Why Do Companies Diversify?

Companies ultimately diversify to improve their sales and reduce business risk. Diversification presents risks and opportunities for companies, but ultimately helps them set and achieve long-term goals and reduce the risk of failure, say authors at Investopedia. Diversification gives companies a financial cushion in the event that one market or product fails to meet anticipated success, and comes in several varieties.

Diversification ultimately entails some long-term planning with respect to allocating resources and ensuring a future market exists. It helps companies branch into new markets by selling new products, which can be a rewarding or risky move.

Diversification exists in several varieties, as does risk itself. Within the category of diversification, financial and business risk are among the most common, say authors at Investopedia. Companies, like investors, may reduce their risk of total losses by expanding into uncharted areas. They might create a new product or improve upon existing products to make themselves stand out from competitors. To do so, they often need to make an investment in new infrastructure and learning new skills.

Despite presenting new opportunities, diversification brings some risks too. It can mitigate, but not eliminate, the possibility of companies going under. Additionally, since companies chart new territories when branching into new markets, there is no guarantee that their products will sell.