Related diversification – where the new business area has connections to the existing businesses of the firm – provides a basis for the firm to be more competitive than two separate businesses. However, there are different ways that the areas of the firm can be related to one another. This article explores some of the different approaches to related diversification.
Related by resources
The first way that diversification can be related is that it uses related resources. The existing resources of the firm can then be used in the new area.
This has the benefit of sharing costs – the capability can now be shared in a different area, with potential savings in costs as well as the opportunity to be stronger in that area than existing firms. Cost savings from sharing the resources into a different area is an example of economies of scope – costs coming down associated with now operating in multiple different areas. If this resource is an area that you are particularly strong on, you may be able to leverage those resources in the new area, and be more effective than other companies only in the one area.
Related by products
Another form of related diversification is being related-by-products. If a company for example makes one line of products – possibly one type of drink, then related-by-product would be to move into another product with similar attributes (e.g., a different type of drink).
The key to being successful with this form of diversification is to consider why your company is going to be more successful operating in both product areas than two separate companies would. Typically, there are some underlying resources that are shared (e.g., marketing, brand, or production), to allow the company to be better than if the two companies were seperate.
Related by customers served
A final way that diversification can be related to the existing business of the firm is if they serve the same customers as are currently being serving. This may involve recognizing that your customers also buy a similar product, and moving into that area.
A key to being successful with this form of diversification is again considering why you would be more successful than two separate firms. Brand may be one possible reason for your existing customers to choose your firm over others. Another possibility may be some greater compatibility that comes from having compatible products that work better together relative to products made by different companies.
Final thoughts: Ensuring that there is an underlying benefit from the diversification
A key thing to ensure when considering diversification is that there is a genuine advantage that comes from you operating in the two different areas. Unless you are actually taking advantage of the related resources, similarity in products, or customers served, then the diversification is unlikely to bring benefits over firms only in one of the areas.
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