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Hidden Diversification Costs

Many business owners over-estimate the benefits and under-estimate the risks of expanding their product or service range.

Hidden Diversification Costs

It's short-sighted to set up a holding company with multiple subsidiaries before you've built a single business with a consistent track record of success. However, the risks of premature diversification aren't limited to aspiring moguls. Many business owners try to do too much, for too many, too soon.

The problem with diversification is that the upside is obvious but the downside is mostly hidden. Yes, you'll probably make more sales by expanding your product or service range, but at what cost?

For starters, you're going to have more cash tied up in stock for those additional product lines (or the operating cost equivalent if you're in a service industry). That will affect your cash flow and the risk of a cash crisis, regardless of the volume or profitability of your additional sales.

More stock means more procurement and control. You'll have to place more orders, manage more suppliers, receive more deliveries, store more inventory, track more stock, and complete more admin. So you'll need to hire more employees, invest in more sophisticated systems, and expand your warehousing.

More stock also means more opportunity for wastage and theft. You'll need more training, supervision, and security, as well as more administrative capacity to deal with the inevitable disciplinary procedures, dismissals, and related headaches.

All of those additional product lines aren't going to sell themselves. You'll need to update all of your marketing assets, train all of your frontline and back office staff, hire more salespeople (or the equivalent for your particular sales channels), and invest in more distribution capacity.

Finally, there's no guarantee that your customers will welcome a larger product range. More choices can make it harder to choose, or find the right option. There's also a higher risk of stock-outs and distribution delays due to all of that additional behind-the-scenes complexity.

So what? If big brands like Woolworths and Pick 'n Pay can pull it off, why can't you?

Of course you can, but is that what you actually want?

If you're trying to build a business that can fund your financial freedom and create generational wealth for your family without too many headaches, then giant corporations probably aren't the best point of departure.

And if you're serious about building a huge company, then you'll probably find that it's a lot easier to simplify first, scale second, and (maybe) diversify third.