The greater the risk, the greater the reward is a well-known business adage and one such risk is diversification. Building new product lines, exploring new markets and taking risks on new ideas can be a great way to expand a business and increase profits.

Diversification success stories and failures are available in equal measure from Apple investing in portable music devices to Northrop Grumman’s short foray into shipbuilding. There are also plenty of warnings to businesses who fail to diversify such as Kodak and Blockbuster.

All business decisions come with a degree of uncertainty and risk but diversification doesn’t need to be a complete shot in the dark if businesses, managers and entrepreneurs ask themselves the following three questions.

Competitive advantage

Before entering a new market it’s crucial to understand what makes the business successful already – specifically, what sets the company apart from its competitors. By taking the time to understand what you do better than your competition you can then see how to apply those strengths to your new endeavour.

At the least, it forces businesses to identify how its strengths can add value to the market it seeks to expand into.

Often what make a business successful are not only their products but also their conduct and ethos. When diversifying, it’s more important to know you are doing it because there is value to add and extract from a market than because it ‘seems’ like the natural progression.

Can we compete as we are?

A major consideration before any diversification is whether the business can compete in the market. If the answer is ‘no’ does that mean the business should abandon its plans? Not necessarily, especially not if the first question was adequately considered.

Sometimes you can have 95% of the ingredients to crack a new market but if you lack a vital element in that final 5% it’ll never work out. If you are missing something you need to work out if you can develop or purchase the final piece before you pull the trigger, or stick your plans in the trash.

The Walt Disney Company is a great example of diversifying through acquisition and development. Since inception, the business has expanded from hand-drawn animation into pioneering CGI, TV broadcasting, theme parks, cruises, on-demand entertainment, apps, toys and music. They’ve done this by acquiring competitors, jumping on bandwagons (but adding value – as per competitive advantage) and aggressively applying their strengths to new markets.

Can we play to win?

If you’ve worked out that you have the abilities, and the assets, to enter a new market, you now need to determine whether you’ll be a bit player or lead actor.

Even an edge won’t make a difference in the long-term because your more-experienced rivals will learn to compete and will likely be able to do it quickly. You don’t need to become an overnight market leader but you need to know if what you can offer is rare, if can it be replicated, or if it can be substituted.

If your competitors can copy you, they will; if they can’t, they will try to find a substitute. The time between you entering the market and them replicating or substituting your competitive advantage is your only window to establish your presence in the market.

If we look at the airline industry we see success for budget airlines in the past 20 years or so with Jetstar and Scoot where others had failed with a similar model 20 years earlier.

Big airlines had a technological advantage over budget airlines in the 70s and 80s that proved not to be so unassailable for the newer budget carriers.

Think about how much you want your new venture to make, and work back from there to determine what you need to do to be more than a contender.

Diversification is not to be taken lightly and smart businesses will do their homework and know when to dive in and when to pull out. By asking themselves these three questions businesses can turn what is often a rushed decision taken under pressure into a logical, strategic one that could elevate their business to new heights.