Product Focus or Diversification
One of the most common characteristics of startups is that they rarely lack great ideas. In fact there are almost always too many great ideas and too few resources to work on them. We often tell clients that they need to focus their teams on just a few key priorities at a time. Thinking about this recently I started reviewing some literature on the subject.
As we would expect the literature is mixed. First, there is this paper in which they state “managers of multiproduct firms are able to achieve greater cost efficiencies than their counterparts in more focused firms by sharing inputs and efficiently allocating resources across product lines in response to changing industry conditions.”
And then there is this paper that found “CEO turnover in diversified firms is completely insensitive to both accounting and stock-price performance, but CEO turnover in focused firms is sensitive to firm performance. Diversified firms also experience less forced turnover than focused firms.” Less forced turnover of the CEO sounds good, especially if you’re the CEO.
However, this paper suggests that “stock market’s responses to announcements of capital investments are more favorable for focused firms than for diversified firms.” A favorable stock market response sounds great…again, especially if you’re the CEO.
This McKinsey study claims that “companies that have managed to find the strategic sweet spot of moderate diversification have not only outperformed both focused and highly diversified companies 81 percent of the time but also generated higher total returns to shareholders every year except one since 1985.” This is further confirmed by this study based on a sample of 270 startups that entered the Security Software Industry from 1989 till 1998. The authors found that those startups that survived were the ones that more aggressively adopt product portfolio strategies.
I like the term used in the McKinsey study of “moderate diversification” which implies that there is some amount of diversification needed to reduce risk of a single product initiative but not enough to stretch a team too thin to the point of distraction. To me it seems that 2-3 major initiatives at a time (preferably these are large enough to take several quarters to complete) is a good balance between focus and diversification.