Why do companies pursue diversification strategy?

Following are the motives for diversification::

 

GROWTH   --The desire to escape stagnant or declining industries  has been one of the most powerful motives for  diversification (tobacco, oil, defense).

 

            --But, growth satisfies management not shareholder    goals.

 

           --Growth strategies (esp. by acquisition), tend  to  destroy  shareholder value

 

RISK  SPREADING       --Diversification reduces variance of profit flows

 

                                       --But, does not normally create value for      shareholders, since shareholders can hold diversified     portfolios.

 

                                    --Capital Asset Pricing Model shows that     diversification lowers unsystematic risk not     systematic risk.

 

 

 

PROFIT                        --For diversification to create shareholder value, the act    of bringing different businesses under common owner   ship must somehow increase their profitability.

 

I agree with my colleagues answers

I Agree with Mr Ibrahim

Diversification is in simple terms "Business risk optimization".  Other strategies followed with it.  Agreed with all answers.

First and foremost to minimize risk. 

A mutual fund for example cannot exceed buying more than5% of their fund of one stock.   

Often companies diversify for a host of good reasons. In other cases, it becomes a survival strategy when single product or service strategy reaches the limits of revenue generation. To achieve genuine success from planned diversification firms must reinforce internal development; pursue value-chain acquisitions, form strategic alliances and joint ventures. Often you will find that each route has its own set of issues like benefits and limitations.

 

A conservative reason to diversify is to avoid major repercussions when an industry or sector suffers a downturn. Some single-business or single-product organizations couldn't survive a lengthy decline in their industry.

Another reason to diversify is that under-served locations or customers have available revenue for somebody in your industry to take advantage of. If your company doesn't diversity and expand to fill the additional demand, competitors are likely to do so. If you get in first, you can often increase your customer base or establish yourself as a top provider.

diversification strategy is mainly used when the current products and/or market are not offering the needed opportunities for growth. It is also used when development in the economy are expected. Some companies may use apply strategy when the have the know how and want to make an efficient use of the available resources (human, knowledge, machines,...).

Although it is a very risky strategy, but may help companies to spread the risks among different markets and products.

Diversification is important to survive in the market. Better to spread the eggs in different basket than to put all in one.