Reviving the Conglomerate– Corporate Diversification– Growth: Evolving Into a New Breed of ‘Quasi’ Conglomerate…

Warren Buffett’s ‘Berkshire Hathaway’ is an example of a successful conglomerate that used capital from its insurance subsidiaries to invest in other unrelated businesses…

Revival of the business conglomerate– A business or corporate conglomerate is a large, often multinational, corporation that owns companies in several different industry sectors. Conglomerates gained popularity in the 1960s as companies that generally engaged in one line of business, then began diversifying the business models through leveraged buyouts, mergers, acquisitions…

The concept of conglomerate or multi-industry corporation is not new and the business model has become common worldwide. At best, the conglomerate is excellent way to maximize profits (and growth) while building protection against economic and other shifts that could weaken a given market or industry. However, the conglomerate experienced turbulent times over last quarter of 20th century and it’s been substantially replaced by newer ideas, for example: Focus on a company’s core competency…

During this era ‘Tom Peters and Robert Waterman’ encapsulated this thinking in book ‘In Search of Excellence’ that encouraged  companies to ‘stick to their knitting’; do what they are good at rather than try to create and manage diverse businesses.

According to Paul Simmonds; undoubtedly conglomerates were a product of the prevailing times when management teams became convinced that they could manage ‘any’ business regardless of its– products, services… and the lack of experience in those sectors. Newly empowered– skilled, successful, confident– management teams were looking to make acquisitions and add-value to their companies; also, there were many companies that were willing targets.

According to Michael Jensen; diversification is way for managers to build empires rather than way to create value… The case against conglomerates is summed up in two words: size and complexity. Size slow decision-making. Complexity creates confusion. These two factors make it hard for even good managers to cope with the challenges of specialized markets and rapid change. In contrast, breaking companies into constituent parts allows managers to focus on business they know something about.

To say that a well-run conglomerate can sometimes succeed is hardly proof that conglomeration is a sound principle. Look behind many apparently diversified successes and they include either or both of the following: First, some degree of focus; e.g., manufacturing, customers-served, technology… Second, rare business minds; e.g., Jack Welch, Richard Branson, Warren Buffett…

In the article Conglomerate Makes a Come-Back by Prof. Shlomo Maital writes: A column in the Financial Times asked: Is the time right for the return of the conglomerate? In the 1960′s, and later in the 1990′s, it became fashionable for large companies to diversify their businesses by acquiring companies in a wide range of different industries. The idea was based on financial diversification, spreading risk. If retailing did poorly, well, perhaps media and entertainment would offset it.

The core of idea came from a Harvard Business School proposition that– management is management– if you could manage an oil business; you could also manage a movie studio, because the basic fundamental principles were the same. This hubris (excessive pride) proved inaccurate. Management is not management universally and there is a core competency of understanding deeply the industry in which one operates, based on long experience.

Many conglomerates failed for this reason. Exxon, for instance, expanded into non-oil industries like– high-tech and failed…  But, is it time to revive the conglomerate business model? And if so, what is the rationale? The reason is simple. A key constraint limiting growth and expansion today is credit and finance. Banks are reluctant to lend, and even when the recovery picks-up, banks will likely be far more stringent with their loans than in past.

The conglomerate, because of their size, clout, and ability to generate cash, will be able to surmount this constraint and supply credit to their constituent businesses. This may prove a key strategic asset. Consultant ‘Ian Harnett’ noted; companies that generate free cash flow for their group can provide risk capital for more widespread investment, when banks’ risk appetite disappears. Look for the conglomerate to return. If it does, it will be a wise reaction to the paradigm shift in finance and financial services that suddenly make companies become their own financiers.

In the article Case for Conglomerate by Randy Myers writes: Corporate landscape is littered with failed mergers and acquisitions, it’s getting hard to argue the advantages of operating in diverse lines of business. Even if you pull it off, numerous academic studies conducted over the past decade suggest you’ll pay a penalty in the stock market; so-called diversification discount relative to more highly focused companies.

No wonder countless firms have sought to ‘unlock’ the value of important subsidiaries by spinning them off as separately traded entities, leaving both parent and child to operate with a more narrow focus. Yet diversification continues to exert an alluring appeal. Why? Done well, it can help to smooth financial results for companies in cyclical industries. More broadly, it can allow firms in mature markets to grow revenues far more rapidly than they could by hewing to their existing lines of business.

According to Larry Shulman; companies that quickly shy away from diversification opportunities may be short-changing themselves and their investors–especially if they are led by executives who are proficient in strategic thinking and capital allocation, and emphasize performance and accountability... Although conglomerates may seem to operate in businesses that have no common thread, Shulman says; the successful ones typically focus on no more than two strategic types of businesses.

By doing so, managers are able to clarify the management process, and improve their odds of success. However, most diversified companies get that way through acquisitions. Few have the patience, breadth of management, manufacturing skills to allow them to branch out into businesses where they have no track record. Yet given enough time, companies can diversify organically…

In the article Who Owns What? Today’s Major Conglomerates and Subsidiaries by Amy Swanson writes: If you wait long enough, history will repeat itself in broad brushes and themes, and even through specific crazes. Lately I’ve been noticing one business fashion, conglomeration, which seems to be returning in a new form: The e-conglomerate.

An e-conglomerate is a high-tech company whose lines of business move increasingly further afield of each other. For example; Microsoft makes money with desktop operating system, servers, and office productivity software — and loses it in their online and entertainment/ gaming divisions. Amazon makes 97.4% of its net sales from media, electronics, and other general merchandise. And yet, the company is investigating other arenas, such as; online payment service provider for other companies, selling Kindle e-book reader, outsourcing software development, cloud-computing.

Then, Google with search engines, advertising, mobile phone design, advertising, user productivity software, enterprise software, clean energy technologies… The company does say that it devotes 70% of its resources to search and advertising, 20% to related businesses that include the apps, and ten percent to areas that are farther afield but have huge potential, such as Android…

Traditionally, high-tech companies are not shy about diversification. HP has enterprise storage, services, software, personal systems, imaging and printing, financial services… IBM might have been the prototypical e-conglomerate, before Lou Gerstner started to change the focus to services and the company began to shed many of its non-core activities… E-conglomeration is possible because the technology needs of so many business areas are similar, lowering the cost of adding a new one.

However, the markets, customers, needs, and practices can completely differ. Just as the dot-coms failed to redefine the basic rules of business, e-conglomerates are not necessarily good for business and shareholders. Money isn’t the issue so much as distraction. Softening management focus, politics, bureaucracy, and an unproven assumption of competency in new areas causes poor forecasting and planning.

I think Microsoft has demonstrated these signs for some time, and Google and Amazon are beginning to as well. Because these companies are so respected, there’s a good chance that others, emulating them, could also start to diversify beyond their ability to control the results. At such times, there’s nothing like a little dose of historic reality to remind us all that the most important rule of success is keeping your nose to that same grindstone.

The case for conglomerates can be summed up in one word: Diversification. According to financial theory, since business cycles affects industries in different ways, diversification can result in a reduction of investment risk. A downturn suffered by one subsidiary, for instance, can be counterbalanced by stability, or even expansion, in another venture.

The case against conglomerates according to Peter Lynch uses the phrase ‘diworsification‘ to describe companies that diversify into areas beyond their core competencies. No matter how good the management team, its energies and resources will be split over numerous businesses, which may or may not be synergistic. However, diversification strategies are essential to expand firms’ operations by adding markets, products, services, or stages of production to the existing business.

According to Joe G. Thomas; ‘diversification’ is a growth strategy. Many organizations pursue one or more types of growth strategies, and a primary reason is the view that ‘bigger is better’. One of the most common reasons for pursuing a conglomerate growth strategy is that opportunities in a firm’s current line of business are limited; requiring consideration of  alternatives in other types of businesses.

For example, Philip Morris’s acquisition of Miller Brewing was a conglomerate move: Products, markets, and production technologies of the brewery were quite different from those required to produce cigarettes; however, both products serve the consumer…

Firms may also pursue a conglomerate diversification strategy as a means of increasing the firm’s growth rate. A study by ‘Marlin, Lamont, and Geiger’; found that a diversification strategy must be well-matched to the strengths of its top management team; to be successful. For example, success of a merger may depend not only on how integrated the joining firms become, but also on how well top executives are suited to manage it.

Diversification can put the business on fast track to growth, but if the strategy fails– it can also be the down fall of the business. It’s vital to thoroughly research new strategies before diversifying. Look carefully at your existing business. Do you have the right managers to cope with a divaricating strategy?

Should you integrate the diversified business into one company or fence the new operation as a business in its own right? Is your organization strong enough to be an umbrella brand, where your core values resonate across the group?

Think hard– understand risks and rewards– good governance and management is about ensuring a brighter future…. diversification, in all forms, must be an ongoing consideration…