Section IIntroduction: Diversification is simply defined as the portfolio strategy that is aimed at reducing the risk exposures through combining various investment varieties. For example, dealing with stocks, bonds and real estate are all processes that move towards achieving a similar goal, but with different mechanisms of business. With this form of diversification, there are low chances of volatility since not all the assets classes of the industries or even the individual companies can move up and down in their total value at the same period of time or rather at a similar time-frame.
It therefore acts to positively minimize on both the upsides and the downsides of investment value thus, allowing for only the more consistent performance in the wide range of economic performances. The upsides of investment value may include the profits, and since the strategies used to achieve a predetermined goal are several, all of the companies have to ensure equitable share of this profit. The same case applies to the downsides which may include the losses. Diversification is mainly a type of strategic form that the managers are using in order to improve the performance of their respective firms.
The facts of studying and using this strategy are motivated by the two seemingly incredible circumstances; the first one is that diversification is continuing to be a very important strategy for the corporate growth purposes. The second fact is that while the Management and Marketing systems always favor the related diversification samples, the Finance sector, on the other hand, makes a strong case against the use of corporate diversification. In order to come up with the better understanding of diversification, it is advisable to address the contradiction that exists on the associative relationship between the use of diversification and the general firm performance.
“Diversification is a means through which the firm expands from its core businesses into other different product markets. ” 1The research done on diversification showed that by 1974, only 14% of the studied Fortune 500 firms engaged their businesses on single portfolios strategies. The remaining 86 % of the firms preferred to diversify their operations. “Many firms according to the research done are diversifying their businesses.
The European corporate managers are also in favor of the diversification strategy. In the recent past, many US firms are beginning to be moderate on their zeal for the diversification and are also consolidating around their respective core businesses. However, it is should be noted that this trend does not have much impact on the Asian corporations that continue to remain highly diversified. ” 2 From any economic activity, there are various costs and benefits associated to the diversification portfolios, for instance, the performance of the firm must entirely depend on how the managers will achieve the balance on the costs and benefits in each concrete case.
The economic perspective also states that the benefits of diversification do not only fall on the managers and investors entirely, but also on the general population, not forgetting the nation since it helps in promoting the national GDP. On its advantageous side, the diversification processes do prolong the firm’s life span. On the other hand, the finance researchers argue that diversification portfolios only benefit the managers, since it buys them the insurance, while the shareholders usually bear all the costs imposed by such insurance.
Carried out research finally indicated that those firms that used the diversification portfolio were perceived to portray longer life spans than those companies that operated on the single portfolios. The reason for this is that when losses occur, they are subdivided among the affiliate companies and the profits shared too. On the other hand, if the company operates on single portfolios, they suffer the entire losses alone, which may lead to bankruptcy and hence closure of the firms.