This study attempts to analyse how smallholder farmers allocate their limited available resources optimally in order to maximize their farms' total net returns and to investigate the factors which determine their agricultural diversification process. The survey covered 150 farmers. Field data was complimented with secondary data collected from key organisations. A pre-tested questionnaire was used to interview smallholder farmers. A logistic regression model was used to determine factors that influence agricultural diversification process. The results show that, the socio-economic factors determine the agricultural diversification, where about seventy one percent of the variability was explained by the included variables. The off- farm income variable has shown high significant level toward diversification. A gross margin analysis was used to examine and compare competitiveness of a set of selected crops having the potentials for diversification. The analyses show that banana has high returns relatively to rest crops. This situation is probable influenced by growth of general demand of agricultural commodities. Therefore, the crops grown by farmers are purely competitive. Furthermore, a linear programming model was used to investigate how farmers allocate their resources in order to maximize farm's total net returns. The results indicate that smallholder farmers' optimal allocation of resources is attained only on banana which maximize net returns to farmers. The maximum net returns per acre are banana 319 953 Tshs, cassava 49 972.00 Tshs, paddy 37 076.00 Tshs, beans 5 368.00 Tshs and sweet potatoes 64 806.00 Tshs. As a result, diversification has been the farmers' major strategy to deal with risks and uncertainties related to weather and marketing system. Therefore, the general conclusion from this study is that, diversification is an inevitable strategic action for smallholder farmers in order to reduce those risks associated to the mono-cropping system, whilst increasing food security and ultimately improving people’s standard of living.