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How Diversification Boosts SME Revenues

July 15, 2016 by Abhishek Rungta under Strategy491 views
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A business faces a higher risk of a downturn and diminishing revenues when it caters to one product or market.  During economic uncertainties, small and medium enterprises are more vulnerable than their larger counterparts.

For a smart business, with a focus on long-term growth, it is important to diversify into different products, industries, and markets.  This not only helps you to boost revenue but minimize risks associated with business uncertainties.

It cannot be denied that diversification holds considerable risks. However, proper planning and execution shields your business during slump besides giving you the wider exposure to safer markets.

A CRISIL study indicates that average sales of MSMEs with a diversified product/service, customer and geography base grew by 18 percent in 2013-14 in comparison with 10 per cent growth attained by businesses with limited or no diversification.  It also stated that track record and experience play a significant role in successful diversification.

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How does diversification shield your business from various risks and aids growth?

Circumvent downturn in a particular product

Relying on a single product is laden with risks. A product may become obsolete and demand may suffer. For instance, if you are a manufacturer of computer accessories, where technological change is rapid, it is imperative for you to keep a tab on changing technology.

Demand for a specific accessory may become low due to obsolescence. In order to prevent a sudden shock to business revenues, you can keep your revenue stream flowing by manufacturing another important accessory alongside.  That’s why, it is also important to focus on product development strategy because your rivals can soon imitate your existing product design.

Evade stiff competition in a particular market and establish stronger base elsewhere

Continuing the above example, if you sell your computer accessory to a specific market where the competition gets tougher every day and your margins are shrinking, it is always better to explore underserved markets. While you keep your existing customers happy, you open accounts with other customers in a different market.  You can expand your customer base there and establish yourself as the key provider.

Stabilize revenue stream through client diversification

Every business is prone to market volatility.  When you focus only on one product, you are at risk of losing significant business when your key customer closes a door on you.  It could happen due to various reasons like availability of better vendor, availability of better price or better credit, change in business strategy, or bankruptcy etc. Under such circumstances, you are left high and dry.

Conversely, client diversity endows security of consistent revenue flow to your business.  You get a better control over your business revenue and few customer drops here and there don’t hurt very much. Even the loss of biggest customer can be contained by spreading your clientele revenue.

Alleviate business risks through sector diversification

When you operate in a single sector, your business is vulnerable to sudden changes in that sector. The sector could be marred by a sudden dip in demand. It could face high taxes and duties by the government that severely affects your margins. In the worst case scenario, there could be a long-term decline in the sector.

For safety reasons, small and medium businesses should at least aim to operate in two sectors to avoid this risk. For instance, if you are an application service provider with an expertise in the medical industry, it could be viable for you to explore other sectors like insurance, retail etc.  Serving different industries not only mitigates volatility concerns but also offers you diverse servicing experience.

Explore geographies to minimize geographical risks

Do not be bound by geographical restrictions. If you serve customers only in one city or area, your long-term business growth is limited to the growth in that city. Step out of your comfort zone and explore new cities where you can find more customers.  Expanding geographies helps your business grow and you are less likely to be affected by slower growth rate in one city.  Ideally, an SME should target at least two cities with regular clients.

Expand your office locations to curtail resource risk

Again limiting your business to a single physical location is susceptible to resource risks. You may have to pay up more for office space. There may be a shortage of skilled labor or raw material in that location. Though your customers are spread across different cities, serving them through a single location could be risky for your business.  A second or third location probably in a different city gives you a sound backup and you can also cater to extra load burdened on single facility.

How to diversify your business?

There’s no doubt about leverages bestowed upon a business through diversification.  However, it is important to pursue diversification with the right approach and strategy in mind.

Diversification does not mean that you have to venture into a new product altogether of which you have no knowledge or associated experience.

Build upon existing resources

To begin with, a business proprietor should consider building upon existing resources like machinery, space, manpower, skills etc.  One should think about exploiting existing resources for other purposes.  Core strengths of a company can be utilized to offer complementary business service. Offering complementary services is a great way to diversify. Customers can benefit from bundled services.

Do not shift focus from core business

Core business operation should not be tampered with during diversification.  Think of ways that require minimum investment whilst opening new markets for you.  This ensures that there is no financial instability due to diversification.

Many a time, diversification is a consequence of natural progression.  Your product line expands with time and experience. With a well-established brand name, your product reach expands. For instance, a make-up product manufacturer making foundation and powder can venture into eyeliner, lipsticks, mascara etc.

Be mindful of your weaknesses

Ideas for diversification also stem from business weaknesses. A business owner should conduct business feasibility in the longer run. Identify the threats it is exposed to.  It could be a product threat that may help to induce slight changes in the design.

It could also be an overreliance on a single customer. Overreliance may limit your product diversification ability due to too much product customization catering to that single customer.  This may stimulate you to diversify your key customer base.

Conclusion: Diversify to stay competitive and boosts revenue

Diversification acts as a catalyst for business growth. However, it can also lead to business losses. Even if you diversify into new products or new sectors, it could be possible that you are unable to find sufficient customers.

Nonetheless, growth and survival are often cited as the most common reasons for business diversification. Every SME should first establish its core business and then tread towards diversification with a mix of right manpower and well-defined strategy.

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