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Diversification Strategy

Updated on March 20, 2024
Article byNanditha Saravanakumar
Edited byNanditha Saravanakumar
Reviewed byDheeraj Vaidya, CFA, FRM

What is Diversification Strategy?

A diversification strategy is a method of expansion or growth followed by businesses. It involves launching a new product or product line, usually in a new market. It helps businesses to identify new opportunities, boost profits, increase sales revenue and expand market share. The strategy also gives them leverage over their competitors. 

How Diversification Strategy works?

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The corporate diversification strategy or product diversification is a prominent approach followed by large-scale businesses. However, diversifying products is usually risky and requires extensive market research and analysis. There are three main types of product diversification – concentric, horizontal, and conglomerate, based on the scope and approach undertaken.

Key Takeaways

  • A business diversification strategy is when companies introduce new products to a new market with the goal of expansion.
  • The diversification approach is more suitable for large multinational corporations. Some examples of the corporate diversification strategy include Amazon and Disney.
  • However, a risk factor is associated with the many benefits that product diversification can offer, like increased sales and high profits. Therefore, companies spend lots of money to understand a market before entering them.
  • The strategy can be implemented by identifying the product, coming up with the product, drafting a strategy, managing finances, and introducing the product.
  • The three main types of diversification strategies include concentric, horizontal, and conglomerate strategies.

Diversification Strategy Explained

The diversification strategy is often opted for by companies that have established a reputation domestically. This gives them scope for growth and enables them to expand to new markets or introduce new products. Usually, there are four approaches to product expansion that businesses can follow. 

The first strategy is market penetration, in which a company tries to increase an existing product’s share in an existing market. This strategy has little risk as the company has already studied the market and has experience operating in it.

The second approach is market development, where a company introduces an existing product in a new market. This approach can be a little risky, as the company has to study the market’s acceptance of the product and appeal to local tastes and preferences. For example, when McDonald’s first came to India, its offerings faced heavy backlash. Therefore, McDonald’s had to modify their offerings, add more vegetarian options, and remove beef recipes from the menu.

The third strategy is product development, in which companies introduce new products in an existing market. This, too, can be a little risky regarding people’s acceptance of the product. However, if the company has launched the product by recognizing a gap in the market, it will be accepted. For instance, when people started turning to vegan diets in the United States, many fast-food chains like Starbucks and Domino’s introduced vegan options.

The last strategy is diversification. Here, companies introduce new products to new markets. This is the riskiest of all approaches, as the company has to study the product’s acceptance, demand, and market situation. Hence, it is expensive too. 

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The Risk Factor in Diversification Strategy

Having understood the basics of diversification, it is now important to know the risk associated with product diversification strategy. 

Diversification can be risky for two reasons – new products and new markets. 

Introducing any product into a new market involves a lot of research to understand the people. If the new product does not appeal to the local tastes, the business can face heavy loss, considering that diversification is expensive. 

Thus the product should be innovative and fill the supply-demand gap in the market. The businesses should first understand the market’s requirement for the product and the culture of the market. This can help them cater to the market better and can also help reduce loss to a great extent. 

Types

The three main diversification strategies are based on the approach undertaken – concentric, horizontal, and conglomerate diversification.

#1 – Concentric diversification 

This method introduces closely related products to the existing market. That is, similar products are added to the current product line. Such a type of diversification brings the focus of a business to a center point, thus concentric. For example, an automobile company adds a solar-powered car to its eco-friendly auto line.

#2 – Horizontal diversification 

Diversifying a product horizontally means introducing new but unrelated offerings to the company’s product mix. Horizontal diversification can also be adapted to launch complementary goods. For instance, a clothing company launching its footwear line.

#3 – Conglomerate diversification 

A business focuses on a completely different product line in this strategy. Hence, this can be extremely risky. The company broadens its scope and targets a different market. The Disney diversification strategy is a suitable example here. 

Example

Now let’s discuss the real-life example of Amazon’s diversification strategy. Amazon is a multinational company that provides various online services such as e-commerce, cloud computing, email delivery, online video, music streaming, e-payment, and affiliate marketing. Apart from this, Amazon also introduced a virtual assistant, Alexa, in 2014. Further, it operates brick-and-mortar stores in the United States.

Thus, Amazon has been successfully following a business diversification strategy that has been helping it grow its profits. Therefore, e-commerce is no more the only major source of income for Amazon. In fact, its cloud service business is now valued at $3 trillion.

Advantages of diversification

Nevertheless, diversification is a good approach for big corporations. It has many advantages and helps businesses explore new opportunities and serve diverse markets. Hence, companies will get higher reach, better brand reputation, and increased profitability. It also gives the companies a competitive edge. 

Consider the case of Disney diversification strategy. Disney started as an animation business but soon expanded to selling merchandise and streaming online content. Disney even opened theme parks worldwide and entered the entertainment industry, thus growing in size and profits.

Frequently Asked Questions (FAQs)

What are the causes of diversification strategy?

The causes of diversification are its obvious benefits that include better business prospects, enhanced brand image, higher profits, and entry into new markets. 

How to implement a diversification strategy?

Product diversification strategy is launching a new product in a new market. Therefore, first, a company has to identify the market. Secondly, it has to develop an innovative product by identifying the need in the market. Lastly, it has to research and study the market and prepare the budget and forecast. 

What are the three types of diversification strategies?

There are three types of diversification: concentric, horizontal, and conglomerate. In the concentric strategy, the business launches a similar product in the existing product line. In the horizontal strategy, the company launches an unrelated, new product in the product mix. Finally, the company adds a totally different product line to its offerings in the conglomerate strategy.

This article has been a guide to Diversification Strategy and its definition. We discuss the risk factor in diversification strategy, strategy types & examples. You can learn more from the following articles –

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Comments

  1. Peace Ahedor says

    Insightful. Thank you

  2. Ezeh philomena says

    Quite helpful. Many thanks

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