Why Conglomerates Are Breaking Up
Kellogg’s joined a growing trend last month when its leadership announced the conglomerate businesses would break up into three companies focusing on snacks, cereal, and plant-based foods in an effort to boost value for their shareholders and focus their funds on their most profitable products.
The announcement came months after General Electric, Johnson & Johnson, and Toshiba decided in late 2021 that the conglomerate model wasn’t working for them, either. Conglomerates became a trend, in part, because they were a way for successful companies and CEOs to grow.
Peter Cohan, who teaches corporate strategy at Babson College and has been writing about conglomerate issues for more than a decade, argues that investors undervalue the conglomerates because the entities own many businesses that are purposely unrelated. All those unrelated businesses operating under one company create operational inefficiencies, investors assume. The inefficiencies lower the price of the conglomerate’s stock, which Cohan calls a “conglomerate discount.”
Cohan recently discussed the growing breakup trend, and what it means for the economy.
What is happening at these conglomerates that makes breaking up into smaller companies a good business decision?
“Breaking up is happening because a generation of top executives is less wedded to the idea of a conglomerate and suffers from FOMO (fear of missing out)—the observation that the conglomerate is missing out on investors’ tendency to drive up the prices of more focused companies to much higher levels.
“Conglomerates were very late to do something about their conglomerate discount. I am sure they were aware of the arguments in favor of breaking up, but they resisted doing anything about it. There are many possible reasons top executives delayed. They convinced themselves that the divisions were more valuable together than broken up; they feared a low sale price for the divisions they would jettison or that overseeing a smaller portfolio would make them feel less important.”
Why have top executives made this decision now, and will it benefit them?
“Companies made this decision because they thought it would drive up their stock price—leaving the company with a more aligned mix of businesses that can produce faster growth more predictably. In the case of GE, breaking up was a simple matter of survival. GE desperately needed capital since it was struggling to generate positive cash flow, so getting a good price for those weaker businesses helped the company.
“Sadly, since November, the stock market has collapsed, and many companies are suffering with the end of the economic boom that spanned roughly a decade from 2010 to 2021. In general, I do not think companies that break up into pieces will enjoy the benefit of being more focused unless they are able to convince investors that their strategy will produce expectations-beating growth each quarter.”
“There are many possible reasons top executives delayed. They convinced themselves that the divisions were more valuable together than broken up; they feared a low sale price for the divisions they would jettison or that overseeing a smaller portfolio would make them feel less important.”
Babson Lecturer Peter Cohan
Can you share additional insights into what the decision means for conglomerates and for the economy?
“Large conglomerates are generally some of the slowest-moving companies, and that lateness often means that their strategic response arrives in the market too late to make a difference.
“An interesting example is Eastman Kodak, which invented digital photography but chose not to commercialize it because it could not turn it into a profitable business. Kodak was aiming for a business model like its original Silver Halide strategy, in which it priced portable Brownie cameras at cost and earned high margins on film, chemicals, and developing prints. Kodak’s failure to commercialize digital photography contributed to a decline in sales leading to its 2012 bankruptcy—as rivals, most notably Apple, made digital photography accessible to the masses.
“The most talented people work for fast-growing startups that are aiming to change the world, so slow-moving conglomerates do not attract and motivate the best talent. This inability to attract and motivate the most talented people puts conglomerates at a competitive disadvantage.
“Nevertheless, conglomerates that become more focused could become more valuable to investors. But, to do so, they must pass some difficult tests. For example, does the more focused company offer products to very large markets? Compared to rival products, do the more focused company’s products deliver the most value to customers? Does the more focused company prevail over competitors in key capabilities, such as engineering, manufacturing, supply chain management, and marketing? Does the more focused company set ambitious growth objectives and exceed them every quarter?”
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