Reducing Business Risk and Expanding Market Size
For many people, diversification is about growing revenue.
Almost every day, when times are good, there seems to be news about one company buying another.
Some of the most recognizable organizations in the world – like GE, Honeywell, and Siemens – operate a collection of diversified businesses across many industries and in many different countries.
For other people, diversification is about reducing risk. Investors diversify their portfolios so that losses in one sector won't necessarily mean financial disaster. And one of the reasons that farmers diversify their crops is to have different harvest times, which reduces the likelihood of a spell of bad weather destroying a year's work.
Corporations use diversification as a risk-reduction strategy, because it can make company profits less vulnerable to industry-specific changes. For example, when energy prices rise, the cost of many consumer goods increases. If your main business is in transportation/shipping then, following this thinking, your company may want to buy a company serving the oil industry – this could help to protect your overall profits.
But while diversification as a strategy can reduce risk, it can also introduce significant new risk, because it can take a corporation away from its core competences.
This article gives you an understanding of what diversification means, the different types of diversification, and why companies and investors diversify in the first place.
What Is Diversification?
Looked at from one perspective, diversification means bringing together a collection of investments or business units in such a way that overall losses are limited if a particular industry, area or business experiences hard times.
Looked at from another perspective, diversification refers to a company entering into a line of business that's outside the business area in which it currently operates.
Unfortunately, this can mean that the company moves into areas where it has limited expertise. This is usually a high-risk endeavor, and is therefore one that needs a great deal of care.
There are four main types of diversification:...