Diversification strategy for SMEs: Better the research lesser the risk
Diversification into newer areas is good for entrepreneurs. However thorough research is needed to mitigate the risk in the new venture.
Last week I met an entrepreneur who had been running an oil business for more than two decades. Recently he took a decision to diversify the business in order to ensure sustainable cash flow and derisk himself from the industry related challenges because the oil extraction industry is undergoing a steady transformation towards brand orientation and it requires a larger capacity.
I was surprised at the level of research he and his brother undertook before embarking on the new business. It was the amazing story of an entrepreneur who has well entrenched in the present business. There is no external debt obligation to meet with. His risk bearing ability is quite high and the real estate value of the industrial unit is steadily raising giving him the comfort of protecting the interest of himself and his family if the business situation goes adverse. In other words, he did not look at diversification out of desperation rather a conscious decision to explore other opportunities outside his present business and its fortune does not exhibit any correlation to present business.
As a part of an exploratory study of new business, he met as many as 400 entrepreneurs who are into this area. He met many machinery suppliers who are also another source of information to understand the industry trends and get hang of key success factors. They leveraged existing trade network to build new trade relationships to sell the products.
They analysed the cost factors very critically and built series of scenarios in the excel sheet to understand the impact of changes in various risk factors. They also developed a model SWOT analysis and strategized to overcome the pains.
Though brothers are not well educated, the amount of thought process and tools adopted to build a business plan is no way less than seen in any MNC.
The result is immensely good. Within three months the production reached full capacity. The learning curve post commercial operation was very small. Almost all the risks are controlled or treated well to prevent them to become a source of lower production.
Diversification Strategies- what is it?
Diversification occurs when an organization moves into areas that are clearly differentiated from its current businesses.
Diversification growth strategies may be appropriate for firms that cannot achieve their growth objectives in their current industry, with their current products and markets. Other reasons for a firm to diversify include the following:
- Markets of current business(es) are approaching the point of saturation or decline of the product lifecycle.
- Current business(es) are generating excess cash that can be invested elsewhere more profitably.
- Synergy is possible from new business.
- Technical expertise can be gained quickly.
There are many other reasons as well.
Diversification always will involve uncertainty; requires in-depth study
Long-term sustainability of the enterprise is the core focus of diversification. However, pursuing that goal is not an easy one. The decision on diversification requires deeper research into multiple areas within and outside the organisation. The issues the questions raise, and the discussion they provoke, are meant to be coupled with the detailed ﬁnancial analysis- The key feature of the meticulous decision-making process. Together, these actions can turn a complex decision into a more structured and well-reasoned one.
Drive from the position of strengths:
Every entrepreneur has certain strengths-inherent as well as acquired in the present business. It is important to take stock of the same as it is crucial for him to identify its unique and unassailable competitive strengths before attempting to apply them elsewhere. The ﬁrst step, then, is to determine the exact nature of those strengths.
When facing the decision to diversify, however, an entrepreneur needs to think not about what they are intending to do but about what it does better than its competitors. Explore whether it has special attributes like first mover advantage?
In one sense, pinpointing strengths forces an organization to identify how it might add value to the new business —be it with excellent distribution, creativity, strong leadership, abundant availability of resources, or superior knowledge. In other words, the decision to diversify is made not on the basis of broad or vague conjectures; rather, it is made on the basis of a realistic identiﬁcation of strengths.
In the instant case, I found that there are few key strengths which made the difference such as :
- Promoters: Passion, Flexibility to learn and incorporate, and Application of tools to analyse the opportunity.
- Finance:No debt in the existing business, Financial flexibility to support the company if there is a delay in onset of growth, Good credit rating
- Market:Growing market and early mover advantage in their place of business, Business network of present business enabled to build trade channels for new business easily.
- Operational Aspects: Abundant availability of inputs including labour, Superior process & technology, and Good connectivity.
Many entrepreneurs ignore vital aspects of transition planning. Diversification is an extremely sensitive transition strategy and it requires one to critically analyse the opportunity and relate to the strengths to manage the risks in the process.
Advice for SMEs to pursue diversification into unrelated areas:
We have the following advice for business owners on how to develop a diversification strategy:
Leverage the existing business’s core strengths: When looking at how to diversify their business, entrepreneurs should start by asking whether they are creating synergies. Can existing assets such as offices and other buildings, machinery, or staff be used for other purposes without adding cost? Does the diversification strategy ensure that the business capitalizes on skills it has already developed?
Address weaknesses: Entrepreneurs should constantly stress test their business. What would happen if it were to lose its biggest client, or if an economic shock or new disruptive technology were to hit demand for a particular product or service? Can the business protect itself from the biggest risks it faces? The solutions may not be hard to find—they could be as simple as gaining a few more regular clients, improving the process capabilities, or adapting an existing product or service.
Ensure that financial resources can sustain existing operations: Any sound diversification strategy must ensure that existing operations will not be compromised. There are lots of ways to diversify, and entrepreneurs should carefully consider the least expensive and less complicated options. There may be ways of opening new markets with relatively small changes to existing products or services. Think carefully from the start about the time, money and other resources involved.
Diversification could be a valuable tool to reduce risk and improve the worth of entrepreneurship journey. However, diversiﬁcation into unrelated newer areas will never be an easy game and entrepreneurs must study their cards carefully.