A company owning another firm in good financial times is quite common. Some of the largest companies in the world operate a series of diversified establishments across many geographical boundaries and industries. For some companies diversification means increasing revenue and for others it means decreasing risks. Business owners diversify with the hope of making up for the loss in one section. In this article, we will discuss about diversification and its strategic tools.
Diversification decreases risk because it makes profits of the company less susceptible to specific changes in the industry. For instance, the rise of fuel prices leads to the increment of many consumer goods. If a business concerns transportation, the business owner may want to purchase a company that serves the oil industry. This keeps profit intact. However, diversification can also divert a company from success as the company can move away from its core competencies.
Features of Diversification
Diversification indicates bringing together a collection of business units and investments. This is done in such a way that total losses are reduced if a certain segment faces problems.
When seen from another perspective, diversification talks about an organization that enters into a line of business that is outside its arena of business.
It means that the company shifts into an area where it has less experience. This is an endeavor which involves a lot of risk and thus, it needs a lot of care.
Types of Diversification
# Vertical diversification
This diversification takes place when the organization goes back to former phases of its cycle of production or shifts forward to other stages in the same production cycle. Same cycle involves final product distribution and production of raw component. For example, if a firm is involved in reconstruction business of houses and office buildings, and the business owner begins to sell construction materials, the supply of raw materials is guaranteed at all times. Moreover the raw materials required to rebuild houses have low price and are good in quality.
# Horizontal diversification
This type of diversification involves developing or creating new products or rendering new services that appeal to the present customer groups of companies. Here, the firm depends on technological and sales relations to the current line of products. For instance, a dairy that produces cheese adds a new kind of cheese to its product line.
# Heterogeneous (conglomerate) diversification
Heterogeneous diversification involves shifting to new services or products that have neither commercial nor technological relation with equipment, present line of product and channel of distribution. This diversification appeals to new customer groups. The actual motive behind diversifying in this manner is the high investment return in the new industry. Moreover, the plan to opt for this kind of diversification leads to extra options that are not directly connected to further development of the main business of the firm. The extra options are strategic partnership opportunities, means to approach new technologies, etc.
# Concentric diversification
This form of diversification constitutes the process of increasing the portfolio of production by adding new products with the target of completely using the present market system and technology. As a strategy, concentric diversification is quite effective from the financial point of view. This is because; the business establishment can benefit from harmony in this model of diversification. It can enforce some investments that are connected to improving the current processes. Business owners who are small time manufacturers of consumer goods use this type of diversification. For instance, dough products or pastries begin to be produced in a bakery.
This model of diversification constitutes the manufacture of profitable goods that are not connected to each other. In most cases, this model is related to large scale investments that offer high returns.
Being a strategic approach, diversification is brought under thorough research that target to investigate its connection to the financial results of the firms. In most studies there is a comparison between related and unrelated diversification results. However, even after this the line of difference between the two is not clear. For many years, related diversification has been thought to be more advantageous than unrelated diversification. But, off late, large companies have tried to prove otherwise. In fact, they have proved that profits can be achieved by unrelated diversification.
Place to Undertake Diversification
Diversification is a significant tool for firms in any location or sector to develop business. But, it is important to keep in mind that successful diversification does not come with a pre-planned recipe. The most suitable diversification is determined by many external and internal factors that affect each firm. These factors should be scrutinized and then considered before being developed into a strategy of diversification. It is also essential that this strategy is applied and modernized as per the changes in the industry standards that are caused by high competition.
Industry for Diversification
Industry choice for business establishments to diversify follows a segmented and macroeconomic investigation to recognize economic fields with industries that are suitable for investment and expected fast growth. But, quite often, current skill plus experience of human resources, general condition of the economy and the personal contacts of the manager of the company decide the arena of diversification in future.
An appropriate diversification ensures competitive advantage to a firm in getting their goals. This will develop the business by entering new line of products and markets can decrease the risk by multiplying their investments. But, there is also a lot of risk involved when implementing diversification. It is the responsibility of the manager or the owner of the company to provide impetus to it and not prove it a failure.
To Wrap Up
From the article, it can be deduced that diversification helps a company in facing hard times in business. If one segment of the business fails, the other segments can make up for the loss faced. The five types of diversification are vertical diversification, horizontal diversification, heterogeneous (conglomerate) diversification, concentric diversification and corporate diversification. It is important that business owners are careful when implementing diversification because, while it can make a company strong enough to face financial changes, it can also take away the attention of the owner from the core competencies of the firm.