Building an effective diversification strategy
Companies investing in diversification strategies:
estimated annual revenue opportunity from Apple smartwatches.
Diversification strategies can have different objectives. Advantages include higher revenue growth potential, market dominance, exploring fast growing markets, and increasing loyalty from existing customers.
Diversification occurs in three main directions when a company departs from its core capabilities: vertically, horizontally, and laterally. These constitute the three main diversification types. Another variation is concentric diversification, which can either be horizontal or vertical. This is where the company stays within its core capabilities.
Most firms want to stay in familiar territories and diversify into adjacent areas, either catering to the same market segment or using existing capabilities to develop a new product. However, if the whole industry sector has reached saturation, diversifying into new market segments to achieve internal growth targets becomes a priority.
Horizontal diversification means developing a new product that appeals to the same market segment. The product hinges on a new technology that requires different know-how and capabilities. Often this new product will be complementary to the existing one, since it targets the same market segment. An example would be Tesla launching Powerwall, a rechargeable lithium-ion battery, Apple launching iTunes to complement its iPods, or Gatorade launching Gx Sweat Patch to detect hydration levels. When done well, horizontal diversification increases revenues and loyalty from a company’s existing customer base.
Vertical diversification is when a company decides to vertically integrate up or down the value chain. The purpose could be to achieve better quality control of the component manufacturing, or better control of the marketing messaging during product distribution. Examples of this include Lego opening Lego stores, Apple opening Apple stores, or car manufacturers acquiring Li-ion battery startups, for example. When successfully deployed, companies can maintain and expand their current market dominance.
Concentric diversification is diversification that happens in either a horizontal or vertical direction, but has to be built on the same or related technologies, or know-how. The core goal of concentric diversification is to complement your current products and enhance the experience of the current customers. In doing so, companies can increase loyalty from their existing customer base. Examples of concentric diversification include Apple Watch and Cola Light.
Lateral (or conglomerate) diversification is when a company expands into a new industry and targets new customers with a brand-new offering. Often it is exploring rapidly growing markets. A special type of this diversification is when a company diversifies into an area that is emerging with no large players in it. This is often referred to as a white space or blue ocean. Examples of lateral diversification are BlackBerry offering security software or IBM moving into quantum computing.
Proportion of worldwide shipments of smartwatches made by Apple in Q1 2022
Compound annual growth rate in the quantum computing market between 2022 and 2030
2022 revenues generated by Tesla’s diversification into home battery storage
Diversification is risky for companies operating outside their in-house capabilities and comfort zone. This risk can be reduced, however, by working with specialists who have deep knowledge of the new area. This is something CamIn is experienced at managing for clients. We build expert teams comprising at least 80% technology and market specialists in the new area and produce objective recommendations on whether to move forward, which areas will prove most lucrative and even potential joint venture partner or acquisition targets. This work reduces the risk of pursuing a diversification strategy and increases the likelihood of generating high returns. Other risks of diversification include diluting brand recognition and shrinking resources from the existing core business.
The goal of the diversification strategy is twofold. Firstly, to analyse all possible diversification directions to pinpoint the best destination (answering the “where to”), and then highlighting exactly how to get there (answering the “how”). There are two main potential pitfalls that derail diversification strategies: flawed direction or flawed execution. Talk to CamIn about how you can derisk your diversification strategy.
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