Question

What are the two general types of diversification and when would one be preferred over the other?

Answer 1

Diversification is an organization’s entry into new markets with newer products. There are two types of diversification strategies namely, related and unrelated.

A company is termed as using related diversification when the business expands its activities to the product lines that are similar to the existing ones. In other words, the companies capitalize on the competitive advantage that it has already established. For example, a computer manufacturing company might also start manufacturing calculators with innovative features.

On the other hand, unrelated diversification lacks commonality in the markets, distribution channels, technology and R&D. The business expansion is into a new market with a new technology or asset. For example, Facebook is in the process of developing apps which is an entirely new product line.

Related Diversification	Unrelated Diversification
Sharing of the existing skills and competencies	New to the business; based on the interest to the owners or the management.
Uses shared marketing skills and knowledge to the new product which is similar to the product line.	Refocuses the company into an entirely new product or market. The product does not have any commonality to the existing product.
Uses the already sales and distribution capacity	TAX benefits are considered in this strategy
Sharing of knowledge, manufacturing and technology know-how	A new take over which requires acquired knowledge on the manufacturing and the technology aspects.
Easy access to the Research & Development	Obtaining liquid assets as needed by the main company
Economies of scale is recognized	Takeover and defending against the odds due to the Takeover
Industry SWOT are already known by the companies	Industry is totally new to the business. The company is not aware of the industry SWOT.

Companies prefer unrelated diversification over related diversification under the following circumstances-

• Company might prefer acquisition to offset the cash flow during off-seasons     
• For profits if there is less revenue in the existing product line
• High risk investment with high potential for returns

Companies prefer related diversification over unrelated diversification in the following circumstances-

• When company wants to use the traditional way of measuring relatedness between two businesses in the same industry
• Low risk investment with high potential for returns
• Companies is familiar with the industry SWOT and knows which is the best competitive advantage

An efficient diversification can be made by the company if it does a cost-benefit analysis of the investments. Factors to be considered while choosing a diversification strategy are:

• Cost in new equipment
• Labor savings cost
• Cost involved in improving productivity or the process
• To serve the existing customer base or cost involved in creating a new one
• More profitability or ROI
• To address safety or environmental and legal issues.