Concept and types of production diversification. Diversification in foreign exchange markets. Proper diversification of the investment portfolio

22.09.2019

Any business, even the most successful one, cannot function unchanged for any length of time. However, there is an important technique that increases the sustainability of the business model and significantly reduces the risk of critical losses under the influence of changed circumstances. It's about diversification.

The external environment is changing, and any model is invariably tested for strength, forcing us to constantly be aware of new trends and adjust our business in accordance with economic trends and changes in the business climate.

What is diversification and why is it necessary?

Generally speaking, this concept the opposite of specialization. Namely, expanding the range of products and services, as well as developing new markets.

Now everyone should ask a basic question: why is this necessary?

The answer will be equally trivial: for the sake of diversification. If you have never heard this word, it can be explained like this: don't put all your eggs in one basket.

That is, in the event of temporary difficulties or a systemic decline in the profitability of one segment of activity, alternative flows must exist and function that will keep the entire system afloat or even compensate for losses in an area experiencing a decline.

Business diversification

First of all, let's look at the diversification of production in business. We are not talking about expanding the model range, since most risk factors will act to the same extent on different models of products of the same type.

The assortment should be as different as the production base allows, taking into account the reasonable level of investment required to master the release of a new product.

An example of production diversification is the Czech concern Česka Zbrojovka, which, in addition to specialized production of weapons, has mastered the production of parts for the automotive and aviation industries using its own equipment and using its own engineering technologies. This is an example horizontal diversification.

A diversification strategy is not only useful for large businesses. For example, you can choose different instruments and reduce the risks when investing.

But remember that any investment in the family budget should be based on financial goals. Diversification is just one way to minimize risks.

The range of services may be subject to a similar expansion. For example, a real estate office simultaneously begins to provide services in the field of insurance not related to real estate, since its material, technical and personnel base allows it.

Another important aspect– diversification of sales markets. This may require bringing production and services into compliance with new standards or developing an appropriate legal framework, obtaining new certificates and licenses.

In any case, the goal remains the same: to reduce losses from complications in one business segment by creating and supporting its alternative segments.

Most investors are familiar with the two main classes of securities: stocks and bonds.

However, in addition to these two types, each of us can make investments in wider range of property classes, such as real estate, commodities, gold, and even certain alternative strategies such as currencies, etc.

As a result, each investor can focus his investment portfolio on safe(bonds) and risky financial instruments(stocks, raw materials, gold).

When talking about diversification with new investors, the answer is that most people get this issue wrong. For example, it is widely believed that if funds are invested in different shares of companies in the same country, then this is already diversification. Or that if you invest in bonds of two neighboring countries, this will also be diversification. However, most often this is not the case.

Well, the most wrong example is investing in investment funds from two management companies or banks that promote the same direction of investment. Yes, such a division can be called diversification between managers, but this is not a process we discuss in its true understanding.

When it comes to truly diversifying an investment portfolio, there are three essential things to consider: risk, correlation, and return.

The process of diversification is a risk management technique in which a portfolio includes many different asset classes with different negative or close to zero correlation. It is best if the selected asset class should achieve positive returns in the long term, but in the short term the financial flow generated by them should not be correlated.

It is for this reason that it is proposed to include in the investment portfolio not only the standard classes of property - stocks and bonds - but also less common types of it, such as real estate, raw materials and precious metals. Thus, the main element of diversification is insignificant correlation of financial instruments.

Risk diversification

However, when talking about a diversified investment portfolio, you cannot expect its results to be too impressive.

The main goal of diversifying an investment portfolio is reduction of overall risk without compromising profitability. At the same time, the profitability of investments is only a secondary concern.

The point of risk diversification is to ensure that a threat to one part of the business or one of the assets does not affect other parts. The less our segments overlap in different risk zones, the greater the security.

Drawing up an investment portfolio of assets with uncorrelated results reduces risk, because while the profit on one asset falls, on another it is likely to grow.

Let's consider the option with securities. It can be argued that by investing in stocks, we contribute to the growth of the economy, but if the economy goes into recession, the prices of most stocks undergo a correction. At such moments bonds can help, on which constant interest is accrued.

But what to do if inflation suddenly begins to rise, currencies devaluate, the price of oil rises sharply, or a military conflict occurs in a certain part of the world? In such cases, owning only stocks and bonds is not the best alternative.

Let's say, when inflation rises, the real profitability of bonds is most often negative, stocks do not provide optimal insurance against a sharp rise in prices, however, if we allocate a certain part of the investment portfolio to real estate, raw materials or gold, then more favorable results can be expected.

Another example is the increase in fuel prices. Very often, this has a negative impact on the profitability of companies, as transportation and other costs increase, causing the stock prices of these companies to also fall. But if energy resources are present in the investment portfolio, then their rise in price generates a counterweight negative changes in prices for shares of transport companies.

Finally, in situations where thoughts of collapse appear financial system, currency depreciation or similar market disasters, most investors invest in gold for the purpose of diversification.

If you already have successful business, then maybe it’s time to move online. For example, you can - the audience on the Internet and offline are different. Some call it market expansion, and some call it diversification, either way it's worth a try.

To assess the performance of a business and staff, we recommend using KPIs; you can read about these indicators.

If you are interested in financial analytics, then from the article at the address you will learn what EBITDA is and what this indicator is used for.

Conclusion

Business diversification allows it is relatively painless to endure temporary difficulties- interruptions in sales, a short-term decline in demand or prices for products - and in the event of a long-term crisis, alternative branches of the enterprise’s activities can come to the fore and become the basis for repurposing the company according to a new strategy.

At the same time, diversification, especially in the case of production, usually requires additional investments - in new equipment, technologies, personnel. The right decision should be based on a comparison of such costs with the price of risk.

A well-diversified investment portfolio will not help avoid short-term losses, however, one thing is clear: with a portfolio of a wide range, i.e., broken down into different asset classes, you can expect approximately the same or slightly higher profitability, at the same time reducing the overall level of risk. This should be the starting point of every new investor.

It’s best to do what you already know how to do and what you understand. Specialization in one particular area of business provides undeniable advantages.

There is no need to scatter your assets, but you have the opportunity to improve without limits. But only as long as it works.

The fact is that any external environment is dynamic, and any business cannot remain unchanged. It needs to be constantly adjusted, focusing on new economic and business trends.

The diversification strategy is the development of new markets, product range and services in order to reduce overall risk without compromising profitability, increase the company's safety margin and its flexibility.

Diversification strategy - what is it?

The external environment is changing, and any model is invariably tested for strength, forcing us to constantly be aware of new trends and adjust our business in accordance with economic trends and changes in the business climate.

What is diversification and why is it necessary? Generally speaking, this is the opposite of specialization. Namely, expanding the range of products and services, as well as developing new markets.

Now everyone should ask a basic question: why is this necessary? The answer will be equally trivial: for the sake of diversification. If you haven't heard this word before, it can be explained this way: don't put all your eggs in one basket.

Business

First of all, let's look at the diversification of production in business. We are not talking about expanding the model range, since most risk factors will affect different models of the same type of product to the same extent. The assortment should be as different as the production base allows, taking into account the reasonable level of investment required to master the release of a new product.

For example, you can choose different instruments where to invest money in order to earn money and reduce investment risks. But remember that any investment in the family budget should be based on an organized plan taking into account financial goals. Diversification is just one way to minimize risks.

Another important aspect is the diversification of sales markets. This may require bringing production and services into compliance with new standards or developing an appropriate legal framework, obtaining new certificates and licenses. In any case, the goal remains the same: to reduce losses from complications in one business segment by creating and supporting its alternative segments.

Investment portfolio

Most investors are familiar with the two main classes of securities: stocks and bonds. However, beyond these two types, each of us can invest in a wider range of asset classes, such as real estate, commodities, gold, and even certain alternative strategies such as currencies, etc.

As a result, each investor can focus his investment portfolio on safe (bonds) and risky financial instruments (stocks, raw materials, gold).

However, most often this is not the case. Well, the most wrong example is investing in investment funds from two management companies or banks that promote the same direction of investment. Yes, such a division can be called diversification between managers, but this is not the process we are discussing in its true understanding.

When talking about true diversification of your investment portfolio, you should pay attention to three essential things:

risk
correlations,
profitability.

The process of diversification is a risk management technique in which a portfolio contains many different classes of assets that are negatively or close to zero correlated. It is best if the selected asset class should achieve positive returns in the long term, but in the short term the financial flow generated by them should not be correlated.

Thus, the main element of diversification is a slight correlation of financial instruments. For example, the graph below shows the 5 classes mentioned:

Here you can clearly see that over a long period of time they all increase in price, but in different short-term periods their changes are different.

Risks

However, when talking about a diversified investment portfolio, you cannot expect its results to be too impressive. The main goal of diversifying an investment portfolio is to reduce overall risk without compromising profitability.

At the same time, the profitability of investments is only a secondary concern. The point of risk diversification is to ensure that a threat to one part of the business or one of the assets does not affect other parts. The less our segments overlap in different risk zones, the greater the security.

Constructing an investment portfolio of assets with uncorrelated performance reduces risk because while returns on one asset fall, returns on another are likely to rise:

Let's consider the option with securities.
It can be argued that by investing in stocks, we contribute to the growth of the economy, but if the economy goes into recession, the prices of most stocks undergo a correction. At such moments, bonds that pay constant interest can help out.
But what to do if inflation suddenly starts to rise, currencies devaluate, the price of oil rises sharply, or a military conflict occurs in a certain part of the world?

In such cases, owning only stocks and bonds is not the best alternative. For example, when inflation rises, the real profitability of bonds is most often negative, stocks do not provide optimal insurance against sharp increases in prices, but if we allocate a certain part of the investment portfolio to real estate, raw materials or gold, then we can expect more favorable results.
Another example is the increase in fuel prices. Very often, this has a negative impact on the profitability of companies, as transportation and other costs increase, causing the stock prices of these companies to also fall. But if the investment portfolio contains energy resources, then their rise in price creates a counterbalance to the negative change in prices for shares of transport companies.
Finally, in situations where there are thoughts of a collapse of the financial system, currency depreciation or similar market cataclysms, most investors direct funds into gold for the purpose of diversification.

Conclusion

Business diversification allows you to endure temporary difficulties relatively painlessly - interruptions in sales, a short-term decline in demand or product prices - and in the event of a long-term crisis, alternative branches of the enterprise’s activities can come to the fore and become the basis for repurposing the company according to a new strategy.

At the same time, diversification, especially in the case of production, usually requires additional investments - in new equipment, technologies, personnel. The correct decision should be based on a comparison of such costs with the price of risk.

A well-diversified investment portfolio will not help you avoid short-term losses, but one thing is clear: with a portfolio that is broad, i.e., spread across different asset classes, you can expect similar or slightly better returns while reducing your overall risk level. This should be the starting point of every new investor.

Source: "predp.com"

Reducing risks and increasing company flexibility

The diversification strategy is about reducing risks and increasing the company's flexibility. Diversification is a phenomenon that characterizes the degree of diversity of types of products, types of activities, etc. at the enterprise. The wider the product line or the more unrelated production facilities, the greater the degree of diversification of the company.

Diversification - what is it?

The purpose of this phenomenon is to maximize profits and increase the sustainability of the enterprise.

Diversification associated with changes in the company's activities is called production diversification. The main difference between diversification and differentiation is the possibility of developing several directions independent of each other at once.

Types

As part of production diversification, the following are distinguished:

unrelated type
associated type, which in turn is divided into:
- vertical diversification,
- horizontal diversification.

An unrelated type of diversification is also called lateral - it involves the creation of a new area that is not directly related to the existing specifics of activity. For example, renting out one of the warehouses while using the remaining premises in the main activity.

A related type of diversification involves the creation of a new area of activity that depends on areas that are already operating. For example, the creation of a network of gas stations by an enterprise that processes oil.

Vertical diversification occurs when a company decides to expand production by “stepping” forward or backward along the production chain. For example, a company that produces bolts and washers begins to produce assembly units.

Horizontal diversification occurs when a company decides to expand its product range based on typicality. production cycle. For example, manufacturers of face cream are starting to produce eye cream. More often new product comes out under the same brand.

The benefits of diversification include:

expansion of sales markets;
beneficial redistribution of free resources;
reducing the risk of bankruptcy;
increase flexibility and adaptability;
fully utilize the existing capacity of the enterprise.

Strategies

The need to develop a diversification strategy arises for an enterprise in the presence of strong competitors, falling demand for current products and declining profits. This strategy gives the company the necessary flexibility and ability to adapt to constantly changing market conditions.

The diversification strategy is based on the idea of changing four components of the enterprise’s activities:

products,
sales channels,
spheres of functioning,
the company's position in the industry.

Before developing a strategy, a potential innovation is analyzed according to three criteria:

costs associated with the implementation of a new project;
existing barriers/boundaries to implementation;
size of potential demand.

It is also possible to take into account additional effects that will arise only when implementing a diversification strategy.

If there are several options, a strategy with the following criteria is selected:

relatively low costs for implementing the strategy;
medium or short payback period;
steadily growing demand for products new to the enterprise.

The strategy also largely depends on the type of diversification:

Unrelated diversification is often costly and difficult to implement,
the linked type is simpler and involves fewer risks.

Diversification of business and company

Diversification of an entire company is possible through mergers and acquisitions, which is a global trend. Mergers and acquisitions have a number of advantages over the development of production diversification:

ready-made production is purchased,
the sales market is developed,
a network of suppliers and intermediaries has been established,
there is interaction with other market participants.

The process of mergers and acquisitions helps reduce costs:

related to the organization of new production or adaptation of the current one to the needs of new products,
expenses for advertising and concluding new supply contracts.

Moreover, along with finished production, the enterprise receives a qualified workforce.

The main risk of company diversification is the undervaluation of its own production and the overvaluation of purchased ones.

Mergers and acquisitions contribute to:

increasing the market share of the enterprise,
increase production capacity,
more effective diversification at lower costs.

Examples

The most striking example of hyper-successful unrelated diversification of a company in the modern market is the English company VirginGroup. It seems difficult to calculate the exact number of directions in which the company is developing. The company gained its fame by mastering the field of sound recording and creating a store selling music records, cassettes and discs.

Currently, the most well-known areas of activity are:

air travel by Virgin Atlantic Airlines;
Virgin Vision film production;
Virgin Money banking services.

An effective example of related vertical diversification is the Czech company Studentagency. Starting with bus transportation in the cities of the Czech Republic, they gradually entered the market of Austria, Slovakia and Germany, targeting tourists and travelers. Now the company is also engaged in providing hotel booking services and organizing excursions.

Subsequently, the features of the production cycle were used to produce disposable razors and lighters, which also began to generate stable income.

Source: "delatdelo.com"

Diversification as a way to combat competition

Diversification strategy is a marketing strategy that allows a company to identify and develop additional lines of business that are different from its current products and services.

In an increasingly competitive environment, the production diversification strategy:

becomes an excellent tool for risk management;
allows you to avoid excessive focusing of efforts on one area of the company's work.

When implemented correctly, a diversification strategy helps maintain a company's performance and profits during periods of economic downturn, stagnation, or dramatic changes in the way the industry operates.

A strategy can bring clear benefits to the company and increase business stability, but requires a detailed assessment of the company’s internal resources, factors environment and in-depth knowledge of market trends.

In this article we will talk about possible types and classification of corporate diversification strategies, we will give examples of successful strategies and consider the correct process for developing a business diversification strategy. The main essence of the diversification strategy is to divide the assets and capital of one company between in various directions activities to reduce the risk of loss of future income.

Diversification can take many forms. In modern practice, there are 4 main types of product diversification strategies:

horizontal,
vertical,
concentric,
conglomerative.

Let's look at each type of strategy in more detail.

Horizontal

A horizontal diversification strategy involves acquiring or developing new products that can be sold to the company's current customers or clients. In this strategy, the company relies on the existing sales level and production technology. An example of horizontal diversification is the addition of a new type of cheese to a dairy company's sales line.

Risks in a horizontal diversification strategy are reduced by increasing product diversity. In the event that one type of product loses its relevance, the company will still have an assortment that allows it to receive a stable income.

Vertical

The vertical diversification strategy involves the company moving “up or down” along the production chain. In other words, the company enters the stages preceding its production cycle or moves forward to the stages subsequent to its production cycle.

The vertical diversification strategy reduces the company's dependence on the decisions of third parties, prevents third parties from receiving excess profits, and closes all important processes within one company.

Examples of vertical integration are the following situations:

The company stops selling its products through individual retailers and opens its own retail and wholesale store.
The company acquires a supplier of resources and raw materials for the production of its goods.
The company opens an auxiliary business selling paints and building materials its core business of home renovation, providing best prices and materials procurement process.

Concentric

The concentric diversification strategy is also called the related diversification strategy. This strategy means expanding the product portfolio with products (or lines of business) that make more efficient or full use of the company's existing technologies and resources.

In other words, following a strategy of concentric diversification, a company creates complementary products or introduces complementary services that help facilitate and improve the consumption of the main product.

This type of diversification is often used by smaller companies, and the new products created tend to be closely related to the company's core business.

For example:

A children's product manufacturer may acquire other small toy manufacturers around the country to increase distribution of its products and gain access to new markets.
Another example would be the introduction of a small bakery's product range in addition to ready-made baked goods, semi-finished products and dough for preparing products at home.

The advantages of a related diversification strategy are:

gaining access to ready-made solutions and experience,
reduction of competition in the segment (when purchasing competing products),
increasing the efficiency of using available resources.

Conglomerate

The conglomerate diversification strategy is also called the unrelated diversification strategy and involves running two completely independent lines of business that do not improve each other's performance. Following the strategy of conglomerate diversification, the company develops completely new business lines and gains access to completely new consumers.

In fact, this is an investment of the company's current profits in new growing and highly profitable industries. Sometimes this type of future diversification allows a company to gain access to new technologies that can improve the current product.

A company resorts to a conglomerate diversification strategy when:

can effectively apply their knowledge and experience in new markets;
has technologies that allow it to gain competitive advantages in new markets;
new markets and industries have significantly high potential.

An example of such a strategy is a situation where a shoe manufacturer enters a new (for itself) clothing market (using its knowledge and experience in consumer preferences and behavior).

The main benefits of an unrelated diversification strategy are that the company can find and develop more profitable businesses in the future and reduce the impact of seasonal downturns in sales of the core business.

The disadvantages (or risks) of such a diversification strategy are the need to allocate significant resources to the development of a new line of business and investments, which may not pay off if management is poor.

International

An international diversification strategy can take one of the two forms described above: linked or unlinked. But we talk about it separately because of its high importance for the company. International diversification is one of the main strategic ways to diversify a company's activities.

They switch to it when diversification at the national level is completely completed. This process requires high management competencies and a properly structured management structure.

The company must develop a marketing strategy not only for each business, but also for each country, taking into account national and regional characteristics of the market and product consumption patterns.

Using the right international diversification strategy, a company can:

obtain significant economies of scale in production,
gain access to rare and valuable resources,
make the most of your resources and reduce the risks of stagnation and decline in sales.

Development of a diversification strategy

A business diversification strategy can be a tool that significantly increases a company's income and competitiveness, or it can lead to failure. How to properly diversify your business? Which diversification strategy should you choose?

Our small checklist will help answer these questions. Follow this plan which will help you in developing your diversification strategy as well as in choosing the right direction to diversify your business.

Step 1: Analysis of business strengths and stability

Before choosing a diversification strategy, consider detailed analysis current activities of the company. Three key things you need to understand:

What strengths does your current business have?
How stable and problem-free is your current business?
Are there free resources and are they sufficient?

A successful production diversification strategy can only be built on strengths current business. Therefore, do not rely on the successful examples of competitors; you are not fully informed about their capabilities and resources and may make the wrong decision when choosing a form of diversification. Analyze all internal resources of the company and draw up full list strengths.

The second important point that we mentioned above is the stability of the current business.

Any initiative, any new idea requires resources and investments that you use in your current business. Therefore, before developing new directions, make sure that your current activities are stable, profitable and productive. And if you already see shortcomings, then invest existing resources in eliminating them and only then consider options for diversification.

And the last point that you should consider at the first stage is the sufficiency of resources. Any new project requires financial and human resources for its implementation. Make sure your company has the minimum resources to consider and evaluate possible areas for business diversification.

Otherwise, either postpone this project or find alternative ways to increase market share (search for subcontractors, joint ventures, affiliate programs, etc.)

Step 2: Finding Directions

Ideally, the choice of a market (or market segment) for business diversification should be made on the basis of serious macroeconomic and industry analysis, as a result of which it is possible to identify areas with high growth rates and a favorable investment climate.

But more often it happens that areas for diversification are determined based on the knowledge and experience of the business owner, as well as taking into account personal contacts and connections. If you are not yet sure in which direction to expand your business, you need to find ideas whose potential and viability you can evaluate.

The easiest way to gather ideas is to brainstorm. Gather a small group of people who understand your business, are subject matter experts, or are strategic thinkers. These people include department heads, market experts, and young ambitious specialists. Often, interesting ideas come from outside experts who have an “uncontaminated” understanding of the market and can look at business differently.

Step 3: Assessing Directions

Planning for company diversification is no different from planning for starting a new business. At the stage of assessing alternative options for sales growth, it is important to study the market in detail, the intensity of competition and identify key competitors, determine consumer preferences, general trends and market dynamics.

As a result, you will have a list of parameters by which you can evaluate the overall attractiveness of each market and choose the most suitable option for your business.

At the end, for each possible direction of diversification, draw the following conclusions:

Do you really know the long-term prospects and potential of the market, and understand the business model of the key players?
Do you really know how to sell effectively in a new market and understand the key sales drivers?
Do you really have enough resources to enter the market and capture your target market share?
Do you have a clear plan for financing diversification, including investments in technology, equipment, product promotion and improving the quality of work with consumers?
Do you have criteria for assessing the effectiveness of the chosen diversification strategy and a clear work plan for 3-5 years ahead?
Is diversification really the best strategy for entering a new market and are there no more effective solutions (partnership, cooperation with companies, etc.).

Step 4: Analysis of the company's overall portfolio

Once you have assessed all possible areas for diversification, take a test step and evaluate each area within the overall product portfolio of the company. A company's portfolio is a combination of all the products and services that a company offers to its customers. The position and role of each product, product line, and business line must be clearly recorded.

The most successful diversification strategy may not fit into your portfolio. They will help you with the assessment various techniques portfolio analysis: BCG matrix, McKinsey-GE matrix, ADL matrix, etc.

Source: "powerbranding.r"

Related and unrelated diversification strategies

There are related and unrelated (conglomerate) diversification. In turn, related diversification can be vertical or horizontal.

The main criterion for determining the type of diversification is the principle of merger:

With a functional merger, enterprises related in the production process are combined.
In an investment merger, the merger occurs without the production community of enterprises.

Vertical integration

Related vertical diversification or vertical integration is the process of acquiring or incorporating into an enterprise new production facilities that are part of the technological chain of production of the main product at stages before or after the production process.

An integration strategy is justified when an enterprise can increase its profitability by controlling strategically important links in the chain of logistics, production and sales of products.

In this case, various types of vertical integration are possible:

full integration of production activities;
partial integration, in this case some of the necessary components are purchased from other enterprises;
quasi-integration - the creation of strategic alliances of enterprises interested in integration without transfer of ownership rights.

Depending on the direction of integration and the position of the enterprise in the production chain, two forms of related diversification are distinguished:

forward integration or forward integration;
backward integration, or backward integration.

A backward integration strategy is used to protect a strategically important source of supply or gain access to new technology, important for basic activities.

With backward integration, the enterprise integrates functions that were previously performed by suppliers, i.e. acquires (establishes) control over sources of raw materials and production of components.

Direct integration consists of acquiring or strengthening control over the structures located between the enterprise and the end consumer, namely the system of distribution and sale of goods. This type The strategy is used when a company cannot find intermediaries with a high-quality level of customer service or seeks to know its customers better.

Horizontal integration

Related horizontal diversification, or horizontal integration, is the combination of enterprises operating and competing in the same field of activity. The main goal of horizontal integration is to strengthen the firm's position in the industry by absorbing certain competitors or establishing control over them.

Horizontal merging allows you to:

achieve economies of scale in production,
expand the range of goods and services,
thus gaining an additional competitive advantage.

Often the main reason for horizontal diversification is the geographical expansion of markets. In this case, companies that produce similar products but operate in different regional markets merge.

A classic example of horizontal and vertical diversification is the penetration of American brewing companies into the production and distribution of soft drinks.

In this case, diversification is associated with expanding the range of products intended for a similar range of consumers. In Russia, horizontal associations are typical for the banking sector. Here they are aimed at expanding the range of banking services and geographical expansion of activities.

Unrelated diversification. This type of diversification covers areas of activity that do not have a direct connection with the main activities of the enterprise.

Diversification is justified if:

opportunities for enterprise growth within the production chain are limited,
competitors' positions are very strong,
The market for basic products is in decline.

With unrelated diversification, there may be no common markets, resources, technologies, and the effect is achieved through the exchange or division of assets / areas of activity.

There are centralized and conglomerate diversification:

The centered diversification strategy is based on finding and exploiting additional opportunities to produce new products in an existing business. Existing production remains at the center of the business, and new production arises based on the opportunities contained in the developed market, the technology used and based on the strengths of the enterprise.
The conglomerate diversification strategy consists of expanding the enterprise through the production of new products that are technologically unrelated to those already being produced and which are sold in new markets. The purpose of this diversification is to update its product portfolio.

The choice of diversification strategy is carried out taking into account the internal capabilities of the enterprise and market needs.

Source: "econom-lib.ru"

Strategies for a Reliable Business

Concentrating a company's efforts on growth in one area allows it to achieve excellence in that area, as management and staff gain greater experience and skills. This makes it easier to implement competitive advantages, creates additional incentives to improve production in order to maintain a “place in the sun.”

At the same time, there is a danger of “putting all your eggs in one basket,” especially if the industry is stagnating or substitute products are emerging.

Therefore, today leading companies realize their growth primarily through diversification (Latin diversificatio - change, variety), invading other areas that often do not have production or functional connections with the main one, mastering fundamentally different types of products.

The key issue of diversification is determining its optimal boundaries and the list of activities that can be included in the company's business. What will the company look like in a few years? How attractive is the field of activity now and in the future? What needs to be done for this?

Diversification allows you to:

reduce economic risks, “stay afloat” in the event of deterioration in economic indicators by type of activity, since possible failures in one area are compensated by success in others;
flexibly redistribute resources from areas with low prospects to those where the latter are high. To do this, it is important to be able to timely liquidate shares of enterprises at their peak and skillfully invest them in growing promising companies;
It is profitable to invest available funds in other industries if your opportunity for growth and profit has been exhausted;
expand existing markets and find new ones, thereby achieving economies of scale;
increase the efficiency of using accumulated potential, ensure full utilization of production capacities, create new jobs;
adapt to market conditions, more actively counteract rivals (including by buying up their enterprises), reduce dependence on partners;
expand, through the acquisition of new resources and technologies, the ability to optimize the product range, financial flows, etc.

At the same time, diversification gives rise to the problem of internal coordination of divisions, increases the uncertainty of the future, and leads to a decrease in the role of the previous core production.

In general, diversification allows the company to solve socio-economic problems of three levels of priority:

Ensuring survival by obtaining a guaranteed level of profit.
Achieving economic stability and financial sustainability.
Gaining a dominant position in the market and solving social problems.

Analysis

The management of a diversified firm always faces three fundamental questions:

How attractive is the relevant field of activity now and in the future?
What will our company look like in a few years?
What needs to be done for this?

The answer to them is provided by a strategic analysis of diversification, consisting of several successive stages.

First of all, the current position of the company and its actions of a strategic nature are studied and assessed, in particular:
- the achieved degree of diversification (the ratio of total sales and sales of a given division);
- features of diversification (related, unrelated, combined);
- the nature of business transactions (domestic, multinational, global);
- focus of active actions (to create and develop new key divisions or strengthen the positions of existing ones);
- steps to expand the portfolio and capture new industries, on the one hand, and get rid of unpromising divisions, on the other;
- using diversification to enhance competitive advantages;
- ratios of investments in different divisions.

Matrix analysis of a diversified portfolio is done on the basis of any pairs of indicators, for example, industry growth rates, market share, competitiveness, long-term attractiveness, etc.
Assessing the attractiveness of the industry in itself and relative to other industries. Based on an assessment of the attractiveness of all areas, they are ranked, because the company's main activities should develop in industries with good growth prospects.
Comparison of the strength of business units based on analysis and assessment:
- the relative market share owned by the corporation (the higher it is, the stronger the competitive position);
- ability to compete on price and quality;
- new product development opportunities;
- the degree to which the experience and skills of personnel correspond to key success factors;
- profitability compared to competitors;
- knowledge of customer needs and the market as a whole;
- production capabilities;
- marketing activities;
- reputation, brand awareness;
- management level.
The assessments of each unit help make decisions about their fate.
Comparison of the prospects of business units based on indicators of growth in production volumes and profits, share in the company’s total income, return on investment, and cash flow.
Strategic fit analysis (how well each division fits into the company's strategic vision). We are talking about whether the division is consistent with other activities into which the company is diversifying (can be introduced), and whether its strategy is well woven into the overall strategy (beneficially complements it).

Divisions that do not meet this requirement are subject to reduction or liquidation, especially when it comes to related diversification.
Ranking departments by investment priority in order to determine where to direct financial resources. This makes it easier to set basic strategic objectives for each of them (aggressive expansion, protection of existing positions and additional investment, review and repositioning, reduction, liquidation).
When ranking divisions, it is necessary to consider whether and how the corporation's resources and experience can be used to strengthen their positions, especially if they are unsatisfactory.
Development of a corporate diversification strategy, which is based on the analysis and assessment of both the portfolio as a whole and individual species activities.

In general, the analysis allows us to answer the questions:

how many divisions operate in attractive industries;
how many of them are in the final stages of their life cycle (maturity and decline);
does the company have enough sources of financing;
whether its core activities provide it with guaranteed profitability and the necessary cash flow;
whether the business portfolio is exposed to seasonal risks and fluctuations and whether its structure allows the company to provide a strong position in the future;
does the company have activities that it does not need;
what is its competitive position as a whole.

Strategy Options

The following options for diversification strategies are distinguished, both related and not related to the main activities of the company.

First of all, this is a strategy for entering new industries, which can manifest itself in different forms:

Acquisition of an existing company (the most popular route), i.e., acquisition of it without its consent (this differs from a merger).
It could be:
- horizontal,
- vertical,
- conglomerate.
Acquisition ensures rapid penetration, helps to immediately obtain the necessary connections with the supplier technical support, information base, well-known brand, stronger competitive positions, reduce the costs of entering the industry.

The result is the rapid achievement of optimal production volume, the elimination of competition, and an increase in the firm's influence in the market.
Creation of a company “from scratch” under the management of the parent company (“diversification from scratch”).
To do this, it is necessary to make large investments, overcome entry barriers, search for suppliers, form distribution channels, etc.

This path is advisable if it requires less costs than buying an existing company, there is time and experience for its implementation, so that it is possible to achieve a significant expansion of production and sales in a calm environment, and competitors, especially large ones, are indifferent to it.
Creation of joint ventures.
This option makes it possible to facilitate penetration into foreign markets, combine the efforts of several entities, and share the risk between them; gain access to local resources, experience, contacts. All this ensures the achievement of greater competitive advantages.

Another direction in implementing the diversification strategy is penetration into related industries.

It allows:

maintain the achieved level of business activity,
transfer experience, patents, technologies from one company to another,
organize joint production and sales in a single system, which reduces investment risks and costs (economies of scale are achieved, for example, through centralization of management, consolidation of sales, etc.).

The most common routes to entry into related industries are:

purchasing strong, well-established companies;
sharing similar technologies, sales channels, opportunities and advertising;
transfer of experience, know-how, brand name;
acquisition of firms in supporting industries to support core production.

The third main direction of implementation of the diversification strategy is penetration into unrelated industries (non-core, conglomerate diversification).

When implementing it, we proceed from the fact that any company that can be acquired on favorable financial terms and has good prospects is an attractive investment target.

Typically these companies include:

companies whose value is undervalued (there is an opportunity to sell them later at a higher price);
companies experiencing financial difficulties (which, after restructuring, can be turned into profitable ones or sold at a more profitable rate);
promising companies that currently do not have funds for investment.

Diversified and non-diversified firms

The following types of diversified firms can be distinguished:

A company with a dominant focus whose resources are concentrated in a core industry but has a small number of businesses in other areas of activity.
A narrowly diversified company with from two to five interconnected areas of operation.
A widely diversified company that includes a large number of related businesses.
A diversified company, diversified into several unrelated areas that unite related businesses.

The main functions of the management bodies of such a company are:

corporate portfolio management, mergers, acquisitions, resource allocation;
formation of strategies at the level of business units and their coordination with corporate strategy;
ensuring coordination between different types of business in order to achieve a synergistic effect;
exercising control over the activities of business units.

The behavior strategies of an undiversified firm in various situations can be implemented as follows:

With weak competitive position and high market growth rates, it is advisable to:
- partial abandonment of the concentration strategy;
- purchasing other firms in the same industry;
- related diversification;
- liquidation of a business (“reverse diversification”) through a merger or sale of assets to a larger firm.
With a strong competitive position and a high market growth rate, the following are preferable:
- continued concentration in this area;
- related diversification.
With a low industry growth rate and a weak competitive position, the company needs to:
- review of the strategy of concentration in one industry;
- merger with a competing company;
- diversification;
- “skimming” and liquidation (“diversification in reverse”).
With a strong position and low growth rate, the main directions of the company's strategy become:
- international diversification (expansion);
- diversification into related industries through the creation of joint ventures;
- vertical integration;
- continued concentration.

In modern conditions of fierce competition, each company strives to strengthen its position in the market, doing everything to respond in a timely manner to changes in market conditions. One of the strategies for strengthening and developing a company is diversification, as a result of which companies with a narrow specialization become diversified conglomerates, the components of which are not interconnected.

It follows from this that diversification is the development of production or an increase in production volumes, through the development of new types in new or existing markets, and the search for strong positions in them.

Diversification is the company's entry into new ones through more effective management. The goal that diversification sets for itself is to achieve increased performance indicators by making maximum use of available resources.

Diversification can be regarded as a redistribution of resources that is carried out at a particular enterprise into new areas of activity that are different from existing ones.

The process of production diversification means a transition to new technologies, industries, markets with which it previously had no connections; in addition, the enterprise’s products must now be new, which requires financing. Diversification also relates to the variety of applications for a company's products, increasing its performance, regardless of what it may be. If the products manufactured by a particular company have a narrow scope of application, but are found various areas use, then such a company will already be diversified.

Main advantages of production diversification

A real chance to get out of an industry that has gone into decline.
The level of dependence on one product or market is reduced.
The company's market power in relation to customers increases.
Increased organization.
Promotes risk redistribution.

Disadvantages of Production Diversification

There may be a need for certain skills (technological) that the company did not previously possess.
Large amounts of funding are required.
Undesirable redistribution of functions from the main enterprise to new business components.

Types of diversification

The following types are widely developed in industry: conglomerate and concentric.

is produced by manufacturing products related to new industries using the company's technology and production facilities. To do this, research and development is carried out within the company, or the technologies and production that are required to ensure the full production cycle of the product are purchased from other companies.
Conglomerate diversification is the acquisition of profitable companies with different areas of activity.

Both types of diversification are complementary. However, only the use of concentric diversification helps to increase the volume of output and, accordingly, increase the profitability of the company. The purchase of an enterprise is rather necessary for the rational redistribution of capital.

Reasons for production diversification

The main reasons that encourage companies to release new types of products and enter new markets with them may be:

release of more profitable types of products to achieve a stable financial position;
introduction into new highly profitable industries;
minimizing the risk of non-receipt of profit.

The reasons for diversification, which can be called the main ones, are caused by the need to increase the efficiency of the company for the long term, and not for a month or a year.

Therefore, they have a direct connection with important strategic decisions.

Diversification methods

Adaptation. The method is that labor and equipment must be used to achieve a wide range of goods and services.

Extension. Productivity is improved by increasing equipment units and the quality of the organizational process. Such changes lead to an increase in the range of products produced by the enterprise.

Absorption. A company that operates in a certain area is acquired (absorbed) by a larger company. This type of diversification is considered the most common. The advantage is rapid implementation in target markets.

. In this case, companies that are approximately the same in size and scope of activity merge with each other.

Joining. An interest in a company expressed by direct participation in or control of another company. The company that joins continues to operate as an independent structure.

Diversification of production is a strategic plan for the creation and development of diversified production.

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Diversification is a phenomenon that characterizes the degree of diversity of types of products, types of activities, etc. at the enterprise. The wider the product line or the more unrelated production facilities, the greater the degree of diversification of the company.

Diversification - what is it?

Diversification (Latin diversus - different and facere - to do) is the process of allocating resources (material, monetary, etc.) in order to expand the range of products and increase market share (sales market). The purpose of this phenomenon is to maximize profits and increase the sustainability of the enterprise.

Diversification associated with a change in the company's activities is called diversification of production. The main difference between diversification and differentiation is the possibility of developing several directions independent of each other at once.

Types of Diversification

As part of production diversification, there are unbound and bound type, which, in turn, is divided into vertical and horizontal diversification.

Unrelated type of diversification also called lateral– it involves the creation of a new sphere, which is not directly related to the existing specifics of activity. For example, renting out one of the warehouses while using the remaining premises in the main activity.

Vertical diversification occurs when a company decides to expand production by “stepping” forward or backward along the production chain. For example, a company that produces bolts and washers begins to produce assembly units.

Horizontal Diversification occurs when a company decides to expand its product range based on its typical production cycle. For example, manufacturers of face cream are starting to produce eye cream. More often than not, a new product is released under the same brand.

The benefits of diversification include:

expansion of sales markets;
beneficial redistribution of free resources;
reducing the risk of bankruptcy;
increase flexibility and adaptability;
fully utilize the existing capacity of the enterprise.

Diversification Strategies

The diversification strategy is based on the idea of changing four components of the enterprise’s activities:

products,
sales channels,
spheres of functioning,
the company's position in the industry.

Before developing a strategy, a potential innovation is analyzed according to three criteria:

costs associated with the implementation of a new project;
existing barriers/boundaries to implementation;
size of potential demand.

It is also possible to take into account additional effects, which will arise only with the implementation of a diversification strategy. If there are several options, a strategy with the following criteria is selected:

relatively low costs for implementing the strategy;
medium or short payback period;
steadily growing demand for products new to the enterprise.

The strategy also largely depends on the type of diversification - unrelated diversification is often more costly and difficult to implement, while the related type is simpler and associated with fewer risks.

Diversification of business and company

Diversification of an entire company is possible through mergers and acquisitions, which is a global trend.

Mergers and acquisitions have a number of advantages over the development of production diversification:

ready-made production is purchased,
the sales market is developed,
a network of suppliers and intermediaries has been established,
there is interaction with other market participants.

The process of mergers and acquisitions helps reduce costs associated with organizing new production or adapting the current one to the needs of new products, advertising costs and concluding new supply contracts. Moreover, along with finished production, the enterprise receives a qualified workforce.

The main risk of company diversification is the undervaluation of its own production and the overvaluation of purchased ones.

Mergers and acquisitions help increase a company's market share, increase production capacity, and diversify more effectively at lower costs.

Examples of company diversification

The company gained its fame by mastering the field of sound recording and creating a store selling music records, cassettes and discs. Currently, the most well-known areas of activity are:

air travel by Virgin Atlantic Airlines;
Virgin Vision film production;
Virgin Money banking services.

A famous example of related horizontal diversification is BIC, which became large and successful through the production of pens. The technology used by the enterprise made it possible to produce pens at a low cost in large quantities. Subsequently, the features of the production cycle were used to produce disposable razors and lighters, which also began to generate stable income.

Evgeniy Malyar

# Business Dictionary

Examples, types and characteristics

The concept of economic diversification can be expressed in simple words by remembering the saying “Don’t put all your eggs in one basket.”

Article navigation

Diversification is a necessary measure in the economy
Definition of the term
Advantages and disadvantages
Types of diversification
What is differentiation
Diversification of production
Business diversification
Diversification Strategies
Diversification of the investment portfolio
Conclusions

The meaning of the word diversification seems clear to many. It is expressed by an English proverb that encourages “not to put all your eggs (or other fragile objects) in one basket,” but to distribute them among different ones. It is better to have several suppliers than to rely on just one. The same applies to types of products, sources of income or markets. What does this concept mean in economics? Where and when did it come from? What are the types of diversification? This will be discussed in today's article.

Diversification is a necessary measure in the economy

The advice about eggs and baskets is very old, but the real problem of finding economic alternatives arose in capitalist countries only in the middle of the last century. It was then that serious economic risks began to arise in the form of energy, oil and other crises, unprecedented before, and associated, first of all, with the collapse of the world colonial system.

The level of international competition has also increased significantly: “young dragons” have emerged in the form of Asian countries (Japan, South Korea, Malaysia, Indonesia). Offer of a high-tech product, previously almost exclusively produced in the USA and several other industrialized countries developed countries, made me think about security measures. The specter of bankruptcy looms before many companies.

Not less problems also arose in the area of habitual sources of resources. Territories that previously served as “gas stations,” “sugar bowls,” or “teapots,” which seamlessly supplied cheap raw materials to Western markets, gained state independence. They were still ready to sell “colonial goods,” but at different prices.

That’s when the active development of diversification methods began, and this happened, as most often happens, forcedly. However, economics itself is a science of management economic activity in conditions of limited resources. Otherwise there would be no need for it.

Definition of the term

Without a clear definition, understanding any category is difficult. The morphology of the word partly reflects its meaning: the term comes from two Latin words diversus and facere, which together mean “to do different things” - this is what the word “diversification” literally means.

Now the official wording. Diversification is a set of measures to expand the range of products, sales markets, supply channels, investments and sources of financing, carried out in order to extract the greatest benefits and level out risks.

Diversification is also possible on a personal level. For example, girls sometimes “give advances” to two (or more) fans at once, and not always because of their frivolity. What if the relationship with one of them deteriorates? There will be a backup option. What is this if not diversification of matrimonial intentions?

An ordinary bank depositor can place his labor savings in one bank, but the sad experience of the bankruptcy of some financial institutions suggests that it is better to open accounts in several.

You can express what economic diversification is in simple words by recalling many examples and even popular sayings: from the already mentioned eggs in a basket to a straw laid in the place where a straw is supposed to fall.

It should be remembered that when expanding the range, markets and other financial and commodity flows, not only the goal of minimizing risks is pursued. This is done primarily to increase the profitability of an economic entity based on the complementarity of sources of profit.

Advantages and disadvantages

The diversification method is used to ensure the financial stability of an enterprise or state. It has a number of advantages compared to focusing on a single counterparty:

an extensive market appears, where, if one buyer (seller) refuses to cooperate, another can be found;
the risk of bankruptcy is significantly reduced;
the potential of the enterprise is revealed wider;
business survivability increases in the event of a decrease in demand for any product or product group.

At the same time, the method is not without its drawbacks. These include:

increasing complexity of management and planning processes;
reducing the concentration of capital in the primary, usually the most profitable direction;
the likelihood of losses, direct and indirect, when developing new types of activities. In the initial period they are almost inevitable.

Despite these obvious disadvantages, focusing on only one supplier or buyer entails excessive threats. Successful examples of diversification of companies that started with a single product demonstrate the need for many options.

The Swedish company SAAB specialized in aircraft manufacturing, but after World War II it mastered the production of cars using aviation technology.

The Virgin Group holdings include huge amount firms different profiles such as film production, retail, air transportation, audio products, operation railway transport, financial activities etc.

Agriculture is characterized by diversification of crop areas. By relying on only one crop, the producer exposes himself to the risk of crop failure.

By creating an infrastructure for the delivery of hydrocarbons in the form of new pipelines, the Russian Gazprom provides a variety of export channels. The risk of blocking one of them cannot lead to a disruption in supplies.

Types of diversification

From the above examples, we can conclude that there are a variety of forms and types of diversification at all levels. The method is used in the following areas of activity.

National economy. The sovereignty of states with few sources of financial revenue is under threat. Economic diversification refers to the elimination of imbalances caused by one-sided development. Critical dependence on one (or few) industries creates conditions for exerting external pressure (often political), which modern world there are many examples.

Production. A drop in demand for any type of product produced by an enterprise can lead to complete ruin if it is the only one.

Activities outside the country. The potential benefits of geographic diversification include, first and foremost, the opportunity to take advantage of favorable tax laws. Cheap labor also encourages many firms to open production abroad. Other advantages may lie in the proximity of raw materials, energy sources, etc.

Debt insurance. The payment guarantee is provided by assets in the form of securities. The more types of liquid insurance reserves there are, the lower the risk of depreciation.

Investments in currency. Both ordinary citizens and entire states, when creating their foreign exchange reserves, take into account possible exchange rate fluctuations, but it is impossible to predict them with 100% certainty. Large reserves most often stored in different monetary units and other types of values.

Labor reserves. Both employers and employees themselves are interested in universalizing personnel qualifications. The former have the opportunity to be interchangeable, while the latter have increased competitiveness in the labor market.

Investments. Investments in securities of various profitable enterprises increase the financial stability of the holder.

What is differentiation

These concepts are sometimes confused due to the similarity in the meaning of the roots of the words - they both mean some kind of separation. Enterprises actually use techniques such as diversification and differentiation. The differences lie in the essence of the processes. During differentiation, existing technological capabilities are separated into independent structures.

For example, one plant produced computer monitors and televisions. Many assembly elements for these products are the same, but during development, the company’s management decided to create an additional workshop designed to produce one of the types of products. At the same time, diversification as such did not occur: the assortment did not fundamentally change, sales markets and supply channels remained the same.

Differentiation can be made according to subject, detail, technological and functional characteristics. The purpose of such separation is to gain competitive advantages due to greater concentration of production resources, lower costs, increased productivity, etc.

One way to differentiate is to create a separate brand. Competitors, acting on the basis of the interchangeability of goods, attempt to replace the products of a specific manufacturer with their own goods (having similar qualities). At the same time, the company is interested in obtaining or maintaining its own monopolistic advantages, for which it is forced to constantly update its model range, fight for quality and take other measures to strengthen its position. Most often, without separating individual industries into independent structures, solving this problem is difficult.

Diversification of production

This is one of the most common types of diversification. Diversification of a company’s production means expanding the scope of the enterprise’s activities to include new areas. An example is Japanese zaibatsu or Korean chaebols (multi-industry corporations), the range of which is extremely wide - from large-tonnage ships to miniature radio equipment.

Such a combination and diversification of production presupposes the presence of general and auxiliary areas, some of which provide large profits in absolute terms, while others are characterized by high profitability with relatively low turnover.

Of course, such a strategy has a negative side effect, expressed in the forced diversion of assets to the development of less profitable and even adventurous programs. At the same time, diversification of business activities represents competition within the company itself: in order to receive financing, a project must prove its promise. In the course of the economic activity of the enterprise, resources are redistributed in favor of the most profitable types of products.

Business diversification

This concept goes beyond and includes production boundaries. Diversification of a company's business always begins with maneuvering in search of the most profitable product, and often leads to a radical change in profile. In some cases, the company's management becomes convinced of the relative unprofitability of the main strategy.

An example is the history of the American concern Westinghouse Electric, which completely abandoned the production of household appliances and radio electronics in the 1950s in favor of energy and precision instrumentation. Some companies successfully develop investment areas in parallel with hotel, printing or other businesses. In this sense, diversification is the development of activities that are in no way related.

Diversification Strategies

There are types of diversification strategy (three), and its types (also three). They should be considered in detail.

Types of Diversification Strategy	Brief description	Examples
Concentric	Also called centered. The technological base remains unchanged. New products are being produced and sales markets are expanding.	The engineering company produces specialized products, cooperates with the space agency and carries out defense orders. The Hilton premium chain builds hotels in an affordable price category.
Horizontal	The possibilities of the already conquered market and available technologies are used. The company produces new product samples aimed at its traditional consumers.	The company, which produced only televisions, is expanding its range to include satellite reception systems, DVD players, audio equipment and other consumer electronic devices based on complementarity.
Conglomerate	Also called conglomerative. It is considered the most difficult to implement. In contrast to centered and horizontal diversification, it involves the production of fundamentally new products that were previously not characteristic of a given company. Requires significant expenditure of resources, attraction of qualified personnel, additional market research, advertising, management restructuring and other necessary measures.	Acquisition of an oil producing company by a media group. Other examples of conglomerate diversification: a bank creates a real estate agency, an airline absorbs a hotel chain, etc.

Based on the listed strategies, the following types of diversification are distinguished:

Types of Diversification Strategy	Brief description	Situations
Unrelated	A conglomerate strategy is used for implementation. Both products and markets are becoming new. The use of old technological resources is excluded.	The takeover or acquisition of new assets most often occurs “on occasion”, at minimal cost. The priority selection criterion is the prospect of accelerated financial growth.
Linked (can be vertical or horizontal)	Vertical. Without changing the general technological principles, new associated capacities are being built up. For example, pellets produced by metallurgical corporations at their processing plants can be used in their own technological cycle or sold to third-party consumers.	Production (capacity) is acquired or absorbed for the production of other goods of a similar profile.
Linked (can be vertical or horizontal)	Horizontal. Companies that produce the same product, but in other regions and countries, are absorbed in order to expand markets geographically.	Expansion of horizontal diversification in the market most often occurs through the acquisition of competing companies.
Combined	A combination of related and unrelated diversification.	Implementing a hybrid extension requires extremely powerful resources. Such diversification as a method is available only to transnational corporations.

Diversification of the investment portfolio

An investment portfolio is a collection of securities owned by one owner. It, in turn, is divided into packages consisting of shares, bonds, currency or obligations, each of which is put into circulation by one issuer.

Obviously, the lower the number of types of securities in the portfolio, the higher the risk of investing in securities. The principle of diversifying investments is the same as in any other case, but the stock market has its own characteristics. It is advisable that the portfolio be divided into packages with the following characteristics:

Profitability. Diversity in itself is of dubious value if the securities do not provide the holder with acceptable interest rates, that is, real profit.
Industry diversification. The influence of crises and other difficult to predict circumstances force majeure, not only individual enterprises are affected, but also entire sectors of the world economy (mining, ferrous or non-ferrous metallurgy, IT, mechanical engineering).
Division by asset class. These could be stocks, bonds, mutual funds or other types of securities, including currencies. For example, with the onset of the global crisis in 2008, holders of many assets suffered, while owners of large sums of dollars, euros and precious metals benefited.
Different territorial affiliation. Stock and currency rates may depend on the country of origin, the situation there and other circumstances, including, for example, natural disasters, mass unrest, wars, etc. Diversification of investments in the region means that securities are issued in different countries.
Absence of mutual correlation. In other words, the safety of investments in projects with independent income is much higher than investments in related enterprises or industries. An example is the situation with a drop in activity in the new real estate market. Construction will slow down, which will lead to stagnation of firms producing brick, cement and other materials.
Diversification of deposits. Not everything follows cash store in one bank, no matter how favorable conditions it offers.

Based on the above characteristics, we can conclude that high diversification of the investment portfolio is the process of the most rational allocation of funds in various types of income-generating assets. At the same time, there is a chance that a drop in profit from one package will be compensated by an increase in the cost of another.

The same principle is used by financial institutions when planning the issuance of borrowed funds. Diversification of a commercial bank’s loan portfolio on the Russian market involves dividing it into the following categories:

Groups of borrowers. Most often, diversification is implemented by setting limits on the issuance of consumer loans in percentage or absolute terms.
Accepted collateral. If the market price for one or another type of collateral (real estate, cars, etc.) falls, the bank may find itself in a difficult position when selling it.
Interest rates. The flexibility of the accrual system serves as a tool for minimizing risks.
Repayment terms. The financial institution diversifies loans in such a way as to maintain an evenness of incoming cash flows. Otherwise, problems with capital turnover may arise.