Software Company Diversification

Software company management teams must make many difficult strategic decisions. One is finding the delicate balance between “focusing on the core business” and “not putting all of your eggs in one basket.”How much software company diversification is desirable?

The answer certainly depends on the details. One obvious way of differentiating how much diversification is appropriate for a specific company is by software company size and maturity. A brand-new startup must focus on doing one thing well, or it may not last long. A large, established company generally needs several new irons waiting in the fire as initial products and market segments mature. Or they risk shrinking in size, rather than continuing to grow. The two ends of the spectrum are pretty obvious. But there is a wide continuum of situations in between, where the proper strategy isn’t as obvious. Let’s look at some factors to consider when formulating your company’s diversification strategy:

How much growth is left in your primary business/market/technology

This may be the first thing you should consider when contemplating the diversification question. Say you’ve hit on a huge market opportunity with room to run and gained good traction. In this case, don’t develop “eyes bigger than your stomach”. Here your best growth opportunity is usually keeping your eyes on that single ball. Everything else being equal, a focused strategy is always easier to execute than a diversified one. So if you have explosive growth prospects ahead as far as the eye can see, it’s better to defer the diversification decision for some time later.

Competition level in your primary business

Strong competition in your primary market is often a factor that can cause a management team to look toward diversification. Or decide it needs to focus on its core market, depending on the details. The key is how competitive your products are in this core market. If you are very competitive, yet caught in a heated battle with that strong competition, the choice is often to stay focused. However, if the competitors are so strong that your company is an also-ran, a decision is frequently made to diversify. On the other end of the spectrum, what if the competitors are weak? That may also allow you to more easily take on some diversification without the risk of losing hold of your profitable core business.

Level of available resources for software company diversification

This is a big key. If you only have the resources to keep one ball in the air, focus on that single ball. It doesn’t matter if you have five great ideas! Pick the one you think is best and sell out to be successful there. I often see early-stage managers make this mistake and try to juggle multiple balls. They aren’t sure which of their ideas is the best. This uncertainty causes them to split their very scarce resources among several ideas. Unfortunately, this usually prevents critical momentum in a single area. It’s also important to measure all types of key resources when considering this success factor, not just the financial ones. Do you have enough skilled engineers, marketers, or management bandwidth? If any of these or any number of other resources are in too short supply, diversification at this time is probably a bad idea.

Ease of extending proprietary technology into adjacent markets

This requires an evaluation of your existing IP. Often software companies have cutting-edge technologies that can be adapted to other market segments and provide a similar differential advantage as in the initial core market. But what if the technology is very specialized? Or you can’t see another good market opportunity to invade using your existing technology as your entry advantage?  In these cases, it’s best to be realistic and look at other ways of diversifying. For example, acquire new technology/product categories, useful in your current segment via M&A.

Can you create or acquire new technologies that your existing market wants?

There’s a lot that goes into answering this question. A lot of it relates to your technical staff. Are they specialists in your existing technologies? Or do you have the type of talent that is constantly coming up with outside-the-box ideas and potential new products?

If there isn’t fertile ground internally for innovative new ideas, you may need to look at acquisitions that can bring fresh technologies and products to your pipeline. These don’t need to be huge, costly acquisitions. You can often acquire highly innovative startups. Startups that are little more than a small engineering team, a core product, and a few initial customers.

Also, are your product managers identifying unmet needs from your existing user base? This is crucial to bringing SUCCESSFUL new products to existing markets. Whether driven by internal development or external technologies/products/companies acquisitions.

Software company diversification to completely new markets with completely new products/technologies is dangerous

Above all, you want to avoid moving into a new market, and also with a completely new product/technology. The odds of pulling this off successfully are very low, roughly equivalent to any new startup company. This is often referred to as a “restart”. It generally occurs when a company looks forward and sees failure ahead. This can be due to a hopelessly out-of-date technology or an evaporating market segment (often due to a technological sea change). I frequently see this from very discouraged management teams. And as a result, they desperately seek “greener grass on the other side of the fence”. But of course, the grass isn’t always greener. This approach should be viewed as a last resort only. Every attempt should be made to diversify into an area where there is some technological or market experience.

Like most strategic decisions, diversification in the software business isn’t inherently good or bad. The circumstances dictate how much you should pursue.  What do you think about the strategic tradeoff between focus and prudent diversification? Leave a comment below with your experiences and views.

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