In business and finance, diversification refers to the practice of investing in a variety of assets to mitigate risk. Unrelated diversification refers to diversification into products, services or markets that are unrelated to the company’s original core competencies.
There are three main types of diversification: (1) related, (2) unrelated, and (3) geographic (Kennedy et al., 2020). Here’s a brief description of each:
- Related diversification occurs when a company expands into new businesses or industries related to its core competencies or products. For example, a manufacturer of automotive parts might diversify by entering the market for aftermarket car accessories. This type of diversification can allow a company to leverage its existing knowledge, skills, and resources to enter new markets and increase its revenue streams. Kennedy et al. (2020) offer the example of Volkswagen acquiring Audi. If they diversify up or down their own supply chain, we call it vertical integration.
- Unrelated diversification occurs when a company expands into businesses or industries unrelated to its core competencies or products. For example, a manufacturer of automotive parts might diversify by entering the market for consumer electronics. This type of diversification can be riskier, as the company may not have the same level of expertise or resources in the new industry. However, it can also offer the potential for greater returns if the new business is successful. Amazon entering the grocery store business by acquiring Whole Foods is a real-life example of unrelated diversification (Kennedy et al., 2020).
- Geographic diversification is the practice of investing in or conducting business in a variety of locations or regions around the world. This may be done to spread risk, reduce the impact of negative events in a specific location, and access new markets and customers. A company might pursue geographic diversification by expanding into new markets, selling products or services to customers in different countries or regions, sourcing materials or components from several locations, or investing in real estate or other assets in different geographic areas. This strategy is used by Starbucks, Target, KFC, and many more (Kennedy et al., 2020).
Unrelated diversification refers to the practice of expanding a business into new industries or markets that are not related to its core competencies or products (Sadler, 2003, p. 103; Chatterjee & Wernerfelt, 1988).
This can involve acquiring new companies or entering into partnerships or joint ventures to gain access to new markets or technologies.
Opportunities and Risks
Unrelated diversification can be riskier than related diversification, as the company may not have the same level of expertise or resources in the new industry. Most unrelated diversification efforts don’t end well for the original company.
For example, Harley-Davidson once tried to sell Harley-branded bottled water (Kennedy et al., 2020). This is one of the reasons related diversification is more frequent on average (Pinheiro et al., 2022).
However, it can also offer the potential for greater returns if the new business is successful. It can allow a company to diversify its revenue streams and reduce its reliance on any one market or industry.
It can also provide opportunities for growth and innovation by exposing the company to new technologies, customers, and competitors.
Overall, unrelated diversification can be a risky but potentially rewarding strategy for businesses looking to expand their operations and increase their stability.
On average, unrelated diversification is less common than related diversification (Pinheiro et al., 2022). It is vital for businesses to carefully consider the risks and potential benefits of unrelated diversification before making any expansion decisions.
| Opportunities of Unrelated Diversification | Risks of Unrelated Diversification |
|---|---|
| Hedging market risk that may exist in one vertical | Company lacks specialized skills in the new market |
| Exposes a company to new consumers | Lack of brand recognition in the new market |
A real-life example of unrelated diversification is the diversification strategy of the lighter brand Zippo.
According to the CEO, the Zippo lighter is seen as “rugged, durable, made in America, iconic” (Associated Press, 2011). The future of the lighter business is, however, bleak. Smoking is becoming less and less popular in many countries, so it made perfect sense for the company to pursue a strategy of unrelated diversification.
Zippo then diversified into “pocket knives, money clips, pocket flashlights, key holders, writing instruments, and tape measures. Trying to figure out which of these diversification options would be winners, such as the Eddie Bauer-edition Ford Explorer, and which would be losers, such as Harley-branded bottled water, was a key challenge facing Zippo executives” (Kennedy et al., 2020).
- From soccer balls to treadmills: A company that manufactures sports equipment, such as soccer balls and basketballs, expands into the market for fitness equipment by acquiring a company that produces treadmills and exercise bikes. The sports equipment company will need to learn about and navigate the fitness equipment market, which may have different product features, pricing, and distribution channels.
- From coffee shops to fast food: A company that operates a chain of coffee shops expands into the market for fast food by acquiring a franchise for a well-known fast food brand. The coffee shop company will need to learn about and navigate the fast food market, which may have different menu offerings, pricing strategies, and customer expectations.
- From restaurants to party planning: A company that operates a chain of restaurants expands into the market for catering by acquiring a party planning company. The restaurant company will need to learn about and navigate the party planning market, which may have different menu offerings, event planning, and customer service expectations.
- From tractors to snowboards: A company that produces agricultural equipment, such as tractors and combines, expands into the market for snow sports equipement. The agricultural equipment company will need to learn about and navigate the recreational sports market, which may have different customer demographics, distribution channels, and marketing strategies.
- From industrial machinery to consumer appliances: A company that produces industrial machinery, such as machine tools and factory automation equipment, expands into the market for consumer appliances by acquiring a company that produces refrigerators and washing machines. The industrial machinery company will need to learn about and navigate the consumer appliance market, which may have different product features, pricing, and distribution channels.
- From pharmaceuticals to cosmetics: A company that produces pharmaceuticals expands into the market for cosmetics by acquiring a company that produces skincare and makeup products. The pharmaceutical company will need to learn about and navigate the cosmetics market, which may have different product development, marketing, and distribution strategies.
- From financial advice to pizza shops: A company that provides financial services, such as banking and investment management, sees market risk, so starts up a pizza shop chain to hedge. The financial services company will need to learn about and navigate the restaurant market, which may have different products, pricing, and regulatory requirements.
- From IT services to medical devices: A company that provides IT services, such as software development and network support, expands into the market for healthcare products by acquiring a company that manufactures medical devices. The IT services company will need to learn about and navigate the healthcare market, which may be subject to different regulations and standards than the IT services market.
- From auto parts to consumer electronics: A manufacturer of automotive parts, which primarily produces brakes and steering components, expands into the market for consumer electronics by acquiring a company that produces smartphones and tablets. The automotive parts manufacturer will need to learn about and navigate the consumer electronics market, which may be different from the automotive parts market in terms of competition, pricing, distribution channels, and customer preferences.
- From clothes to home furnishing: A retailer of clothing and accessories, which operates a chain of stores selling fashion apparel and accessories, expands into the market for home furnishings by acquiring a company that produces furniture and home decor products. The retailer will need to learn about and navigate the home furnishings market, which may be different from the clothing and accessories market in terms of design trends, material sourcing, and distribution channels.
Conclusion
Diversification refers to the practice of investing in or conducting business in a variety of assets or markets to spread risk and reduce the impact of negative events on a portfolio. There are three main types of diversification: (1) related, (2) unrelated, and (3) geographic (Kennedy et al., 2020).
Unrelated diversification occurs when a company expands into businesses or industries that are not related to its core competencies or products (Sadler, 2003; Kennedy et al., 2020). Unrelated diversification can be a risky but potentially rewarding strategy for businesses that are looking to expand their operations and increase their stability. It is important for businesses to carefully consider the risks and potential benefits of unrelated diversification before making any expansion decisions.
References
Associated Press. (2011, March 21). Zippo’s burning ambition lies in retail expansion. The Daily Journal. https://www.smdailyjournal.com/business/zippo-s-burning-ambition-lies-in-retail-expansion/article_80c8ef2e-4495-5823-8e02-9bff74109b2f.html.
Chatterjee, S., & Wernerfelt, B. (1988). Related or Unrelated Diversification: A Resource Based Approach. Academy of Management Proceedings, 1988(1), 7–11. https://doi.org/10.5465/ambpp.1988.4979378
Kennedy, A. by R., Jamison, with E., Simpson, J., Kumar, P., Kemp, A., Awate, K., & Manning, K. (2020). 8.3 Diversification. https://pressbooks.lib.vt.edu/strategicmanagement/chapter/8-3-diversification/
Pinheiro, F. L., Hartmann, D., Boschma, R., & Hidalgo, C. A. (2022). The time and frequency of unrelated diversification. Research Policy, 51(8), 104323. https://doi.org/10.1016/j.respol.2021.104323
Sadler, P. (2003). Strategic Management. Kogan Page Publishers.
Tio Gabunia is an academic writer and architect based in Tbilisi. He has studied architecture, design, and urban planning at the Georgian Technical University and the University of Lisbon. He has worked in these fields in Georgia, Portugal, and France. Most of Tio’s writings concern philosophy. Other writings include architecture, sociology, urban planning, and economics.
This article was peer-reviewed and edited by Chris Drew (PhD). The review process on Helpful Professor involves having a PhD level expert fact check, edit, and contribute to articles. Reviewers ensure all content reflects expert academic consensus and is backed up with reference to academic studies. Dr. Drew has published over 20 academic articles in scholarly journals. He is the former editor of the Journal of Learning Development in Higher Education and holds a PhD in Education from ACU.