What’s a Conglomerate (+ Case Studies)
A conglomerate is a company which is made up of several or many other smaller companies.
The conglomerate is referred to as the parent company while the constituent companies are called subsidiaries.
These companies don’t start as conglomerates. They often begin as any other business with the owner being the normal entrepreneur.
Anyone therefore can be the president or chairman of a large conglomerate.
It’s also important to note that the subsidiaries are often companies in different industries from the parent company.
And with more growth, the parent company may also have foreign companies as part of it. This is how many conglomerates become multi-national companies.
The parent company is the one responsible for the running of the whole network. Still, every subsidiary runs its operations by itself. All the same, they all report to the management of the parent company.
This means that the structure of a subsidiary may change, especially at the top, once it becomes part of the conglomerate.
How does a company become a conglomerate?
Every big company starts small. It is through sustained growth that the size increases.
If you are looking to own a multinational company, do not be set back by the challenges. You should also not be discouraged by the small beginnings.
Companies become conglomerates when they start acquiring other companies. It may start as a way of boosting their sales outside their immediate industry.
It may also be a way of expanding to other industries to cushion themselves from the risks involved in operating in a single industry.
This is what is called diversification.
Companies which grow very fast get to a point of reduced growth, even though they still want to grow. To sustain the growth and increase it, they can use any legal means to expand.
One common way is by going outside their immediate industry.
To become a conglomerate, one option is to buy out another company.
Another way of going about it is by acquiring the controlling stake in a smaller company.
With the controlling stake, you essentially become the decision-maker.
This new business automatically becomes part of your empire.
There are some companies which are increasing by acquiring other smaller ones. In some cases, the big companies buy smaller ones which have something that interests the bigger ones.
A good example of this is the conglomerates in the digital world.
The Facebook Conglomerate
Facebook was started by Mark Zuckerberg and his fellow co-founders as a social media company. It grew well and became very large.
To date, it is the biggest social media platform both in the number of active users as well as in revenue.
But Facebook has not been operating solely as the social media company it was originally designed to be.
With increased competition and demand for more features from its users, there was need for changes.
First, there was the FriendFeed acquisition. This was a real-time feed aggregator. The cost of the acquisition remained private.
One thing which was however obvious, is that Facebook had made a good deal. It was getting the team from FriendFeed, which was previously working at Google.
Then in April 2012, it bought Instagram for $1 billion. The company has made several acquisitions including WhatsApp. Of these, one that was quite different from it was the Oculus VR acquisition in March 2014.
Oculus, a virtual reality company, didn’t seem related to social media in any way.
Not only is Facebook diversifying under its own umbrella but increasing the revenue channels.
ADVANTAGES OF CONGLOMERATES
Conglomerates offer many benefits to their owners. If this wasn’t the case, there wouldn’t be many taking that route.
But as it is evident, this is a sure winner when it comes to business strategy.
All you need is money. If you have the money to buy other companies, go ahead and do it.
To know the benefits, here are some advantages of running a conglomerate.
This is the most obvious benefit of going the conglomerate way.
As the parent company, there is no denying that you get a share of the subsidiaries coming your way.
Depending on the size of your stake in the subsidiary, the extra income could be big enough to jump-start a dying company.
If company A is a conglomerate making $1 billion a year, acquiring the controlling stake in company B which makes $1 million per year is a direct boost in revenue.
Essentially, A can be said to be making $1.1 billion in annual revenues after the acquisition.
With increased revenues, there is a lot that can be done. This gives company A more financial muscles to expand some more.
If there was a competitor threatening it, then the playing field could quickly be leveled.
This puts A into the right position to not only stand against its competition but also fight them.
Increased revenues can help increase innovation, improve service delivery and other business aspects which can put A squarely at the top.
Reduced Investment Risk
Being in business is an investment. If you are an entrepreneur, you know this very well. You have invested your money, skills, knowledge, passion and most importantly, your time.
Being an investment, your business is a risk. To start the business, you risked. To keep running it, you are risking.
The bigger it grows, you are risking a big fall. Risks are written all over the walls of your business.
One way of minimizing the risk is by diversifying. It is the wisdom which comes from the saying that you should never put all your eggs in one basket.
You can bet that the basket can fall and all the eggs in it break.
This can be disastrous since broken eggs cannot be repaired.
When you diversify your business offerings, you mitigate this risk.
It is like putting your eggs into three different baskets and having them carried by three different people.
As all three walk towards the same destination, the chances of safe arrival of your eggs are increased.
What gives conglomerates the edge is that they diversify outside their industry.
In comparison, businesses like brick-and-mortar stores expand by opening new outlets in different locations.
Though this is also beneficial, it does not give them a soft landing similar to that enjoyed by conglomerates.
Subsidiaries Benefit from Internal Capital Markets
The smaller business also benefit from being taken over by a larger company.
Like in the Facebook and Instagram example, Instagram has experienced massive growth after the acquisition.
Take a look at the graph below showing the monthly active users since Facebook purchased it.
This has been occasioned by the availability of a more experienced human resource helping them become better.
Also, the investment done by Facebook provides a great opportunity and motivation to learn and improve.
Still, there is a bigger benefit available for the subsidiaries.
Money is always a necessity in business.
After an acquisition by a large company, money becomes readily available. In conglomerate terms, this is known as an internal capital market.
With internal capital markets, money is made available within the company for those who need it. Like a good human parent, the parent company financially supports the subsidiaries.
This works like the public financial markets where there are investors looking for a company to invest in.
Just as professional investors do, the parent company can pump money into the subsidiary which is struggling.
This way, the struggling company is able to access the necessary funds without the danger of extra cost. In this arrangement, there are no expensive interests to be paid.
There is therefore enough peace of mind as the money is being put to use since there is no external pressure.
DISADVANTAGES OF CONGLOMERATES
Anything which has an advantage also has a disadvantage.
With the above advantages indicating the good of the conglomerate business, here are some cons of the same.
Decrease in Conglomerate Stock Value
As the overall business grows, its stock value decreases.
This is because of the nature of the business model employed by conglomerates.
The stock value of the individual companies adds up to a value that is higher compared to what the parent company‘s stock value is.
This is the result of how the management of the conglomerate handle financial matters.
As a business, there are values which are usually withheld from the public.
This is to avoid a situation where the competitor has insight about the workings of the subsidiaries.
At the same time, investors who want to diversify their own portfolio prefer a direct approach rather than arrangement.
Instead of investing in a conglomerate which has diversified its business, they want to control their own diversification.
In this case, the investor will do his homework and decide which of the subsidiaries are worth investing in.
But investing in the conglomerate itself would rarely be an option.
This dislike of the parent’s stock by investors is what affects its prices.
Potential Difficulty and Inefficiency in Management
This happens as a result of too much diversification.
With more companies joining the family and from different industries, the management is stretched thin.
This becomes a bigger problem when the management is not well familiar with the industry the subsidiary operates in.
This makes it difficult for the management to make good decisions to guide the subsidiaries. They largely have to depend on the management skills and industry knowledge of the subsidiary manager.
This makes the job of the top managers very difficult.
To minimize this, the top managers can undergo training on the new industry being represented in the network.
This means extra effort and more time spent familiarizing yourself with the industry instead of running the main business.
Increased Management Overhead
Business expansion for conglomerates has no end in sight; and it’s not coming any time soon.
The subsidiary has its own management. The people holding management positions make decisions which are best for the company. But at the same time, they are reporting to the management of the parent company.
For the conglomerate’s management, this is an indirect way of managing the subsidiaries. It is just like management by proxy.
This creates a business overhead because there are multiple layers of management.
These don’t necessarily add any value to the smaller company.
Difficulty in Knowing the Subsidiaries’ Performance
The conglomerate often reports its performance as a group.
The combination of the financial performance of all the subsidiaries with the parent company does not normally reflect the true picture of the situation.
With such a report, it becomes very difficult to know how well the individual companies are performing. Obviously, they cannot be all at the same level of profitability.
Often there are those which will not be financially stable.
This will rarely be disclosed. It is sensitive data reserved for the management. The internal arrangements like the internal capital markets can be used to improve any business not doing well.
But the problem is that this can discourage potential investors from putting their money into such companies. Investors, analysts and regulators often find it difficult to know the performance of individual companies.
Although potential investors can get discouraged, current investors may suffer loss too.
They are also quite in the dark in regards to the financial status of the companies they have invested in.
As a result, they will not know when to sell their shares or hold onto them.
This kind of uncertainty is not preferred by any investor.
To fully understand how conglomerates form and do business, let’s look at two conglomerate examples. These are big and well-known companies.
In the course of their lives, they have engaged different strategies and managed to remain standing strong to this day.
This company was started in 1806 by William Colgate who was a soap and candle maker. The company was initially called William Colgate & Company.
After his death in 1857, his son took over and changed the name to Colgate & Company.
In 1896, they sold the first toothpaste in a tube. During this time, another company was developing. B.J. Johnson Company was making soaps out of palm and olive oils.
The soap’s popularity made the company rename to “Palmolive.” Palmolive here stands for the oils, palm and olive.
Colgate was later bought by Palmolive. Later, the joint company became Colgate-Palmolive.
Operating many brands in the household, personal care products, food products, health care, industrial supplies and other sectors, here are some colgate acquisitions.
- In 1976, Colgate bought Riviana for about $180 million. This put Colgate into the foods industry.
- In 1987, it bought Softsoap for $40 million and 528,735 shares of Colgate common stock. The individual brands in the deal (Softsoap, Village Bath Products and the Sesame Street brands) were reported to have a value of around $65 million.
- After the acquisition of the Mennen Company in 1992, the “Total” toothpaste is introduced overseas. This acquisition was valued at $670 million. This was for personal care products.
- Colgate bought Suavitel to venture into fabric softening products.
According to Colgate’s 2018 annual report, they had $15.5 billion worth of worldwide net sales.
Proctor & Gamble
Founded in 1837 by William Procter and James Gamble, Procter & Gamble is a big company. Its products are divided into segments which include beauty, health care, fabric & home care and Baby, Feminine & Family Care.
By August 2014, P&G had a total of 165 brands.
Of these, 65 were the fastest-growing in the company’s portfolio. As a result, 100 brands were being dropped or sold off to focus on the profitable ones.
Here are some of the notable acquisitions by P&G.
- 1930 saw P&G go international. It acquired Thomas Hedley Co, a British candle and soap manufacturing company.
- In 1957, it bought Charmin, a toilet paper and flushable wipes brand.
- It bought Norwich-Eaton Pharmaceuticals Company in 1982 for $371 million in cash. At this point in time, its annual revenues were $11 billion.
- 3 years later, it bought Richardson-Vicks Inc. which had previously been targeted by Unilever N.V. for a takeover. The merger cost $1.2 billion.
- The CoverGirl brand became part of P&G after the purchase of Noxell Corp in 1989. The deal was worth $1.3 billion.
- 2010 saw the acquisition of Ambi Pur, an air freshener business unit of Sara Lee Corp. The cost of this purchase was $470 million.
P&G’s unaudited 2018 annual report shows net sales of $66.8 billion. It is also worth noting that the dividends per common share have been increasing through the years.
Conglomerates may not be what many companies rush to become but it certainly is in the minds of many business owners.
Apart from the joy of having a big business spanning different industries and countries, there is also the diversification factor.
Diversifying a business is a necessity.
The risks involved in settling in only one industry are huge.
When you diversify, you get to secure your investments across multiple business environments.
These come in the form of different geographical locations and business industries.
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