What Is a Diversified Company?
A diversified company is a type of company that has multiple, unrelated businesses or products. Unrelated businesses are those which:
- Require unique management expertise.
- Have different end customers.
- Produce different products or provide different services.
One of the benefits of being a diversified company is that it buffers a business 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.
How a Diversified Company Works
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.
One common form of a diversified company is the conglomerate. Conglomerates are large companies that are made up of independent entities that operate in multiple industries. Many conglomerates are multinationals and multi-industry corporations. Every one of a conglomerate's subsidiary businesses runs independently of the other business divisions, but the subsidiaries' management report to the senior management of the parent company. Taking part in many different businesses help a conglomerate's parent company cut back the risks from being in a single market. Doing so also helps the parent lower costs and use fewer resources. But there are times when a company grows too big that it loses efficiency. In order to deal with this, the conglomerate may divest.
- A diversified company owns and/or operates in several unrelated business segments.
- 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.
- Conglomerates are one common form of diversified company.
- Diversified companies come with their own specific benefits and limitations.
Diversified Companies in Practice
Some of the historically best-known diversified companies are General Electric, 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.
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.
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.