There are always risks when a company diversifies away from its core capabilities. But there are many ways to reduce and manage those risks. We share our views on crafting an effective diversification strategy.
Diversification strategies can have different objectives. Advantages include higher revenue growth potential, market dominance, exploring fast growing markets, and increasing loyalty from existing customers.
How can companies approach diversification?
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.
Understanding the different forms of diversification
Understanding horizontal diversification
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.
Understanding vertical diversification
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.
Understanding concentric diversification
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.
Understanding lateral (or conglomerate) diversification
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.