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Diversification (marketing strategy)

Diversification is a form of corporate strategy for a company. It seeks to increase profitability


through greater sales volume obtained from new products and new markets. Diversification can
occur either at the business unit level or at the corporate level. At the business unit level, it is
most likely to expand into a new segment of an industry which the business is already in. At the
corporate level, it is generally and it is also very interesting entering a promising business outside
of the scope of the existing business unit.

Diversification is part of the four main marketing strategies defined by the Product/Market
Ansoff matrix:

Product-Market Growth Matrix is a marketing tool created by Igor Ansoff and first published
in his article "Strategies for Diversification" in the Harvard Business Review (1957). The matrix
allows marketers to consider ways to grow the business via existing and/or new products, in
existing and/or new markets – there are four possible product/market combinations. This matrix
helps companies decide what course of action should be taken given current performance. The
matrix consists of four strategies:

• Market penetration (existing markets, existing products): Market penetration occurs when
a company enters/penetrates a market with current products. The best way to achieve this
is by gaining competitors' customers (part of their market share). Other ways include
attracting non-users of your product or convincing current clients to use more of your
product/service, with advertising or other promotions. Market penetration is the least risky
way for a company to grow.
• Product development (existing markets, new products): A firm with a market for its
current products might embark on a strategy of developing other products catering to the
same market (although these new products need not be new to the market; the point is that
the product is new to the company). For example, McDonald's is always within the fast-
food industry, but frequently markets new burgers. Frequently, when a firm creates new
products, it can gain new customers for these products. Hence, new product development
can be a crucial business development strategy for firms to stay competitive.
• Market development (new markets, existing products): An established product in the
marketplace can be tweaked or targeted to a different customer segment, as a strategy to
earn more revenue for the firm. For example, Lucozade was first marketed for sick
children and then rebranded to target athletes. This is a good example of developing a
new market for an existing product. Again, the market need not be new in itself, the point
is that the market is new to the company.
• Diversification (new markets, new products): Virgin Cola, Virgin Megastores, Virgin
Airlines, Virgin Telecommunications are examples of new products created by the Virgin
Group of UK, to leverage the Virgin brand. This resulted in the company entering new
markets where it had no presence before.

Ansoff pointed out that a diversification strategy stands apart from the other three strategies. The
first three strategies are usually pursued with the same technical, financial, and merchandising
resources used for the original product line, whereas diversification usually requires a company
to acquire new skills, new techniques and new facilities.

Note: The notion of diversification depends on the subjective interpretation of “new” market and
“new” product, which should reflect the perceptions of customers rather than managers. Indeed,
products tend to create or stimulate new markets; new markets promote product innovation.

The different types of diversification strategies

The strategies of diversification can include internal development of new products or markets,
acquisition of a firm, alliance with a complementary company, licensing of new technologies,
and distributing or importing a products line manufactured by another firm. Generally, the final
strategy involves a combination of these options. This combination is determined in function of
available opportunities and consistency with the objectives and the resources of the company.

DIVERSIFICATION: GROW OR BUY?

Diversification efforts may be either internal or external. Internal diversification occurs when a
firm enters a different, but usually related, line of business by developing the new line of business
itself. Internal diversification frequently involves expanding a firm's product or market base.
External diversification may achieve the same result; however, the company enters a new area of
business by purchasing another company or business unit. Mergers and acquisitions are common
forms of external diversification.

INTERNAL DIVERSIFICATION.

One form of internal diversification is to market existing products in new markets. A firm may
elect to broaden its geographic base to include new customers, either within its home country or
in international markets. A business could also pursue an internal diversification strategy by
finding new users for its current product. For example, Arm & Hammer marketed its baking soda
as a refrigerator deodorizer. Finally, firms may attempt to change markets by increasing or
decreasing the price of products to make them appeal to consumers of different income levels.

Another form of internal diversification is to market new products in existing markets. Generally
this strategy involves using existing channels of distribution to market new products. Retailers
often change product lines to include new items that appear to have good market potential.
Johnson & Johnson added a line of baby toys to its existing line of items for infants. Packaged-
food firms have added salt-free or low-calorie options to existing product lines.
It is also possible to have conglomerate growth through internal diversification. This strategy
would entail marketing new and unrelated products to new markets. This strategy is the least used
among the internal diversification strategies, as it is the most risky. It requires the company to
enter a new market where it is not established. The firm is also developing and introducing a new
product. Research and development costs, as well as advertising costs, will likely be higher than
if existing products were marketed. In effect, the investment and the probability of failure are
much greater when both the product and market are new.

EXTERNAL DIVERSIFICATION.

External diversification occurs when a firm looks outside of its current operations and buys
access to new products or markets. Mergers are one common form of external diversification.
Mergers occur when two or more firms combine operations to form one corporation, perhaps
with a new name. These firms are usually of similar size. One goal of a merger is to achieve
management synergy by creating a stronger management team. This can be achieved in a merger
by combining the management teams from the merged firms.

Acquisitions, a second form of external growth, occur when the purchased corporation loses its
identity. The acquiring company absorbs it. The acquired company and its assets may be
absorbed into an existing business unit or remain intact as an independent subsidiary within the
parent company. Acquisitions usually occur when a larger firm purchases a smaller company.
Acquisitions are called friendly if the firm being purchased is receptive to the acquisition.
(Mergers are usually "friendly.") Unfriendly mergers or hostile takeovers occur when the
management of the firm targeted for acquisition resists being purchased.

There are three types of diversification: concentric, horizontal and conglomerate:

Concentric diversification

This means that there is a technological similarity between the industries, which means that the
firm is able to leverage its technical know-how to gain some advantage. For example, a company
that manufactures industrial adhesives might decide to diversify into adhesives to be sold via
retailers. The technology would be the same but the marketing effort would need to change. It
also seems to increase its market share to launch a new product which helps the particular
company to earn profit. However, there's one more example, Addition of tomato ketchup and
sauce to the existing "Maggi" brand processed items of Food Specialities Ltd. is an example of
technological-related concentric diversification.

Horizontal diversification

The company adds new products or services that are technologically or commercially unrelated
(but not always) to current products, but which may appeal to current customers. In a competitive
environment, this form of diversification is desirable if the present customers are loyal to the
current products and if the new products have a good quality and are well promoted and priced.
Moreover, the new products are marketed to the same economic environment as the existing
products, which may lead to rigidity and instability. In other words, this strategy tends to increase
the firm's dependence on certain market segments. For example company was making note books
earlier now they are also entering into pen market through its new product.

Another interpretation

Horizontal integration occurs when a firm enters a new business (either related or unrelated) at
the same stage of production as its current operations. For example, Avon's move to market
jewelry through its door-to-door sales force involved marketing new products through existing
channels of distribution. An alternative form of that Avon has also undertaken is selling its
products by mail order (e.g., clothing, plastic products) and through retail stores (e.g., Tiffany's).
In both cases, Avon is still at the retail stage of the production process.

Conglomerate diversification (or lateral diversification)

The company markets new products or services that have no technological or commercial
synergies with current products, but which may appeal to new groups of customers. The
conglomerate diversification has very little relationship with the firm's current business.
Therefore, the main reasons of adopting such a strategy are first to improve the profitability and
the flexibility of the company, and second to get a better reception in capital markets as the
company gets bigger. Even if this strategy is very risky, it could also, if successful, provide
increased growth and profitability.

Rationale of diversification

According to Calori and Harvatopoulos (1988), there are two dimensions of rationale for
diversification. The first one relates to the nature of the strategic objective: diversification may be
defensive or offensive.

Defensive reasons may be spreading the risk of market contraction, or being forced to diversify
when current product or current market orientation seems to provide no further opportunities for
growth. Offensive reasons may be conquering new positions, taking opportunities that promise
greater profitability than expansion opportunities, or using retained cash that exceeds total
expansion needs.

The second dimension involves the expected outcomes of diversification: management may
expect great economic value (growth, profitability) or first and foremost great coherence and
complementary to their current activities (exploitation of know-how, more efficient use of
available resources and capacities). In addition, companies may also explore diversification just
to get a valuable comparison between this strategy and expansion.

Risks

Diversification is the riskiest of the four strategies presented in the Ansoff matrix and requires the
most careful investigation. Going into an unknown market with an unfamiliar product offering
means a lack of experience in the new skills and techniques required. Therefore, the company
puts itself in a great uncertainty. Moreover, diversification might necessitate significant
expanding of human and financial resources, which may detracts focus, commitment and
sustained investments in the core industries. Therefore a firm should choose this option only
when the current product or current market orientation does not offer further opportunities for
growth. In order to measure the chances of success, different tests can be done:

• The attractiveness test: the industry that has been chosen has to be either attractive or
capable of being made attractive.
• The cost-of-entry test: the cost of entry must not capitalize all future profits.
• The better-off test: the new unit must either gain competitive advantage from its link with
the corporation or vice versa.

Because of the high risks explained above, many companies attempting to diversify have led to
failure. However, there are a few good examples of successful diversification:

• Virgin Media moved from music producing to travels and mobile phones
• Walt Disney moved from producing animated movies to theme parks and vacation
properties
• Canon diversified from a camera-making company into producing an entirely new range
of office equipment.
• Nirma Ltd. Moved from soda ash business to cement industry.
• Indian tobacco Company Ltd has diversified into lifestyle products, food business,
packaged industry.
• General Electric is present in Banking, Real Estate, Aircraft Leasing and many more
industries.

Diversification Strategy: Pros and Cons

Every concept has its own pros and cons. Given below are pros and cons of diversification which
need to be taken into consideration when opting for the same.

Advantages of Diversification
There are several methods by which diversification strategy can be implemented, the most
common among which are acquisitions and joint ventures. Diversification can help the companies
to achieve their potential in a developing economy. In case of concentric diversification a strong
brand name can help in leveraging the new products belong to that brand. Diversification strategy
can help the company in spreading their customer base. It also helps in enhancing the product
portfolio of the company by introducing complimenting products in the market.

Disadvantages of Diversification
In case of diversification through acquisition, one needs to ensure that the people at the
managerial level are well-versed with the process that needs to be followed for the company to be
acquired. If you are not armed with people who can handle these things, starting from the grass
root can turn out to be tedious task. One needs to take into consideration the efforts required to
run the business, and if the efforts required are more than the profit you get, it is better off to stay
away from the venture. Lack of knowledge about the current position of the market can really
backfire on you from all sides. Going against the core values of the company, just for the sake of
profit is also not advisable, which again limits your options.