Diversification

Growth has to come from somewhere. When the core market is exhausted, firms reach for diversification, and that is where many of them come unstuck.

Diversification is growth by entering new products or markets beyond a firm's existing activities. It ranges from related diversification, into areas that share technology, customers, or capabilities, to unrelated diversification, into businesses with little in common with the core.

Related usually beats unrelated

The evidence broadly favours related diversification. When the new business can share capabilities, customers, brands, or assets with the existing one, the move can create real economies of scope and transfer hard-won skills. Unrelated diversification has a worse record, because the discipline that made a firm excellent in one domain rarely transfers to another, and the centre ends up overseeing businesses it does not understand.

The attraction and the trap

Diversification is tempting for sound and unsound reasons. The sound ones include spreading risk, reusing underused capabilities, and finding growth when the core matures. The unsound ones include managerial empire-building, the wish to escape a declining business by buying a glamorous one, and simple over-confidence that competence is portable. The unsound motives are common and expensive.

The test of better off

The cleanest discipline is the better-off test: the new business and the existing ones must be worth more together than apart, after the costs of running them jointly. If the only logic is that the new market is attractive, that is a reason for someone to enter it, not necessarily for this firm. Attractiveness without a genuine connection to the firm's strengths is how diversification destroys value while looking like ambition.

Diversification done from strength, reusing real capabilities into adjacent ground, is among the most powerful routes to growth. Done from boredom or vanity, it is among the most reliable ways to dismantle a good company.