Thursday, June 30, 2011

Diversification: One Path to Increasing Revenue


- Nancy Boese, Growth Group Consultant –

Companies have different stages of development and the decision to diversify into new markets or new products can be daunting.  Several situations provide indications a company may be ready to diversify.  Companies should consider diversifying for any of the following reasons:

  • One customer exceeds 50% of the total revenue
  • One industry exceeds 50% of the total revenue
  • Company has reached a plateau in sales and the market is saturated
  • Company has reached a plateau in sales and opportunities are available in new markets
  • Company has excess cash and can purchase a business to expand its markets

Many options exist to solve these situations.  One factor to consider is the level of risk the company is willing to take for diversification.  A renowned business tool, the Ansoff matrix (below), identifies the options for expansion and the related level of risk.

Diversification Matrix

The Ansoff Matrix provides four options for diversification:

  • Market Penetration:  The company increases revenue with existing products in existing markets.  The intent is to increase its market share.
  • Market Development:  The company sells existing products to new market segments.
  • Product Development:  The company develops new products/services to sell to its current customers.
  • Diversification:  The firm grows by developing new business opportunities with new products for new markets.

There is risk involved with each quadrant also.  The Market Penetration quadrant with existing products and existing customers is the least risky, takes the least amount of money, and provides the quickest results.  The highest risk section is Diversification.  This area takes the longest to develop, requires extensive investment of time, people, resources, and money.  The Product Development and Market Development both have a higher level of risk than using the Market Penetration strategy.  The level of risk for these two areas is dependent on development time, financial commitment, and company resource requirements.

To determine which opportunity the company should pursue, several steps need to be completed.  The first is to conduct market research.  This can include any or all of the following:  Primary research, which could include surveying current or future customers, in-depth interviews, focus groups, and various other techniques.  A wealth of information is also available through secondary sources.  Research conducted by various government offices, trade associations, or private companies can help provide a base for discussion and analysis.  For example:  If the company decided to use the Market Development Strategy and wanted to diversify geographically, information could be gathered on the area’s economic situation, number of customers in the area that meet the target market definition, and other pertinent information.

Once the information has been gathered and analyzed the company needs to establish what they want to accomplish with their diversification strategy.  Establishing realistic goals to accomplish the outcomes desired by the company is vital for determining if the diversification strategy is working.  The outcomes should be easily extracted from the accounting system or customer relationship management system.

Reaching agreement on which diversification strategy to use can be the most challenging step.  There are different decision making models which can be utilized.  In general, the company wants to determine which opportunity will best help accomplish the goals already established.  In addition, the company may need information on costs, staffing, new infrastructure requirements, etc. to identify the best diversification strategy.

Once the decision is finalized regarding the diversification strategy, a detailed implementation plan needs to be developed.  The implementation plan provides a road map for what tasks need to occur, who is responsible for accomplishing the task, and deadlines.  This road map helps hold individuals accountable for moving the diversification initiative forward.  The plan and accountability is critical to the success of the diversification initiative.

The opportunities to diversify a company are varied.  Companies may decide not to complete all the background work before setting up a diversification strategy.  This can be dangerous to the company if they do not have all the internal players in agreement that this is the right move.  It’s crucial that the management team fully supports the diversification strategy, so they need to be included in the decision-making process, and make sure they understand the implementation as the company moves forward.  This will be instrumental in the overall success for the company’s diversification efforts.

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