Business Diversification

Introduction

This tutorial will guide you through the concept of business diversification. It explores the importance of diversifying a business, the tests to evaluate potential diversification opportunities, and the strategies for entering new industries. Understanding these principles can help you create added value for shareholders and ensure long-term success for your company.

Step 1: Evaluate Industry Attractiveness

Before diversifying, assess whether the new industry is appealing and offers growth potential.

• Conduct Industry Analysis: Research the industry’s growth rate, competitive landscape, and profitability.
• Profitability Benchmarking: Ensure that the new industry has the potential for profits and returns on investment that are equal to or better than your current business.

Step 2: Assess the Cost of Entry

Evaluate the costs associated with entering the new industry to ensure they won’t hinder profitability.

• Cost Analysis: Calculate the total investment required for entry, including startup costs, operational expenses, and any potential liabilities.
• Return on Investment (ROI): Compare the potential ROI against your current business to ensure it justifies the investment.

Step 3: Determine the Better-Off Test

Ensure that entering the new business will create additional value.

• Synergy Evaluation: Analyze how the new business will work with your existing operations. Look for opportunities for cost savings or increased revenue through collaboration.
• Strategic Fit: Consider whether the new business aligns with your company’s overall strategy and goals.

Step 4: Choose Your Diversification Strategy

Decide how you will enter the new industry based on your resources and goals.

• Acquisition: Purchase an existing company in the target industry for immediate market presence.
• Internal Development: Build the new business from the ground up, which may take longer but allows for more control.
• Joint Ventures: Partner with another company to share resources and risks while entering the new market.

Step 5: Decide on Related vs. Unrelated Diversification

Determine whether to focus on businesses that are related to your current operations or to branch out into completely different industries.

• Related Diversification: This involves expanding into industries that are connected to your current business. It can help leverage existing resources and capabilities.
• Unrelated Diversification: Entering a completely different industry can spread risk but may stretch your management and resources too thin.

Conclusion

Business diversification can be a powerful strategy for growth and added shareholder value when approached thoughtfully. By evaluating industry attractiveness, assessing costs, ensuring synergies, and choosing the right entry strategy, you can make informed decisions that align with your business goals. As a next step, consider conducting thorough market research to identify potential industries for diversification.