The Benefits of Diversification

Is it time to diversify your business? Adding new products and service lines or starting new companies within a group can significantly enhance your ability to grow rapidly. However, it’s important to pursue a strategy that is right for you and your company.

Businesses diversify for a number of reasons. Perhaps the most basic of these is survival. By definition, a company that focuses on a narrow range of products will only have access to a finite number of customers. That’s fine if the market as it stands is big enough to support several competing businesses, but if the pool of customers is small, the cost of running the company may outstrip the potential for revenue. In these circumstances, diversification into new product lines may be essential to the long-term viability of the company.

In the case of cyclical business, diversification can help regulate cashflow throughout the year. For instance, a business that supplies heating equipment is likely to sell the bulk of its products through autumn and winter, as demand falls away with the approach of summer. If the company remains focused on heating it will need to sell enough during the high period to make up for the dip in revenue during the fallow months. An alternative is to diversify into a product that will balance sales across the seasons; air conditioning, perhaps.

But diversification is not just about survival. It’s a tried and trusted growth strategy. New products or business lines will enable you to make more sales to existing and new customers and (depending on how you diversify) expand into markets that would otherwise have been closed to you.

Diversify and grow

There are many ways in which to diversify. The most straightforward of these is to provide a natural extension of the goods or services that you already offer to customers. For instance, internet retailer Charles Tyrwhitt started out by selling quality work shirts to customers who wanted to trade up from high street providers such as M&S. From that small beginning, the company went on to offer a range of complementary products, such as ties, suits, cufflinks, women’s clothing and accessories. It was a natural progression that nonetheless drove rapid growth.

On a bigger stage, the Coca-Cola company is best known for Coke, but popular as that drink is, it certainly isn’t to everyone’s taste. To maximise market share the company offers a broad range of soft drinks, from orange through to diet versions of Coke itself.

A variation of this theme is the addition of complementary services. For instance, manufacturers can boost revenues by not only acting as suppliers but also providing follow-up services such as maintenance. This approach can be particularly useful when the economic cycle turns down. In hard times, customers don’t necessarily have the inclination to invest in new machinery but they will spend on maintaining the equipment they’ve already got. Thus, a manufacturer that provides both goods and services can maintain a consistent revenue stream.

Diversification can also take the form of brand extension across an apparently unconnected range of products or companies. For instance, the Virgin brand has been stretched across transport (trains, planes, holidays), music (record retail and recording), telecommunications (TV and mobile phones) and financial services. This kind of diversification has worked because of the strength of the Virgin brand. It is seen as youthful, buccaneering and often providing better value than established players in the market. The allure of the Virgin brand has been instrumental in driving expansion.

In contrast, many business owners expand by forming new companies that operate under different brand and/or trading names and sell unconnected products within a group structure. There are some advantages to this approach. Brand extension carries a certain degree of risk. For instance, delays or problems with Virgin trains could conceivably hit the perception of Virgin Atlantic airlines. By trading under a different name you can ring-fence one business from another in terms of public perception and reputation. Perhaps more importantly, by establishing each company as a separate entity, you also ring-fence the finances. In that respect, if one business fails it can be wound up in an orderly fashion without necessarily affecting other businesses within the group.

Getting your timing right

It’s probably unwise to rush into diversification, even if your survival depends on it. Business advisors tend to caution that the core business (that is, the original business) should be trading successfully before any new venture is launched. Launching a new product or business will inevitably eat up management time and divert attention from other parts of the operation.

Developing and launching new products or starting a new business within a group can be a costly undertaking. For instance, let’s say you expand your product range and see an increase in turnover. That’s good news, but profits could dive unless the rise in revenues is sufficient to outstrip the associated increase in costs.

The risks associated with diversification become more acute when you move away from your comfort zone. Extending your product range to appeal to an existing customer base (i.e. cufflinks and ties to match your shirts) is relatively low risk. Launching an unrelated product to an established customer base carries a higher risk. Selling new products to a whole new marketplace is seen as the riskiest approach of all.

But it can pay off. The key is to plan carefully. Do your market research. Get the right managers in place and ensure any new venture is properly funded. You should also look carefully at the financial and corporate structures. Do you keep everything within the existing business or establish a new entity?

With the right people, business plan and structure in place, diversification can serve to supercharge growth.