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This is the second of three articles on Diversification for founding entrepreneurs. Part One, Diversification vs Di-worse-ification, argued that diversification is not always a positive move and that careful analysis should be applied to any diversification decision.  This article suggests five categories that merit such analysis.

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Competitive advantage is a necessity in successful business. This article will remain focused at all times on three types of competitive advantage: productcustomer, and core competencies. This article begins with an alternative that includes all three types of advantage, suggests a diversification alternative based on each type of advantage, and concludes with an alternative that excludes all three types of advantage.

In using this model, we stray from the technical definition of diversification toward a practical definition. Technically, diversification means introducing a new product to a new market. In the technical definition, a new product to an existing market fails to qualify; an existing product to a new market also fails to qualify. Practically, diversification will mean any change that brings revenue diversity. In our practical definition, that change can be an increase of marketing channels, market audiences, products, markets + products (technical diversification), and even portfolio assets.

Channel Development

“Because maximizing your current competitive advantage comes first”

A channel is a marketing term that means any path between your business and your customers that results in sales. Channel development means increasing the number of those paths.

Channels include field sales, retailer sales, direct mail sales, network sales, referral sales, partner sales, and countless types of online sales. Most businesses stop developing their channels long before they exhaust all options, therefore reaching only a portion of their target market. Analysis is needed to determine which channels are viable, but identifying those channels should be the first place any business looks when seeking a broader source of revenue.

Channel development is first because it allows you to apply all three types of competitive advantage. Your success-to-date implies that your product has some advantage over its competition, you know your clients (and market) better than your competition, and you have some core competency that beats your competition. Since you can apply all three types of current advantage, you risk less. The only risk is whether the new channel will work.

Win the first battle before beginning a second. Maximize your return from current competitive advantages by developing channels that increase your market penetration.

Market Development

“Because you know your product better than anyone”

A market is a specifically identified group of people with similar demographic and psychographic traits that lead them to respond to your product in similar ways. Market development means introducing your existing product to new groups.

Identifying new markets is a marketing and sales process that comes through focus groups, market surveys, and creative experimentation. Most businesses stop identifying their target markets long before they exhaust all options, therefore reaching only a portion of their potential customers. Analysis is needed to determine which markets are viable, but identifying those markets should be the second place any business looks when seeking a broader source of revenue.

Market development is second because it allows you to use your current product advantage. Your success-to-date implies that your product does have some objective advantage over its competition. Since you can apply one type of current advantage, you risk less. However, be aware that you will need to consciously exclude what you used to know about your target market. Since your new market may not react like your old market, overconfidence may cost you money.

Win the second battle before beginning a third. Maximize your return from your current product through market development.

Product Development 

“Because you know your customers better than anyone”

A product is a ready-for-sale offer that improves the lives of your customers (B2C) or the businesses of your clients (B2B). Product development means introducing your existing customers to new products.

Producing new products is a marketing and financial process that may result in upsell offers, integrated solutions, new technology, or fulfillment of current customer requests. Most businesses stop investing in new products long before they exhaust all options, therefore reaching only a portion of their potential Customer Lifetime Value. Analysis is needed to determine which products are viable, but identifying those products should be the third place any business looks when seeking a broader source of revenue.

Product development is third because it allows you to use your current market advantage. Your success-to-date implies that you do know your clients better than your competition. Since you can apply one type of current advantage, you risk less. However, be aware that you will need to consciously exclude what you used to know about your product. Since your new product may be different than your old product, overconfidence may cost you money.

Win the third battle before beginning a fourth. Maximize your return from your current customers through product development.

True Diversification

“Because you know your core competencies better than anyone”

True (technical) diversification means introducing a new product to a new market. Diversification means applying your core competencies in an entirely new context of both product and customer.

True diversification is a complex creative process that may result in acquisition of new strategic assets, new applications of existing assets, or new combinations existing assets. Successful diversification may not be possible for every business, having already found an ideal application of their skills. Analysis is needed to determine if true diversification is viable, but identifying those opportunities should be the fourth place any business looks when seeking a broader source of revenue.

True diversification is fourth because it allows you to use your current core competencies advantage. Your development of successful products and customer relationships implies that you yourselves are better than your competition in at least one core competency. If you can apply this core competency, you risk less. However, be aware that you will need to consciously exclude much to most of what you used to know about your business. Since your new business may be different than your old business, overconfidence may cost you money.

Win the fourth battle before beginning a fifth. Maximize your returns from your core competencies through true diversification.

Portfolio Development

“Because you know your risks better than anyone”

Portfolio development means to shift from thinking like a businessman to thinking like a portfolio investor. Portfolio investing means hedging your financial risks by diversifying broadly into financial markets, including equities, bonds, real property, and commodities.

Remember that business is about making money. Since the S&P grows at an average of 7 percent annually, your goal as a business is to grow by at least 8 percent annually. If your potential diversification opportunity—or even your current business–is unlikely to grow at that rate, your money might be more wisely invested elsewhere. Analysis is needed to determine if beating the market through your own business is unlikely enough to merit joining the market through portfolio investing, but avoiding the risk of underperforming the market benchmark is a smart alternative to throwing money away on an unlikely new venture.

Portfolio development is fifth because it allows you to use your money in a way that doesn’t require a competitive advantage. Your money is worth as much as any other equity investor. If you can avoid the need for advantage, you risk less. However, be aware that you will need to consciously exclude goals of beating the market. Since running a business is different from investing in one, overconfidence may cost you money. Increased insight into your industry, investing, or business in general needs to rise to the level of being a “core competency” to be worth betting your money on it.

Win the fifth battle before losing a sixth. Maximize your return from your money through portfolio development.

Conclusion

“Because success means being the best”

In any attempt to add revenue diversity through a new venture, remember that keeping up with the current competition is not enough. Success means beating the current players at their own the game. If truly no one is in the game, success means beating the likely players who will enter the game when they see what you’re doing.

To avoid losing before you begin, remember to consider assets, synergy, and learning.

Competitive advantage usually requires both tangible and intangible assets. Owning some of the required assets is not enough. Limiting yourself to opportunities in which you have or can immediately acquire all required assets is a good way to avoid investing money in a race you can’t finish.

Competitive advantage is often a synergy of your total combination of core competencies, products, target market, and assets. Adding, removing, restructuring, or reapplying any of these can produce unexpected results. Limiting yourself to opportunities that maximize synergy is a good way to avoid opportunities that eliminate synergy.

Competitive advantage requires continual learning to be maintained. All new opportunities will result in learning, but only some opportunities will result in learning that helps your current business. Limiting yourself to opportunities that teach you more about your current business is a good way to avoid opportunities that distract you from your current business.

Next Steps

The difficulties of evaluating these choices for each situation require the expertise of a CFO. Companies without a full time CFO should consider hiring a part time CFO. While hiring a temporary CFO is an option, companies diversification benefit strongly from a permanent solution. An outsourced CFO is the most affordable way to gain long-term expert advice without the high cost of an expensive internal officer.

Please speak with Preferred CFO for any additional questions.

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