The dangers of the diversification road

Branching out into different areas can be a lucrative way to draw in extra revenue, but firms must go in prepared, warns Simon Groves

As the battle to win business in the face of low-cost competitors from India, China and Eastern Europe becomes even tougher, more UK firms should diversify – using their skills to branch out into different industry sectors. This could generate new income streams and protect them from slumps in their traditional markets.

However, organisations should not stray too far from their core business expertise when diversifying, expanding or even when acquiring new companies. If they enter into uncharted territory, particularly a sector that seems to be booming quickly, companies could overstretch themselves and end up dealing with unfamiliar business issues.

As well as looking to target new niche areas, it is also important for firms to monitor the industries they are currently working in to see how the sector is performing and how individual companies are doing. If there are problems with the market place, or other businesses are suffering, then it is very likely that there will be a knock-on effect.

Businesses need good information to keep tabs on situations such as these and this can be gleaned from suppliers, colleagues and even competitors in the industry, as well as analysts, economists and trade papers, or other interested parties such as business insurance brokers.

For example, many of the companies supplying big retailer Allders realised that the payment issues they were experiencing with the store were a precursor to major problems. Suppliers were warned of the credit risk and so found new customers and therefore reduced their reliance on Allders, ensuring a continued income when the retailer did go bust, as well as limiting their exposure to bad debt.

UK businesses should try to stick to what they know and not move into an industry that is completely new to them. If they do, there will inevitably be a steep learning curve and by the time they find their feet, the opportunity for success may have passed.

However, some firms have been spectacularly successful by moving into a new industry sector, such as mobile phone manufacturer Nokia. The company began life as a paper producer and only made its first telephone less than two decades ago, but it is now one of the biggest mobile phone makers in the world.

However, other companies have fallen on their faces when diversi-fying, usually by acquiring high-flying businesses in industry sectors far removed from their own.

For example, French water firm Vivendi became a media empire when it purchased many of the film and music interests of Universal. Several analysts claimed that Vivendi paid too much for its media acquisitions, which resulted in the chief executive being fired and many of the new concerns being sold on again.

Virgin boss Richard Branson has had mixed fortunes applying his brand to different businesses. Famous originally as a record label and then as a music store, Virgin’s outsider image worked well as an airline and for other lifestyle products, but less so when Branson moved into trains, soft drinks and cosmetics.

The problem is that not only do firms need an understanding of the areas in which they hope to diversify, but potential customers also have to be convinced by the logic.

An aerospace manufacturer can see where the engiexpertise of an automotive supplier can be successfully transferred, but consumers are less likely to buy a soft drink from the record company that brought us the Sex Pistols.