Software Company Diversification

One of the difficult strategic decisions that software industry management teams have to make is finding the delicate balance between “focusing on the core business” and “not putting all of your eggs in one basket”.

One obvious way of differentiating how much diversification is appropriate for a specific company is by company size and maturity. A brand new startup better be very focused on doing one thing well or they may not last very long. A large, established company generally needs to have at least 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 own 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. If you’ve hit on a huge market opportunity with a lot of room to run and have gained good traction, it’s often unwise to develop “eyes bigger than your stomach”. In this environment 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 sometime down the road.

Competition level in your primary business

Strong competition in your primary market is often a factor that can cause a management team to either look toward diversification or decide it needs to focus on it’s core market-depending on the details. The key is how competitive you are: if you are very competitive and yet caught in a heated battle with that strong competition the choice is often to stay focused. However, if that competition is so strong that your company is an also-ran, a decision to diversify is often taken. On the other end of the spectrum if the competition is 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

This is a big key; if you only have the resources to do one thing well it’s critical to keep you focus on a 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. They aren’t sure which of their ideas is the best and this uncertainty causes them to split their very scarce resources among multiple paths. Unfortunately, this usually dooms them to not gaining critical momentum in a single area. It’s also important to measure all types of key resources when considering this factor, not just financial. 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 just 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, such as acquiring new technology/product categories via M&A that are usable in your current segment.

Can you create or acquire new technologies which 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 many need to look at acquisitions which can bring  fresh technologies and products to your pipeline. These don’t need to be huge, costly acquisitions; often you can acquire highly innovative startups which 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 usually crucial to bringing SUCCESSFUL new products to existing markets, whether driven by internal development or acquisition of external technologies/products/companies.

Diversifying to Completely New Markets with Completely New Products/Technologies is very dangerous

Above all you want to avoid moving into a completely new market with a completely new product/technology. The odds of pulling this off successfully are very low, roughly equivalent to that of any brand new startup company. If fact, this is often referred to as a “restart”. It generally occurs when a company looks forward and sees certain failure ahead due to a hopelessly out-of-date technology or an evaporating market segment (often due to a technological sea change). I often see this from managements that are very discouraged and desperately seeking “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 really 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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