DIVERSIFICATION – One Path to Increasing Revenue
March 31, 2011
By Nancy Boese, Michigan Small Business and Technology Development Center. From SBAM’s member-only Focus on Small Business magazine.
Companies have different stages of development and the decision to diversify into new markets or new products can be daunting. There are several situations that indicate a company may be ready to diversify. Companies should consider diversifying for any of the following reasons:
- One customer is over 50 percent of the total revenue
- One industry is over 50 percent 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
- Company has excess cash and can purchase a business to expand its markets
There are many options to solve these situations. One factor to consider is the risk the company is willing to take to expand. A renowned business tool is the Ansoff 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.
What are the Risks?
There is risk involved with each quadrant. 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 would be Diversification. This area takes the longest to develop and 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.
1. 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 vital information.
2. Once the information has been gathered and analyzed, the company needs to establish what they want to accomplish with their strategy. Establishing realistic goals that will accomplish the outcomes desired by the company is vital to evaluating if the diversification strategy is working. The outcomes should be easily extracted from the accounting system or customer relationship management system.
3. Reaching an 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.
4. 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 making the changes happen. 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 you do not have all the internal players in agreement that this is the right move for the company.
It’s crucial that the management team understands the diversification strategy, so include them 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.
Nancy Boese oversees the Michigan Small Business and Technology Development Center’s Growth Group Team, which assists second-stage companies with growth strategies.