Product DiversificationExplained & Defined

Written By:
Lisa Borga

Reviewed By:
FundsNet Staff

Product diversification is a process in which a company expands into a new segment of an existing industry or into a new industry altogether.

In many cases, a company may identify an opportunity to expand the market for its product and increase profitability.

This can help to prevent a product from becoming obsolete, expand its markets and help ensure its survival.

Product Diversification Explained

Product diversification is a process in which a company expands the market for a product.

In most cases, product differentiation will entail adding new capabilities to an existing line of products.

This may include adding new technology, a sibling product, or making changes to achieve sales in a new geographic market.

By performing product diversification, a company extends its operations into new areas and markets, thereby increasing the opportunities for profits and mitigating the risks associated with reliance on one area of operation.

There is a risk, however, that the company could spread its operations too thin or even dilute its brand by adding new product lines.

Regardless, product diversification is a commonly performed business strategy.

Product diversification can take many forms, including introducing guidelines for a completely new product or making changes to an existing product.

For example, a manufacturer of cola may choose to introduce a diet version of its beverage simply by changing the sweetener to a lower calorie option but otherwise leaving the formula the same.

In this case, the diet cola would introduce the company to a new segment of its market for weight-conscious consumers.

This will expand the cola company’s audience and, if successful, improve its revenue and act as a complement to its existing brand.

In some cases, simply making changes to a product, such as repackaging, renaming, or repricing an existing product, can be enough to successfully achieve product diversification.

Why Do Companies Perform Product Diversification?

Beyond simply increasing revenue, there are a number of reasons that a company may wish to diversify.

This includes:

• Avoiding Obsolescence: Markets are continuously evolving and changing, and new developments can render an existing product outdated or simply obsolete. A company may attempt to prevent its products from suffering this fate by adapting them with new technology or advancements.
• Incorporating New Developments: In performing research and development, companies can come across new opportunities to develop new products to introduce to their current market. Once these opportunities are discovered, a company can choose to diversify its products.
• Expanding Markets: In many cases, a company may choose to introduce new products into their product lines in order to attract new customers. Companies may diversify their products in order to attract alternative demographics.
• Preventing Overspecialization: In some cases, a company may choose to develop and introduce new products just to avoid overspecializing in a market. This can help to expand a company’s consumer base and reduce the risk of investing too much in a particular revenue source.
• Changing Consumer Behaviors: Changes in consumer tastes can impact the profitability of certain products and provide opportunities to diversify. One example of this is the growth in demand for environmentally friendly products. This has presented many opportunities for companies to introduce eco-friendly products to their lines. Often shifts in product diversification provide a way to adapt to changes in consumer behavior.

Common Diversification Techniques

There are many ways to engage in product diversification.

However, some common techniques for expanding within the original market include:

• Repackaging: The way in which products are presented to consumers can be altered in order to appeal to a distinct audience. For example, an upholstery cleaning product for the home may be repackaged in order to market it for automobiles.
• Renaming: Renaming a product can often allow it to retain its original purpose yet allow it to be sold in a different geographical area. Often this is combined with repackaging and can allow the product to match the culture of the area in which it will be sold.
• Repricing: The price of a product can be altered in addition to limited changes in the product itself in order to sell it through new channels. For example, sunglasses sold through convenience store outlets may receive a higher quality lens coating and a change in price in order to sell them through fashion outlets.
• Resizing: A product may be able to be repackaged to sell in different quantities to meet different consumer needs. For example, a common food product such as peanut butter may be able to be sold in individual jars in grocery stores, but by packaging it in quantities of tens or hundreds, it can also be sold in outlet stores.
• Expanding Brand: Companies can potentially expand their current brand by filling in gaps in their product line, such as by expanding into higher or lower-end products. For example, a high-end jewelry company may produce a cheaper line of products for more cost-conscious consumers.

Risks of Product Diversification

Entering a new and unfamiliar enterprise can present significant risks for a company.

In many cases, the skills needed to run a diversified entity may be far different from what a company and its leadership are familiar with.

As a result, the existing structure, systems, talent, and leadership may not be sufficient to successfully introduce the new product.

This can not only result in failing to introduce a successful new product to the market but also impact the company’s profitability and stockholder returns.

In order to prevent these risks, it is crucial to weigh the advantages of diversifying against the risks of such a new enterprise failing.

The risks of failure are particularly high when the product is significantly different from those the company already provides as well as when barriers to entry are high.

In these scenarios, the potential for growth may not be worth the risk.

In most cases, a company should invest in product diversification in growing markets where no other company is already meeting consumer demand.

In this case, if the estimated revenue is greater than the costs of developing and marketing the proposed product, then the company likely should invest in the opportunity

Advantages & Disadvantages of Product Diversification

Advantages

• Product diversification divides investments into several markets or market segments which can help shield a company from a downturn in any one area.
• Product diversification can help to move a company’s activities away from a declining product area toward those with higher potential.
• A diversified company will have greater stability against changing economic conditions.

Disadvantages

• A diversified company will be unable to respond to changes in market conditions as quickly as a more focused company and may be slower to innovate.
• The company’s focus on its core operations may suffer from dividing its attention among multiple areas. This could lead to a loss of profit and growth in the original market area.
• By failing to focus on a particular market segment, growth opportunities may be overlooked.
• Product diversification may demand entirely new skill sets, and a lack of expertise in new areas creates a high risk of failure.

Examples of Product Diversification

Many well-known companies are examples of successful product diversification.

For example, General Electric began as a merger between two electric companies before investing heavily in diversifying its operations.

Now General Electric is a multinational corporation that operates in many sectors, including venture capital, power, aviation, healthcare, rail transport, and more.

Walt Disney is another well-known successful multinational corporation with a strong history of product diversification.

The company began primarily focused on its core animation operations and diversified into many other sectors.

These now include theme parks, vacation resorts, cruise lines, live-action television productions, movie studios, and more.

The Bottom Line

Product diversification is the practice of expanding into new market segments and markets.

This is crucial for any company’s survival as market trends, and consumer behaviors shift.

Companies must remain alert and ready to pursue opportunities for product diversification as they arise and weigh the benefits and risks of diversifying.

Key Takeaways

• Product Diversification is the process of expanding into a new industry or industry segment.
• When performed successfully, product diversification can boost profitability and spread a company’s operations across multiple segments reducing the risk of business failure.
• Product diversification can help to prevent an existing product line from suffering obsolescence and declining sales.