Business Diversification vs. Focus in Tech Companies

What are the biggest factors that drive a company toward either a relentless focus on its core business or a penchant for business diversification? In my experience, the background, personal experiences, and attitudes of the CEO or founders. It really depends upon what these folks are used to and comfortable with. A CEO who came up through the finance function and has had exposure to many acquisitions or roll-up platforms tends to continue that approach when they become a CEO. This is regardless of whether that may be the most appropriate thing for the company they are leading at that time.

“Deal junkies” from all functional areas usually fit the same profile and lean toward business diversification. Conversely, a CEO who came up through the product development function might identify closely with a specific type of technology or market. As a result, the company strategy may stick closely to that core business, come hell or high water.

All of this is human nature, really, and is quite understandable. But I believe it’s often wrong for the company they lead. Many of these decisions to focus or diversify occur at important inflection points for a company. And it can have a huge effect on downstream success or failure. I believe top management must step out of its comfort zone and make these decisions with greater objectivity. So, what criteria should be considered when contemplating business diversification or a core business focus? Let’s take a look at a suggested sample set of questions to put on the whiteboard in your strategy session. Just to get the discussion started:

What stage is your company (and products) in its lifecycle?

This may indeed be the most important question on the list to ask yourself. If the company is currently in a period of high growth and everyone is running hard, execution is critical. Any discussion of business diversification efforts can be very difficult in these circumstances. This is sometimes unfortunate, because it is usually best to plan for the next growth driver BEFORE the current one has run its course. But taking your eye off the execution ball at such a time can also be quite dangerous. So this can be a real balancing act.

Strategic planning really needs to be done with a long-term view. So it’s best if you can at least find the time for a discussion of “what comes next”. But in many, if not most cases, if you’re growing nicely and can see adequate opportunities in closely adjacent (and therefore low-risk) technologies/markets, it may be best to continue that focus. Only once you believe that the runway for your current technology or addressable market is ending, does it usually make sense to consider major diversification efforts.

How horizontal or vertical is your IP/Technology?

The more horizontal your hardware or software technology is, the easier it will be to diversify a tech company’s revenue streams. If you’ve built your company on IP and market knowledge that is extremely vertically focused and doesn’t appear to be directly transferable, this adds risk to any diversification activity. Many times, the underlying technology in a highly focused, vertically oriented traditional software, SaaS, or hardware company is nothing special. At least when compared to what exists in other market segments. The differential advantage in these cases is often customizing this commoditized platform for the target vertical segment. This competitive advantage doesn’t translate well to other market segments. Be careful to do an objective analysis of this horizontal vs. vertical question before you plunge into business diversification.

Is there excess capital for business diversification or core activities?

Often, it’s an excess of financial resources that leads a management team to consider business diversification. Of course, this can be “fool’s gold” if it causes unwise investment of money. The first order of business should almost always be to dedicate the amount of money – no more but no less – necessary for continued success in the company’s current core business. That’s true no matter how you may define success. Make sure that you can do that first.

If you can’t, in almost all cases, any thoughts of diversification should be delayed until the circumstances change. Once that is done, it’s important to decide how to get the best return on this committed capital. In many cases, the best risk/reward move is to put it into something safe, like low-risk bonds, because it keeps you from getting too aggressive in diversification. Some people won’t let money burn a hole in their pocket, which can lead to reckless diversification. Any business diversification effort should be approached cautiously and as systematically as possible, due to the inherent risks.

Optimal ROI in your current business with all resources deployed?

This is a question about the size and resources available to you. As opposed to the size and attractiveness of your current market. I’m not just talking about money here. But also overall talent, depth of your management bench, promising IP/technology which has not yet been deployed, and the company’s brand reputation in the market. As an example, if you have started in a small vertical market and are “killing it” with a company that actually has the resources to do much more, you may not have the luxury of maintaining a focus on this current core market for very long.

This phenomenon explains why large, multi-billion-dollar technology corporations might not even blink at ignoring potential market opportunities of less than $1B in sales. Because it won’t move the needle on its financial results, no matter the level of success. For a younger company starting in a market that is “too small” to support them in the long run, this is even more problematic. In both cases, diversification may be a necessity rather than a choice if strong business growth is to continue. The converse is if you are in a market you’re just able to scratch the surface of with your current level of resources, it only makes sense to stay put and continue to focus on the core business.

Are your results waning, even with good current execution?

Sometimes it just feels like you’re reached the “end of the rope” in your current market segment. It may be that you’ve just “run out of room” to grow. Because of a large market share or a small market size. Or on the other end of the spectrum, you’ve never really been able to compete successfully enough with dominant players in the segment to reach a profitable share. Sometimes, it just feels like you have to move on and “re-invent” the business. Hopefully, you can do this in a way that at least some of the company’s core competencies (management skills, technologies, processes, etc) are transferable to the new business area. This will reduce risk.

Business diversification is sometimes a necessity

But sometimes diversification is inevitable. It MUST be done if the company is to be a going concern in the long run. This is really the one exception to the advice I provided above about focusing on your core business. That is,  if the company really doesn’t have excess financial or other resources.  All good things come to an end. And sometimes, unfortunately, they never get started. Realizing this situation and taking decisive action toward business diversification, regardless of the perceived risks involved, is essential. Sometimes, not taking bold action is the most risky strategy of all.

 How do you approach the inevitable focus vs. diversification decisions that pop up in nearly every business? Fill us in on your thoughts with a comment below.