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This is the third of three articles on Diversification for founding entrepreneurs. Part One, Diversification vs Di-worse-ification, argued that diversification is not always a positive move and that careful analysis should be applied to any diversification decision.  Part Two, 5 Ways to Diversify your Revenue Base, suggested five categories that merit such analysis. This article explores the 4th of those categories, True Diversification.

To recap, True Diversification is launching a new product to a new market. That means learning a new business and learning about new clients. While that process can both hedge your risks and expand your revenues, true diversification is difficult and runs serious risk of hurting your existing bottom line.

Because successful business requires beating all current and near-future competitors for at least some demographic, true diversification is most likely to succeed when your new business is built on some Core Competency. The remainder of this article explores the idea of core competency.

Core Competency

The term core competency comes from a 1990 Harvard Business Review article by C.K. Prahalad and Gary Hamel called The Core Competence of the Corporation. The term was defined as “the collective learning in the organization, especially the capacity to coordinate diverse production skills and integrate streams of knowledge.”

Prahalad and Hamel offered three identifying features of a core competency.

1.    Creates Customer Benefit

2.    Difficult to Imitate

3.    Applicable Across Markets

Creates Customer Benefit

Core competencies are more than just bragging rights. They are part of your competitive advantage. In fact, they are the essence of your competitive advantage.

For example, Wal-Mart is in the retail business but it beats other retailers because of its skill at logistics. Logistics and shipping create customer benefit by keeping prices down. If Wal-Mart wanted to diversify out of the retail business, it might do so by finding other businesses that require skill at logistics. Their core competency provides a reason to believe they might be successful.

Difficult to Imitate

A core competency that is easy to imitate fails to help a company toward being competitive. Competitive advantages must be difficult to imitate to have long-term value. That goes double for a core competency on which you hope to launch a new product for a new market.

For example, internet retailer Alibaba made waves with its 2014 IPO as investors paused to consider its ability to take on Amazon. Amazon’s core competency is shipping. On the back of its warehouse infrastructure, unique software, and experienced workers, Amazon delivers quickly, consistently, and securely. Alibaba may be China’s internet retailer, but its system functions more like ebay and with many of the same problems. Alibaba has yet to pose any serious threat to Amazon.

Applicable Across Markets

The purpose of a core competency is to assist with diversification, so it needs to be applicable outside of its current context. To get to a broadly applicable core competency, search for the essence of your product’s competitive advantage.

Tesla is a leader in the electric sports car world. Experts call them wonderfully made cars, but their most important competitive advantage is that Tesla cars can go as far as 200 miles on a single charge. That requires an extremely powerful and long-lasting lithium battery. Recognizing their lithium battery as their core competency inspired Tesla to enter the solar energy business. They’ve repurposed the battery to store large amounts of electricity, launching them to the cutting edge of the solar business.

Conclusion

Identifying your core competency is only the first step. Before jumping into a new business, be sure that your core competency can stay ahead of any competition.

The next step is finding a profitable context for your core competency. Each situation will be vastly different, but search for markets in which you can acquire all necessary assets, where your core competency is a natural synergetic fit, and the learning you’ll gain will improve your core competency.

Next Steps

Identifying core competencies in preparation for true diversification is one of the responsibilities of a competent Chief Financial Officer. Companies without a full time CFO should consider hiring a part time CFO. Preferred CFO offers an outsourced CFO option that represents the most affordable way to gain long-term expert advice without the high cost of an expensive internal officer.

Please speak with Preferred CFO for any additional questions.

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