The Revival of the Conglomerate?

Is there a revival of the conglomerate in the U.S. economy?

The conglomerate has a somewhat troubled heritage. It is considered by researchers in strategy and finance to be of dubious value, and it has fallen out of favor since the 1970s with corporate leaders and financial markets. Yet, in the 21st century, the conglomerate appears to be making a comeback.

The conglomerate is a specific kind of Multi-Business Enterprise (MBE) in which the different businesses within the enterprise have minimal interdependence. Academics in strategy have always viewed with suspicion the claim that conglomerates (or unrelated diversifiers) create value for investors. Much of this suspicion can be traced to the conglomerate merger wave in the 1960s, spearheaded by companies such as LTV, ITT, and Textron. The primary driver of the conglomerate in that era was financial: These companies essentially argued that they were able to allocate and manage capital better than the capital markets. But, theorists have been quick to point out that the rationale for a pure conglomerate was always weak because investors could diversify on their own. A pure conglomerate was hard to justify except in the rare situations where it reduced bankruptcy risk or where scale gave the conglomerate access to a lower cost of capital. Beyond theoretical objections, however, there is empirical evidence of what has been called a “conglomerate discount”—the value of many conglomerates is less than the sum of their parts, a condition that leads to clamor from activist investors to break conglomerates into their constituent components.

Although we tend to think of conglomerates as belonging to bygone era, a number of today’s leading companies, especially in terms of market value, might seemingly qualify as conglomerates. As a convenient label, let us call them Seemingly Conglomerate Enterprises (SCE). Take for example the Apple Corporation. Starting out as a personal computer company (Apple Computer as it was known then), Apple has evolved into an enterprise that now encompasses many spaces: music entertainment (iPod and iTunes), tablet computing (iPad), smartphones (iPhone), and set-tops for video entertainment (Apple TV). More recently Apple has ventured into other spaces, such as payment systems (Apple Pay), Luxury watches (Apple Watch), telematics/automotive systems (Car Play), and applications in the health and fitness area. Apple’s ambitions, however, are much broader if its recent (and rumored) investments are any guide. Apple’s forays into the driverless smart automobile (or at least the “brains” of such an automobile) would be a significant step away from its current scope, and its investment in China in the ride-sharing space (Didi Chuxing) represents another significant departure from its core business. Apple is not an isolated example.

Consider the evolving scope of Google/Alphabet or Amazon as they transcend their original product/market boundaries. Google has moved beyond its core search engine to become a platform for search, storage and organization of user content, cloud services and commerce across multiple devices, including a significant presence in smartphones through its Android operating system. Google’s reorganization and the creation of Alphabet is an explicit recognition that Google was considering entering business that were not related to its core search business. Similarly, in creating a significant presence in cloud and web services, Amazon has moved beyond its original scope of online book retailing or its more recent scope of becoming an all-purpose retailing platform.

Apple, Alphabet, and Amazon defy the general expectation of sub-par economic performance and the lower investor returns usually associated with conglomerates. What separates these enterprises, Seemingly Conglomerates, from the conglomerates of the past? What is their strategic logic? Why are these cutting-edge enterprises of today moving in this direction at this time? And, how do they beat the expectations of poor performance associated with multibusiness firms with a wide-ranging portfolio of businesses?

A closer examination of SCEs, such as Apple and Alphabet, suggests the following observations:

They are not Pure Conglomerates

While Apple may participate in several competitive spaces, there are some common core elements that hold it together. Apple’s current businesses and their ecosystems are interlinked loosely or tightly through Apple’s concept of the “digital hub” strategy of linked “platforms.” The successful realization of this strategy has led to Apple creating and dominating linked eco-systems in digital music, tablet computing, and smartphones. Similarly, Alphabet has as its guiding mission the goal of organizing and providing easy and universal access to the world’s information. Different platforms provide different mechanisms to achieve this goal in different locations (on computers, mobile phones, tablets), or in different applications (mail, productivity suites, automobiles).

Strategic Logic of Superior User Experience

The underlying strategic coherence for both Apple and Alphabet is the uniformly high quality of user experience they aspire to, and actually do, offer, regardless of context or product. Each of these brands promises a very high quality user experience that leads, especially in the case of Apple, to an emotional bond with the brand that engenders deep customer loyalty. By providing the most relevant searches through its PageRank algorithm scanning of the largest set of indexed web pages, Google elicits in customers a higher willingness to pay in return for a perceived unique experience. Apple’s buyers routinely pay significantly more for its products relative to competitors, whether computers, tablets, or smartphones. Google attracts advertisers through the precision with which they can target potential customers, and, with the help of analytics, improve this precision, providing a higher ROI relative to its competition.

Consistent Operating Logic

The operating logic at Apple rests on a set of capabilities and management disciplines, including its unwavering devotion to Design Thinking and Simplicity. This operating logic is what allows Apple to create “insanely great products” that help deliver on its strategic promise of a superior customer experience. Apple’s forays into driverless cars, ride sharing, and luxury watches (a segment where Apple is second only to Rolex) appear to stretch the company into completely new areas. The question is whether Design Thinking and Simplicity can be applied to these initiatives to create the superior customer experience that will allow Apple to transform these businesses. Google’s operating logic is driven by the organization of small project teams whose members work closely together to deliver innovative solutions that not only provide continuous improvement of the customer experience but also create new solutions by allocating time when team members are encouraged to work on their own ideas.

The “Deconstruction” of Enterprises

The growth of the SCE in the 21st century can be traced to the “deconstruction” of the modern enterprise. “Deconstruction” is the ability of the modern enterprise to disaggregate its operating activities, focusing on only those in which it possesses a distinctive competence, and to retain those critical activities as its core, outsourcing noncore activities to collaborators or strategic partners. Deconstruction allows Apple, for example, to focus on design and software, and on the key mission of seamless integration of hardware, software, and solutions, while depending on collaborators, such as Foxconn, Samsung, and TSMC for much of its value-added in manufacturing. Google also does not manufacture its Nexus handsets or the driverless cars it is pioneering. Relative to the SCE, the conglomerate of the past was more vertically integrated within each of its component businesses. However, the delivery of superior seamless customer experience demands systems integration capabilities of the highest order in the age of the disaggregated enterprise. In deconstructed enterprises, intangibles such as customer brand perception and superior customer experience may play a more critical role than merely shared activities—or horizontal integration—which were often considered the cornerstones for synergy in the multibusiness firm. Similarly, the integrity of the brand as experienced by customers is achieved through an internal operating logic based on a set of capabilities and management disciplines applied consistently across the many businesses in the firm.

Some caution is warranted, however, when generalizing from the above analysis on at least two counts. One, when analyzing, especially for investment, an enterprise that appears to be a conglomerate, it is important to understand if it is just a portfolio of unrelated businesses or if these businesses are held together by a coherent strategic logic and a consistent operating logic—before simplistically dismissing the conglomerate form as not worthy of attention. And, two, before an SCE invests in a new industry, it should examine critically whether the coherent strategic logic and the consistent operating logic will be just as valuable in the new arena as in its current product/market offerings.

The jury is still out as to how long and how far these SCEs will be able to extend their strategic and operating logic. Will Apple continue to generate stellar performance if and when it moves into driverless cars or other new spaces? Will Alphabet be able to extend its scope into driverless cars and wearable devices profitably?

At the very least, the deconstruction of the modern enterprise suggests that we may need to revise our understanding and analysis of multibusiness corporations and reconceptualize them based on their strategic and operating logic.

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