Diversify to Manage Risk Effectively
Many factors determine a booming business. Diversification is a strategy commonly adopted by businesses to boost sales and profits from new products and/or markets. Depending on the stage that your business is in, diversification can offer many benefits, such as buffering your company from major fluctuations in the industry. As an example, if your business is only involved in the production and export of corn; an outbreak of plague that affects corn crops would adversely impact your company.
However a diversified company with several unrelated businesses or revenue streams would be better positioned to manage the crisis because its funds and resources are not completely tied up in any one sector.
In addition, diversifying also enables your company to explore new markets and opportunities.
Explore New Opportunities
There are numerous types of diversification undertaken by businesses. Concentric diversification occurs when a firm leverages its existing knowledge and ventures into an industry similar to the one it is already in. Horizontal diversification, on the other hand happens when a business incorporates products or services that are unrelated to its current products to its mix, aimed at attracting current customers. For example, a shampoo manufacturer engaging in horizontal diversification might introduce anti-frizz hair serums to boost sales.
As a real-life case study, Australian owned company Wesfarmers undertook horizontal diversification by establishing Kleenheat Gas in the 1950s. Its earlier operations included wool and wheat merchandising and oil distribution to remote areas. The Kleenheat Gas venture tapped into another aspect of the energy industry and proved successful.
Diversification strategies that are meticulously planned and executed have the potential to deliver great results. Some businesses may opt to diversify (overseas or locally) for several reasons, including a pessimistic outlook on the stability of the established market and improving the adaptability of their company to financially uncertain and difficult times. It may be that your company is “forced” to diversify in response to difficult economic conditions or it could be due to new opportunities that present.
Business diversification varies widely – firms may venture into an industry entirely unrelated to their current specialisation or develop a new product line similar to their existing products. No matter the type of diversification, it is important for companies to consider several factors:
- Financial Planning
- Market Research
Expanding globally or starting a new product line from scratch is costly – does your company have the financial ability to do so? A good tip is to look through your accounts and assess how you can improve your business productivity prior to diversifying.
Thorough market research and analysis is vital to the success of any business venture. The process often reveals important information, such as the profitability and feasibility of your proposed product or service in the target market and the strengths and weaknesses of your competitors.
Who are your biggest competitors in your target market? Sound market research offers insight into your strongest rivals and enables you to tailor your product or service so that your business has a competitive edge.
On the flip side, undertaking diversification without proper planning can lead to great volatility and little benefit overall. It’s easy to spread your capital too thinly when diversifying without proper financial planning and market research.
Acclaimed investor Warren Buffett said, “Wide diversification is only required when investors do not understand what they are doing”. Over diversification may prove to be inefficient, increase a company’s investment cost and lead to below average returns. Certainly, diversifying is not something to be entered into lightly without proper due diligence. However, if the planning and research is sound and the scope for business growth is there, it may well lead to exciting new opportunities.