Friday, March 6, 2015

Five Arguments Against Diversification

Diversification is a sound financial planning strategy, but does it work for building a company?

My wife wanted to buy a new blender recently, because she burned out the motor in the old one.

I don't care too much about blenders, but the available options raised some interesting questions about being the most elite blender manufacturer.

Consider this: How does Vitamix get away with charging $700 for a blender when big reputable companies like Cuisinart and Breville make high-quality blenders for less than half the price?

I think it's because Vitamix does just one thing, and they do it better than anyone else.

Great companies stand out because they poured all their limited resources into one big bet. WhatsApp was "just" an efficient messaging platform. So what? But then Facebook acquired them for $19 billion.

GoPro makes the best helmet mounted video cameras in the world. That's what they do, and that's what they are known for. And many companies are drooling at the possibility of buying them.

In business school, the conventional view is that you should diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category takes a hit on sales, another line of your business will hopefully boom and bring some overall stability.

But building a company is not the same as managing a big investment portfolio.

The problem with selling too many things – especially for a young company – is that you risk watering down everything you do to the point of mediocrity.

Here are five reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else:

(1) It Will Increase the Value of Your Business

When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart. This will boost your company's value.

We know this is true because analyzing 13,000 businesses using Sellability reports, we consistently find that companies with a monopoly on their product get acquisition offers that are about 42% higher than the average offer multiple.

(2) You Can Create a Brand

Big multinationals can pour millions of dollars into each of their brands, which enable them to sell more than one thing.

Kellogg can own the Corn Flakes brand and also sell Pringles because they have enough cash to support both brands independently. Even so, every new product comes with a dilution of your marketing dollars.

It's hard enough for a new company to build one well-recognized industry name and almost impossible to create two without massive amounts of outside money (which dilutes equity).

Remember, a strong company is more about the brand than about any individual within the company.

(3) You'll Be Easy to Find on Google

When you type "helmet camera" into Google, GoPro is featured in just about every listing. This is despite the fact that there are hundreds of video camera manufacturers.

It's easy for GoPro to optimize their website for the keywords that matter when they are focused on selling only one product. This makes it easy to people to find them, even if they didn't realize that's what they were looking for.

(4) Every Employee Will Be Able to Deliver

When you do one thing, you can train your staff to focus on service and execution.

When you offer dozens or hundreds of products and services, you reduce focus and specialization, and it can go beyond the competence level of junior staff.

Having employees that can refine their skills and knowledge in a specific area means they can deliver better results for your customers.

(5) Most Importantly: It Will Make You Irresistible to an Acquirer

The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves.

GoPro is rumored to be a tasty takeover target for a consumer electronics manufacturer or a content company that wants a strong edifice in the action sports video market.

Even though there are various huge consumer electronics companies that could just manufacture their own helmet-mounted cameras, GoPro is so far ahead of their competitors (the #1 brand channel on YouTube!) that it would be easier to just buy the company rather than trying to fight for market share against a leader with such a dominant head start.

CONCLUSION

Diversification is a useful, even necessary, for your stock portfolio. And it often makes sense for a massive company with billions in sales too.

But when when it comes to building a business in the earlier stages, diversification is a pathway to mediocrity.

You should have a laserbeam focus on your product or service when your company is young. Focus leads to success.

(Want to see how your own business is doing on the major metrics of sellability? Get your sellability report here.)