Corporate diversification is a strategy companies use to enter a new market or industry in which they do not currently operate. This approach is a method for pursuing growth and expansion into new areas. By moving into different fields, a company can open new channels for revenue and broaden its business footprint. While a powerful tool, diversification also introduces challenges such as increased organizational complexity and a potential loss of strategic focus.
Related Diversification
Related diversification occurs when a company expands into business areas that are similar or connected to its current operations. This approach creates a strategic fit, allowing the new venture to benefit from the company’s existing strengths. These strengths can include established technology, a strong brand reputation, or efficient distribution channels. The goal is to achieve synergy, where the combined entity is more valuable than its individual parts.
Synergy allows a company to leverage its core competencies. For example, a business with expertise in a particular technology can apply that knowledge to a new, related product line, reducing research and development costs. This sharing of resources can lead to economies of scope, where producing two or more products together is cheaper than producing them separately. This creates a competitive advantage that can be difficult for other firms to replicate.
An example of related diversification is Apple Inc. Originally a computer hardware company, Apple expanded into software, digital music players with the iPod, and eventually smartphones with the iPhone. Each new venture was related to its core competency in technology and user-friendly design. This allowed Apple to leverage its powerful brand and loyal customer base to successfully enter and redefine new markets, creating an interconnected ecosystem of products and services.
The Walt Disney Company provides another example of related diversification. Starting with animated films, Disney expanded into theme parks, merchandise, and media networks. Each of these businesses reinforces the others; a successful movie drives merchandise sales and creates new attractions for the theme parks. This interconnectedness allows Disney to maximize the value of its intellectual property across various, yet related, entertainment platforms.
Unrelated Diversification
Unrelated diversification, or conglomerate diversification, is when a company expands into industries with no direct connection to its existing operations. Unlike related diversification, the primary driver is financial rather than operational. The main goal is to manage risk by spreading investments across a portfolio of different markets, much like an individual investor diversifies their stock portfolio.
This approach does not seek operational synergy, and the subsidiaries of a multi-industry corporation often run independently. The parent company’s role is one of oversight and capital allocation, directing funds to businesses with the highest growth potential. Success is measured by the financial performance of the portfolio rather than efficiencies from shared resources.
An example of a company built on unrelated diversification is the Virgin Group. Founded by Richard Branson, Virgin operates in a wide array of industries, including airlines (Virgin Atlantic), music (formerly Virgin Records), and telecommunications (Virgin Mobile). These businesses have very little in common in terms of technology, production, or customer base. The common thread is the Virgin brand and a corporate culture of innovation, but the day-to-day operations are distinct.
Another example is General Electric (GE), which for many years operated in sectors from aviation and healthcare to energy and financial services. This broad portfolio was intended to provide stability, as a downturn in one industry could be offset by growth in another. However, managing such a diverse collection of businesses can be complex and may lead to a lack of focus.
Vertical Diversification
Vertical diversification is a strategy where a company expands to control multiple stages of its production process or supply chain. This approach involves moving either backward to control inputs or forward to control outputs. The goal is to streamline operations, reduce costs, and gain more control over the value chain.
Backward Integration
Backward integration occurs when a company moves “upstream” to control the supply of its raw materials or components. By acquiring or developing its own supply sources, a business can ensure a stable flow of necessary inputs. This strategy helps control the quality of materials, reduce dependency on third-party suppliers, and can lead to cost savings.
For instance, a furniture manufacturer might purchase a lumber mill to secure its wood supply, giving it direct control over the quality and cost of its raw material. Similarly, electric vehicle maker Tesla has pursued backward integration by investing in lithium refining for its batteries. This strategy helps insulate the company from supply chain disruptions and price volatility.
Forward Integration
Forward integration involves a company moving “downstream” to control the distribution of its products and its relationship with the customer. This can involve acquiring distributors or establishing direct-to-consumer sales channels. The motivations are to capture a larger profit margin and directly manage the brand experience.
A clothing manufacturer that opens its own retail stores is an example of forward integration, as it controls how its products are presented and sold. Athletic apparel giant Nike uses this strategy by opening its own retail stores and a robust e-commerce platform. This allows Nike to sell directly to consumers instead of relying solely on third-party retailers, giving it greater control over pricing and customer data.
Horizontal Diversification
Horizontal diversification is a strategy focused on offering new, often unrelated, products to a company’s existing customer base. The connection is the customer relationship and brand loyalty, not the production process or technology. The aim is to leverage the trust customers have with the brand to sell them something new. This allows a company to increase revenue from the same set of customers.
This strategy is seen when a company adds complementary products to its lineup. For example, a coffee shop that starts selling branded mugs and breakfast sandwiches is using horizontal diversification. The new products are different from the core offering but appeal to the same people visiting the stores. Similarly, beverage giants like Coca-Cola and Pepsi have expanded from soft drinks to offer bottled water, juices, and snack foods to their existing consumer base.