1. Why do companies
diversify? When do companies consider diversification?
Diversification is a technique
incorporated by the companies to reduce the risks of failure by investing the
resources of the company in different directions that would help increase in overall
profitability and competitive advantage in the market. This involves researching
and studying the trends involved in the markets of the industries in which the company
is trying to invest and indulge into.
The companies tend to
consider diversification into different industries to mainly reduce the risks involved
in investing into a single direction. Though there is no complete confidence in
providing zero loss, the diversification technique would help the companies to
focus and make sure the success of a long-range financial propagation in the future.
There may be many
significant reasons for a particular company portfolio to consider diversification.
These specific reasons differ depending on the organization’s trends and
behaviors. If the company’s entire existing stocks are into a particular industry,
say for example, airline industry, the company would have a risk of reduced
value if there is a significant issue related to the airline industry. To
reduce this type of risk, the company can try and invest into another industry,
lets say, railway to balance the risk involved with its airline stock. Even better
possibility of diversification involves stock investments into a totally unrelated
industry or a entirely different sector. Here, it would be some other industry or
a sector other than a transportation sector. May be, the company consider some
retail industry to invest the stocks, so that the entire value of the company would
not affected if there is an issue in one particular industry.
2. Describe related and
unrelated diversification, and why a company would choose one diversification method
or the other.
The related diversification basically involves the improvement of the organization
by making synergetic combinations with another business which has a certain level
of commonalities that would help in the increased market power along with
increased profitability by utilizing the common structure existing with them. This
in turn helps in reduced investment, reduced R&D and marketing costs and strategic
Diversification: The unrelated type of diversification involves agreement and
investments into another business which is entirely different from the existing
business’s core focus. The synergetic combination resulted as a consequence of
this type of diversification has totally unrelated investments, R, market
thrust and structures.
Depending on the
organization’s portfolio and size, it can decide on the specific diversification
strategy to incorporate into its strategy. Usually, small businesses tend to invest
into a related diversification so that there are low investment costs and major
advantages increasing market share compared to involvement into a unrelated
3. Describe what can cause
diversification to fail.
There are several causes
that might lead a company’s downfall when involved in some sort of diversification
depending on the factors that the company has initially started with the idea
of diversifying its investments and stocks. The same causes can lead the
company to grow better with a better possibility of gaining profitability but
then the same factors when miscalculated or misunderstood can cause huge
failure to the company.
Following are a few of
these causes that might be possible factors for the diversification failure.
Financial miscalculations: Though the diversified result that
company acquires from a certain level of diversification is profitable to the
organization, there is always a risk involved in miscalculating the available
resources and finances to manage the combined competencies that occur after diversifying.
Risk in increased market share: There is an increase in the scope
of the company’s market share and power resulted from the diversification. But
the increased market share would directly increase the competition that needs
to be understood and faced by the company in the long run.
Incapability of assessing the combined growth: Depending on the
type of the diversification incorporated by the organization, the
inefficiencies involved in making good decisions to manage the resources and strategies
for a combined growth would always be a variable and has to be accounted for
Investing in a protection from the risk: As a result of research
and study on the risks involved in the diversification, the company would need
to invest in to a risk protection plan which is basically an investment that
would not have any direct compensation in the profitability to the company.
4. When seeking to enter a
new industry, describe the advantages and disadvantages a company may face when
exploring acquisition to enter the new industry.
The major technique that
companies pursue while trying to involve in either vertical integration or diversification
is following the acquisition trend. This is considered when the company is looking
towards a better, easier and faster method to have its market presence established
to gain an increased profitability. This technique helps the company to enter
into a new industry where the barriers for a new entrant are set really high
that the company if tried to enter independently would end up in losses rather
than gaining an advantage.
There are certain
advantages and disadvantages involved in implementing an acquisition by a
company. These are discussed below,
Increase in revenue due to combined
Improved access to supplier and distribution channels
Profitability due to combined efforts of R&D
Access to more resources and knowledge in the market
Savings in time and energy of the combined resource capability
Risk of disturbed cultural differences in the companies involved
Increased confusion in the combined assets
Losses due to misguided acquisitions which might increase overall
Wastage of time and money
on pre and post-acquisition activities