The conglomerate model has returned to the spotlight as economic conditions decline. Hakan Samuelsson, chief executive of German industrial group MAN, has said that its diverse holdings, which are subject to differing business cycles, put it in a better position to weather recession. Ekkehard Schulz, head of steel and industry conglomerate ThyssenKrupp, has also pointed to the model as a way to offset market risk. This issue therefore raises a question for more streamlined businesses. If managers spot an opportunity to buy a non-core company at a steep discount, should they act on it? Do the advantages of breadth outweigh investors’ disdain for unfocused groups?
Ben W Heineman Jr
Properly conceived and run, the conglomerate model is more than countercyclical. It can provide market intelligence on a developing nation or difficult market from different perspectives. It can move managers across businesses, giving them diverse experiences that broaden their skills and make them more flexible. A cash flow business can help support a capital intensive business without incurring as much debt for the group as a whole. If it can present one face to the customer, a conglomerate can effectively cross-sell and augment orders and sales. These are important, enduring performance benefits flowing from the conglomerate model that might overcome current market disfavour. But to attain them managers must be skilled at cross-business motivation and integration. A single bolt-on for the purpose of providing countercyclical revenue – as opposed to a thoughtful conglomerate strategy – would not seem the way to go. Multi-business companies in the US such as United Technologies, Honeywell and General Electric have, for decades, had success in realising significant benefits from a diverse portfolio beyond countercyclical revenues.
The writer is former senior vice-president and general counsel of GE and author of ‘High Performance with High Integrity’
While conglomerate structures may appear to offer more resilience in tougher economic climates – as the constituent businesses may span a series of end markets and regions – it is worth remembering that these structures are often the result of capital allocation decisions that have generated and will continue to generate poor returns for shareholders. Therefore, while they may represent a port in a storm, they are fundamentally unattractive business models. This is often because the areas that “demand” the most investment tend to be the areas performing well and subsequently where prices for assets are the most rich. The business models that I believe have been genuinely underappreciated are larger vertically integrated business, such as major oil companies. These are better able to produce good returns for shareholders over the cycle since their structure acts largely, though not entirely, to dampen volatility of earnings and thus make the capital allocation process more manageable.
The writer is head of European equities at F&C Investments
It is clever and opportunistic for Mr Samuelson and Mr Schulz to rationalise the diversity of MAN Group and ThyssenKrupp as an advantage; a great narrative to feed to jittery capital markets. The fundamental logic, however, is hard to defend. The conglomerate adds a layer of costs and bureaucracy, so it must add an even greater level of value to individual business units to provide a net benefit. It is hard to find data to support that notion, especially in broadly diversified groups. In fact it is conceited to think that the conglomerate can outmanage its focused competitors across an entire diverse portfolio. GE is famously cited as the one sustained shining example of that conceit; but it is questionable whether its diverse portfolio is an advantage anymore. Private equity groups have made hundreds of billions buying companies at a “steep discount” and turning them round. But they make their money by buying, turning round and then selling rather than by managing a portfolio.
The writer is dean of the Rotman School of Management at the University of Toronto
Proponents of the conglomerate model argue that the benefits of a smoothed earnings and share price performance outweigh the economic costs. There is a challenging set of hurdles to overcome, though. First, sophisticated investors take account of the profit and risk contribution of different divisions and adjust their overall portfolio to achieve the profile they require – by investing across the market they have more options than conglomerate management. Second, can managers justify their claims to improve performance if they have to understand multiple and different business units? Finally, what shared benefits are achievable across different businesses in terms of infrastructure, procurement and other functions – can they offset the increased complexity and costs of ownership? At its most basic the conglomerate model has been superseded by two other forms: investment fund managers who now hold quoted shares with clearly understood performance and risk profiles in different weightings; and private equity, which takes on opportunities with high risk profiles and relies on highly incentivised management to deliver results.
The writer is partner and head of finance and performance improvement at Ernst & Young
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