What is Diversification

Diversification is an investing strategy that manages risk. It helps you to spread your money across different investments. And it also helps to manage risk and increase potential turns by balancing out the ups and downs.

If one part of your portfolio takes a hit, the rest can help you afloat, and it might bring in gains, and is also recommended for a long-term goal, like retirement. Also If you want to make your portfolio get back on track, you need to consider seeking advice from a financial advisor, who will guide you towards your financial goals.

Synonyms

• Variety
• Expansion

Types of Diversification Strategies

There are various types of approaches businesses and investors use to spread risk and enhance growth potential by expanding into new markets, products, or industries.

Below are the types of diversification;

1. Horizontal Diversification 

Horizontal diversification happens when a business expands by adding a new product or service that is different from its current offerings. But still have something that would likely appeal to their customers.

Horizontal Diversification is Best Fit For:

• Businesses that are operating in a specific industry where competition is high.
• Businesses in industries where the market is only so big.

Pros:

• It helps companies expand their marketing reach
• It builds efficiencies and broadens opportunities.
• It helps businesses overcome tough competitive challenges.

Cons:

• It caught the attention of the regulators.
• Growing too quickly can drain your resources fast.
• The risk of failure (when the expected benefits don't turn out).

2. Vertical Diversification

Vertical diversification is when a business expands by moving forward or backward along the production line. Forward vertical diversification means moving closer to the consumer. Just like when an iron mining company purchases a steel factory to get closer to the end product. 

Backward vertical diversification means moving upstream in the supply chain. Such as when Netflix decides to create its own movies instead of just streaming content made by others. This type of strategy helps businesses gain more control and potentially increase profits by tapping into different stages of their industry.

Vertical Diversification is Best Fit For:

• Companies facing trouble because of an unreliable supply chain
• Companies that depend heavily on their suppliers.
• Companies looking to grow their market share.

Pros:

• It eliminates reliance on suppliers.
• Having control of your supply chain can give you a competitive edge.
• It benefits from economies of scale

Cons:

• There is high initial expenditure and operating costs.
• There's no guarantee that you'll click with the current team culture.
• It takes the focus off the core business.

3. Concentric Diversification

Concentric diversification focuses on expanding your product or service lineup in a way that is closely related to what you can offer. Often using the same technology or production methods. For instance, if you run a pizza place, you might need to start offering hand pie.

Diversification is Best Fit For:

• Companies that have underused resources
• Companies that are facing downturns in their industries.

Pros:

• Increases your market share without having to invest as much as other methods.
• Makes the most of what you have and improves what you already have.
• Allows for business cooperation.

Cons:

• Require skills that current staff don’t have.
• It is harder to adapt and stay flexible with market changes.
• Going overboard too quickly can leave you with not enough resources and focus.

4. Conglomerate Diversification

Conglomerate diversification is a type of growth strategy where a business adds new products or services different from the existing ones. It’s all about exploring new markets that have nothing to do with the company’s original focus.

Conglomerate Diversification Best Fit For:

• Businesses in industries that experience seasonal ups and downs.
• Businesses that have strong brand equity.

Pros:

• Can draw new audiences to the brand.
• It can generate a unique and independent source of income.

Cons:

• Just because a brand seems strong doesn’t always mean it’s enough to make a successful transition.
• Can weaken the current brand
• The cost of entry can eat into the profits of your current product line.

Benefits of Diversification Strategies

Diversification is a recommended investment strategy for a reason. Below are the benefits of following a diversification strategy:

1. Steadier Returns

Diversifying your investments can lead to a more stable and predictable return, smoothing out the market volatility.

2. Risk Reduction 

Diversifying your investments across various asset classes helps spread risk. If one investment doesn’t do well, the others that are performing better can help balance things out.

3. Liquidity

Diversification ensures that you have investments that can easily be turned into cash when you need it, giving you a safety net in emergencies.

4. Minimized Portfolio Volatility

A diversified portfolio usually has lower price fluctuations, which can help you rest easier knowing your investments aren’t bouncing around too much.