Business diversification is a development strategy that involves businesses expanding into new markets or industries. If you're interested in learning more about the practice and what it could do for your business, this guide addresses the multiple benefits associated with diversifying your offerings. We also cover its potential risks and outline how SMEs commonly fund these efforts before answering some frequently asked questions.
If your business has reached the next stage of its growth journey, you might be considering diversifying. Whether you run a consultancy business looking to branch into cybersecurity or a cafe intent on experimenting with upscale dining, diversifying your offerings can be an incredibly exciting idea. Not only does it give you scope to develop new products and services, but it also provides you with an invaluable way to tap into new markets. However, increasing your business's variety isn't a decision that should be taken lightly.
For business owners who are on the fence about diversifying, this article outlines five benefits associated with branching out before citing possible risks involved with the strategy. Read on if you're curious about business diversifying and the potential advantages it could bring to your small-to-medium-sized enterprise (SME).
BUSINESS DIVERSIFICATION: AN OVERVIEW
Diversification is a strategy where companies expand a particular area of their business. It can involve businesses developing new products or services for their existing customer base, for a similar market, or for a different clientele entirely. Despite the potential challenges associated with diversifying, it’s one of the most effective ways to achieve stability and growth in the long term.
The practice can look very different depending on the nature of the venture and the market they are looking to break into. To understand its nuances in greater detail, below we address the four main types of business diversification.
- Horizontal - Horizontal diversification is when businesses develop new products or services for a similar market. By diversifying horizontally, your new assets can complement your core business and appeal to your current customers. Examples of horizontal business expansions could include a hairdressing company producing its own line of hair care products.
- Concentric - Similarly to horizontal diversification, this practice refers to a company expanding its current range to feature related products or services. However, this strategy sees them create offerings that are more in line with their core business. For example, if an ice cream manufacturer produces a new line of ice creams, they would be diversifying concentrically.
- Vertical - Vertical diversification is a growth strategy where businesses diversify their operations across the supply chain. This method can include forward or backward expansions and could consist of processes like purchasing raw materials or transporting goods off to be sold. For example, a confectionery maker could diversify vertically by establishing their own distribution channel.
- Conglomerate - Conglomerate diversification takes place when companies expand their offerings to attract new customers. Unlike when businesses expand horizontally, this normally sees company’s deviate from their core business model. Examples of concentric diversification could include a tech company producing its own line of stationery products.
WHAT ARE THE BENEFITS OF DIVERSIFYING?
Now we’ve covered the different types of diversification, let’s take a look at why this strategy is such an attractive option for ambitious entrepreneurs.
1. More customers
A business would be nothing without its customers. The more it's able to attract, the more successful it's likely to be in the long term. Unfortunately, many SMEs with limited offerings find it extremely hard to ready new consumers. This is why diversifying their products and services can be such a tempting course of action.
In particular, vertical and conglomerate diversification are some of the easiest ways businesses can tap into much wider audiences. This is because vertical expansion allows businesses to benefit from B2B sales alongside B2C sales, while conglomerate expansions have the potential to connect them with a completely fresh pool of consumers.
The strategy is also beneficial because it allows SMEs to draw in new customers without investing heavily in new staff and resources. Therefore, for business owners looking to attract new buyers without setting up a new company or radically restructuring their current business model, diversifying can make a lot of sense.
2. Greater income security
Running a business is always going to feature a certain element of risk. Whether it’s market disruptions or public health emergencies, no business owner can predict what tomorrow holds. Whatsmore, due to their comparatively limited revenue streams, smaller businesses are typically even more vulnerable to challenges, especially if they’re in their early days. But despite this, there are actions business owners can take to minimise these risks.
By diversifying their companies offerings and introducing them into new trading sectors, they will instantly have more markets to rely on. If carried out successfully, this has the power to multiply a SMEs income stream while broadening its presence on the market. For businesses that currently only cater to single segments, this is one of the best ways to minimise risk and guarantee a more secure future.
3. More consistent demand
If your venture offers a limited amount of products or services, it’s possible that you deal with repetitive patterns of demand. For instance, if you’re a hospitality business, it’s likely that your busiest months will be through the summer, whereas demand for heating and snow removal services pick up more in the colder months. Likewise, if your company is of a cyclical nature, it may be especially sensitive to the wide economy. This means that your earnings may be dependent on periods of economic expansion and contraction.
To deal with these quiet periods, many businesses use their excess funds to research and develop less seasonal products or services. By diversifying what they offer, it's easier for businesses to balance their sales across all seasons. This can make them more resilient to fluctuating demands and more agile in the long run.
4. Lower production costs
When retail businesses choose to diversify, they typically produce goods that are similar to the items they already offer. By doing so, they are often able to benefit from economies of scope. This is the theory that states the production of one good reduces the costs of producing a similar product. The economies of scope allow SMEs to diversify their stock and increase their revenues without needing to invest in new manufacturing machinery. This keeps the cost of production low without compromising the quality of the end product.
Similarly to the economies of scale, this technique allows businesses to maximise their revenues by producing goods in larger quantities. Moreover, this method also allows them to create products with different characteristics, as long as they share similar production factors to their core assets. As long as they don’t opt for conglomerate diversification, where the products bear no resemblance to their current line, this can be an effective way to cut down costs in the long run, especially for businesses with robust manufacturing capabilities.
5. Broader brand recognition
Business owners should never understate the importance of branding. It allows their company to build relationships with customers and exposes it to new audiences. The greater brand recognition your business has, the more successful it’s likely to be. This is why SMEs need to do everything in their power to improve the exposure of their brand.
Fortunately, aside from its clear profit-making potential, diversification can also be used as a savvy marketing tool to boost your brand's recognition. By attaching your logo to a range of new products and services, you're able to improve the visibility of your company. Depending on what type of diversification you choose to pursue, this can promote your brand to similar audiences or different demographics entirely. Compared to other, less organic marketing methods, this is a particularly effective way to extend your brands reach.
NO DIVERSIFICATION ATTEMPT IS RISK-FREE
As you can see, diversifying has the potential to benefit your business in more ways than one. However, before you jump the gun and uproot your SMEs current model, you need to be aware of its risks.
As with any type of business launch, there’s always a chance your efforts won’t be successful. No matter what sector you’re operating within, there’s no guarantee your new products or services will be received well by customers. Whether your new offering doesn’t align with your core business or it simply doesn’t meet demand, it’s incredibly hard to predict how a diversification attempt will play out. Therefore, to prevent a potentially profitable project from failing, it's important that you conduct as much research as possible before you bring your new offering to the market. Springboard your businesses expansion with Kriya Unfortunately, no matter which diversification blueprint you choose to follow, expanding your business is likely to come at a premium. In other words, the start-up costs associated with product or service expansions tend to be large. Since small businesses rarely have an excess of spare cash in their reserves, business financing is commonly used to front these initial expenses.
If you’re looking to use business financing to launch your company's diversification, Kriya might be able to help. We offer a range of flexible solutions that are designed to remove cash flow barriers for small businesses. We don’t believe in unnecessary fees and complicated paperwork, and all of our offerings feature reasonable terms. If you like what you’re hearing, visit Kriya to find out more.
FREQUENTLY ASKED QUESTIONS (FAQ)
What is diversification in business?
Diversification is a strategy where companies expand on a particular area of their business. It can involve businesses developing new products or services for their existing customer base, for a similar market, or for a different clientele entirely. Despite the potential challenges associated with diversifying, it’s one of the most effective ways to achieve stability and growth in the long term.
What are the main types of business diversification?
The main four types of business diversification include horizontal, concentric, vertical and conglomerate diversification. In the case of horizontal and concentric diversifications, businesses add the same or similar products and services to their range. With vertical diversification, companies expand across the supply chain, and with conglomerate diversification attempts, businesses deviate from their core offerings.
Why should your company consider diversifying?
Diversifying your offerings can benefit you in a number of ways. For instance, it can increase your brand exposure, attract new customers to your business, open up new revenue streams, minimise seasonal risks and lower production costs due to economies of scope.
How can the economies of scope reduce start-up costs?
Similarly to the economies of scale, economies of scope allows businesses to maximise their revenues by producing goods in larger quantities. Moreover, this method also allows them to create products with different characteristics, as long as they share similar production factors to their core assets. This is especially beneficial for businesses with promising manufacturing capabilities.
What are the risks of diversifying your business?
As with any type of business launch, there’s always a chance your efforts won’t be successful. No matter what sector you’re operating within, there’s no guarantee your new products or services will be received well by customers. To prevent a potentially profitable project from failing, it's important that you conduct as much research as possible before you bring your new offering to the market.
How do most businesses fund their diversifications?
Unfortunately, no matter which diversification blueprint you choose to follow, expanding your business is likely to come at a premium. Since small businesses rarely have an abundance of spare cash in their reserves, business financing is commonly used to front these initial expenses.