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What is diversification strategy? When you have a broad range of investments as an individual, you have what is known as a diversified portfolio. Your investments might include stocks from various blue-chip corporations, bonds, cash and other securities. This is desirable because some investments, such as stocks, are riskier than others, such as bank deposits. They are subject to market risks, but they generally carry a higher rate of return, which is why a savvy investor would include them in their investment plan. By spreading out their money across various instruments, with each carrying a different risk, it balances rewards with risk. It’s hedging your bets by not putting all the eggs in the same basket.
This is what diversification strategy means to an individual investor. The same principles apply to an organization that wishes to diversify its holdings and investments. It may invest in several industries or expand its product portfolio to maintain its competitive edge. A diversification strategy enables an organization to take advantage of market fluctuations to maintain an overall return on investment that is more stable over time.
A diversification strategy can help an investor, individual or corporate, persevere through difficult times. Now that we’ve seen what is diversification strategy, let’s focus on the types of diversification strategy an organization can adopt.
Types Of Diversification Strategy
Organizations may choose a diversification strategy that suits their needs. Whether it’s a small business or a sprawling multinational, most organizations can benefit from a diversified portfolio. Here’s one way in which types of diversification strategy are categorized:
Defensive Diversification VS Offensive Diversification
Defensive diversification is the act of reducing the risk in an investment portfolio by diversifying its product offering to offer something new to an old customer. In an offensive approach, a company will enter new markets to find a new customer base.
There are other ways to group diversification strategies. Here are some more types of diversification strategy:
Horizontal Diversification
When an organization has investments in different areas of the same business, it’s known as horizontal diversification. It could be a new product offering, distinct from its existing products, which appeals to its old customers. For example, Amazon sells the e-book reader Kindle to its customers who already buy its e-books.
Vertical Diversification
When one business is invested in different levels of the supply chain, it is called a vertical diversification strategy. For example, an organization might be involved in farming, selling fresh and frozen produce and production and sale of ready-to-eat meals.
Concentric Diversification
In a concentric diversification strategy, a portfolio includes more than one similar product. These types of diversification strategy involve branching out with a diverse offering of associated goods or services. For instance, if a toothpaste maker introduces a new brand designed for users with sensitive teeth, it’s an example of concentric diversification.
The logic of these types of diversification strategy applies whether it is an individual investor or a company. Let’s look at some industry-specific diversification strategy examples next.
Diversification Strategy Examples
To achieve a diversified portfolio, organizations need to think beyond their existing product, industry and geographical location. This isn’t easy, particularly for a newer business, but it’s important to cushion against the ups and downs in demand and supply, customer preferences and trends, rising input costs and regulatory shifts. Here are a few diversification strategy examples to show how your organization might approach this..
Concentric Diversification
Say you run an ice cream shop. You are present in one location in a high footfall mall. You offer eight classic flavors in a cup or cone. Over time, you increase your product line to include new flavors that are unique to your brand. You add waffles and crepes to the menu to capture those patrons who want something additional. You add drinks too with an espresso machine and a soda fountain.
Horizontal Diversification
In our diversification strategy examples, you start with one location for your ice cream shop and it is doing very well. But rising real-estate costs have been eating into your profits and there’s no physical space to expand. There’s also a new competitor that is gaining ground rapidly. You open three new outlets to increase revenue and brand penetration. While you must make a significant investment initially, you know it will pay off in the three-year horizon.
Vertical Diversification
Now that you’ve expanded your flavor offering and footprint, it might be time to consider complementary businesses. Home delivery of ice cream is a natural extension of your product. For this, you might have to develop a unique product line that holds up better to home freezers and delivery cold chains. For our diversification strategy examples, you may add other at-home dessert experiences as well, such as a line of shelf-stable ice cream toppers and cone-making kits.
When developing a diversification strategy, there are many factors to consider. Understanding what is diversification strategy is the first step in creating a more robust organization. With Harappa’s Select A Strategy program, you’ll learn Thrive Skills like Decoding Ambiguity, Overcoming Bias and Assimilating Knowledge to help you with complex decision-making.
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