Diversification on the surface appears to be an appealing business strategy, acting as a hedge against changes in specific niche industries. The problem with diversification, and the reason why it often fails, is that it involves moving outside a company's area of expertise.
Imagine a small business with a narrow niche, for example, a small family-owned pizza shop. What routes could it take to diversify? A low risk one would involve perhaps adding low-fat pizza, bread sticks or salads in addition to pizza. This doesn't move far from its core business, involves minimal capital investment, and can easily be rolled back, but doesn't offer much protection against a downturn in the pizza business.
Next, what if the pizza store ownersused their savings to by an auto repair shop, forming a sort of mini-conglomerate? Although this might work as a hedge against weakness in the pizza market (assume auto repair and pizza sales do not track similar economic indicators), the problem is that the family's expertise in the pizza business doesn't really translate into expertise in auto repair, and so it is a risky decision. A more sensible choice might be creating a small line of frozen pizzas to sell through local supermarkets or developing a modest sit-down Italian restaurant next door to their pizza delivery store.
As well as the problem of lack of expertise in the new area, another issue in diversification is that it may expose you to multiple risks.
As with diversification success, there are many reasons that could explain why diversification strategies are often unsuccessful. Market volatility and entering into a new venture within such turbulence could be one potential reason why diversification strategies that are undertaken can refuse to yield success. Another reason would be focusing on the potential upside and failing to understand difficult conditions. If "rewards for managers are usually greater when a firm is pursuing a growth strategy," focusing on these rewards as opposed to conditions that surround the diversification strategy might be where the failure lies.
Additionally, some diversification strategies such as mergers might not succeed because of lack of institutional support. Having the right personnel that can facilitate the strategy is key, ensuring that "well suited top executives are to manage that effort." Some diversification strategies simply cost too much money to initiate and sustain, taking away focus from the core success that organizations had experienced. These are reasons why diversification strategies can fail. Some of these reasons can be seen when examining why unsuccessful diversification strategies resulted.