The Growing Need for Diversified Business Model Portfolios

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Jinder Kang

Jun 7, 2022 • 22 min read
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Successful businesses emerge not just from superior products and services but also from deploying a range of business models that shape or define the markets they operate in. In a hypercompetitive landscape, it’s not enough to deliver an outstanding product. When necessary, businesses must also find new opportunities in how they create and capture value, building a portfolio of business models that can sustain growth.

Diversification is a core topic in strategic management. In this guide, we focus on a type of diversification that has traditionally been unexamined in sufficient depth but has proven to be a key driver of innovation in the digital economy — business model diversification.

Consider the rise of subscription-based models that supplement or have entirely replaced upfront payments for content, software, digital services, and even for physical goods. Think of the optionality available to consumers among ad-supported, ‘freemium’, and fully paid models when accessing online information and services.

Successful companies today often run a number of business models at the same time. Having a portfolio of ways of creating and capturing value, when grounded on sound analysis and execution, can drive growth, minimize risks, and deliver financial returns. This is particularly important in sectors vulnerable to rapid innovation cycles that can disrupt traditional or existing business models.

What is business model diversification?

Business model diversification is the activity of engaging in at least two ways of creating or capturing value, each with its own distinct monetization mechanism.

For clarity, diversification (in general) takes several forms. In corporate strategy, business model diversification is one of four types of diversification. The other three, which you may be more familiar with, are as follows:

Horizontal or product diversification

This pertains to the expansion into multiple goods, products, or services. Think of companies in the fast-moving consumer goods (FMCG) industry such as Unilever, Procter & Gamble, and Nestle, which manufacture a variety of product categories (e.g. packaged food, beverages, cosmetics, personal care, cleaning products, etc.).

Vertical diversification

This pertains to expansion into different stages of the value chain, whether upstream of downstream. Think of a fast fashion brand that manufactures their clothes and apparel through their own factories but also outsources some to third-party suppliers. Then, they directly sell their products through stores they own and operate but also sell them to retail chains.

Geographical diversification

This pertains to conducting business in regional and global markets, which may require deploying different strategies for each market (e.g. direct presence, joint ventures, partnerships with distributors, resellers, or licensees). Think of fast food or restaurant chains with branches in a number of countries, which could be directly owned or franchised.

Four types of diversification Summary
Business model diversification Engaging in at least two ways of creating or capturing value, each with its own distinct monetization mechanism
Horizontal or product diversification Expanding into multiple goods, products, or services
Vertical diversification Expanding into different stages of the value chain, whether upstream or downstream
Geographical diversification Conducting business in regional and global markets, which may require deploying different strategies for each market

For those considering to diversify their company’s business models, there are three types of business model portfolios that you may end up building: independent, complementary, and nested. While these might not be perfectly distinct in the real world, companies can deploy a combination of these.

  • Independent business model portfolio: This pertains to expansion into business models that work in isolation from one another. The UK-based conglomerate Virgin Group is a prominent example of this, especially when it started as a record label and then ventured into a wide range of unrelated businesses such as travel, telecommunications, banking, soft drinks, airlines, cinemas — some of which it has already divested from.
  • Complementary business model portfolio: Companies that deploy this strategy enter into synergistic business models whether or not they’re structurally independent. For instance, think of retail banks that offer credit cards, investment products, insurance, and even their own fintech platforms on top of their regular savings and loan products.
  • Nested business model portfolio: Nested business models are structurally integrated by a technology platform in a way that the individual business models are critically dependent on one another. Consider products from Apple whereby the software, particularly the operating system (OS) and the ecosystem of apps, are virtually inseparable from Apple’s desktops, laptops, tablets, and smartphones.

Strategic diversification, according to Harvard Business School professor Michael Porter, is about combining business models that efficiently relate to and mutually reinforce one another, forming a system of activities rather than a collection of isolated businesses. This way, the strategic fit across business models raises the value of each business line while also contributing to the company’s overall competitiveness and financial performance.

Why do businesses need diversified business model portfolios?

Entering new business lines and building a portfolio of ways of monetizing value is vital to an organization’s growth — and survival, in some cases. Here are the leading reasons why companies need business model diversification.

It offers unique opportunities for increased performance

Taking on new business models offers the potential to generate growth and deliver financial results. Consider Netflix as an example of how business model diversification eventually worked in their favor. Netflix leveraged two different business models — DVDs by mail and online streaming — to compete with movie rental incumbents, such as Blockbuster.

Netflix did not rely on conventional diversification strategies at first. The company offered the same movies to their US-based customers in both of its business models, but with different subscription fees, a choice of physical versus digital rentals, and value-added online features including personalized suggestions.

Going into online streaming contributed to its market share expansion in the US, which then served as a springboard for international expansion and a wider range of content, including original programming. With DVD rentals virtually extinct, Netflix is now the benchmark when it comes to online streaming and at-home media consumption.

It enables economies of scope and eliminate redundancies

A traditional argument for any form of diversification is that related businesses within the same firm can pool resources, and as a result, their aggregate cost would be lower than if the products and services were produced individually.

This is known as 'economies of scope’, which occurs when various goods are produced from a single process or a shared pool of resources. This is particularly common in capital-intensive and technology-focused industries where physical assets or digital infrastructure are shared across business models.

Consider Tesco, which is not only a grocery and general merchandise retailer, but also manufactures and brands their own products. For instance, Tesco manufactures their own biscuits, cookies, and other types of snacks, which they supply to their own stores and to other retailers as well.

The company also produces many other product categories (e.g. frozen fruits and vegetables, coffee and tea, ready-to-cook meals, etc.) with a wide range of varieties. Those within the same or related categories are presumably produced from shared resources (e.g. raw materials, suppliers, factories, talent) helping Tesco achieve economies of scope.

It helps reduce volatility and risk

Conventional ways of diversification spreads business risk across industries, product categories, customer segments, and geographical markets. With business model diversification, companies can benefit from different or independent monetization strategies from a common pool of business assets to secure stable returns and reduce financial risks.

This is especially applicable to industries exposed in highly uncertain environments, such as biopharmaceutical companies. A key risk in this sector is the latency between investment and return, which can be exceedingly lengthy and may not even pay off. One of the strategies that pharmaceutical firms employ is by diversifying their revenue sources, such as consumer healthcare products, R&D services, and royalties from intellectual property.

It maximizes existing resources while developing new capabilities

Companies are likely to benefit from diversification if executives expect that the new business model they’re contemplating will maximize the utilization of their firm’s existing resources while satisfying an important market need.

Amazon, for example, began in 1994 with a single business model of selling books online. For 2021, it reported $386 billion in net sales across its portfolio of business models. Amazon invested extensively in data centers and the construction of an automated web infrastructure, the primary purpose of which was initially to power the growing traffic on its eCommerce platform as it expanded its product offerings.

Along the way, Amazon amassed technical capabilities in web and data infrastructure to the extent that it started offering these technologies to enterprises, which they’ve also made available to customers of any size, including startups and individual developers.

Out of this business model diversification, they’re now one of the leading cloud computing providers in the world. While their eCommerce business continues to account for the majority of the company’s revenue, Amazon Web Services (AWS) is a high-performing business unit.

They continue to leverage the capabilities they’ve built by expanding to newer businesses such as memberships (Amazon Prime), content production and streaming (Amazon Studios and Prime Video), cashier-less grocery (Amazon Go), and many others.

It levers to overcome business stagnation

Companies in mature industries with stagnant long-term growth are those that typically need to explore diversification in growth businesses. For example, long-established department stores and grocery chains continue to explore various digital commerce models such as open marketplaces and subscription-based ordering. Successful retail players see eCommerce not simply as the shift into selling goods online but an opportunity to create new ways of generating revenue.

Even for startups, stagnating growth (in the form of new users, revenue, and other KPIs) is a common concern especially when faced with the need to raise fresh capital from venture investors. Experimenting with new business models that can give a boost to stagnating business metrics.

For example, game publishers went through industry-wide stagnation when a sizable chunk of their revenue only came from purchasing the actual game, whether in CDs or downloads. With the advent of in-app purchases, initially driven by mobile games, publishers have been able to monetize any form of digital good such as avatars, extra lives, weapons, and even unlocking levels.

The established infrastructure or ecosystem can support new business models

Nested business model portfolios benefit from shared and highly integrated resources. This is probably unique to digital businesses wherein companies leverage their existing technology capabilities and infrastructure to experiment with new business models.

This is why tech giants such as Google, Meta, and Amazon have a certain level of tolerance for risk because their depth of resources and talent can support going into new offerings, whether in software, hardware, and content, among others.

This is also why the so-called “Super Apps” have gained some traction, especially in Asian markets (e.g. WeChat, Grab, Gojek). Super Apps bundle a variety of services such as ride-hailing, food delivery, parcel delivery, messaging, payments and fintech, online shopping, and many others into one app.

The technology infrastructure and user base they initially built for just one or two of these models became a catalyst strong enough to support newer business models within the same app.

The top reasons why companies need business model diversification Description

It offers unique opportunities for increased performance

Taking on new business models offers the potential to generate growth and deliver financial results.

It enables economies of scope and eliminate redundancies

Various goods are produced from a single process or a shared pool of resources. This is particularly common in capital-intensive and technology-focused industries where physical assets or digital infrastructure are shared across business models.

It reduces volatility and risk

Companies can benefit from different or independent monetization strategies, from a common pool of business assets to secure stable returns and reduce financial risks.

It maximizes existing resources while developing new capabilities

Optimizng the utilization of a firm’s existing resources while satisfying an important market need.

It levers to overcome business stagnation

Successful retail players see eCommerce not simply as the shift into selling goods online but an opportunity to create new ways of generating revenue. Long-established department stores and grocery chains continue to explore various digital commerce models such as open marketplaces and subscription-based ordering.

The established infrastructure or ecosystem can support new business models

A common approach among digital businesses wherein companies leverage their existing technology capabilities and infrastructure to experiment with new business models.

When business model portfolio diversification is too risky and should be avoided?

Going into new business models is never a risk-free strategic decision. Here are some key areas to watch out for when executives need to think twice before diversifying.

When the incumbents have an overwhelming advantage

Moving into a new business model can be exciting. However, managers must temper this excitement when their soon-to-be competitors have a clear and overwhelming advantage. This isn’t to say that businesses shouldn’t aspire to be disruptors, but that companies should place competitive risk high in their agenda when incumbents are the Coca Colas and Pepsis in their sector.

The Virgin Group found this the hard way when they launched Virgin Cola in the late 90’s. It initially outsold Coke and Pepsi in the UK within the first two years but eventually fizzled by capturing only 3% of UK market share before it was continued by 2009.

A statement from Richard Branson, founder of the Virgin Group, was particularly illuminating and instructive for those wanting to go into new business models with powerful incumbents. He said, “... Coca-Cola had a lot more firepower than us. They poured all of their huge resources into squashing us, and soon Virgin Cola was gone from the shelves.

The lesson we learned was about the need to put purpose at the heart of your business, and really differentiate. If you are taking on a business far larger than yours, you have to be so much better than them.”

Insufficient resources and competency to venture into a new business model

Companies that want to diversify into portfolios of business models must match their ambition with the appropriate commitment of resources and competencies.

Executives must recognize that taking on multiple business models may result in resource dilution. Entering into new business models may require fresh capital, infrastructure, personnel training, and other costs, some of which may be required from the established business as well.

In fact, this is one of the key arguments leveled against conglomerates. While they may have financial resources to pour into new businesses and hire competent managers for their new subsidiaries, the executives at the conglomerate itself or the “headquarters” may not have sufficient expertise to oversee them.

Weak synergies within the business model portfolio

Managers must meticulously and regularly assess the relationships among business models in their portfolio. In situations where a business model isn't providing the expected synergies, companies should be willing to pivot or divest in order to focus on and strengthen business models that work.

Think of Amazon’s Fire Phone, which was released in 2014 and eventually dropped by the following year. The Fire Phone, along with Amazon’s other devices (e.g. Kindle, Fire TV, Dash Button, Echo), were offered in conjunction with access to Amazon’s digital products (e.g. Prime subscription and e-books).

However, among the company's business models, several of Amazon's device offerings appear to have the weakest synergy in their portfolio according to an analysis published in MIT Sloan Management Review.

At that time, Amazon's diversification into electronics manufacturing only partially utilized the company's expertise in eCommerce, big data, and digital technologies, which are quite distinct from consumer electronics and hardware development

If the new business model could cannibalize existing ones

Related business models also have the potential to cannibalize each other when product offerings compete against one another or share the same customer base. Cannibalization causes a reduction in sales when the new product effectively replaces an existing one.

It’s also often unintentional, especially when the new product draws customers away from an established product and eventually diverts corporate resources away from it and into the new business.

This is often the concern when retail companies begin establishing their eCommerce business. The opportunities from digital retail, which offers a variety of business models, could threaten sales from their brick-and-mortar presence and spread their attention thinly.

Similarly, this has been the trend for enterprise software providers when clients have the option to choose between their cloud-based offering or traditional on-premise deployments. In certain scenarios, cannibalization could also be a deliberate strategy to transition into more cost-effective or profitable business models and divest from the traditional offerings.

Win by maximizing business model linkages

Having a diversified business model portfolio enables firms to increase long term value for their shareholders and customers by leveraging existing resources. While companies need to build new capabilities for new business activities, these benefit the entire business portfolio especially when these are comprised of complementary or nested business models.

On the other hand, business model diversification, just like any other type of diversification, is not a guarantee of improved performance. When building a diversified business model portfolio, companies must be rigorous in assessing the linkages across established and prospective businesses.

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Jinder Kang

Innovation Consultancy Lead at Netguru

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