Diversity or focus: Which strategy is best for a growing business?

Growing Business assesses when it's the right time to diversify a business, and when it's best to stick to the task in hand

First, a true story.

It’s late afternoon on a west coast mainline train. With Manchester only a few minutes away, an airliner comes into land at the local airport, framed by the train window. In the seat opposite a teenager talks excitedly into a mobile phone while her friend cracks open a can of cola and takes a long drink. Normally, none of these things would seem remarkable – except in this case there is a unifying factor. The train, plane, mobile phone and soft drink can all bear the Virgin brand. Sometimes it seems that Richard Branson is the unofficial ruler of the world.

The Virgin Group is one of those organisations where diversification has almost become a brand value in itself. Few people expect Branson to rest on his laurels and the result has been an empire of often-disparate ventures, united under the familiar red and white V logo. And while not all of the group’s businesses succeed, the sheer volume of its revenues provide illustration of just how effective a diversification strategy can be in driving growth.

Not that you necessarily have to follow the example of the Virgins and Easy Groups of the world in stretching a single, over-arching brand into new business areas. Many companies diversify under a range of trading names, with each being tailored for the market in question. And while in some cases the diversification strategy will be carried out within a single company, many entrepreneurs prefer to ring-fence new businesses as separate corporate entities or proceed through joint ventures with others. In short, there are plenty of options to consider and while the growth prospects of your current business may be limited by factors such as the size of the customer base, by diversifying you can shake off the revenue inhibitors.

But launching new products or business units will require management time – your time. And if the new venture doesn’t work out as planned, you could well find your pre-existing business has been damaged by the lack of attention. Diversification certainly shouldn’t be entered into lightly and there may be times when it’s better to stick to your knitting. So what are the ground rules? How will you know when the time is right to branch out or if you’re better off sticking with your existing business?

As your business develops, why diversify?

Often a decision to diversify is a direct result of an opportunity presenting itself. As your business develops, there will undoubtedly be times when widening your product offering or range of services is a natural progression. For instance, Charlie Osmond, co-founder and joint MD of Freshminds recalls how his company’s expansion into the recruitment market was the result of a single client inquiry. “We started off supplying graduates for temporary research work,” he says. “Then one of our clients asked if we could help them find permanent staff.”

As Osmond points out, the fit between research and recruitment was next to perfect. The client who wants a highly educated part-time researcher in March could well want a full time member of staff, drawn from the same graduate talent pool, in June. Equally, the graduate seeking temporary research work before a world trip might return from the said gap year in search of a good career. In both cases Freshminds is a natural point of contact. “As soon as we got the request we knew it would be an easy add-on – we knew that it would integrate with what we were doing,” says Osmond. “Now it is hard to imagine one side of Freshminds’ business being so successful without the other.”

Toby Stephenson, small and growing business partner at accountancy firm PKF agrees that one of the most compelling reasons to diversify is a complementary and strategic ‘fit’ between one business and the next. “A good example is a business buying into its own supply chain,” he says. “For instance, we worked with a business that used a lot of fabricated steel. So it bought a fabricated steel manufacturer.”

Alternatively the fit may be directly related to seasonal business cycles. If you happen to sell ice cream for a living then finding a balancing ‘cold weather’ business will help you escape the tyranny of summer peaks followed by winter troughs. Richard Downs of Iglu.com – a travel website business that began by supplying ski holidays before moving into areas such as villas and tropical holidays – knows that situation well. “We were operating at 120% during the peak winter months but during the summer we were operating well below capacity. We had built up a strong customer base and many of those customers were asking us what we did in the summer. We launched villa holidays and moved on from there.”

Alternatively, diversification can be a means to raise revenues while maintaining a more or less fixed-cost base in areas such as HR, payroll and invoicing. Or it could be driven by a desire to use up spare factory capacity or space in an office that you’re paying for but not using.

Business pitfalls

Which is not to say that if you can tick one or more of the above boxes, you should run headlong into new business ventures. “I wouldn’t advise anyone to diversify until the core business is stable,” says Simon Franks, chief executive and founder of Redbus Films. “We didn’t think of doing anything other than the core business until we’d been making a profit for three years.”

The logic here is pretty compelling. While an existing business requires significant amounts of management time and energy, diluting that executive bandwidth by launching something new could result in a situation where both ventures suffer. “There are plenty of examples of people launching a new business with the result that everything goes to pot in the core business,” says Stephenson. And it’s not just a problem that afflicts those who branch out to pastures new too soon. Even a well-established business can suffer if management is spread too thin.

So how do you avoid this? A good starting point is the management structure. “You need to create a situation where the entrepreneur or owner-manager oversees everything that is happening within a group, while setting up teams to run the day-to-day,” offers Stephenson.

Certainly, that was the approach taken by Iglu.com. Downes says the company delayed its expansion from ski holidays to villas until he was certain that “the management pillars were in place” in key areas such as sales, marketing and customer care. Once they were, he was freed up to focus on the launch of new businesses.

Stephenson stresses that management teams must be given not only responsibility but the power to move things forward. “You have to empower them to make decisions, you have to give them their head – and you have to reward them,” he says.

For some that will mean an uncomfortable loss of control. But whether they are responsible for running divisions within a single organisation or standalone businesses under a group structure, your managers will need freedom if they are to flourish.

Indeed, one means to diversify successfully is to encourage existing staff or talented outsiders to take charge of their own projects. For example, Yo! Company’s Simon Woodroffe’s aims to capitalise on the success of the Yo! Sushi restaurant chain by launching other businesses under the Yo! banner. As he explains, his role is not to run the companies on a day-to-day basis but to provide his chosen managers with the support they need. “We don’t launch a business unless someone is driving,” he says. “I’m there to be a resource. I tell people – this is your business, you run it. I am a service to you.”

The power of the brand

To date, the Yo! brand has been applied to Yo! Sushi itself (a restaurant chain), Yo! Japan (a clothing business operating under licence), Yotel (a soon to be launched hotel venture) and Yo! How, a vehicle designed by Woodroffe to pass his business expertise on to others. His other restaurant brand Yo! Below no longer operates. Although not on the scale of Virgin or easyJet, the principle is the same. Take a brand that has a resonance with the target audience and apply it across a range of businesses.

According to Peter Shaw, a director of brand consultancy Corporate Edge, the key to success is to understand the strengths of the brand in terms of what it represents to the consumer. Once you’ve done that, you can begin to look at businesses where it will make sense to use that trade name. Get it right and you save yourself an awful lot of time and money on marketing new names.

On the other hand, he warns against over-stretching brand power. “If you take Virgin – it’s seen as a challenger brand. It goes into markets and shakes them up. It has worked well in the airline and mobile business but I’m not sure if the brand brings much to the soft drinks and Vodka markets,” he muses.

Woodroffe agrees that a fit between brand and business is important. “The Yo! brand is all about innovation,” he says. “Yo! Japan hasn’t been as successful as we would have liked because I don’t think it has been innovative enough. That’s something we’re looking at.” In contrast, he believes Yotel – which draws some of its inspiration from Japanese capsule hotels – will capture the imagination in an otherwise traditional UK market.

But perhaps the most obvious way to exploit the power of your brand is to expand into closely related business areas. Iglu was already in the travel business through its skiing operation, so – aside from the frosty name – it wasn’t an enormous leap to expand into other areas of the holiday market. “40% of our business comes from repeats and referrals,” says Downes. “By using the Iglu name, we were able to get that repeat and referral business across ski, villas and tropical holidays.”

Structure and finance

As Shaw points out, a weak business that fails to meet the expectations of customers can inflict some pretty severe reputational damage on a sister or parent company sharing the same brand name. Equally, a loss-making business venture can be a major drain on an otherwise profitable core business – just look at the damage ONdigital visited upon the long-suffering shareholders of Carlton and Granada. So, for every opportunity you really have to weigh up the risk and reward.

You can mitigate the risk by ring-fencing the finances. For instance, within a single operation, you should ensure that budgets are in place and that the business plan includes targets and milestones to help assess whether the new product line is delivering on its promise. Khilan Dodhia, a director of venture capital company Barclays Ventures sees it in terms of appropriate controls. “We would want to see the trigger points to allow us to assess success or failure,” he says. However, Dhodia stresses that you have to be flexible about milestones as business plans rarely, if ever, work out according to schedule. “You have to be pragmatic about shortterm targets,” he says.

On the other hand, you might opt to use the same brand but under a different company structure. For instance, you might take a stake in a business that carries your company’s name while allowing the managers or another business party to invest in and even drive the project. However, Dhodia warns that you shouldn’t necessarily expect support from your existing private equity investors for this strategy as they would fear their stake in any profitable diversified business would be diluted. “From an equity perspective, we would want a share in each venture,” he says. “A changed structure could cause us severe problems.”

And in the case of untried products, your equity investor could be your best friend. “Bank finance should be available if you want to diversify,” says Dodhia, “but the repayment period will tend to be fixed, so you will be reliant on the diversified programme to finance the loan. VC finance can be more flexible than bank finance, in that respect.”

However, it is worth bearing in mind that your decisions on how to structure the new business could have tax implications and you should plan accordingly. “If you are foreseeing a loss in the early stages, try to ensure that it can be set against profit elsewhere in the business,” advises James Burns, a tax partner at KPMG. “Tax planning should be part of the business plan,” he advises.

Given that you never quite know when a business opportunity is going to present itself, there is never a right or wrong time to diversify. However, whenever you do it, it pays to think long and hard about where the business is now and where you want it to go, while making sure that the finances and management resource are in place.

Diversification should be an engine for growth, but new projects can fail spectacularly. The greatest fall from grace in recent times has probably been ONdigital, the venture which put Carlton and Granada head-to-head with BSkyB as broadcast platform operators. The Virgin Group, has taken the concept of diversification to the nth degree has had out-and-out failures, such as Virgin Bike and Virgin Cars. Easy Group has struggled with cinemas and pizza delivery.

On the success side, Virgin Atlantic probably surprised most commentators and Virgin Mobile has been a strong performer. While few UK entrepreneurs can boast to have the profile of Branson, many have quietly and successfully built their product offering. Redbus has moved from distributor to producer, taking in advertising along the way and Innocent Drinks has progressed from smoothies to a whole range of fruit based drinks and yoghurts.

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