What Is International Diversification?
International diversification is the process of a company or investor beginning to do business with or invest in other countries or regions. One reason for international diversification is risk management, because this enables the investor or business to make the best of each area’s financial swings. While both an investor and a business can make money from this approach, they do it in different ways. This diversification can be beneficial when the domestic currency is weakening, but it loses its advantage when the domestic currency strengthens.
Many investors and businesses start off domestically, investing money or doing business in the area where they live. There are many advantages to this, such as not having to worry about how foreign entities are regarded by nationals, and it can be easier to watch over the business or investment. At the same time, investing or doing business only in the domestic area can lead to risks, because there is nowhere to turn if the domestic financial situation goes downward.
This leads many people to use international diversification as a risk management technique. For example, someone who only invests in domestic companies that make electronics may find that things get hard if electronics stop selling well in the domestic area. With international diversification, an investor can allocate funds to international areas that are experiencing better electronics sales and still profit from his investments.
Investors and businesses both use international diversification, but the way they use it is different. An investor seeks out companies that are doing well in a particular area or are experiencing increased currency strength. After finding proper areas in which to invest, the investor will buy stocks from the international companies. Businesses will extend themselves to other areas either by building international offices or by exporting. Building offices often takes more time and work but may help make a better profit, while exporting tends to be more versatile and easier to start.
One weakness of international diversification is the strengthening of domestic currency. When the domestic currency is weak, international currencies can be traded for much more domestic money, which will help the investor or business. As the domestic currency strengthens, the international currencies can be traded for less, which means the investor or business may no longer make a profit strong enough in international markets to justify the extra work needed for diversification.
@ddljohn-- Yes, but I don't think that a business determines where it's going to do business only by looking at the currency rates. That country also needs to have potential, meaning that there have to be potential buyers of that good in that country.
Can't the issue of changing value of domestic currency be avoided? I mean there are countries where the national currency is never going to be more valuable than the American dollar. Or at least it won't happen any time soon.
Obviously, it's a risk to do business in countries with a stronger currency like the European Union or Japan. But this is not an issue in many other countries with currencies that have much less value in comparison to the US dollar.
I think one another advantage of international diversification is that resources and labor are often cheaper in other countries. So profits are greater.
This is why many businesses are diversifying and establishing business in other countries. Some businesses have even shifted all of their manufacturing facilities to other countries to take advantages of cheaper resources and labor.
The only issue that we need to think about as consumers is that this might result in illegal and unethical labor practices like child labor.
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