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Should You Diversify?

Diversification is a tempting option for boosting short-term earnings, but it can compromise long-term wealth and freedom.

Should You Diversify?

In the current economic circumstances, and for the immediately foreseeable future, many entrepreneurs will be tempted to diversify out of desperation. You should do so too, if it will help you survive. But make sure you prepare for potential pitfalls later down the line, because it can compromise your financial freedom.

(We cover the relationship between diversification, business value, and ownership wealth in more detail during Ownership Wealth & Freedom).

When investing, diversification is a sound strategy for mitigating risk. Whether you're buying property, equities, or some other asset class, it is self-evidently sensible to hedge against volatility by not putting all of your hard-earned cash into a single basket.

However, in a business context, diversification is primarily a growth strategy. Sure, it can help safeguard against catastrophic external forces like averse regulation, raw material shortages, or a global endemic. But it is, first and foremost, intended to drive growth by tapping into unfulfilled market demands.

The benefits of diversification are obvious: done right, it can introduce new (and possibly more profitable) income streams that complement (or even end up dwarfing) your current core business. But there are also potential disadvantages that often go unseen in the rush for short-term gains:

#1 Brand dilution

Attempting to be all things to all people is entrepreneurial folly 101. Doing so will expose you to an unnecessarily broader pool of competitors while simultaneously making it harder to stand out. Diversification breeds uncertainty, and uncertainty kills demand.

#2 Market risk

Customers do not share identical needs, transactional criteria or buying behavior. Every time you diversify, you introduce more variables that could swing to your disadvantage. It is very easy for a downturn in one market to have a deadly domino effect by compromising the rest of your business model.

#3 Operational complexity

Diversification won't just stretch your operational resources, it will also introduce more complexity that will make management more challenging. Budgets have to be revised, organisational structures adapted, and resource allocation updated. There is also the risk of bruised egos, unhealthy competition, entrenched organisational norms, and other human foibles that can compromise the execution of your strategy.