Related diversification can help drive revenues and profits.
Companies utilize various growth strategies. Some choose an organic growth strategy and increase market share in their existing industry by focusing on marketing and sales. Other companies expand their industry footprint through mergers and acquisitions or enter new industries through a diversification strategy. Concentric diversification occurs when a company expands by entering into an industry related to its current operations.
Since all for-profit businesses have as their reson d’etre increasing the value of the company for its owners. businesses typically diversify to increase the value of the company for owners and investors. Companies also diversity to reduce risk and utilize excessive cash on the balance sheet. Concentric diversification is also called related diversification. Related diversification is a diversification strategy for driving shareholder value increases. Businesses implement a related diversification strategy to attain “synergy.” Companies achieve “synergy,” which occurs when businesses perform better as a whole than as the sum of their parts, through sharing resources. combining operations and transferring knowledge.
One example of concentric diversification is sharing resources or facilities. Companies do this to achieve economies of scale and reduce costs. For example, a metals distributor who needs a larger warehouse may contract with a manufacturing company that has a processing facility with extra space. The manufacturer benefits because it operates on just-in-time principles and now part of its raw materials are
now on site. The distributor benefits from the space, the equipment and the warehouse management expertise of the manufacturer.
Another way to achieve concentric diversification is through strategic partnerships. Strategic partnership results when to companies enter into a formal business relationship to obtain benefits greater than they can achieve on their own. By combining skills and resources, they both can achieve their goals faster. Companies may enter into a contract or may form a wholly separate but related business known as a joint venture. For example, a billing software company with strong ties to the energy industry may strategically partner with a much larger customer relationship management, or CRM, software company. The billing software provider gets the opportunity to expand to a different industry via the partnership and the CRM company gets to build deeper inroads into the energy industry.
Companies also concentrically diversify through mergers and acquisitions. Mergers happen when two companies of approximately equal status combine through the exchange of stock, with only one entity remaining. Acquisitions involve the purchase of one company – either the company’s assets or stock –by another. For example, Coke purchased several beverage manufacturers to expand beyond the soft drink industry to the beverage industry. Coke’s acquisitions of Vitamin Water, Honest Tea, Fuze Beverage and Core Power were concentric diversification moves, providing it with brand recognition in new categories.