Diversification Strategies

The term diversification is used to describe a business strategy based on variety. Diversification strategies are the plans that involve choosing one or more options to improve the likelihood of success in diversification. There are many forms of diversification, and describing a few of them will illustrate what diversification strategies are and why they are important.

In investing, diversification means spreading risk by making investments across a variety of forms: small company stocks, large company stocks, bonds, money market instruments, banks, certificates of deposit (CDs), domestic and international companies, and on, and on. The hope is that by diversifying, the risk of a failure in any one type or size of investment is mitigated or at least reduced in impact on the entire portfolio of investments.

In business strategy, the meaning of diversification is similar, but the application and execution is different. Diversification strategies in business may be horizontal, in which expansion moves into similar product or service areas but in different geographic or price/specification market segments. Or the diversification strategy may be vertical (also called vertical integration or backward integration), whereby an organization acquires the suppliers of the raw materials, components, or goods and services it uses in its business or activities.

One of the latter forms of vertical diversification, called vertical integration, was very popular in the early 20th century, following the success of legendary giant Henry Ford, whose Ford Motor Company once owned everything from the iron ore mines to the steel mills that produced the steel and iron used in Ford automobiles.

Horizontal diversification became more popular in the mid-20th century with the creation of large conglomerates and financial holding companies. ITT under the leadership of Harold Geneen was one such noted conglomerate. These businesses diversified into many unrelated industry segments whose only common thread was financial ownership and central corporate management. Many failed because they lacked the breadth of management skills to effectively manage these large and diverse enterprises.

Later in the 20th century, companies such as Dover, Danaher, and Tyco attempted to capitalize on parts of the conglomerate-based horizontal diversification but to date their success has been mixed. The concept of concentric diversification was embodied in Tyco's purchase of CIT Financial, diversifying into an activity that surrounded its other business units and at least theoretically added value to the overall corporation. General Electric's success in diversifying both concentrically (via GE Capital) and as a conglomerate (aircraft engines, plastics, broadcasting, appliances, and so on) has been difficult for others to emulate successfully because of the range of management know-how and strategic skills needed to manage such widely diversified corporations.

Vertical diversification in other forms has met with moderate success. One primary example is that of producers also being retailers of the products they produce. Companies such as Hallmark Cards do the creative development of many items in their assortment, produce or procure those items, and then sell them through company-owned and -operated stores (as well as through leased departments and stand-alone retail sales to regular retailers). This requires a great breadth of product offering and skill in marketing to avoid channel conflicts in pricing and products.

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