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Diversification strategy

Diversification is designed to even out bumps in the time profile of profits and cash flows. The ideal form of diversification is to engage in activities which behave in exactly opposite ways. When sales and profits are relatively low in one area, the adverse consequences can be offset by participation in a sector where sales and profits are relatively high.

Both strategies, restaurant or hotel options, are operating in the hospitality sector and although the hotel is development beyond the present product and market, it is still within the broad confines of the ‘industry’. They are both driven by and dependent on a strong economy and will move in the same direction with fluctuations in the economy.

However, risk might be partially reduced by spreading the activities into operations in different areas of the hospitality industry such as restaurants and hotels. Poor performance in one area can potentially be offset by good performance in another area, so spreading risk is a strategy you can potentially use to reduce total risk for Nehby. However, in order to generate substantial reductions in unsystematic or specific risk, Nehby would have to move into markets outside the hospitality business.

Nehby might obtain benefits from geographical diversification with the development of the hotel, as you would be operating in a different region in Ceeland. John has identified that the restaurant business in the capital is becoming increasingly more competitive. Opening a hotel in the north of Ceeland may have a positive impact on revenues as the north is being identified as a high growth area. Total risk could be reduced as your portfolio becomes geographically spread.