Why over-diversification is not a good strategy

by Ashvini on August 18, 2011 · 4 comments

in Business

Reading the book, on Andy Grove, by Richard Tedlow,I was struck by one fact;The focus of corporation that he was heading.

I have often read on internet, recommended by experts and drummed across the TV, value of diversification. Diversification is often said that is very important to reduce risk and to make sure that you don’t put all your eggs in one basket. They say that diversification is the rule you should apply to all your investment decisions, ventures and enterprises. In the days when I was working in a 9to 5 job , I was often told that it is a good idea to know something about everything.

I really am not doubting the wisdom of this strategy. Diversification is a great way to build portfolio in your job, investment or venture. If some parts of your business/investment are not working that great, diversification makes sure that you at lease have some that are working good. The risk is spread because you have your effort or money spread across various avenues.

It is however important to note that in an effort to diversify the entrepreneur should not overdo it. Diversification as a hedging strategy is good when the portfolio is not very large. A quote often used in these circumstances is “Not to put all your eggs in one basket”. Too much services or a huge portfolio of products may not be only “not” beneficial but also sometimes counterproductive.

Here are a few reasons I think why over-diversification is risky for your venture.

A new product launch can be costly

If you are about to launch a product into a category were you were non existent, please understand that such a launch may be costly . If your category is not explored before , you will need to seek early adopters, while if there are other products in the category you will have to spend a considerable time and resources to make traction against market leaders.

A new product may overstretch your budget

Creating and marketing a new product will require new processes to be set up, new employees to be hired and new infrastructure to be set up. It is possible that new products may overstretch your budget and take money that you could have invested somewhere else into creating and sustaining new products

A new product will require more support

When a company sells a new product often it will have to hire new staff or stretch the existing staff to meet new requirements. This involves cost and efforts .

A new product might lead to distraction

It is quite possible that focus on the new product may cause distraction to existing business. It might lead to loss of customers in original business.

Intel at the start of its journey was into memory units market. When the competition arrived, it proved too costly for Intel to remain in the memory market. It jumped wholeheartedly into microprocessor development and with a singular focus became a market leader.

General Electric too decided to get off from all businesses that were not either number or number two.

No doubt that there are companies that have been successful by diversifying into other unrelated areas but most of them have succeeded by having a razor sharp focus on a few areas. If you do have capacity and competence to execute multiple business, it is good, otherwise it makes sense to focus on few areas that your business is best in.

Put all your eggs in one basket — and watch that basket!

MARK TWAIN, The Tragedy of Pudd’nhead Wilson

In your opinion, is too much diversification helpful ? As a business, how much you would diversify ? Would love to hear your opinions.

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{ 4 comments… read them below or add one }

Veronica Cervera October 14, 2011 at 11:09 pm

I agree. Diversification is mostly used only as a hedging strategy for small to medium-sized portfolios. They say having 7 great ideas is all the person ever going to need. There’s really no need to diversify that much. In most cases, one will NOT be able to produce much in their 6th or 7th idea and will be able to know as much.

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Mouh August 26, 2011 at 8:00 pm

Well, diversification is paramount in my opinion. As Adrienne said, in online business, if you rely on one source of traffic, you’re putting all the eggs in one basket. If something bad happens, you’ll lose all the traffic. It happened to those who advertised their websites on Google. When the latter made changes, some people lost millions. This is just because Google updated its terms!

This doesn’t mean I don’t agree with you. I do know that overdoing things is generally counter-productive.

Mouh
:)

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Adrienne August 22, 2011 at 10:45 pm

Hi Ashvini,

I totally 100% agree about diversification whether you are speaking about financial investments or taking on new business ventures.

Since I don’t have the “big company” behind me, I don’t have to worry about the employees status should I take on launching a new product but I can see from your point of view some of the areas people need to be concerned about. At the same time, that shouldn’t hold you back to trying new things are venturing outside your comfort zone.

I do know that from an advertising standpoint as well, “putting all your eggs in one basket” can be suicide. What if that type of advertising no longer works due to some changes Google has made. Once again, not a pretty sight.

You definitely can get us to thinking on that subject, that’s for sure. Appreciate you sharing this as always. Making us think overtime my friend.

Have a fabulous day!

Adrienne

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Ashvini Kumar Saxena August 24, 2011 at 5:40 pm

Hi Adrienne,

Thanks for visiting this blog once again.

I think you really captured the essence from both the sides. Diversification as a tool is very much desirable ( to reduce risk ) . However over diversification can be too risky as well. I often see fund advisers propagating diversification as if diversification is the solution to all the risk. Sometimes concentrating energy in a few areas help as well.
I really appreciate your comment and hope to see you back soon :)

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