Contents
- What is diversification?
- Why is diversification necessary?
- Types of diversification
- Advantages and disadvantages of diversification
- Rules for successful diversification
What is diversification?
Diversification is a strategic approach that allows for effective risk distribution and stable income by creating variety in business or investments. This concept is based on the well-known saying “Don't put all your eggs in one basket,” which emphasizes the importance of resource allocation. If one “basket” fails, others remain untouched, minimizing losses.
Examples of diversification can be seen in various areas: parents send their children to different clubs, freelancers work with multiple clients, and companies expand their product lines to increase resilience and profitability. A classic example is Unilever, which manages over 400 brands, allowing it to effectively respond to market changes.
Why is diversification necessary?
The primary goal of diversification is to minimize risks. The more diverse approaches and tools a company uses, the more stable its performance results. This helps avoid unexpected losses in conditions of market volatility, inflation, or political changes. Furthermore, diversification promotes business development and the creation of competitive advantages. For instance, during the pandemic, many companies adapted to new conditions by developing online sales or introducing new products.
Diversification also helps achieve the main goal of any business—profit generation. Variety in production and sales approaches makes the process more resilient to crises and unexpected changes in the economy.
Types of diversification
There are several types of diversification that can be classified as follows:
- Production diversification: Involves expanding the product range, launching new production lines, and implementing modern technologies. For example, a company producing gingerbread may launch a line for making bagels.
- Price diversification: Means offering products in different price categories, allowing access to various market segments. For example, the product range may include both inexpensive and exclusive items.
- Business diversification: Involves spreading risks across various projects, including launching new businesses. For instance, if the main business faces difficulties, the company may develop a new product to offset losses.
- Investment portfolio diversification: Involves investing in various financial assets, which helps minimize risks associated with declines in specific asset prices.
Advantages and disadvantages of diversification
Diversification offers numerous advantages for businesses. It helps:
- Reduce the risks of unexpected losses.
- Simplify entry into new markets.
- Decrease the likelihood of downtime due to the loss of key employees.
- Allow for a smooth exit from less profitable markets.
However, diversification does not always lead to success. There are well-known cases of companies failing in their attempts to expand their horizons, such as when Colgate launched frozen semi-finished products that did not meet consumer demand. Such examples highlight the importance of understanding the target audience and their needs.
Rules for successful diversification
For diversification to be beneficial, several key rules must be considered:
- Do not spread yourself too thin across too many directions.
- Work in areas where you already have experience.
- Avoid investments in similar assets.
- Do not launch unrelated products under one brand.
- Research the target audience to understand their needs.
- Base new products on clear calculations and justifications.
- Develop a promotion strategy and consider all necessary resources.