Product Diversification: The Good, Bad and Ugly
By Darrell Dvorak ©Why Not Magazine 2011
If your company is not growing, it’s likely stagnating, and perhaps even heading toward oblivion. That’s why, large company or small, growth is usually among a firm’s top strategic objectives, especially during periods like today of general economic stagnation or decline. And in their search for growth, companies invariably look to expand their scope of business beyond current products, markets and customers – in short, to diversify.
Unfortunately, successful diversification is difficult and rare. So before tackling it, management should consider several threshold issues.
Degree of Marketing Diversification
Diversification inherently requires different marketing strategies than what a company is used to. This matrix[1] helps to assess how challenging the difference might be by examining strategies relative to a company’s current products and markets/customers.
For example, creating a new product is easier than creating a new customer base, so offering current customers additional products related in some way to those they already purchase (A) may be less difficult than trying to sell current products to a somewhat different customer base (B). Thus, General Mills may be more successful adding a children’s breakfast drink to complement its cereal product line rather than trying to convince parents to eat Cocoa Puffs in addition to merely buying them for their kids.
Yet strategies A and B are likely to be less challenging than diversification that requires selling new products new markets/customers(C).
A recent study by McKinsey & Co. indirectly validates the critical importance of examining marketing strategies required by different types of diversification. They identified customer input as one of three keys to success in to developing and introducing new products. Such input is usually easier to gather where the respondents are current customers or are in some important way related to current customers. [sidebar reference]
Degree of Diversification Risk
Assessing business strategies should always examine risks as well as opportunities. When it comes to diversification, risks arise from the need to pursue new marketing strategies, from the additional complexity that is created, and potentially from the larger size of the company.
The matrix used above can also be modified to illustrate the degree of risk of particular diversification strategies. Illustrated below is my assessment of risk based solely on the need to pursue new marketing strategies, ranging from low (green), to moderate (yellow), to high (red).
To better appreciate the magnitude of risk that diversification can entail, consider the experience of Procter & Gamble, which has a long track record of new product success. Their CEO recently said that “only 15% to 20% of new [consumer package] products succeed. P&G's success rate is a little over 50%. But we were at that industry average in the '90s.”[2] Although we can’t be sure exactly where on the matrix P&G’s product development occurred, it doesn’t seem likely that it was in the yellow or red zones – yet at one point P&G’s success rate was only 15%-20%. And, more recently, P&G explicitly noted that “finding fresh applications for existing products is less costly than trying to plant new names in consumers’ minds.” [sidebar reference] And just two months ago, P&G announced that, while it is open to acquisitions, they aren’t a core part of its growth strategy.[3]
In short, the odds of product diversification failure seem to be significantly higher than the odds of diversification success. As a famous movie character once said, “Act accordingly.”
Opportunities to Partner
Sometimes diversification is best accomplished by working with a value-adding partner rather than going it alone. This is most common in technology-based industries, because technology tends to “branch” into diverse applications that may not fit with a firm’s existing marketing experience and capabilities. For example, biopharmaceuticals often address a range of therapeutic indications, but firms cannot easily market to a broad array of medical specialists. In order to capture value from all important markets, biopharmaceutical firms regularly license or sell rights to treat certain conditions, thereby capturing some incremental revenues and profit without investing in new marketing capabilities.
One Humongous No-No
Firms repeatedly pursue diversification as a way to reduce the risks their company represents for their investors. Yet this claim has also been repeatedly demolished by pointing out that investors can and do diversify their investment risks more directly, precisely and cheaply by diversifying their own investments. Invoking this rationale for a diversification strategy justifies replacing a company’s CEO, CFO and Board of Directors.
In conclusion, unless you’re fortunate to be among firms such as Intel, Wal-Mart and Google, who have significant growth opportunities in their product/market cores, you will regularly have to wrestle with diversification issues. In this event, it’s best to remember the wisdom of late, great management consultant, Peter Drucker:
“Diversification is not something that can be either condemned or recommended as such. It is therefore a major task of top management to decide what diversification and how much a particular company needs to make the most of its strengths and to get the best results from its resources. One starting point must be the question ‘What is the least diversification this business needs to accomplish its mission, obtain its objectives, and continue to be viable and prosperous?’ But at the same time the question ‘What is the most diversification we can manage, the most complexity this business can bear?’ should also be asked.”[4]
Act accordingly.
[1] The matrix is a familiar extension of one originally developed by Igor Ansoff and published by the Harvard Business Review in 1957.
[2] Businessweek.com, April 2, 2009.
[3] Online.wsj.com, November 20, 2009.
[4] Drucker, Peter F., Management, 1973.
By Darrell Dvorak ©Why Not Magazine 2011
If your company is not growing, it’s likely stagnating, and perhaps even heading toward oblivion. That’s why, large company or small, growth is usually among a firm’s top strategic objectives, especially during periods like today of general economic stagnation or decline. And in their search for growth, companies invariably look to expand their scope of business beyond current products, markets and customers – in short, to diversify.
Unfortunately, successful diversification is difficult and rare. So before tackling it, management should consider several threshold issues.
Degree of Marketing Diversification
Diversification inherently requires different marketing strategies than what a company is used to. This matrix[1] helps to assess how challenging the difference might be by examining strategies relative to a company’s current products and markets/customers.
For example, creating a new product is easier than creating a new customer base, so offering current customers additional products related in some way to those they already purchase (A) may be less difficult than trying to sell current products to a somewhat different customer base (B). Thus, General Mills may be more successful adding a children’s breakfast drink to complement its cereal product line rather than trying to convince parents to eat Cocoa Puffs in addition to merely buying them for their kids.
Yet strategies A and B are likely to be less challenging than diversification that requires selling new products new markets/customers(C).
A recent study by McKinsey & Co. indirectly validates the critical importance of examining marketing strategies required by different types of diversification. They identified customer input as one of three keys to success in to developing and introducing new products. Such input is usually easier to gather where the respondents are current customers or are in some important way related to current customers. [sidebar reference]
Degree of Diversification Risk
Assessing business strategies should always examine risks as well as opportunities. When it comes to diversification, risks arise from the need to pursue new marketing strategies, from the additional complexity that is created, and potentially from the larger size of the company.
The matrix used above can also be modified to illustrate the degree of risk of particular diversification strategies. Illustrated below is my assessment of risk based solely on the need to pursue new marketing strategies, ranging from low (green), to moderate (yellow), to high (red).
To better appreciate the magnitude of risk that diversification can entail, consider the experience of Procter & Gamble, which has a long track record of new product success. Their CEO recently said that “only 15% to 20% of new [consumer package] products succeed. P&G's success rate is a little over 50%. But we were at that industry average in the '90s.”[2] Although we can’t be sure exactly where on the matrix P&G’s product development occurred, it doesn’t seem likely that it was in the yellow or red zones – yet at one point P&G’s success rate was only 15%-20%. And, more recently, P&G explicitly noted that “finding fresh applications for existing products is less costly than trying to plant new names in consumers’ minds.” [sidebar reference] And just two months ago, P&G announced that, while it is open to acquisitions, they aren’t a core part of its growth strategy.[3]
In short, the odds of product diversification failure seem to be significantly higher than the odds of diversification success. As a famous movie character once said, “Act accordingly.”
Opportunities to Partner
Sometimes diversification is best accomplished by working with a value-adding partner rather than going it alone. This is most common in technology-based industries, because technology tends to “branch” into diverse applications that may not fit with a firm’s existing marketing experience and capabilities. For example, biopharmaceuticals often address a range of therapeutic indications, but firms cannot easily market to a broad array of medical specialists. In order to capture value from all important markets, biopharmaceutical firms regularly license or sell rights to treat certain conditions, thereby capturing some incremental revenues and profit without investing in new marketing capabilities.
One Humongous No-No
Firms repeatedly pursue diversification as a way to reduce the risks their company represents for their investors. Yet this claim has also been repeatedly demolished by pointing out that investors can and do diversify their investment risks more directly, precisely and cheaply by diversifying their own investments. Invoking this rationale for a diversification strategy justifies replacing a company’s CEO, CFO and Board of Directors.
In conclusion, unless you’re fortunate to be among firms such as Intel, Wal-Mart and Google, who have significant growth opportunities in their product/market cores, you will regularly have to wrestle with diversification issues. In this event, it’s best to remember the wisdom of late, great management consultant, Peter Drucker:
“Diversification is not something that can be either condemned or recommended as such. It is therefore a major task of top management to decide what diversification and how much a particular company needs to make the most of its strengths and to get the best results from its resources. One starting point must be the question ‘What is the least diversification this business needs to accomplish its mission, obtain its objectives, and continue to be viable and prosperous?’ But at the same time the question ‘What is the most diversification we can manage, the most complexity this business can bear?’ should also be asked.”[4]
Act accordingly.
[1] The matrix is a familiar extension of one originally developed by Igor Ansoff and published by the Harvard Business Review in 1957.
[2] Businessweek.com, April 2, 2009.
[3] Online.wsj.com, November 20, 2009.
[4] Drucker, Peter F., Management, 1973.