better-off test: do these new products have a synergy or competitive advantage?
Companies that diversify in order to mitigate risk do so because of unsystematic risk. This refers to risk in the specific market, and could be caused by a competitor getting stronger or going out of business, for example.
Competition
When competition is strong, businesses will tend to compare their strategic assets to provide a competitive advantage. Strategic assets refer to the specific resources or capabilities of your company that are scarce or difficult to replicate.
The types of companies who will diversify to protect their company from the competition may merge with such competition. In this case, they take out the competition and begin sharing in the profits. Plus, there are now fewer consumer options which means that pricing is less competitive. This type of diversification may allow businesses to raise their prices.
A different approach to diversification for competitive purposes is to match or outshine your competition with new goods. In this case, you may choose to pair up diversification with a penetration pricing strategy in order to undercut your competition. The idea with this is to create loyal, returning customers who then make larger purchases in the future.
Profits
Finally, businesses may choose to diversify in order to raise profits. Concentric diversification is a popular and proven strategy in this case.
For example, coffee shops will add to their line with food supplements such as sandwiches and pastries. This may be used as an upsell at the till point and increase profits. Risk of diversification remains small as the products are similar to those already proven to sell.
In a similar vein, gyms may choose to add a sauna room or physio room to their premises. This would not require any added space, but could be rented out to add another stream of income, thus diversifying.
