Conglomerates have been an enigma for the better part of their half a century of existence. It is challenging to build a successful conglomerate and exceptionally difficult to run one. In recent times of financial crisis, conglomerates world over once again find themselves under intense scrutiny. Popular opinion tends to simplify the issue around conglomerates by attributing a ‘conglomerate discount’ and prophesying their universal dismantling. We have studied models of conglomerate evolution over the last 50 years across the world to understand their strategic rationale and believe that the answer is more nuanced and difficult to generalise. In this series of three articles we explore the strategic rationale for conglomerates and how they can think about becoming ‘premium’ conglomerates — especially in the Indian context. The first article considers the rationale behind conglomerates. Specifically, we will explore three themes. First, describe the different trajectories followed by conglomerates across different geographies. Second, explore the traditional sources of competitive advantages for conglomerates. Third, discuss how new market forces have shaped the structure of conglomerates world over.
Firstly, the logic for creation and evolution of conglomerates is different for different geographies. The evolution of conglomerates in the Americas and Europe are a result of the macro-strategic context under which conglomerates were born. During the time when conglomerates were coming into existence in these markets, value creation was observed to be highly imputable to (i) growth and (ii) relative market share position (as espoused in the BCG Growth-Share matrix). Conglomerate structures helped strengthen both these attributes for a corporate. As product markets were not geographically integrated, it was relatively easier for companies to grow by adding new products and services (product diversification) within their home markets rather than enter new geographies (geographical diversification). On the market share dimension, by diversifying across the value chain (i.e. being present across buyer and supplier industries) as well as related industries, companies were able to drive greater market share through preferential buyer-seller relationships and scope economies.
American conglomerates were led in the mid to late 90s by iconic leaders, many with preferences for multi-business models. European conglomerates historically had a dominant family ownership with different family members driving different businesses with cross-holdings of stakes. In Asia, conglomerates thrived due to benefits of consolidated cooperation structures e.g. creation of complex constructs such as the Keiretsus in Japan and Chaebols in Korea. In India, the emergence of conglomerates can be traced to leading business houses taking strategic asset positions through acquisition of licenses or scarce physical assets (e.g. mines, land etc). Subsequently businesses have emerged around these strategic assets leading to creation of conglomerates.
Secondly, conglomerates have enjoyed some unique sources of competitive advantage, mainly based on addressing key market failures. In order to pursue their growth strategies, conglomerates needed access to resources — most importantly talent and capital. During their initial years, conglomerates observed that highly skilled talent was not available ‘off the shelf’ to fuel their diverse growth aspirations. These conglomerates started addressing this talent market failure by creating internal talent markets. High quality training and development resources were deployed to create a cadre of management that could be leveraged across disparate businesses — most notable example being the creation of Crotonville for General Electric. Similarly on the capital market side, conglomerates with large balance sheets started accessing debt at lower cost and possibly in higher quantity — ‘debt coinsurance’ feature of conglomerates.
Thirdly, as product markets globalised, trade boundaries blurred, talent and capital markets became more efficient, the bar on efficiency and governance within the conglomerates started increasing, often resulting in the dismantling of conglomerates. In America, some conglomerates were forced to deconstruct due to increased investor activism arising out of capital structure, strategic and governance issues. In Europe there was a clearer trend towards deconstruction due to emergence of the EU (resulting in reduction of geographical trade boundaries) and a new generation of owner families adopting a ‘portfolio investor’ mindset as they withdrew from operational involvement. Some of these conglomerates found individual divisions to be sub-scale or straddled with inferior technology. This forced them to sharply prioritise and prune low priority businesses. Europe therefore still has some conglomerates surviving but they are in highly adjacent businesses and less diversified than surviving American conglomerates.
Asian conglomerates have reacted to increased shareholder activism, policy environment changes and need to attract high quality talent at senior leadership positions through decentralisation (using highly advanced divisional or deemed company structures).
Going forward, Indian conglomerates will be under increasing scrutiny for value creation and governance. Depending on which peer path they traverse (American, European, Asian), they will need to proactively and very sharply redefine the strategic rationale for their portfolio and their governance models. Our next article examines if they will be able to rise to this challenge.
Ashish Iyer is partner and Asia-Pacific leader, strategy practice, BCG and Yashraj Erande is principal, BCG. Views are personal