Diversification

Definition

Diversification refers to the strategy of expanding a company's operations by entering into new markets or offering new products and services. This approach is often aimed at reducing risk by spreading investments across different areas, thereby minimizing the impact of a poor performance in any single market. By diversifying, organizations can enhance their resource base and achieve greater stability in uncertain environments.

5 Must Know Facts For Your Next Test

1. Diversification can take two main forms: related diversification, where a company expands into a new area related to its existing business, and unrelated diversification, where it enters completely different markets.
2. Organizations often diversify to mitigate risks associated with reliance on a single product line or market, especially in volatile economic climates.
3. Diversification can lead to increased market share and customer base as companies introduce new products or services to existing or new markets.
4. Resource dependence theory suggests that organizations are motivated to diversify in order to gain access to critical resources and reduce dependence on external suppliers.
5. Successful diversification requires thorough market research and strategic planning to ensure that the new ventures align with the organization's overall goals.

Review Questions

• How does diversification relate to risk management in organizations?
  • Diversification is closely tied to risk management as it allows organizations to spread their investments across various markets or product lines. By entering multiple areas, companies can cushion themselves against the poor performance of any single venture. This strategy effectively lowers the overall risk profile of the organization, as losses in one area may be offset by gains in another, leading to more stable financial performance.
• Evaluate the advantages and disadvantages of related versus unrelated diversification strategies.
  • Related diversification can lead to synergies through shared resources and expertise, enhancing operational efficiencies and brand strength. However, it may also limit a company's exposure to new growth opportunities if overly focused on existing markets. In contrast, unrelated diversification opens up new avenues for growth but can lead to a lack of expertise and increased complexity in managing disparate operations. The effectiveness of each strategy depends on how well the organization aligns its resources and capabilities with its overall objectives.
• Critique how resource dependence theory explains an organization's decision to diversify in response to environmental uncertainties.
  • Resource dependence theory posits that organizations strive to minimize their reliance on external entities for critical resources. In times of environmental uncertainty, this drive becomes crucial as firms may face supply chain disruptions or changes in consumer demand. Diversification serves as a strategic response to mitigate these risks by broadening the resource base. By entering new markets or developing new products, organizations can secure alternative sources of revenue and reduce vulnerability, thus aligning their strategies with the unpredictable nature of their external environments.

Related terms

Risk Management: The process of identifying, assessing, and controlling threats to an organization's capital and earnings, often involving strategies like diversification.

Strategic Alliances: Agreements between two or more organizations to pursue a set of agreed-upon objectives while remaining independent entities, often used to facilitate diversification.

Market Penetration: A growth strategy aimed at increasing sales of existing products or services within the current market, which can complement diversification efforts.