Related diversification – moving into an area closely connected to the firm’s original operations – has the potential for benefits relative to two separate firms. This article explores some benefits that derive from increasing the firm’s scope through diversification.
Opportunities from related diversification
Potential to Share resources across areas
One of the key advantages of related diversification is the ability to share key resources across different areas. Key resources and capabilities of the firm can be utilized in a new area – potentially giving the firm a competitive advantage relative to other firms that may not pose comparable resources. There may for example be technology and product features that can be used in the new area. Support functions can also be shared with cost savings relative to a company only operating in one of the areas.
Potential to increase economies of scale
Given that the related diversification is closely connected to the operations of the firm, there may be economies of scale benefits that come from expanding into the new area. The same machinery for example can be shared in the new area, allowing the fixed cost of the machinery to be spread over a larger number of products produced. Purchasing volumes of the raw material be greater – potentially reducing the cost per unit.
Potential to create new products
Building up related capabilities may ultimately allow further new products to be developed. Combining the capabilities of the original business areas, with new capabilities of the related area that the firm has diversified into may allow a brand new third area to be expanded into – relying on both original capabilities.
Potential to share distribution channel
The existing distribution channel for the company can make it easier to launch a related product, that can be sold alongside the original one. Retailers may be happier dealing with an existing supplier relative to a new company, and customers likewise may prefer to buy from a company that they trust.
Potential to charge a higher price
There may be some situations where operating in two related areas may allow you to charge a higher price than if the operations were separate. Combined under one brand, the products may be more valuable – potentially able to integrate well with each other and function better than if they were produced by separate companies.
Why related diversification is considered better than un-related diversification
Related diversification – moving into areas that are similar to the areas that you currently operate in – is typically considered much more likely to yield benefits for the firm than unrelated diversification. The reason is that there are simply much more opportunities for revenue enhancement or cost savings with related diversification than is possible with unrelated diversification. If you are moving into a completely different area there is often simply limited opportunities to share resources and capability across the different areas.
Final thoughts: Beware of imagined synergies
While there are opportunities for cost savings or revenue increases through related diversification, it is important not to overstate synergy opportunities. It is not uncommon for managers to see a lot of possible synergies – many of which don’t actually transpire. Be sure that you can actually identify the specific ways that the expansion will yield improvements, beyond very high-level discussions of potential synergies.