Current global affairs highlight more than ever the importance of diversification in business. Look at China’s actions of late which are impacting Australia’s barley and beef industries as one excellent example. One major customer decides to be difficult, pull the pin or use trade as leverage and the impact can really hit home. Consider the business that services clients from only one industry (such as tourism or hospitality) or perhaps the tradie who does business with just one builder or principal contractor. One must also consider not only our own diversification but that of our customers as there are frequently flow-on effects. Whilst we may retain great diversification, do most of our clients do the same? Although diversification does not guarantee we will not experience a loss or be at threat, diversification is certainly one of the most important components of a successful business reaching long-range financial goals and ensuring risk is minimised.
Why diversification in business is critical
- We should not aim to have all our ‘eggs in one basket’, but rather spread our risk around. This is a philosophy used in investment, finance and business; almost any concept which revolves around money and the reduction of risk.
- Avoid being at the ‘mercy’ of one client. I mentioned above the scenario where Australia is copping flack that can affect two of our export industries. What if a client deems that you will take a rate cut of 20% and if they are your primary source of business (and they know that) then they know you really can’t walk away. I’ve seen this occur in the telecoms industry as well as a number of other industries.
- Balance – just like in an investor’s strategy who seeks balance of the portfolio, so we should seek balance in business.
- Seasons can cause issues for business as well – so having diversification of services means you can potentially work all year round. A lawn mowing business might diversify into tree cutting, pruning, turfing. These are all related, but mean that come the slow-growing winter, they still have consistent workflow from the other income streams.
- Diversification equates to more opportunity for financial return.
- Unit prices are usually higher as the client hasn’t got as much ‘buying power’.
- It reduces volatility and instability.
- Globally, doing business with one specific country will be affected by currency changes. If the Aussie dollar drops to the US dollar and you’re buying, then your costs can suddenly skyrocket, without the set price actually changing.
- Our customers also dictate what we do as well. As people began wanting more healthy food choices, companies like McDonald’s diversified into healthy food options in order to not only retain their market share but potentially increase their market share.
- Customer expectations will also play a part. For some time there has been a push for ‘Australia Made’ and more recently a huge push to ‘Buy Local’. With businesses struggling, there is a strong push for each of us to look after our local communities, our local businesses and generally try to keep the Aussie dollar local. Buyers more than ever are now looking at labels to ascertain where the product was made. If all your products are made overseas, then some customers may choose to buy elsewhere.
Pitfalls of diversification in business
Whilst the benefits of diversifying are long and in my opinion outweigh the pitfalls, I did want to share the pitfalls as well. Every business owner needs to make an informed decision and weigh up pros and cons.
- It takes more resources and time to be diversified (particularly in having a range of products or services) so overall the costs of R&D, production, servicing, delivery etc can be greater.
- You reduce the niched perception of expertness if you have a large range of products or services.
- Admin costs are greater; for example if you have more clients, it means raising more invoices (but reality is that your pricing will be higher too, so it does get negated).
- Brand damage. Imagine if KFC sold tacos, fish and sushi, as they are well known as a fast-food chicken outlet.
- Operationally you’ll need more systems, processes, team and equipment.
How to have a variety of clients
- Do your research and then implement a well-thought-through strategy.
- Plan in detail how it will occur and be actioned.
- Ascertain if you need extra or special resources.
- Determine how the change will work in practicality; set (and document) a clear process.
- Set a clear policy; ie no single client shall represent more than 15% of total turnover.
- Ensure all your sales team know this so that they hunt in the right areas.
- Ensure your marketing speaks to your ideal client, in that “we service small to medium-sized” – in other words, we don’t service one or two large companies.
- Access all new opportunities and be willing to say ‘no’.
I had an offer made to me years ago in a prior business which would have tied up 50% of my employees to one client. To take that large new client on, I would have had to either grow my team substantially overnight or ditch some of my mostly good quality and valued existing clients. I assessed that my business would then be at the mercy of that one client and to lose 50% of my income would have had a major impact and so I said no thank you to that opportunity. This was a big decision, but one which I never regretted.
How to diversify in the existing situation
- Yes, this is substantially harder. You’ll need to review your situation, investigate, set strategy and plan how it will be done. Directors and key personnel should be involved but involved in a very confidential way. Look at the big picture and the business’ long-term sustainability.
- Will you need extra resources?
- What will need to change?
- Commit to the change and get everyone on board (especially if the diversification is to a new region, service, product).
- Phase-out the existing situation. If you’re selling primarily to only one customer you might gradually reduce sales to that one client whilst nurturing new client relationships.
- Growing more in other areas will equate to the ratio of sales per client or industry or geographical region changing and more balance occurring. This will be gradual and over years and possibly even decades depending on the size of your business.
- Globally some Governments are offering industries incentives to exit China and help ease the pain of this diversification. One example is Japan who is putting $2.2 billion of its Covid-19 economic stimulus packing into supporting a manufacturing shift away from China.
What can you diversify?
This can be industry, clients, products, services, regions, suppliers, staff … anywhere there can be variety. If you diversify say clients, but all are in the same industry, some threat is alleviated, but not all. Every business should do a risk assessment to determine where the risks are and build a plan to remove, reduce or at least mitigate that risk. Diversification may well be one of your risk reduction strategies.
If you are looking for assistance in assessing your risks, building strategy or general assistance with your small to medium-sized business, then I’d love to hear from you – simply reach out to me or call on 0411 622 666.