What is a 'Diversified Company'

A diversified company is a company that has multiple, unrelated businesses. Unrelated businesses are those who (1) require unique management expertise, (2) have different end customers and (3) produce different products or provide different services. One of the benefits of being a diversified company is that it buffers a company from dramatic fluctuations in any one industry sector. However, this model is also less likely to enable stockholders to realize significant gains or losses because it is not singularly focused on one business.

BREAKING DOWN 'Diversified Company'

Companies may become diversified by entering into new businesses on its own, by merging with another company or by acquiring a company operating in another field or service sector. One of the challenges facing diversified companies is the need to maintain a strong strategic focus to produce solid financial returns for shareholders instead of diluting corporate value through ill-conceived acquisitions or expansions.

Example of a Diversified Company

Some of the most well-known American diversified companies are GE, 3M, Sara Lee and Motorola. European diversified companies include Siemens and Bayer; diversified Asian companies include Hitachi, Toshiba, and Sanyo Electric.

The general idea behind "diversifying" is the spread or smoothly of financial, operational, or geographic risk concentrations. Financial markets generally focus on two sources of risk: unique or firm-specific risk and the other, systemic or market risk. According to capital market theory, only market risk is rewarded, because a rational investor always has the opportunity to diversify, hence eliminating unique or idiosyncratic risk

Knowing investors vary capital costs based on risk-return profiles, businesses often use a strategy to diversify themselves from within. Critics can point to entities growing for the sake of growth under the guise of diversification. Bigger businesses generally pay executives more, enjoy more press, and can fall prey to entrenchment and status quo. Whereas one observer might see diversification; another may see bloat.

The best management teams can balance the alluring desires of business diversification with the practical pitfalls of growth and the challenges it brings with it.

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