Definition of diversification
Diversification is a risk management technique a company uses that makes use of a wide variety of investments within the company. The under lying principle behind this system is that asserts that different kinds of investment on an average will give in higher returns and also create a lower risk than an individual investment in a company. The main aim of diversification is to reduce or minimize the risk of the company.
Diversification tries to even out the random risks that a company can have and provide with a better way to improve on investments, and neutralize the negative performance of investments in the future. It is a well known fact that maintaining a well balanced and diversified company can help a company in yielding cost and minimize the risks involved. An investment in securities would yield far more profits for the company but in a limited time when compared to big investments.
Diversification strategies are made use of to expand the operations of the firm by adding different strategies to a business. The main aim of diversification in a company is to allow the company to establish itself apart from its current operations. There are two types of diversification strategies. Concentric diversification is when a new venture is strategically related to the existing lines of business, and Conglomerate diversification is when there is nothing common between old and new business strategies, that is both the businesses are not related in anyway.
Example to explain diversification
The best example to explain diversification is a company that makes an initial investment of $20,000 as stock to the company and then puts another $20,000 as another stock, the risk involved in such a case would be the company having more risk. Diversification would first allow a sale of $10,000 that can be put into the second stock, which would help in minimizing the risk.Similarly, if business A has a stock of $10,000 and business B has a stock of $10,000 then both the companies have a lower risk factor if they invest $5000 of their two stocks so that they have a diversified company.