Diversification: Advantages, Disadvantages and How to Assess Whether It Is a Good Idea

1. Introduction

Diversification is a strategy used by most companies where the company undertakes to venture into business avenues or areas that are mainly different from the original business. The main objective of diversification is to ensure growth and survival of the company in the long term. In this paper, we are going to discuss the concept of diversification, its advantages and disadvantages and how companies can assess whether diving into new business opportunities is a good idea for them.

2. What is diversification?

Diversification can be defined as a strategic move undertaken by a company to enter into new businesses or industries that are different from its current line of business. This is usually done in order to mitigate risks, maximize profits and secure the future of the company. Diversification can either be horizontal or vertical. Horizontal diversification is where a company enters into a new market with products that are similar to those that it already offers while vertical diversification is where a company enters into a new market with products or services that are related to its current offerings (Miles & Snow, 1978).

There are several reasons why companies engage in diversification. The first reason is that it provides an opportunity for the company to enter into new markets and hence expand its customer base. This is particularly important for companies that are operating in highly competitive industries where there are few opportunities for growth. Diversification also allows companies to tap into new sources of revenue and hence increase their profitability. In addition, diversification gives companies the opportunity to spread their risks across different businesses and industries thereby reducing their exposure to risk.

3. Why do companies engage in diversification?

As mentioned earlier, there are several reasons why companies engage in diversification. The first reason is that it provides an opportunity for the company to enter into new markets and hence expand its customer base. This is particularly important for companies that are operating in highly competitive industries where there are few opportunities for growth. Diversification also allows companies to tap into new sources of revenue and hence increase their profitability. In addition, diversification gives companies the opportunity to spread their risks across different businesses and industries thereby reducing their exposure to risk.

4. When is diversification a good idea?

Diversification is only a good idea if it is done for the right reasons and if it is well thought out. Companies should not engage in diversification just for the sake of doing so but rather they should have a clear plan and strategy on how they intend to achieve their objectives. In addition, before venturing into any new business, companies should conduct a comprehensive analysis of the industry and the market to ensure that it is profitable and that there is enough demand for their products or services.

5. How can companies assess whether diversification is a good idea?

There are several ways in which companies can assess whether diversification is a good idea. One way is to use an industry attractiveness-business strength matrix which consists of nine cells which help map out the relative attractiveness of an industry and the company’s strengths within that industry (Hofer & Schendel, 1978). Another way is to use a portfolio analysis which helps assess how different businesses within a portfolio contribute to overall risk and return (Ansoff, 1957).
No matter what method is used, it is important for companies to remember that diversification is only a good idea if it is done for the right reasons and if it is well thought out. Companies should not engage in diversification just for the sake of doing so but rather they should have a clear plan and strategy on how they intend to achieve their objectives. In addition, before venturing into any new business, companies should conduct a comprehensive analysis of the industry and the market to ensure that it is profitable and that there is enough demand for their products or services.

6. Conclusion

In conclusion, diversification is a strategy used by most companies where the company undertakes to venture into business avenues or areas that are mainly different from the original business. The main objective of diversification is to ensure growth and survival of the company in the long term. There are several reasons why companies engage in diversification such as expanding their customer base, increasing their profitability, and reducing their exposure to risk. Diversification is only a good idea if it is done for the right reasons and if it is well thought out. Companies should not engage in diversification just for the sake of doing so but rather they should have a clear plan and strategy on how they intend to achieve their objectives. In addition, before venturing into any new business, companies should conduct a comprehensive analysis of the industry and the market to ensure that it is profitable and that there is enough demand for their products or services.

FAQ

Diversification can help companies to mitigate risk and improve financial performance by providing them with exposure to a variety of different economic conditions.

Diversification affects a company's financial performance by allowing it to spread its investment risks across a number of different investments, which can potentially lead to higher returns.

The risks associated with diversified companies include the potential for underperformance in certain economic conditions and the need for active management to ensure that the company's portfolio is properly diversified.

Managers can effectively manage a diversified company by carefully selecting the industries and companies in which they invest, and by monitoring the performance of their portfolio on an ongoing basis.