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Diversifying a business portfolio: The pros and cons

According to Wikipedia, a simple layman definition of diversification is ‘a corporate strategy to enter into a new market or industry which the business is not currently in, whilst also creating a new product relative to that new market’. Diversifying a business’ portfolio or range of services or products can help a business significantly boost its revenues and profits, if executed correctly. Nonetheless, there are some problems or burdens that arise with such a move. Below we take a look at the three main categories of diversification and their core advantages and disadvantages.

Diversification typically occurs in one of three ways, or a combination thereof:

  • Vertical Integration
  • Horizontal Diversification, and
  • Geographical Diversification.

Vertical Integration

This is when a business is incorporated or amalgamated along the value chain (such as being the supplier, manufacturer and distributor), both upstream and downstream where one efficiently supports or feeds the other. The benefits are obvious in that the business participates in profiting from various levels of the supply chain. Risks are also minimised as there is no longer reliance on third party providers at the respective points of integration. Here management must, however, be wary of creating a system so integrated and internalised that it becomes too rigid. Business requires flexibility in these dynamic and constantly evolving times. New ideas and trends occur at a rampant rate these days and the company must always be ready to change quickly too – either to mitigate losses or capitalise on opportunities.

Horizontal Diversification

This is shifting out of the core industry or production into other related or unrelated industries/sectors, which normally still appeal to the same consumer markets in question. Management has to be ready to handle the problems that come with launching a new product or products that deviate from the existing. These teething problems can be challenges affiliated with product interpretation, product placement, market penetration and competition. First and foremost, the product has to appeal to its target market or intended audience. It has to offer them something of value. If it fails to achieve this primal goal it will not succeed.

However, if planned and implemented carefully, you can become a much more powerful and vibrant brand in the future if you introduce an idea/product that extends the relationship people have with your brand in meaningful ways. Extensive research is imperative if the new product is to resonate with the target market. If handled effectively this move will allow a company to reach new target markets and boost sales considerably. This further increases stakeholder confidence in the company and attracts more business opportunities.

Geographical Diversification

This entails capturing new previously untapped markets, by moving into new geographical territories to overcome the limited or saturated growth opportunities within the local context. It is a crucial point to ensure that the business is ready for expansion into other regions. Markets differ vastly, consumer cultures can be distinctive, buying habits unpredictable and socio-political, socio-economic factors considerably unique in different regions. Undoubtedly, geographical growth in a business that is ready for such a transition, where proper market research has been conducted, can represent excellent growth prospects. However, businesses must tread with caution, a case in point being The Platinum Group. This group, a clothing retail giant in South Africa, is one that crashed very quickly after expanding to Mauritius, among other pressures. Finances have to be readily available to back the project, without compromising capital needed to sustain existing operations. Research and gathering of relevant data/market intelligence has to be done meticulously to see if the brand can be received and a sustainable footprint created. Moving into an area where the market cannot relate to the business brand or product/service and the USPs is not advisable.

This article outlines the three basic types of diversification and highlights the main advantages and risks. If you are considering growth opportunities for your business, definitely look at diversification. At the same time make sure your core offerings are reinforced and will not be compromised by the move. Research is paramount together with proper planning and associated industry-specific PR and communications. Also, look out for future articles that explore the types of diversification in more detail.

Proudly brought to you by the National Small Business Chamber (NSBC).

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