Due to the global financial situation, some business owners may be thinking that they should diversify from their current income streams. This is opposed to selling out. When you diversify, you keep your current business running (perhaps in an altered state) and commence a new line of products or services. Is this a good idea?
Diversification can sound like a good idea but it does need to be thought through carefully. Really, diversifying into another business line should be treated like commencing a new undertaking from the start. However, you may have some existing infrastructure and personnel that will assist you. Nevertheless, I think it is a good idea to approach the idea as if you were commencing a new business with all the planning and thinking that this entails.
If your enterprise is not currently profitable, diversifying may not be the solution. Indeed, it could make the situation worse. Why isn’t your business currently profitable? Is this just a temporary thing or is this what you experience most of the time? If you are running an unprofitable or low profit business, before you launch into another enterprise, you had better find out why the current business is not making money so that you don’t take some of the problems into the new products or services that you are selling.
There is a view that public companies that conduct several business lines produce a poorer return on shareholders funds than companies that focus on one thing. I don’t have any data to back up this statement but I know of some respected business commentators that share that view. Why would this be? It is because the management of the company cannot give its full and proper attention to any one particular business line. Therefore it is mismanaged and under resourced.
The same problem can arise for a small business. The owner or manager is usually time poor and for any new offering to the market that is going to be developed, it must be given proper time and energy or everything may fail, including the existing operations.
So when is a good time to diversify? Consider these situations.
Seasonal sales. If your business has ups and downs in sales throughout the year it can be good to have an alternative source of income that can plug the holes during the down times.
Marginal benefits in expanding the existing operations. By analysing your market you may consider that your existing business has little practical ability to expand beyond its current level. This could be for various reasons. One reason might be that you consider that the extra effort and cost in increasing your market share will equate to, or be greater than, the extra benefits that you will get from that market share.
A great opportunity presents itself. Sometimes an exciting prospect presents itself. You may have just been lucky or you may have been searching for this opportunity. The availability of great opportunities will only be for a limited time. If you don’t seize the opportunity, then someone else will. If you have the time and resources, this can be a good reason to diversify.
The existing enterprise runs very successfully with little owner input. This is the ultimate goal for the owner of an enterprise. You get to the point where you do not need to work in the business, unless you choose to. This means you are running a well systematised operation and the thinking that you have put into your existing enterprise can be applied to a new one.
You have surplus capital. I once read that Warren Buffett (one of the world’s most respected investors) said that the most important decision that a company makes is what to do with its capital. Should it reinvest it or should it return it to its shareholders? Theoretically, a company should return its capital to its shareholders if it believes that it cannot obtain a return on the funds in excess of what the shareholders could obtain if they invested funds elsewhere. So, if you have surplus capital, should you invest it in another commercial undertaking or should you return it to the owners?
Diversifying can sound like a good idea, but make sure the conditions are right before you leap into it.