To meet the expectations of their customers, complete their offer or generate additional income, companies may need to expand their activities and even develop new ones. This modality of extension is called diversification. Implementing an effective diversification strategy helps ensure a company’s growth and overall performance.
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What is a diversification strategy?
We speak of diversification when a company seeks to develop or acquire one or more new areas of activity. This strategy therefore makes it possible to broaden the portfolio of activities, production and targets of a company. This may result in the development of new products or entry into one or more new markets.
The diversification strategy is opposed to the specialization strategy which consists of concentrating the activities and skills of a company towards a single field of activity. Companies are diversified when they are present in at least two fields of activity. The need for diversification of activities generally becomes stronger when companies are located in an area far from their production or marketing base. Diversification is then an alternative offered to a company that participates in its development strategy.
The different types of diversification
There are several ways to diversify, the strategic option can develop from different angles.
- Horizontal diversification.
- Vertical diversification.
- Geographic diversification.
- Concentric diversification.
- Conglomerate diversification.
- Total diversification.
The horizontal diversification, or product diversification, allows companies to develop new products in their current market. However, the means of production, the technologies used and the target clientele remain unchanged.
Companies opting for a vertical diversification develop their activities within their main sector, thus leading to a modification of their value chain. The integration of activities can be done in two ways: upstream and downstream. Backward integration allows companies to ensure their supply by integrating the activities carried out by their suppliers. As for downstream integration, it gives them the possibility of ensuring the distribution of their services and products.
In the case of a geographic diversification, companies are establishing their activities in new areas. This presence can be local, national, continental or global. This type of diversification requires the development of new skills. Indeed, it targets customers and markets with different consumer habits and cultural specificities.
The concentric diversification jointly deploys the elements of horizontal diversification and those of vertical diversification. It is based on the transfer of skills already acquired and existing technologies. Its purpose is to develop new or old products or services in order to acquire new markets or maintain existing markets. These products created are often closely linked to pre-existing activities. The diversification of activities is then done in stages, it develops in a logic of progression. First, companies can offer new products or services to their current customers. Then, they will be able to assimilate new professions to develop more innovative or high-performance products and win over new customers.
The conglomerate diversification, or conglomerate, results in the desire of companies to embark on one or more new businesses by carrying out activities that have no common point with existing activities. These are separate activities that relate to separate markets. Thus, when an activity is in difficulty, it can be compensated by another more profitable activity.
Diversification is referred to as total when a company wants to both create new products and conquer new markets. It is then a question of a concentric diversification carried out to the maximum of its possibilities.
There are many reasons why businesses diversify. First of all, you should know that companies that diversify do not all endure the same economic situation. In the case of a healthy business, diversification is in the perspective of growth. On the contrary, for a company in difficulty, diversification aims at economic recovery. A diversification strategy can thus be put in place to meet the following objectives:
- reduce a company’s dependence on a field of activity or a market;
- ensure the survival of a company in decline;
- compensate for the lack of profitability of an activity or product;
- convert to more promising activities;
- seize growth opportunities;
- look for synergies;
- gain a competitive advantage.
What are the benefits of a diversification strategy?
The implementation of a diversification strategy offers many opportunities for development for companies opting for this strategy.
- Reduce and better distribute operating risks.
- Improve their profitability.
- Vary sources of income.
- Diversify their clientele.
- Acquire new skills.
- Benefit from greater synergy between their activities.
- Enhance strategic skills and areas of activity.
- Optimize costs over the long term.
- Generate significant revenue.
- Obtain additional market share.
- Acquire new business potential.
- Gain flexibility.
- Increase their notoriety.
How to implement a diversification strategy?
The extension of a company’s activities through diversification must be the subject of a global strategic reflection. Before implementing such a strategy, companies must study their environment to adopt the most appropriate option for their situation. To do this, they must carry out positioning studies and analyze the costs and risks of each possibility of diversification. They must also define their strengths and weaknesses, as well as the key success factors allowing them to remain competitive in a specific market. Indeed, for companies located in a competitive market, it is important to build a solid and lasting competitive advantage.
Several strategic analysis tools make it possible to choose the most favorable diversification option for the company:
- the SWOT matrix;
- the Ansoff matrix;
- the BCG matrix.
The SWOT matrix is an internal and external diagnostic tool for the company. It identifies the strengths and weaknesses of companies as well as the opportunities and pressures generated by its external environment. The SWOT matrix makes it possible to know whether diversification can and should be considered, while also identifying the type of strategy to be implemented.
The Ansoff matrix helps companies choose the best development strategy to adopt taking into account their products and markets. This tool makes it possible to formulate numerous strategic options according to different factual parameters: objectives, size of a specific market, penetration rate, etc. Thanks to the Ansoff matrix, companies can reflect on different areas of growth and validate, among other things, a specific diversification strategy.
The BCG matrix allows companies to assess the balances of their portfolio on their various activities and to determine the main priorities for action. Using this tool, they will be able to justify the allocation of resources to each of the areas of strategic activity in which they operate and develop. The BCG matrix makes it possible to measure the efficiency of each of these areas and therefore the profitability of a strategic decision such as a possible diversification option.
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