What is Diversification?

Diversification is a business and investment strategy that involves branching out into new areas or operations. This can mean different things for business leaders and investors. Nonetheless, diversification usually involves the same goals whether you want to invest or run a company.

Diversification as a business strategy

Diversification is a common business strategy that can be used to fuel a company’s long-term growth. Once the company has established success with a given sector, product range or market it diversifies in order to target a new market of prospective customers.

There are numerous ways in which businesses can diversify, including:

• Establishing a presence in a new location

• Launching a new product or range that appeals to a different market

• Expanding its offering of products or services

• Applying your offering to a new industry (e.g. consumer technology expanding into healthcare or industrial electronics)

• Acquiring or merging with another company

• Embarking on joint ventures, such as co-branded products, with another company

Diversification as an investment strategy

The term diversification is also commonly used in the realm of investment. Many may choose to diversify their investment portfolio by investing in a different asset or asset class. Investing in a different asset class may introduce an element of risk but offer higher potential yields for the investor. Alternatively, it may help to reduce risk by preventing the investor from putting all of their proverbial eggs in the same basket.

For instance, property is traditionally seen as a safe investment, offering modest but reliable yields over time. Those looking for a greater short-term yield and are happy to increase their financial risk may wish to diversify by investing in a more volatile asset class like forex, cryptocurrencies or commodities. Commodities are often used by investors to hedge against inflation as their value tends to rise in line with inflation.

Alternatively, for investors that tend to focus on financial vehicles, diversification is an important way to reduce risk. Some markets are more volatile than others, and a diversified portfolio can capitalise on new opportunities in different areas and make gains that can mitigate losses elsewhere.

As well as investing in different asset classes, one can diversify by:

• Investing in different companies, industries and sectors

• Investing across different geographical and political borders

• Investing across both long and short-term vehicles

The benefits of diversification

Balancing a diversified portfolio can be complicated and time-consuming, but can help investors to manage long-term risk while increasing their chances of short-term rewards. It’s important to note, however, that while diversification can help to mitigate non-systemic risks such as the volatility of a single asset or asset class, it cannot reduce systemic risks (e.g. economic recession).

In business, diversification can lead to exponential growth in revenues as new markets, market segments and areas are introduced to the company’s offering. Amazon has gone from being an online bookstore to one of the world’s largest retailers due to diversification.

However, diversification can bring risk if new products or markets are not thoroughly researched to ascertain their viability. Even the biggest companies from Google to Coca-Cola have tried to diversify with products that failed to resonate with their target markets.

Diversification FAQs

Why is diversification important for investment?

Diversification can help investors to better manage non-systemic risk by ensuring that losses made in one area can be mitigated with gains elsewhere.

How can businesses use diversification for growth?

Diversification can fuel growth by establishing a company’s brand in new markets or introducing existing customers to new offerings and increasing their lifetime value.