Diversification

Q. I own a small company. I have some ideas for diversification into other businesses. Do you have any thoughts about how to do this successfully? What pitfalls should I avoid?

A. Diversifying beyond your core business can be a profitable move. It can also be a cash-sucking money loser. Following the tips below will help ensure that you stay on the positive side of the ledger.

• Succeed in your core business before diversifying. If your current business is floundering, we’d suggest resisting the temptation to diversify. Diversification may seem attractive. The grass is always greener on the other side of the fence. Unfortunately, diversifying will inevitably increase the complexity of your challenge and therefore, reduce your probability of success. If your core business is not succeeding, you may make the decision to shut it down and launch a new venture. However, if you aren’t ready to throw in the towel, we suggest that you work to push your current business into the black, before diversifying and increasing complexity.

• Consider expanding your core business before diversifying. If your core business is successful, pursue more of the same. You already know how to succeed in this endeavor. Grow the enterprise you know before accepting the risk associated with a new venture. Consider expanding your business geographically. Open an office in a new city. Seek new distribution. Expand your product and/or service offerings.

• Forward or backward integrate with caution. It can be tempting to forward or backward integrate. After all, you are familiar with these businesses. You buy from them or sell to them. However, there are risks.

• Forward integration – If the sprockets you make are used in making widgets, becoming a widget maker may seem to be an obvious step, but be careful. You’ll be competing with your customers—expect to lose many of them. Most businesses won’t buy from companies with which they compete. So before you pick this fight, make sure you can win it.

• Backward integration – Bring in-house the production of products or the providing of services that you currently purchase. While safer than forward integration, there are risks. Make sure that you have enough volume to make the diversification profitable or be clear that you can secure additional customers for the new product or service. If the only customers for the new product or service are your direct competitors, this could be a tough row to hoe.

• When diversifying, maximize the probability of success by building on strengths. If you have made the decision to diversify, do it in a way that minimizes risk and maximizes the likelihood that you will succeed. To do this, diversify into:

• Adjacent businesses – Consider moving into businesses that are very similar to your core business. For example, a residential property manager might diversify into commercial property management. Take small steps. After managing a small apartment building, move into managing a small office building or a building that is mixed use (i.e., retail on the first floor and residential units on the upper floors).

• Businesses that leverage your existing capabilities – Take the time to understand your core skills—those things you do significantly better than others. Diversify into businesses where these skills are critical to success. Be careful about moving into businesses that require core skills you do not possess. That’s a recipe for failure.

• Businesses that leverage your existing infrastructure – You may be able to utilize existing physical assets (e.g., trucks, computer system, headquarters building, etc.) or pieces of your current organization (e.g., salesforce, accounting, human resources, etc.). This can help you get more out of the assets and the people you already have.

Moving into a new industry is risky business. Following these tips when you are considering diversifying your business can help you avoid costly missteps and increase your probability of success.