Is it always prudent to diversify your business?

The financial services industry has spent a lot of time and money encouraging investors to seek diversification in their portfolios. And there is certainly a lot of merit to the concept. Assuming that you can build a portfolio of non-correlating assets, allocate them in the right proportions, and hedge a bit along the way, you can mitigate risk, reduce volatility, and make money over time. Of course, that's easier said than done. Does the same idea hold true for your business? Should you follow the same model that promises to work for your other investments? The answer is: maybe.

Add new businesses that will support your existing model

How hard is it to run a business? Choose from the following three selections: 1) it's hard; 2) it's hard; or 3) it's hard. Great! You picked the right answer. Now if you think that running one business is hard, try running two or three. If you feel that you need to diversify, make sure that when you add another business to the mix that it helps your existing business. It's always amazing to watch CEOs, who are struggling to meet their goals, start hunting for an unrelated acquisition or send their business development team off on a quest to diversify into "a new area." What are they thinking? Do they really believe that they are going to do a better job if they have additional, unrelated businesses to run?

Don't attempt to remedy weaknesses merely through diversification

The quest for diversification is often used as a cover for weakness in a business. The fact is that diversification alone will not make a weak business stronger. If you start with weakness, and divert your attention to something else, you will create even more weakness. Unless you have the capability to ditch your current business in favor of another one, the parallel between investing in businesses and running businesses breaks down. And for some reason, many CEOs do not see this when they are in the thick of the diversification game.

Start with strength, and diversify to reinforce it

If your company is out in front of your competitors, and you have a team in place to carry it forward, then taking steps to diversify can pay dividends. There is no doubt that you will be increasing risk by taking your eye off the ball for a moment. That's always the case. However, if you look for new businesses that reinforce your existing strengths, and you are careful to protect your existing operations, the diversification step can make perfect sense. In concept, you can employ some of the same techniques that investment managers do when they diversify their portfolios. It's just a lot more complicated when you are responsible for the bottom line.