Business organisations always strive to be versatile in terms of products and service offered, as well as targeted markets and demographics. Staying a “one-trick” pony will likely lead to stagnation, and leave your firm highly vulnerable to many threats in the long run.
Therefore, flexibility is crucial. The great Igor Ansoff – considered the father of strategic management in business – created his eponymous Ansoff Matrix to explain the four main growth strategies available to all businesses, and the toughest of these also happens to be the key to remaining versatile in business – diversification.
Diversification entails everything mentioned in that opening sentence – creating new products or markets, or gaining access to them through various measures, such as acquisitions and R&D. As you can see, there are many sub-strands to diversification.
In many ways, horizontal diversification epitomises the challenges inherent in wider business diversification. So, let’s first learn what it is, and how it differs from other diversification strategies.
What Is Horizontal Diversification?
In horizontal diversification, the first thing to remember is that your business will be mainly targeting existing customers – not new ones. Since the customers remain the same, the element of risk is also somewhat minimised in this form.
Indeed, the risk comes from the product end of the equation; you will be trying to bring in new products or services, often located in industry segments outside your current area of specialisation. The selection of the products or services in question is determined by your existing customer base.
The main consideration is that this new product serves an existing need among your loyal customers, often with links to the current product you are selling. For example, if you sell notebooks, adding pens and pencils would serve the same target demographic.
If the new products have any form of technological, logistical, or manufacturing connections or synergies with your business capabilities, then the element of risk (and its associated expenses) can be further reduced. For further clarity, this classical horizontal strategy can be labelled as what is known as concentric diversification.
An important thing to remember is that horizontal diversification does not involve adding totally unrelated and alien products to your business. That strategy belongs to another riskier subtype of horizontal diversification, known as conglomerate diversification.
Horizontal Diversification vs Vertical Diversification
There are many different subtypes of diversification strategies available to businesses, but perhaps the clearest distinction can be drawn between horizontal and vertical strategies. In vertical diversification or integration, your firm will try to enter another level of the product manufacturing chain.
Based on our earlier example of notebooks, venturing into the production of paper – which is a raw material for your existing product – might make for a sound strategic move. Or you could also consider opening branded retail shops for your notebooks and stationery.
In horizontal diversification, however, you stay on the existing level of production, without trying to take over the role of vendors, suppliers, or distributors.
Horizontal Diversification vs Conglomerate Diversification
This is a more extreme sub-type of horizontal diversification. While concentric diversification asks you to look at products or services that have some connections or links to your current field, conglomeration does the opposite. Here, your focus is on entering brand new fields that may have no relation to your existing product lineup.
This type of diversification carries a high risk due to extreme unfamiliarity with products, manufacturing processes, and technological factors. On the flip side, though, the potential for rewards is also greater, including access to new markets and new customers.
Routes to Horizontal Diversification
Diversification can involve several elements, such as acquisition of new staff, new patents and technologies, investment in capital assets (new machinery equipment), or copious investments in R&D. Depending on the level of familiarity with the new product, it can involve some or all of these steps.
This is why mergers and acquisitions (integrations) are one of the most common paths opted for by corporations looking to diversify. Bigger firms will often look to buy out a smaller business that specialises in the product or service they want to start selling; in the long run, it is more economical and efficient than starting from scratch.
Disney's acquisition of Pixar is a transparent and high-profile example of this process, with Disney – an iconic company – possessing heavy expertise in traditional hand-drawn animation. Pixar, on the other hand, is involved in a related, albeit more modern, craft of computer graphics animation (CGI). Both serve the same entertainment demographic – children and families – so it made perfect sense for the more prominent company – Disney – to horizontally diversify into CGI through acquisition, rather than attempting to compete.
The Pros and Cons of Horizontal Diversification
Despite all of its apparent risks and uncertainties, horizontal diversification holds the promise of growth for a business. Staying in relative inertia can be fatal for any corporation; in a very competitive arena, opponents are always looking for a competitive edge. The reality is that if there is a promising avenue for diversification and you do not grasp it, one of your rivals will.
By removing your dependence on a single product or range, horizontal diversification can also help minimise long-term risk. When foraying into familiar areas (concentric diversification), the existing knowledge and resources of the firm can be put to optimum use. PepsiCo foraying into snacks, which has a substantial synergy with soft drinks, is a great example of this.
Such a move doesn't always work out favourably, though. In stark contrast, Pepsi’s close rival, Coca-Cola, made a disastrous foray into winemaking in the 1980s. Despite making all the right moves – buying an established brand with excellent distribution networks in a related field with high synergy – the move was a total failure. The profit margins in the wine business were simply not attractive enough for a company of Coca-Cola's size and standards.
In another example, big oil companies such as BP and Exxon diversified into mineral extraction in the 1970s, since they had experience in a related field of drilling for oil. Again, this was a failure, as they lacked one critical asset: low-cost extraction techniques.
Aside from highlighting the high levels of risk involved in what may have seemed like good diversification ideas, these examples also throw up some key questions. For instance:
- Does your company have any strategic assets that would be put to better use after diversification?
- Will the planned diversification allow your firm to have an edge on the competition?
- Does your firm have all the key resources and assets to remain competitive in the new product market after diversification?
- If the answer to the last question is no, can your firm economically acquire the missing variables?
- Or else, can you redefine the new product segment using your existing skills and R&D to render the opponents ineffective?
If your firm has convincing answers to all these questions, then a horizontal diversification might be a solid strategic move. If the answer is in the negative to all or most questions, though, then it's a stark reality that any form of horizontal diversification might end in a costly failure for you and your organisation.
Was this article helpful? Let us know your thoughts in the comment section below.