January 24, 2011 10:57 pm

Breaking up is not a sign of failure

Demergers may seem mundane but carry less risk

Three characteristics unite modern conglomerates: they abhor the conglomerate label; they rarely acknowledge the need to change shape until they decide to do so; and they never admit that external pressure prompted their break-up.

ITT used to be one reason conglomerates were shy of the title. During the 1970s, Harold Geneen built a company with 2,000 business units, from Sheraton to Wonder Bread. He preferred to call ITT a “unified-management, multi-product company”. But in his 1984 book Managing, he wrote: “I would like to think that the public has come to appreciate that a conglomerate, per se, is not an offence in nature.”

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Andrew Hill

Fat chance. Geneen, for all his skills, added to suspicion about conglomerates. It hardly helped that his ITT was accused of bribery, complicity with the CIA (in undermining Salvador Allende, president of Chile) and lack of accountability. His successor, Rand Araskog broke ITT up in 1995, conceding later that he should have done it 10 years before, when corporate raiders first attacked the multi-product mammoth.

Now, ITT is again splitting itself three ways, to investors’ delight. Demergers are in vogue: Marathon Oil, Fortune Brands and Fiat have all spun parts of themselves off, or plan to. British “multi-industry company” Smiths Group is under pressure to sell businesses. General Electric is concentrating on its industrial operations.

But although focus is in and sprawl is out, the conglomerate still has its time and its place. In fast-growth countries, that time is now. As Tarun Khanna and Krishna Palepu point out in their 2010 book Winning in Emerging Markets , where institutional voids exist – as in, say, India – conglomerates, often family-controlled, can fill the vacuum. They move capital and people internally instead of relying on scant or non-existent external financial or human resources.

In developed markets like the US, United Technologies, Danaher – and even GE – continue to champion diversification.

Large private equity funds look like conglomerates, though an unfortunate appetite for leverage has temporarily obscured their main virtue: an ability to manage diverse operations more directly – and with fewer distractions – than listed company shareholders can.

So the question is not how soon the model will disappear – it won’t. The question is how to manage a conglomerate and, equally important, how to decide when its time is up.

On the public markets, this question lies behind fund managers’ assertions that they could assemble a portfolio of single-sector companies, each well run, instead of owning a conglomerate that trades at a discount to the sum of its parts.

Steve Loranger, chief executive of the modern ITT, faced an easier decision than his predecessors: US government budget cuts made it obvious the group’s defence equipment business was holding back the shares. But few emperors time their empire’s break-up well. Most have to feel activist shareholders’ hot breath on their necks before they yield. Even Mr Loranger had faced investor threats to shake up the board.

Still, it is human nature for leaders to want to emulate corporate titans, feted for managing vast corporate dominions. Andrew Campbell of the Ashridge Strategic Management Centre likens bosses’ resistance to communist leaders’ stubbornness as the Soviet bloc disintegrated.

Ed Breen, who led Tyco into a three-way break-up in 2007 and still runs the industrial arm, told me: “You’ve got to take your ego out of the conversation and ask: what’s best for the business?” Instead, some leaders can turn from masters of management to masters of self-justification, publicly hailing the benefits of breadth and scale right until the moment they convert to the cult of focus and specialisation.

It makes more sense to keep the structure under constant scrutiny. Compared with the glory of a big merger, selling once-core operations or splitting the business up seems humdrum. But such deals are no admission of failure. Research shows demergers cost less, carry fewer risks, and eventually create greater value than disruptive takeovers. Conglomerate management is just ordinary company management, writ huge. Expansion, by judicious acquisition or organic growth, is a fine goal. But only executives who show over time they are adding to owners’ wealth, not getting in the way, deserve market laurels. If that means more disposals and demergers and fewer self-destructive bids and self-aggrandising autobiographies, I’ll be the first to applaud.

andrew.hill@ft.com

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