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“For a company that has taken its original or main business as far as it can go, diversification as a means of channeling surplus resources should certainly be considered. For a company that has not yet developed its main business to the full potential, however, diversification is probably one of the riskiest strategic choices that can be made.” – Kenichi Ohmae, Former Head of McKinsey & Co’s Tokyo
Corporate diversification refers to companies pursuing several unrelated lines of businesses as a strategy for reducing business risk without (hopefully) affecting returns. Diversification has its own benefit for the companies some of which can be strategic while others may be purely financial in nature. There are a few reasons why companies choose to diversify –
1. Synergy – When companies merge, they can best utilize their resources to reduce operating costs. Better management practices from a high end to low end can be shared in business for overall growth. Through pooled financial resources and risks, efficiencies can be enhanced.
2. Market Power – There is high chance of an increase in market share with two companies coming together but it may not result to increased profits.
3. Profit Stability – With core business being seasonal, it ensures that other business could lead to better stability in terms of corporate profits.
4. Financial Performance – It improves as the core business sustains itself on its money making ventures and utilizes that cash flow to form new ventures that cause additional profits.
5. Growth – It is a principle reason for diversification which is quick due to pooled in technology and experience.
It definitely makes more sense to diversify when the core product line has an uncertain future. Also, it indicates that the market risks get spread with diversification. History has shown success is not guaranteed with diversification. While... [continues]
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