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Published September 29, 2022
A weekly look at issues facing Wyoming business owners and entrepreneurs from the Wyoming Small Business Development Center (SBDC) Network, a collection of business assistance programs at the University of Wyoming.
By P.J. Burns, regional director (Campbell, Crook, Johnson, Sheridan and Weston counties), Wyoming SBDC Network
Companies often consider their next stage of growth to be diversifying their offerings and investments. This means they may try moving into new areas related to their core business while continuing to run the original business. Diversifying can involve radical steps, such as acquiring a new business; developing new products or services; or moving into something completely different.
Diversification can be a risk-reduction strategy, as breaking into new markets and industries can help them achieve greater profitability. Adding new products and services in new markets, as well as targeting new customers, may give businesses a greater chance at increasing profitability.
There are three types of diversification techniques:
-- Concentric diversification involves adding similar products or services to the existing business. For example, when a computer company that primarily produces desktop computers starts manufacturing laptops, it is pursuing a concentric diversification strategy.
-- Horizontal diversification involves providing new and unrelated products or services to existing consumers. For example, a notebook manufacturer that enters the pen market is pursuing a horizontal diversification strategy.
-- Conglomerate diversification involves adding new products or services that are significantly unrelated and with no technological or commercial similarities. For example, if a computer company decides to produce notebooks, the company is pursuing a conglomerate diversification strategy.
Of the three types of diversification techniques, conglomerate diversification is the riskiest strategy. Conglomerate diversification requires the company to enter a new market and sell products or services to a new consumer base. A company incurs higher research, development and advertising costs. Additionally, the probability of failure is much greater in a conglomerate diversification strategy.
If a business is considering whether it should diversify, there are some questions to ask that may help a business determine how it should attempt to do so and to further assess the likelihood of success.
What can a company do better than any of its competitors in its current market?
Before diversifying, managers must define not only what their company does but particularly what it does better than its competitors.
Just as it is important to take stock of the pantry before going shopping, it is crucial for a company to identify its unique and unassailable competitive strengths before attempting to apply them elsewhere.
Think not about what your company does, but about what it does better than your competitors. Pinpointing strategic assets is a market-driven approach to defining your business. It forces an organization to identify how it might add value to an acquired company or a new market. This can be accomplished with excellent distribution, creative employees or superior knowledge about information transfer.
In other words, the decision to diversify is not made on the basis of a broad or vague business definition, such as “We’re in the entertainment business.” Rather, the decision is made on the basis of a realistic identification of strategic assets: “Our excellent distribution capabilities could radically improve the performance of the acquired company.”
What strategic assets do we need to succeed in the new market?
Once your company has identified its strategic assets, you can consider this second question. To successfully diversify, a company must have all -- not just some -- of the necessary strategic assets.
As in poker, the lesson for companies considering diversification is the same: You have to know when to hold them and know when to fold them. If a company is holding only a pair of strategic assets in an industry in which most players have a better hand, there’s no point in putting money on the table -- unless, that is, the next question can be answered in the affirmative.
Can we catch up to or leapfrog competitors at their own game?
Companies considering diversification need to answer another pair of questions: If we are missing one or more critical factors for success in the new market, can we purchase them, develop them or make them unnecessary by changing the competitive rules of the industry? Can we do that at a reasonable cost? Those assets must be obtained one way or another; otherwise, moving forward into new markets is likely to backfire.
Will diversification break up strategic assets that need to be kept together?
If you have cleared the hurdles that the preceding questions raise, you then need to ask whether the strategic assets they intend to export are transportable to the new industry or market. Too many companies mistakenly assume that they can break up clusters of competencies or skills that, in fact, work only because they are together, reinforcing one another in a particular competitive context. Managers need to ask whether their strategic assets are transportable to the industry or market they have targeted.
Will we be simply a player in the new market, or will we emerge a winner?
Even if you storm into new markets with all of the required competencies -- put together in the right combination -- your business could still struggle to gain a foothold. So, to achieve a sustainable advantage, diversifying companies need to create something unique. A company’s competitive advantage will be short-lived, and diversification will fail if competitors in the new industry can imitate the company’s moves quickly and cheaply; purchase the necessary strategic assets in the open market; or find an effective substitute for them. In other words, there is no point rushing into a new market unless you have a way to beat the existing players at their own game.
Of course, no company will intentionally diversify into an industry in which it will lose money. But, when considering a new market venture, you must decide how much money you want to make. For shareholders, being a contender is not enough. They seek winners, and winning is about unique and competitively meaningful strategic assets.
Diversification of your business is a complex game, no matter if your business is a single-person operation or if it is a large entity. When diversification seems like the logical next step, the next risk or the next strategic advancement, be sure to connect with your Wyoming SBDC Network adviser first to discuss your options and make a successful game plan.
The Wyoming SBDC Network offers no-cost advising and technical assistance to help Wyoming entrepreneurs think about, launch, grow, reinvent or exit their business. In 2021 alone, the Wyoming SBDC Network helped Wyoming entrepreneurs start 80 new businesses; support 4,077 jobs; and bring a capital impact of $9.2 million to the state. The Wyoming SBDC Network is hosted by UW with state funds from the Wyoming Business Council and funded, in part, through a cooperative agreement with the U.S. Small Business Administration.
To ask a question, call 1-800-348-5194, email email@example.com, or write Dept. 3922, 1000 E. University Ave., Laramie, WY 82071-3922.