Evaluating diversification

It's often said, "The grass is always greener on the other side." This phrase has additional appeal during lean times, especially when "green" has the face of George Washington.

A recession tends to bring out the entrepreneur in everyone. Business owners see opportunities in areas they haven't considered, and business models are turned upside down. Often, declining revenues in one market spark creativity and inspiration to try something new or diversify. Finding ways to leverage your existing experience to tap into a more lucrative market is a matter of defining your company's competitive advantage in a new way.

Examples

Many roofing contractors have responded to the recession by evaluating ways to apply their skills in new markets. D.C. Taylor Co., a national roofing contractor based in Cedar Rapids, Iowa, has had a huge swing in business during the past two years.

Bill Taylor, chief executive officer and chairman of D.C. Taylor, says: "In November 2001, our orders declined 75 percent from 2000 levels. Those levels lasted for 90 days. This business cycle wasn't a recession. It was a depression among our best customers. We hunkered down and changed our strategy."

Taylor realized his typical customers—large, publicly traded manufacturing companies—were hit harder during the downturn than smaller, privately held companies. He also knew he had a unique resource, a team of salespeople with direct relationships with prospects and clients. As a result, Taylor's sales force shifted its focus to privately held businesses that used the good times to plow earnings back into their companies. Many smaller, more conservative companies that didn't have to answer to Wall Street were better prepared for the economic decline because of their prudence during boom times.

Taylor also moved away from the new construction market as a way to increase margins and increased the percentage of revenues earned through maintenance agreements.

For D.C. Taylor, the results of Taylor's strategy shift have been positive. The company began to turn around within one year.

"Currently, we are earning increased margins on smaller jobs," Taylor says.

Matt Millen, principal of Millen Roofing Corp., a Milwaukee-based contracting company that specializes in high-quality, steep-slope roofing, also understands the drive for diversification, as well as the potential downside.

"We've always been a specialized contracting company focused on selling expertise, service and reliability," Millen explains. "Now, we see other contractors expanding into this type of work without experience or expertise. It's during times like these, tough times, that bad roof systems [are installed]."

Millen Roofing has seen increasing competition in this tough environment. As a result, Millen broadened the company's geographic focus and took on smaller jobs than usual.

"We expand into neighboring states when the pickings are slim. It's a natural process," Millen says. "We also pay more attention to the maintenance component of our business, but our work product is the same. We have a clearly defined market, and we are not changing our position."

Skokie, Ill.-based Tecta America Corp., a large, national roofing consolidation, was affected in the West by the high-tech bust and East by Sept. 11, 2001, events. The company also has felt the squeeze of increasing insurance prices across the nation and reacted by honing its focus.

"When there are forces beyond your control, you focus on improving performance of the things you can control, including safety, productivity and operational efficiency," explains Mark Santacrose, chief executive officer of Tecta America.

The results have been positive. Tecta America implemented a safety program designed by two of its contractors in Minnesota, enabling it to decrease its incident rates by 30 percent and undertake additional risks.

Tecta America also used its size as an advantage. The company made three acquisitions, opened four branches and expanded facilities at five operations during 2002.

"The economic picture for us now is unstable but improving," Santacrose says. "We're quite bullish on the industry for 2003."

What are you to do?

Considering strategic shifts, such as geographic and product diversification, is a tricky balance. On one hand, a declining economy tends to force business owners to reverse negative sales trends. On the other hand, experience and relationships are built over time, and new markets can be more difficult to crack during an economic decline.

What are the factors to consider when evaluating a shift in business strategy, and how can you determine the best time to take action?

Unfortunately, business owners almost never have the opportunity to consider these questions and alternatives in periods of relative calm.

Typically, unplanned external or internal events necessitate decisions that dramatically can affect a company's future. These decisions often are made when enough time or information isn't available to weigh all the strategic alternatives or their potential results.

A measured approach

One way to hedge on quick decisions is to make incremental changes that can be adapted. For example, Millen Roofing has taken small steps during the recent economic decline but kept its business strategy the same. As more information becomes available regarding the effects of increasing competition, Millen Roofing may evaluate further strategic changes.

This try-and-see approach may seem to go against touted techniques of strategic planning. The idea, however, is an old one that may warrant consideration.

In the article "Strategic Change: 'Logical Incrementalism,'" James Brian Quinn, former professor of management at the Tuck School of Business at Dartmouth College, Hanover, N.H., promoted a measured approach to strategic change.

In 1978, Quinn wrote: "A step-by-step approach clearly is necessary to guide and assess the strategic fit of each internal or external diversification candidate."

Specifically, he writes that by providing a coping mechanism for making decisions with limited information; building a framework upon which to make future decisions; and fostering organization awareness, understanding, acceptance and commitment needed for implementing strategic changes, a decision maker can begin to take steps toward incremental change.

A broader approach

Taking an incremental approach to change doesn't prevent a company from making large strategic shifts over time. Sometimes, however, a more dramatic, quick change may be needed. For example, sudden, significant revenue declines usually create an immediate need to evaluate and change business strategies. Also, current markets tend to move more quickly than those of the past.

In many cases, severe reality, such as significant drops in revenues, etc., forces business owners to compress the process of evaluating alternatives and options.

Even in these times, it's important to consider the following questions before steering your organization in another direction:

What does your company do better than its competition? Think about what has made your company successful. Some companies distinguish themselves through highly skilled labor, and others compete by efficiency or cost. It's important to conduct this analysis as systematically and analytically as possible. Think about why you have won certain jobs and lost others. Consider the common thread in your portfolio of experience.

How can your differentiators add value in other markets? This question forces management to consider markets that require similar strategic assets. Strategic assets are a company's unique set of resources and skills that create a competitive advantage. Credibility plays an important role here. You must be able to convince potential clients that your previous experience provides a strong foundation for growth in a new market.

For example, D.C. Taylor's salespeople's relationships and knowledge of the manufacturing industry enabled the company to change its focus to a subset of that industry—privately held businesses in locations affected less severely by the recession. The company now uses crews with special expertise located in slower markets to fill gaps in busier areas.

What skills and resources do you need in a new market? One of the most common mistakes managers make is discounting the importance of some factors required to enter a market. For example, a lack of existing relationships may be an obstacle too difficult to overcome in the short run.

Most times, companies must have a competitive advantage over existing players to successfully enter a new market. In some cases, however, management is able to leap frog the competition through acquisition by changing the rules.

An example comes from the U.S. steel industry. When TXI Nucor Corp., a steel company in Charlotte, N.C., and Chaparral Steel, Midlothian, Texas, began using new recycling steel mills in the United States, the old iron ore mills couldn't compete. The new mills didn't have access to mines, but they changed the rules by using almost free raw materials in the form of salvaged cars and demolished buildings. Eventually, these new mills ran the traditional ore mills out of business.

Can you just play in this new market, or can you win? Companies that enter new markets and succeed must bring something new—a competitive advantage that is difficult to imitate or substitute. Southwest Airlines, Dallas, is an example of a company that won by introducing the concept of cost-efficient, short-haul flights and abandoning the traditional hub-and-spoke airline model. These moves have changed the rules in the airline industry and positioned the company to succeed as the industry struggles.

What are your alternatives? Opportunity costs—the lost opportunity to take an alternate course that might have been suitable for a company—also come into play. It takes significant energy for an organization to diversify, and you should carefully consider the implementation of a significant change.

What can you learn from the change? Sometimes, entering a new market or diversifying your business can create additional opportunities. New information also could help a company in its current markets. The process of evaluating alternative markets, strategies and opportunities always will give you fresh ideas about your current market. This research and evaluation phase also will help ensure the "green" you see can be tacked onto your bottom line.

Diversify

Diversification, in one form or another, is one of the most important tools you have to address unstable economic environments. Considering changes to the type, location and methods of business your company performs can position your company for a quick recovery.

Laura Schieber is principal of Right Angle Marketing, a marketing consulting firm in Dallas.