In economics and finance, diversification refers to the practice of investing in a variety of assets to reduce risk. Independent diversification refers to diversification into products, services, or markets unrelated to the company's original core competencies.
There are three main types of diversification: (1) related, (2) independent, and (3) geographical (Kennedy et al., 2020). Here is a brief description of each:
- Appropriate diversificationoccurs when a company expands into new businesses or industries related to its core competencies or products. For example, an auto parts manufacturer might diversify by entering the aftermarket auto accessories market. This type of diversification can allow a company to leverage its existing knowledge, skills and resources to enter new markets and increase its revenue streams. Kennedy et al. (2020) provide the example of the takeover of Audi by Volkswagen. When they diversify their own supply chain up or down, we call itvertical integration.
- Independent diversificationoccurs when a company expands into businesses or industries unrelated to its core competencies or products. For example, an auto parts manufacturer might diversify by entering the consumer electronics market. This type of diversification can be more risky as the company may not have the same level of expertise or resources in the new industry. But it can also offer the potential for higher returns if new business is successful. Amazon's entry into the grocery business through its acquisition of Whole Foods is a real-world example of independent diversification (Kennedy et al., 2020).
- Geographic Diversificationis the practice of investing in or doing business in a variety of locations or regions around the world. This can be done to spread risk, reduce the impact of adverse events at a particular location, and gain new markets and customers. A company may seek geographic diversification by expanding into new markets, selling products or services to customers in different countries or regions, sourcing materials or components from multiple locations, or investing in real estate or other assets in different geographic areas. This strategy is used by Starbucks, Target, KFC and many others (Kennedy et al., 2020).
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Definition of independent diversification
Independent diversification refers to the practice of expanding a firm into new industries or markets unrelated to its core competencies or products (Sadler, 2003, p. 103; Chatterjee & Wernerfelt, 1988).
This may involve acquiring new businesses or entering into partnerships or joint ventures to gain access to new markets or technologies.
chances and risks
Unrelated diversification may be more risky than related diversification because the company may not have the same level of expertise or resources in the new industry. Most independent diversification efforts don't end well for the original company.
For example, Harley-Davidson once attempted to sell Harley-branded bottled water (Kennedy et al., 2020). This is one of the reasons why the diversification involved is more common on average (Pinheiro et al., 2022).
But it can also offer the potential for higher returns if new business is successful. It can allow a company to diversify its revenue streams and reduce its dependence on any one market or industry.
It can also provide opportunities for growth and innovation by exposing the company to new technologies, customers and competitors.
Overall, independent diversification can be a risky but potentially rewarding strategy for companies looking to expand their operations and increase stability.
On average, unrelated diversification is rarer than related diversification (Pinheiro et al., 2022). It is crucial for companies to carefully consider the risks and potential benefits of independent diversification before making expansion decisions.
| Opportunities for independent diversification | Risks of independent diversification |
|---|---|
| Hedging the market risk that may exist in an industry | The company lacks specialized skills in the new market |
| Introduces a company to new consumers | Lack of brand awareness in the new market |
Unrelated Diversification Case Study
A real-world example of independent diversification is Zippo's diversification strategy.
According to the CEO, the Zippo lighter is considered "tough, durable, made in America, iconic" (Associated Press, 2011). However, the future of the lighter business is bleak. Smoking is becoming less popular in many countries, so it made perfect sense for the company to pursue an independent diversification strategy.
Zippo then diversified into "pocket knives, money clips, flashlights, key holders, writing implements, and measuring tapes." Trying to figure out which of these diversification options would be winners, like the Eddie Bauer-edition Ford Explorer, and which would be losers, like Harley-branded bottled water, has been a key challenge for Zippo executives” (Kennedy et al., 2020) .
10 examples of independent diversification
- From football to treadmill:A company that makes exercise equipment such as soccer balls and basketballs expands into the fitness equipment market by acquiring a company that makes treadmills and exercise bikes. The exercise equipment company needs to understand and navigate the fitness equipment market, which may have varied product features, prices, and distribution channels.
- From cafes to fast food:A company that operates a chain of coffee shops expands into the fast food market by acquiring a franchise for a well-known fast food brand. The coffee shop business needs to familiarize itself with and navigate the fast food market, which can have different menu offerings, pricing strategies, and customer expectations.
- From restaurants to party planning:A restaurant chain company expands into the catering market by acquiring a party planning company. The restaurant business must learn and navigate the party planning market, which can have different menu offerings, event planning, and customer service expectations.
- From tractor to snowboard:A company that makes agricultural equipment such as tractors and combines expands into the snow sports equipment market. The farm equipment company must understand and navigate the recreational sports market, which may have diverse customer demographics, sales channels, and marketing strategies.
- From industrial machinery to consumer equipment:A company that makes industrial machinery such as machine tools and factory automation equipment expands into the consumer appliance market by acquiring a company that makes refrigerators and washing machines. The industrial machinery company needs to understand and navigate the consumer equipment market, which may have different product features, prices, and distribution channels.
- From pharmaceuticals to cosmetics:A pharmaceutical company expands into the cosmetics market by acquiring a company that makes skin care and makeup products. The pharmaceutical company needs to familiarize itself with and navigate the cosmetics market, which may have different product development, marketing, and sales strategies.
- From financial advice to the pizza shop:A company that provides financial services such as B. banking and investment management, sees market risks and therefore founds a pizza shop chain to protect himself. The financial services company must familiarize itself with and navigate the restaurant market, which can have different products, prices, and regulatory requirements.
- From IT services to medical products:A company that provides IT services such as software development and network support expands into the healthcare products market by acquiring a company that manufactures medical devices. The IT service company needs to familiarize itself with and navigate the healthcare market, which may be subject to different regulations and standards than the IT service market.
- From car parts to consumer electronics:An auto parts manufacturer that primarily makes brakes and steering components expands into the consumer electronics market by acquiring a company that makes smartphones and tablets. The auto parts manufacturer needs to understand and navigate the consumer electronics market, which may differ from the auto parts market in terms of competition, pricing, distribution channels, and customer preferences.
- From clothing to furnishings:A clothing and accessories retailer operating a chain of fashion clothing and accessories stores expands into the home furnishings market by acquiring a business that manufactures furniture and home decoration products. The retailer needs to understand and navigate the home furnishings market, which may differ from the apparel and accessories market in terms of design trends, material sourcing and distribution channels.
Conclusion
Diversification refers to the practice of investing in or doing business in a variety of assets or markets in order to spread risk and reduce the impact of adverse events on a portfolio. There are three main types of diversification: (1) related, (2) independent, and (3) geographical (Kennedy et al., 2020).
Independent diversification occurs when a company expands into businesses or industries unrelated to its core competencies or products (Sadler, 2003; Kennedy et al., 2020). Independent diversification can be a risky but potentially rewarding strategy for companies looking to expand their operations and increase stability. It is important that companies carefully consider the risks and potential benefits of independent diversification before making expansion decisions.
references
Associated Press. (2011, March 21). Zippo's burning ambition lies in retail expansion. The daily paper.https://www.smdailyjournal.com/business/zippo-s-burning-ambition-lies-in-retail-expansion/article_80c8ef2e-4495-5823-8e02-9bff74109b2f.html.
Chatterjee, S., & Wernerfelt, B. (1988). Connected vs. unconnected diversification: A resource-based approach.Procedures of the Academy of Management,1988(1), 7–11. https://doi.org/10.5465/ambpp.1988.4979378
Kennedy, A. von R., Jamison, mit E., Simpson, J., Kumar, P., Kemp, A., Awate, K., & Manning, K. (2020).8.3 Diversification. https://pressbooks.lib.vt.edu/strategicmanagement/chapter/8-3-diversification/
Pinheiro, F.L., Hartmann, D., Boschma, R., & Hidalgo, CA. (2022). The timing and frequency of independent diversification.research policy,51(8), 104323. https://doi.org/10.1016/j.respol.2021.104323
Sadler, P. (2003).Strategic management. Kogan Page Publishers.
Tio Gabunia (B.Arch, M.Arch)
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Tio Gabunia is an academic writer and architect from Tbilisi. He studied architecture, design and urban planning at the Georgian Technical University and the University of Lisbon. He has worked in these fields in Georgia, Portugal and France. Most of Tio's writings concern philosophy. Other writings include architecture, sociology, urban planning, and economics.
Chris Drew (PhD)
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This article was peer reviewed and edited by Chris Drew (PhD). The verification process is ongoingHelpful professorinvolves a PhD-level expert fact-checking, editing, and contributing to articles. The reviewers ensure that all content reflects academic expert consensus and is supported by references to academic studies. dr Drew has published over 20 scientific articles in peer-reviewed journals. He is a former editor of the Journal of Learning Development in Higher Education and holds a PhD in Education from ACU.