The challenge of branching out

Six years ago, Britt Eckelmann came up with a profitable but ultimately doomed idea. Her small Berlin-based architectural practice, CPM Architekten, would add janitorial services to its operations to help smooth out cash flow peaks and troughs. This first stab at diversification had unforeseen and unhappy consequences, however. “It was not good for our reputation,” says Ms Eckelmann.

With hindsight, she likens the move to a gourmet restaurant setting up a sideline in fast food. “People asked ‘Why are they bothering to do this if their core business is successful?’ ” It was a point made not just by clients – her employees asked the question too.

Diversification makes sense in certain contexts: expanding into a growth sector can re-energise a business in a declining market; offering a range spreads the risk; and introducing goods or services that sell strong­ly when the core business is not busy helps keep sales consistently buoyant. But, as Ms Eckelmann discovered, the wrong diversification can threaten a promising enterprise. More recently, she has diversified successfully into energy consultancy, which fits her business’s reputation in the eyes of both the customers and her staff.

David Hsu, associate professor of management at the University of Pennsylvania’s Wharton school, says div­ersification by entrepreneurs requires self-knowledge and planning. He says the ques­tions to ask are: “Does the area I am trying to get into effectively leverage what I know? Are we organisationally equipped to del­iver in the new domain? Is my expansion strategy logical, or is it sending out mixed signals about the quality of our brand?”

Martin Jones, managing director of PH Jones Group, an installer and maintainer of domestic heating systems in the UK, which diversified into utility metering and property maintenance, says research is critical. After taking over the family business from his father in 2001, he spotted an opportunity to diversify after meeting a consultant who had handled the administration of a big national competitor that had gone bust. “He told us the business had had a utility metering operation that was actually very profitable,” says Mr Jones. Through him, Mr Jones hired a former employee of the business, who introduced him to prospective clients. That set Mr Jones on his way to building a metering operation that contributes revenues of £13m today, of a total of about £76m ($121m, €91.5m). Mr Jones calculates that successful diversifications since 2004 have contributed almost £28m of a £54m increase in turnover.

He admits, however, that another diversification – upgrading equipment in telephone exchanges – fared less well, because his market research was sketchy: “We didn’t really understand the routes to market or how telecoms firms behave [as buyers].”

Expanding into an area that relates closely to your expertise reduces risk. But if a more radical diversification is needed, finding an experienced partner could make the venture less hazardous.

For her second attempt, Ms Eckelmann teamed up with an energy management business to form e-two-energy, which advises clients on reducing their carbon footprint. CPM Arch­itekten has a 49 per cent stake in the venture, which last year had a turnover of €3.7m – expected to rise this year – compared with CPM’s €1.2m. Cross-marketing from e-two-energy has helped keep CPM’s revenue up during the recession, she says.

Without an experienced partner, Ms Eckelmann would have struggled to crack the market: “We could have employed specialists, but personally I would have found it difficult to sup­ervise something I wasn’t expert in.”

Natasha and Chris Ashton, co-founders of Petplan, USA, a pet insurance company, also found having the right partner offset their inexperience – eventually. Two years ago they set up Fetch, a pet-health magazine, using a local printer. The production costs were colossal. But now they use a print broker, who slashed the unit costs and secured listings, from September, in leading retailers. “Had we had someone with publishing experience on board from the get-go, the magazine would have been profitable much earlier,” says Ms Ashton.

She declines to detail how the two businesses contributed to overall turnover of $13.4m in 2009, but the figure for Petplan alone in 2008 was $4m, and she expects the combined turnover from Petplan and the fledging magazine to rise to $20m in 2010.

A dilemma for diversifiers is wheth­er to run new ventures separately from the core company. Mr Jones, who wants to create a multi-skilled workforce, is going for maximum integration by assimilating both a facilities management business he acq­uired in 2008 and the metering operation under the PH Jones brand. “In our market, bigger businesses get bigger opportunities,” he says.

Sometimes diversification works better at arm’s length, however. To appeal to a general readership, the Ashtons gave Fetch a separate identity. “As the magazine has evolved we have really toned down [the link to insurance],” says Ms Ashton. “We al­ways have a full ad on the back cover [for Petplan], but other than that we keep Petplan in the background, so the magazine really is seen as a genuine effort to keep pets healthy.”

After her first diversification backfired, Ms Eckelmann was keen that the architectural practice and the energy venture should have discrete brands and separate management teams – “if something goes wrong, the original business is less at risk”. But CPM Architekten’s architects and e-two-energy’s consultants cross-promote and collaborate on projects.

All the entrepreneurs agree that diversification can trans­form a business but it eats up management time.

Mr Jones has made a huge personal sacrifice of time in pursuit of building “one organisation, not five divisions”. He is currently leading an intensive employee communications program­me and a group-wide rebranding. The latter meant dropping PH Jones’s distinctive flame and water logo for a more abstract identity. Getting everyone to see the bigger picture is tough. Even today, says Mr Jones, “we still have employees who think we are just a heating business”.

For the Ashtons, the pressures of running two fast-growing, but different – one insurance, one publishing – businesses side-by-side encroaches greatly on the time they spend with their small son. That is, Ms Ashton says, “one hell of a trade-off”.