Diversification

economic-dictionary

Diversification consists of making heterogeneous what was previously homogeneous, so that what was previously uniform now has different variations.

This word comes from Latin and has a root that is "divērsus" and a suffix, "ficar." It could be considered that its meaning is to make something different that was not before.

This concept is widely used in different areas, including economic, business and financial. We will see it in more detail below.

Types of diversification

Diversification, as we have mentioned before, can refer to several areas of study. We will focus on those related to the economy.

  • Diversification in macroeconomics. It refers to the economic policies followed by different countries to produce a greater variety of goods or services. The objectives may be to reduce dependence on abroad or increase exports. However, there is a risk of losing the competitive advantage of specialization.
  • Business diversification. It consists of increasing the variety of products or services offered in order to reduce risks or increase profits. This can be done horizontally (within the company) or vertically (acquiring those from suppliers or customers). It can also be related (similar products) or unrelated (different products).
  • Portfolio diversification. This is related to investments in fixed or variable income financial assets. The main objective is to reduce the so-called specific risk, since the systematic risk cannot be reduced in this way.

Examples of diversification

There are several examples that can be considered as ways to diversify. We will focus on the business and financial aspect.

  • Uber, the passenger transport company, diversified its business by offering moving or food delivery services. It would be a horizontal and related strategy.
  • McDonald’s created its own home delivery system when this service began to be sued. It would be a related and vertical forward strategy, as it is a post-meal phase.
  • Mercadona (in Spain) has its own exclusive suppliers. They make you a wide range of different products. We would be facing a vertical diversification strategy and not related or conglomerate.
  • Large investment funds in fixed and variable income diversify. Whether they are fixed income, equities or mixed, they have a considerable number of different values. In this way, if a debtor defaults or a company goes bankrupt, only a small part of the capital is lost.
  • A private investor who analyzes the profitability and risk ratio of different companies to create a portfolio of stocks. You decide to have a 70% proportion of stocks with little risk and low profitability and 30% in others with greater volatility but more capacity to generate profits. This is another case of diversification.

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