The Advantages of Diversifying Your Business—And How to Do It
By Alexander Bachmann, ALLBUSINESS.COM
As both an entrepreneur and an investor, one of the most common questions I get is, "Why put the effort into looking for new lines of business when you have something that's already working and has the potential to be developed further?" To this, I bring up a metaphor, "Can you sit in an ordinary chair with just one leg?"
The answer is that you could if you were great at balancing, and some people might enjoy that challenge. However, what happens if that leg breaks? Now imagine that each leg on the chair is a business unit you're pursuing—even if one or two legs break, you can still stay seated, even though it's a bit of a balancing act.
The simple truth is that business ventures often die for one reason or another. There are some foreseeable, avoidable reasons, like poor market fit or lack of capital. But other things, such as currency devaluations or a global pandemic, can't be anticipated.
Diversification is a way to mitigate these potential risks and losses, but you must do it carefully. Otherwise, you'll run the risk of failing because your focus is too divided.
There are many other potential benefits of diversification, and here are a few tips for making the most of it.
Leverage new markets to stimulate growth
Every entrepreneur is chasing growth, but they don't always have a concrete idea of what that means. It's important to remember that a business can only achieve so much vertical growth before it either plateaus, combusts, or becomes a monopoly. In all three cases, this type of growth ultimately will lead nowhere.
For example, if a company is incredibly successful, it can become a monopoly in its space, like Google, Amazon, and Meta. These mega companies can no longer utilize their tried-and-true strategies for growth. They start losing traction over time, as we saw with Facebook. To remedy this, Meta acquired Instagram in a "horizontal growth" move that allowed the company to capture a new audience and bring back some users that had abandoned the platform.
Too many founders are focused on providing investors with 30 to 40% year-over-year vertical growth numbers—and this is not sustainable. Instead, once a business has a well-established management team and things are running smoothly, owners should start looking for new markets to achieve cross-vertical growth.
Treat new lines of business like investment projects
Another familiar problem companies can run into when trying to diversify is not knowing when to give up on a project that isn't yielding results. Devoting resources to R&D and expansion is important, but knowing when to stop pursuing an idea is equally important. For my businesses, I treat every new idea like an investment project. It needs to have actionable hypotheses, a dedicated amount of investor capital (i.e., budget allocation), and a defined runway.
As an example, since September 2021, I have had a team working on trying to turn an existing business feature into its own line of business. Unfortunately, I recently had to close the project because it was not feasible to bring the product to market, despite the year and a half spent looking for ways to make it work. The risk was no longer worth the investment, so it was time to move on.
There is no precise formula for a business to follow when it comes to determining how long to infuse cash into a diversification project, but founders must set a timetable and budget and stick to it, even in the face of losses.
Look for synergistic business opportunities
There are two basic types of diversification: synergistic and experimental. With the first, your company looks to related verticals for expansion and security. The Facebook to Instagram pipeline is one such example, and Disney's National Geographic and Marvel acquisitions are another. However, there are also experimental lines of business, such as Google's attempt to branch into the social messaging space with Google Hangouts.
Both modes of diversification have merit, but new businesses should focus more on horizontal integrations than large jumps to a new space. Finding niches within your current company's industry is a great way to make the most out of R&D investments while also pursuing horizontal growth for additional security.
The automobile industry is well-known for this. Many manufacturers will start with a core set of car models and eventually expand into related markets, like trucks or SUVs, or even make the leap into aircraft manufacturing, as we've seen with Honda.
Remember that focus trumps diversification
Founders are notorious for spreading themselves too thin. They are visionaries and creatives, so they always have new ideas they're excited to test. However, the mark of a truly great entrepreneur is someone who can direct their focus on the venture in front of them without becoming distracted by other projects.
Business owners must realize there is a difference between intentional diversification and experimenting simply because they have a promising new idea. One of the best strategies for developing new lines of business is to surround yourself with intelligent, competent people who can help you determine whether an idea is worth investing resources into or not, and then delegating to them when it’s time to pursue the new project.
Diversifying is the key to mitigating the risks of keeping a company running, and it's also an excellent way to expand your organization's reach through related projects, making it more sustainable in the long term.
FAQs on diversification and growing a business
What are 3 reasons why businesses adopt a diversification strategy?
Diversification can help with long-term growth, risk mitigation, and the overall sustainability of your business model.
What is an example of a diversified business?
Popular examples are Apple and Disney. Both expanded their original offerings into related and unrelated verticals to become the industry giants they are today. Apple grew from PCs to music to mobile devices and beyond, and Disney grew from an animation studio into real estate, merchandise, and global entertainment.
What makes a company diversified?
A diversified company operates in several different segments that are often unrelated, usually through the acquisition of an already operational business or through entry into a new market.
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