In financial markets, the idea of diversity is more prevalent. However, it helps to lower risk and boost your profit line even in conventional business. Don’t put all of your eggs in one basket is the simplest way to define this phrase.
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What, in plain English, is diversification?
The word «diversus» is derived from the Latin words «facere,» which means «to do.» It involves creating new forms of production, breaking into new markets, and reorienting them toward a larger consumer base. These actions are taken to lessen the financial risk in order to gain further advantages.
To lessen the possibility of insolvency and deposit loss, capital is allocated to comparable activities and assets. The selection of prospective locations, however, has the biggest impact. A crisis can quickly seize the entire complement of available instruments when a businessperson or trader constructs a portfolio without considering liquidity or other financial criteria. And the outcome could be unfavorable.
The rationale behind the diversification approach
Diversifying manufacturing and offering makes sense for business development. At the same time, several objectives are pursued. To maximize coverage of the market, the first step is to establish subsidiaries and a network of branches. The second is the development of a sizable network of suppliers and customers who can make up for one another in the event that collaboration is temporarily or permanently terminated.
Measures to diversify an organization’s economy can avoid many negative aspects:
- When the demand for one type of product / service drops, they are quickly replaced by others that are in greater demand.
- Leveraged trading requires a constant flow of funds, so it is appropriate to spread costs / income over multiple profitable projects.
- The possibility of full production self-sufficiency in raw materials, goods, warehouses, means of transport.
- The presence of reserve areas for investing current profits, so that in the absence of growth in key projects, the owner can ensure the company’s development through other programs.
- When it comes to the stock market and other financial assets, diversification plays a role in spreading your investment across different instruments. In addition to many stocks of commercial companies, government bonds are bought, private mutual funds are sponsored, real estate, foreign exchange, precious metals and other valuables are purchased.
A high degree of diversification is achieved through a variety of ways. This provides a flexible structure on the interior or outside for the business or individual shop. Here, everything hinges on the task at hand, the need for steady internal development, horizontal market growth, and the application of a variety of methodologies.
The investment efficiency is increased through the following activities:
- Establish long-term planning and a sustainable management system. If you correctly calculate the necessary business processes, it will be easier to do without external funds, shortages of liquidity and the presence of liabilities / receivables.
- Launching a completely new product line that does not match the current list, which increases the degree of market presence and eliminates the likelihood of a sharp drop in sales due to the loss of interest in one of the types of products.
- Selection of the investment portfolio in such a way that the depreciation of one of the assets is accompanied by an increase in the liquidity of the others.
- Synchronized launch of diversified production to ensure presence in different market sectors.
In production, geographical diversification is often used: the opening of representative offices, branches and subsidiaries. When it comes to the forex market or the stock exchange, the buying rate for the asset with the highest growth prospects in the near future is selected. As macroeconomic rates change across states and new regulatory standards emerge, the investment portfolio is reviewed to exclude risky assets.
Strategies for diversification
Diversification techniques do exist, although they are rarely applied in their «pure» form. Usually, a comprehensive strategy is created that enables you to react quickly to developments in the financial markets, commodities, manufacturing, import, and asset retirement.
These are the most typical forms of diversification strategies:
- Concentric. Opportunities for the emergence of new forms of goods and services are found in already-existing activities.
- Horizontal. Current production, the product line, and the launch of new ventures are all being developed.
- Conglomerate. establishing subsidiaries for a range of operations (compared to the main company). This occasionally leads to diversified businesses with a single founder.
Additionally, there are alternatives for combinational, horizontal, and vertical diversification. Such a classification is quite arbitrary because each business or trader is different from the others and it is pointless to apply general rules to any of them. Making your own development plan and following it while putting it into action will be more profitable.