I don’t consider myself a worrier. I consider myself a realist.
That statement should be placed within the context of what I consider to be one of the most important considerations in business — diversification.
Without diversification, you are always just one step away from ruin. With diversification, you can be several steps away — with each step being less likely to occur than the previous.
With that in mind, in this article I want to focus upon what I consider to be the two distinct methods (or scales) of diversification, and the reasons as to why you should follow both.
Micro Level Diversification
One of the biggest arguments I hear against diversification is that it is tough to achieve. In fairness, it’s not a terrible argument. After all — establishing one stream of income is difficult enough — doubling (or tripling) up on that can be a real challenge.
I’m going to get onto how that challenge isn’t as great as you may feel a little later on, but first of all, let’s discuss the kind of diversification that doesn’t require multiple streams of income — at least, not on a macro level.
In any business, there is the potential for what I call “micro level diversification”. This is the division of income streams within a single business model.
My freelance writing business is an example of micro level diversification. I don’t have one big client who could ruin me in one fell swoop — as much as possible, I divide my income across various clients. If I lose one or two clients, it wouldn’t be the end of the world. My income stream, as a whole, is relatively secure.
Let’s consider another example. When my father was first getting into property, he had one very simple rule, which was that one tenant could not exceed 10% of his total rental income. That was another form of micro level diversification — he never put himself in a position where one tenant could ruin him.
Not only did this mean that his income stream was relatively secure, it also meant that none of his tenants were (or are) ever able to hold him to ransom. He always had the financial upper hand by ensuring that his portfolio was properly diversified.
This kind of diversification is possible with just about any business. If you run an eCommerce store like Steve and his wife, diversification could take shape in the form of multiple products, and/or multiple product ranges. Micro level diversification is something that every business owner should seek to achieve.
Macro Level Diversification
This is the type of diversification that many business owners consider extremely difficult. Let’s face it — most of us have worked tooth and nail to establish our businesses. The idea of setting up an entirely new venture is pretty intimidating.
But let’s for a moment focus on why it is such a good idea. First of all, micro level diversification, whilst always a good idea, is still open to risk. That risk is generally in the form of market forces.
Here’s an example. Going back to my freelancing business, if demand for freelance writers of my ilk drops drastically, the diversity of my clients is unlikely to have much of an impact upon my reduced perceived value. Or for my father’s business, if rents drop across the board, the value of my father’s property portfolio will drop, regardless of how many tenants he has.
The idea of macro level diversity is that you open up a new stream of income that is completely separate to your existing business. If you have two viable businesses in two different markets both operating profitably, your exposure to risk decreases dramatically.
With that said, let’s return to the argument that establishing a second stream of income is difficult. Well, it is — but I can almost guarantee that it’ll be a damn sight easier than it was to establish the first.
Not only are you far more experienced, you may have capital to invest. An alternative stream of income could be as simple as investing in dividend-yielding stocks, or property. Or, you could use your existing knowledge and apply it to a different market.
This is what I am trying to do with my business. The bulk of my existing income comes from my freelance writing work, but I am building up a modest income from my blog, and am also working on two other projects (an information product and an authority site). All things being well, in a year’s time, I could have four or more distinct streams of income.
Diversification is Necessary
You could go through life riding on the back of one business model and never experience severe financial pressure. I’m sure it has happened. But I would rather prepare for the worst and try to get ahead whilst the going is good.
That is why I will always preach the valuation of diversification — both on a micro and macro level. With that in mind, tell us — do you think that your business is suitably diversified? If not, do you have plans to change that? Let us know in the comments section!
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