What are the three types of diversification?

Diversification and globalization are the keys to the future."

- Fujio Mitarai

At times, businesses create completely different products and enter brand new markets. This is known as diversification. Diversification can often be a successful growth strategy but, as most strategic decisions in business, it also has its disadvantages. Let's take a look.

Meaning of Diversification in Business

Diversification is when a business expands into a new industry or segment it does not already operate in.

Diversification can be considered as a growth strategy. It takes place when a business is entering a completely new market, segment or industry.

Your business may introduce a new product into the supply chain to increase profitability. This product could be related or completely unrelated to your current product offerings. There are multiple types of diversification and each of them takes a different approach to competitive strategy.

Types of Diversification

There are four main types of diversification strategies:

• Vertical diversification: also known as vertical integration, is when you expand forward or backwards in your supply chain or production process. During vertical integration, the business combines two or more stages of production that are usually operated by other companies.

  An online clothing retailer (that does not own any of the production processes) buying and operating the factory that their clothes are produced in.

  This type of strategy could lower your costs in the long term, as all your operations are 'in house'.¹

• Horizontal diversification: when your business expands into products or fields that are somewhat unrelated to current business activities.

  If you are a company selling fragrances, you might expand into selling other products like hair care or body wash

  The new products are not directly related, but if customers enjoy your fragrances they could be interested in buying other cosmetic products that use the same fragrances.

• Concentric diversification: when your business starts producing products that are similar in the type of technology or expertise it requires to produce them.

  If your business is known for selling soft serve ice cream but you now consider selling popsicles too.

  The new product is similar to your original product and you already have the expertise in ice cream production. This type of diversification can be beneficial for boosting sales in a market where the original product is experiencing a decline.

• Conglomerate diversification: is when your business develops products that are completely unrelated to their current product offering. It is known as conglomerate diversification, as the parent company owns all separate, individual subsidiaries.

  A company that sells laundry detergent starting to sell jeans.

Business Diversification Example

One example of a company that has recently been reported to diversify into new markets is Netflix. Recently, the company had announced that it will offer mobile video games to its subscribers, in addition to a Netflix online shop that will sell limited-edition clothing and apparel based on viewers' favorite shows.²Netflix offering video games could be seen as concentric diversification, as the company most likely already has great software and development resources for producing technology-based content.

A Netflix shop could be considered as conglomerate diversification as the company does not have previous experience in selling physical goods. Netflix has previously collaborated with clothing retailers but has never been the partner who manufactures the clothing.

There has been some controversy surrounding Netflix's diversification. Critics argue that there is a difference between passive engagement with entertainment (watching shows or movies) and active engagement with entertainment (playing video games or making music). It is possible that current subscribers of Netflix use the platform for passive entertainment and would not be interested in playing video games. Developing video games is also not one of Netflix's core competencies and the gaming industry is very competitive, so it could be hard to penetrate the segment and engage customers.

The Ansoff Matrix

A common way of examining growth strategies for businesses is by implementing the Ansoff Matrix (see Figure 1 below). The matrix is a two by two grid that plots new and existing markets on one of the axes and new and existing products on the other. This grid can be used for strategic planning. It is made up of four different quadrants:

• Market penetration: a type of growth strategy where the business focuses on producing its existing products in its existing markets. The goal of market penetration is to increase market share.

• Market development: is a type of growth strategy where the business attempts to sell its existing products in new markets.

• Product development: is a type of growth strategy where the business tries to sell new products in existing markets.

• Diversification: is when the business tries to sell new products in new markets.

Importance of Diversification

Diversification can be an important step for a business that is looking to expand. However, it is important to keep in mind that diversification has its benefits and limitations.

Advantages

Some of the advantages of diversification are:

• Diversification often leads to increased profitability.

• Businesses can tap into industries, markets and segments that have not been reached yet.

• Diversification can also minimize risk during an economic or industrial downturn, as the business has multiple sources of revenue and income.

• Diversification can also help with marketing. A wider reach can boost brand recognition and brand image.

• Diversification can lead to more efficient use of resources and capabilities and even result in economies of scale.

Disadvantages

Some of the disadvantages of diversification could be:

• There could be a lack of expertise in one field if the business is operating in multiple industries, which can reduce the business's competitiveness.

• Diversification can also be confusing to customers if the business is known for a signature product or offering.

• It can be quite costly to diversify (hiring employees, training, acquiring new resources, etc.) which is why it is important to weigh the benefits and risks of the diversification.

• If the company is widely diversified, they also risk a reduction in innovation and research and development.

• It could be harder to budget and plan financially when there are multiple operations involved.

Diversification - key Takeaways

• Diversification is a growth strategy.
• Diversification takes place when your business introduces a new product into the supply chain to increase profitability.
  
• Vertical diversification, also known as vertical integration, is when you expand forward or backwards in your supply chain or production process.
• Horizontal diversification is when your business expands into products or fields that are somewhat unrelated to current business activities.
  
• Concentric diversification is when your business starts producing products that are similar in the type of technology or expertise it requires to produce them.
• Conglomerate diversification is when your business develops products that are completely unrelated to its current product offering.
• The Ansoff Matrix is a useful tool for strategic planning.
• Diversification can lead to increased profitability, brand image and recognition.
• On the other hand, it could be confusing to customers and costly to diversify.
  

¹ Lighter capital, https://www.lightercapital.com/blog/what-is-diversification-strategy-definition-examples/

² Jeroen Kraaijenbrink, Why Netflix's expansion into gaming is not a good strategy, 2021. https://www.forbes.com/sites/jeroenkraaijenbrink/2021/09/02/why-netflixs-expansion-into-gaming-is-not -a-good-strategy /? sh = 478b7b6964a4

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