Written by Albert Bonello, Chief Financial Officer AX Group
One of the most difficult decisions that businesses face across the globe is whether to diversify or not. Business diversification can open up a number of opportunities, but the risks and uncertainty tied to this strategy can have long-term repercussions. So why do businesses opt for diversification?
First thing that comes to mind is the concept of spreading of risk. It’s smart to hedge against fluctuations between industries, looking towards different audiences, evolving what the company knows about customers’ needs and their expectations.
Unfortunately, I have seen some businesses realise the need for diversification at a very late stage and hence the circumstances in which this critical decision is taken are generally rushed and not properly thought out. Managers and financial analysts are under pressure when asked to prepare projections, analyse market trends and look at competitive benchmarks. So what factors are to be taken in consideration to achieve a structured approach towards diversification?
Companies need to carry out an internal analysis to identify the processes and abilities that generate sustained competitive advantage, which competitors cannot easily obtain. These are very often referred to as strategic assets. Such strategic assets may be a management team with strong entrepreneurial skills, the company’s superior purchasing power, or extensive customer knowledge base in a specific industry. For instance, for the AX Group, the diversification from the construction industry into development happened fairly quickly. The Group built capital on the construction work that was contracted and started diversifying into the development of its own property portfolio.
Very often, companies fail with diversification because they assume that having some of the identified strategic assets is sufficient. Therefore, companies must ensure that a proper gap analysis is carried out to ensure that they have all the identified strategic assets in hand prior to moving forward with diversification. Any missing strategic assets can either be acquired externally, developed internally or be adapted to accommodate better customer expectations. Very often the strategic assets held need to be moulded and adapted to fit with the strategic assets acquired in order to create synergy and finally result in a successful diversification strategy.
A long-lived successful diversification strategy is one that is unique; not easy to imitate or substitute. How easy is for competition to catch up by acquiring or imitating strategic assets built? Can competition create similar strategic assets that might be an alternative to customers? For example, Amazon had initially started as an online bookseller but eventually the company became the largest retailer of consumer goods, even if it lacked a physical store network. Amazon was able to leverage its existing strengths by identifying and adapting the strategic assets necessary to create an alternative to the traditional retail industry.
Shareholders and investors alike would expect that a successful diversification strategy will give a competitive edge against other players. Before the AX Group decided to branch out into the care business, which in itself has many similarities with the hospitality division, management carried out a gap analysis to understand the strategic assets that were essential prior to taking this bold move. Many of the strategic assets were already held by the Group. A few of these strategic assets were the centrality and neighbourhood of the identified site, the internal technical expertise on how to properly plan and develop the property and the extensive experience in the 4 star and 5 star hotel industry. Notwithstanding, a number of strategic assets and processes had to be adapted and acquired. For example, the Group had to acquire knowledge of the healthcare industry and eventually mould this knowledge with the existing hospitality and development processes to create a unique concept.
Above all, a structured approach towards diversification will lead to organisational efficiency that will enhance the internal expertise and knowledge for future diversification decisions.
If planned well, diversification will lead to organisational growth and ultimately increase shareholders’ wealth.