The economy, and the companies within it, continue to evolve and change as time progresses. This is especially true for conglomerates, which have transformed their very essence over time.
The beginnings of conglomerates
Conglomerates, which are corporations with controlling stakes in numerous independent subsidiaries, embody some of the most elaborate organizational frameworks of any business. Typically operating across a myriad of industries, the development of these mammoth corporations began in the early 1960s during a period in the U.S. commonly referred to as the “conglomerate boom.”
Favorable economic conditions, such as low-interest rates and heightened market volatility, enabled this ludicrous business concept to thrive and expeditiously grow, outpacing comparable enterprises with a singular, specialized focus. Traditionally, the distinctly differentiated operating segments of conglomerates are incrementally accumulated over time through repeated mergers and acquisitions, which systematically broadens the scope and extensivity of the company’s business portfolio.
This was especially true during the economically prosperous environment of the ’60s, when debt financing, primarily conducted through leveraged buyouts, enhanced the accessibility of acquiring other companies. For businesses looking to expand the breadth of their operations, this provided a particularly auspicious opportunity.
The downfall of organizational complexity
Many companies pursued a genuine interest in exploring strategic diversification. Others, however, had illegitimate intentions to exploit this opportunity, characterized by the common goal of manipulating their perceived paper return on investments. The exorbitant number of businesses that realigned their agendas to prioritize inorganic growth culminated in an economic bubble, called the “conglomerate fad.”
This overhyped phenomenon sustained a remarkable peak in 1968 before the excitement rapidly faded as a result of the Federal Reserve’s Federal Open Market Committee (FOMC) raising interest rates to combat strengthening inflationary pressures. This resulted in the fragmentation of many disreputable conglomerates; however, properly established names with scalable business models, including ITT Corporation ($NYSE: ITT), Berkshire Hathaway ($NYSE: BRK.B) and General Electric ($NYSE: GE), successfully endured macroeconomic pressures and continued to experience growth into the forthcoming decades.
Advantageous attributes of conglomerates
Several idiosyncratic properties of the organizational configurations of conglomerates prove inherently assistive in sustaining consistent growth and reliability. The distinctive characteristics that enable this can be categorized into two distinguishable categories: internal benefits, which contribute to operational resiliency, and external benefits, which pertain to the upholding of brand reputation and credibility.
First, to examine the former point of functional advantages, the most notable quality that conglomerates intrinsically benefit from, on account of their business model, is widespread diversification. Companies with diversified involvement across different geographical regions, customer bases and exposure to various industries are disproportionately better equipped to mitigate risk, as their susceptibility to sector-specific events is minimal.
Moreover, their diversified exposure to an array of industries allows for naturally occurring synergistic opportunities among internal operating segments. This irrefutably provides a competitive advantage over companies that focus on a single sector and would need to outsource to achieve comparable results, thus incurring substantial expenses in doing so.
The latter point, about the extrinsic benefits of conglomeration, encompasses a multitude of ways in which conglomerates retain an edge in customer acquisition and investor relations when compared to their less diversified competitors. Conglomerates can establish unparalleled brand recognition through their omnipresence, thereby enhancing their consumer recognition and increasing brand visibility.
By merit of this stance in the marketplace, coupled with established longevity, consumers perceive conglomerates as more reputable and are therefore more likely to purchase goods and services from them. In addition, conglomerates are the epitome of highly suitable investment vehicles and are generally attractive to investors who seek diversified exposure within a single equity. Furthermore, most of the major conglomerates’ stocks offer a dividend yield, which incentivizes prospective investors. These fundamental operating properties of conglomerates have enabled them to flourish into some of the largest and most profitable companies globally.
Widespread dismantlement
The sentiment around traditional conglomerates has been on a gradual decline over the past few decades, in many cases leading to the separation of their respective segments. Even some of the largest conglomerates, including household names such as General Electric ($NYSE: GE) and Motorola ($NYSE: MSI), have undergone extensive restructuring over the past few years to “deconglomeratize” their operations.
Over time, a plethora of factors have contributed to traditional conglomerates becoming obsolete, depleting the interest of consumers and investors alike. To a certain degree, this is attributed to the introduction and explosivity in alternative investment assets such as mutual funds, which provide a more efficient and dependable way to allocate capital in a diversified manner. Overall, the drawbacks of traditional conglomeration have seemingly begun to outweigh the aforementioned strengths, resulting in these companies’ stocks underperforming major indexes.
The widespread adoption of this pessimistic outlook has undermined the perception of these companies and, more recently, led industry leaders to question the justification for their very existence. When General Electric ($NYSE: GE) announced the breakup of its company in 2021, Chairman and CEO Larry Culp said he would “bet on the benefits of focus every day far more than the often illusory benefits that come from [internal] synergies.” This prevailing outlook has caused nearly all of the traditional conglomerates to restructure in some way and, in many cases, dissolved their assemblage of segments into separate entities entirely.
Resurgence and outlook
People with even a rudimentary understanding of the stock market are familiar with the “Dot Com Bubble” of 2002, which brought unprecedented volatility, specifically in the evolving technology sector. What is less discussed, however, are the subsequent implications that meaningfully pivoted how high-growth technology companies conduct operations, shifting them toward a strategy that strikingly resembles that of old-fashioned conglomerates.
Given how impactful the internet has become across nearly all industries, it is only logical that mega-cap technology companies began to inadvertently embrace conglomerate-resembling characteristics as part of their mission to remain at the forefront of innovation. This insurgence of technological advancement across industry lines has led tech-centered companies to venture outside their primary businesses and participate in acquisitions that, at first glance, may seem unrelated to their current practices.
Examples of this “tech umbrella” business philosophy are abundant and include several prominent components of the S&P 500 index. Amazon ($NASDAQ: AMZN) for instance, which is primarily known as a top player in the e-commerce space, also operates various other seemingly unrelated business segments, including but certainly not limited to digital streaming services, grocery stores (Amazon Fresh and Whole Foods), smart home services (Ring Doorbell and WiFi), mobile services (Audible and Kindle), space exploration (Blue Origin) and the largest cloud service provider globally (Amazon Web Services).
Other major examples include Google’s ($NASDAQ: GOOGL) acquisition of YouTube in 2006, Apple’s ($NASDAQ: AAPL) acquisition of Beats Electronics in 2014, and Facebook’s ($NASDAQ: META) expansion into augmented reality and other Web-3 technologies.
While the principal objective of these corporations, like all business endeavors, is to capitalize on revenue-generating prospects, the reason they so frequently partake in acquisitions and expansionary ventures is that many of them retain high cash reserves, permitting a greater risk tolerance for expenditures outside their general scope of business. Thus far, these strategic efforts to broaden the products and services offered have proven impressively successful for these companies. The remaining question is whether, in all eventuality, these companies will face the same fate as traditional conglomerates — or whether modern-day technology will allow them to thrive in perpetuity.