Question

How does the example below, show that there could be a problem with risk reduction through goal of diversification in businesses?(within a firm)

ex.1 First Reason, Firm stockholders can diversify their portfolios at much lower cost than a corporation, and they don't have to worry about integrating the acquisition into their portfolio.

Answer 1

In referring to the given Example, Diversification in Business is the risk management technique that mixes a wide variety of investment within a portfolio, Wherein the entry of a company into new lines of activity through a process of internal development or through an acquisition. The Diversification is the collection of businesses under one corporate umbrella.

Single Business strategy may have number of advantages but also a number of risks that may creates weak profitability.The Diversication Start to make sense only when its considered to be Top Priority and consideration of Not good time to diversify.

• Its not good time to diversify the portfolio during the strong competitive position and rapid market growth.
• Its not good time to diversify the portfolio during the weak competitive positon and rapid market growth.
• Diversification of portfolio can be considered to be top priority during the strong competitive position and slow market growth
• Divesrsification of portfolio can be considered to be top priority during the weak competitive position and slow market growth.

There might be the cases that has to be taken into consideration that; The major strategic issues may happen in diversification inorder to mitigate the risk through the goal of diversification of Business that may affects the stockholder value of the respective firm. While integrating the acquisition into their portfolio;

• The growth satisfies the managers of the firm not stockholders.
• The growth strategies may tend to destroy the stockholders value.
• It may reduce the variance of profitflows, Where the firms stockholders can be only the holder of the securities.
• The Synergies that exist between the core Business and the new Business can be affected.
• The main drawback is due to differences in organizational cultures.
• The Internal Development of the new Businesses may affected due to problems in requirment of considerable time and investment at the beginning phase of the firm.
• The Internal Development of the new Business may affected when there is difficulty in assessing the risk associated with new investment oppertunity.

Diversification that offers the companies like cost reduction, asset depreciation and risk reduction provide advantages like synergies or the expansion , creation and improvement of long-term strategic assets, wherein resource diversification contributes to regional development and long-term sustainability. Since the diversification is a form of growth marketing strategy for an organization and seeks to increase the profitabillity through greater sales volume obtained from new products and new markets, may need for an evaluation of factors that influence diversification strategies such as;

• Availability of workforce resources of the firm
• Government regulatory policies of the firm
• Dynamic capabilities of the firm
• Financial Health that outlays the significant size of the firm.
• Considering the Three types of diversification strategies like - Concentric, Horizontal and Conglomerate.

As the Corporate diversification is the leading example of the agency relationship between the stockholders/shareholders and managers, diversified firms may subject to larger asymmetric problems than the focused firms, where the sources of which are more transparent. Therefore, the information asymmetry between the firm shareholders and firm management can decrease transparancy while detecting value-relevant information; Hence-forth thereby difficulty in determination of the present or future value of the firm and difficulty in making diversification decisions as they invoves many domains. The appropriate measures can be implemented only by analyzing the factors that influencing the diversification strategies.

If you liked the answer please give an Up-Vote, Thank you!