The Death of the Conglomerate
Introduction
Bigger isn’t always better and a rising tide doesn’t lift boats that are too heavy to float. Conglomerate companies might be able to absorb market changes initially. However, over time, the behemoths, weighed down with multifaceted divisions and bloated management structures, eventually fail to adapt quick enough to shift with the inevitable ebb and flow of the everchanging market. With this failure comes the sinking of their proverbial boats. As conglomerates increasingly seek to divest and spinoff their non-core business units, the conglomerate model’s historical prestige is quickly diminishing calling into question its effectiveness and future in the role of corporate organization.
Horizontal, Vertical, and Conglomerate M&A
Mergers and acquisitions, when executed successfully, are often advantageous methods for achieving corporate growth. Most transactions fall into one of two categories. Horizontal integration merges a company’s competitor into its existing business to expand their market share and leverage economies of scale. Vertical integration occurs when a company acquires a supplier or customer to reduce operating, production, or distribution costs. However, conglomerates operate outside of horizontal and vertical integrations by acquiring companies in adjacent or unrelated businesses.
Rise of the Conglomerate Model
The passage of anti-trust legislation in the early 1900s significantly altered the merger and acquisition landscape of the United States. Intending to breakup existing monopolies and prevent anti-competitive transactions, the Clayton Act of 1914 and the Celler-Kefauver Act of 1950 set the stage for the ensuing conglomerate boom. These acts prevented large companies from engaging in many vertical and horizontal integrations, which left the companies desperate to provide growth to shareholders through acquisitions. Their solution was to acquire companies, that had no chance of being perceived as monopolistic, as the acquisition targets were completely unrelated to acquirer’s core business.
Another reason for the prevalence of conglomerates is the popularization of the M-form model of organizational structure. The multi-divisional form (M-form) of organizational structure is where diversified companies separate themselves into multiple divisions where each division’s day-to-day operations are managed by division heads and larger planning and strategy decisions are made by top corporate management. The M-form was in effect in several large companies long before its popularity, but it was the storied consulting firm McKinsey & Co that truly commercialized this method of organizational management through its trove of consulting engagements with blue-chip companies.1 These engagements influenced companies such as General Electric, Sears, and PepsiCo to expand beyond their industries and venture into unfamiliar territory in an attempt to leverage their managerial and organizational expertise in new markets.
The Textbook Conglomerate
Empirically, the expertise of an appliance manufacturer is of little to no value to a movie producer. Yet, the quintessential American conglomerate, General Electric (GE), surmised exactly the opposite in 1986 as they acquired NBCUniversal. Ironically, GE had created NBC in 1926 under its Radio Corporation of America (RCA) division in order to promote the purchase of RCA branded radio sets manufactured by GE.2 As anti-competitive practice laws came into the picture, GE was forced to divest both RCA and NBC in 1932. Fast forward 54 years, and executives at GE believed that the same superior management principles they applied to manufacturing washing machines could be applied to producing Back to the Future. GE eventually sold control of the faltering NBC business to Comcast in 2009 and used the cash to fund its expansion into oil & gas services.3 Less than ten years later, GE would buy oilfield services company Baker Hughes for $78.4 billion and integrate its existing oil & gas services into the business. But this didn’t last long either. Just a year later in 2018, GE announced they would spinoff the Baker Hughes business unit for an expected value of $8.2 billion,4 resulting in nearly $70 billion of value being wiped out in a year.
Recently, GE announced the split up of the company into three separate entities, each with an industry-specific focus.5 As a textbook conglomerate, GE acquired companies in diverse industries, in which they had no actual expertise, with the assumption that their management would create a diamond out of clay. In due course, this was rarely successful, and GE’s historic collapse over time is synonymous with the inevitable death of the conglomerate model.
Corporate Shopping Spree
The brick-and-mortar retail wasteland extends across modern America as “anchor” storefronts sit destitute and vacant in hundreds of shopping malls. Many of these now empty stores were once a Sears location. Once, the first retailer to become publicly traded, Sears is now bankrupt. How did the highly regarded retail titan fall so far from grace? The answer is by executing seemingly synergistic vertical expansion into materially different industries and falling asleep at the helm as the competitive landscape of its primary industry rapidly changed.
Sears began as a mail-order watch retailer and quickly became the most successful consumer goods retailer in the country.6 In 1910, Sears bought plow maker David Bradley Manufacturing and in 1962, they merged David Bradley with Newark Ohio. The two companies were then merged again as Sears bought the stove manufacturer George D. Roper Corporation. Sears would later sell its home appliance manufacturing business to GE in the 1980s. Over its lifetime, Sears would expand its manufacturing operations into creating branded tools, clothes, and even cars. Sears also ventured heavily into the financial sector, launching insurance provider Allstate, named after the company’s car tire brand, to sell insurance in stores. Sears bought stockbroker Dean Witter Reynolds which it used to expand into the credit card provider market with the Discover Card.
Sears had a long history of involvement with real estate, making their first foray into the industry by purchasing over 40 acres in Chicago where it built a sprawling corporate complex. This would serve as their corporate headquarters until the construction of the 108-story Sears tower, which was once the tallest building in the world and is now known as the Willis Tower. Sears built the skyscraper in the 1970s but struggled to find and retain tenants. Within 20 years of its completion, Sears sold and vacated the tower as the company faced financial woes.7 During this time, Sears also acquired real estate broker Coldwell Banker to participate in both residential and commercial real estate services. This merger lasted less than a decade before Sears divested the commercial real estate side of the business into the now market leading firm CBRE. Sears would later divest the residential real estate business as well into what is now known as Reology.
Through all its acquisitions and divestitures Sears ultimately focused on the wrong business. Its retail operations fell victim initially to Walmart and Target, with online retailers like Amazon serving the final blow. Though hindsight is 20-20, Sears would have been better off divesting its crown jewel retail business to pivot its focus to one of the many companies that have been successful to this day like Allstate, CBRE, or Discover. These three Sears subsidiary alumni now have a combined market capitalization of almost $100 billion8 while Sears was bought out of bankruptcy in 2019 for only $5 billion.9
Shiny Object Syndrome
Leaders of major companies in mature industries sometimes fall victim to “shiny object syndrome”, the tendency to focus on whatever business is new and trendy. This often leads to companies endeavoring into industries where they are outmatched by the competition, or even themselves. Even when the trend isn’t a fad, companies can still struggle to integrate a new business into an existing conglomerate. This was the case with Exxon who determined in the late 1970s that they would become the world’s biggest and best technology company. Exxon quickly bought up a multitude of companies that made everything from fax machines to semiconductors, consolidating them into its new “Exxon Office Systems” division. This corporate shopping spree didn’t come cheap, as Exxon spent over $1 billion to compete with Xerox and International Business Machines.10 However, Exxon faced a major culture clash between the division and its legacy oil drilling and refining business.11
The bureaucracy of Exxon handcuffed its office systems division which needed to be agile and forward thinking in order compete with Xerox and International Business Machines. Ultimately, Exxon shuttered their office systems division in 1984. Through this debacle, Exxon learned a hard lesson in corporate strategy and development. In order for an acquisition or new venture to be successful, companies must ensure that the two cultures are compatible with each other. Implementing Exxon’s highly structured and risk adverse style of management into its technology business was unsuccessful, as are most mergers between two very different cultures.
Hungry for Growth
As fast food and casual dining establishments, such as McDonalds and TGI Friday’s, swept the nation in the mid-1900s, grocery brands became concerned about changing consumer tastes and the growth prospects of the industry. To assuage these concerns, several food and beverage conglomerates decided to grab a piece of the proverbial pie for themselves. Pillsbury bought Burger King, Steak & Ale, and Bennigan’s. PepsiCo bought Pizza Hut, Taco Bell, and KFC. General Mills bought a small seafood chain called Red Lobster and launched Italian food restaurant Olive Garden.
Pillsbury, PepsiCo, and General Mills all eventually sold or spun off their restaurant holdings. Pillsbury spun off Burger King to counteract the restaurant division’s drag on Pillsbury’s earnings.12 PepsiCo spun off its restaurant division into what is now known as Yum! Brands in an effort to focus on its more profitable core business of food products and beverages.13 General Mills spun off its restaurants into Darden to allow its management to focus on its existing business without the distraction of managing the restaurants.14 Through these experiences, all three conglomerates discovered that the high-margin industries of today can just as easily become the low-margin industries of tomorrow.
The Remedies
Executives at struggling or stagnant conglomerates or diverse companies are not helpless. There are several areas on which company leaders can focus in order to set their companies up on the right course.
1. Long-term strategic vision is paramount to the success of the company and allows its decision makers to determine which parts of the company have the most upside and which parts lack potential.
2. Divest business units that don’t align with the company’s long-term strategic vision. While conglomerates fund their high growth businesses with new capital or with legacy business unit profits, consider divesting the lower growth businesses to fund high-growth business units or ideas. Streamlining the company’s focus allows the company to be agile in the market and quickly employ tactics to consistently stay ahead of its competitors.
3. Acquire companies that allow the company to achieve long-term growth and realize lasting efficiencies. Healthy mergers and acquisitions can be an excellent method for achieving these goals where organic growth and internal restructuring just isn’t enough. Focusing on synergistic transactions where the company can expand its presence while remaining aligned with its long-term strategic vision can provide the company with the strength needed to become, or stay, an industry-leader.
4. Executive compensation for leaders and key decision makers within the organization should be structured in a way that encourages healthy risk taking and good stewardship of the business. Too often are executives pressured into and rewarded for taking risks bankrolled by capital that could be returned to shareholders or deployed in such a manner that would increase the long-term value of the company.
5. Financial health is an important area of focus to minimize the cost of capital for the firm through maximizing the stability of the firm’s balance sheet. Conglomerates tend to rely upon the sheer magnitude of the organization to lower capital costs. However, this has a tendency to backfire eventually, as lenders become weary of the potential negative impact of troubled business units. A focused, agile company with a solid financial foundation can obtain the optimal capital from the ideal investor and lender base.
1 McDonald, The Firm: The Story of McKinsey and Its Secret Influence on American Business
2 Britannica, “National Broadcasting Co., Inc.”
3 The Wall Street Journal, “Comcast Buys Rest of NBC’s Parent”, February 13, 2013
4 Journal of Petroleum Technology, “GE To Spin Off Baker Hughes”, June 25, 2018
5 The Wall Street Journal, “General Electric, Once a Manufacturing Giant, Breaks Up”, November 9, 2021
6 Britannica, “Sears”
7 NBC News, “Willis Who? Sears Tower Gets New Name”, July 16, 2009
8 Capital IQ market data as of May 1, 2022
9 Reuters, “Sears Chairman Confirms new $5 billion Bid to Save Bankrupt Retailer”, January 10, 2019
10 United Press International, “Exxon Looks for Buyer of Office Equipment Business”, November 28, 1984
11 Washington Post, “Exxon to Quit Office-Systems Business”, November 28, 1984
12 Sun Sentinal, “Burger King, Firm to Split”, November 7, 1988
13 Washington Post, “Pepsico Spins Off Restaurant Chains”, October 8, 1997
14 Orlando Sentinal, “Spinoff Carries Darden’s Name”, March 29, 1995
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About the Author
Mr. Hoelscher has worked in the financial consulting and professional services industry for over 5 years where he has gained valuable knowledge in financial analysis, research, consulting, valuation modeling, and investment management. As a Senior Associate at ValueScope, Mr. Hoelscher assists the ValueScope team in advising clients on mergers and acquisitions, litigation support, valuations of various assets, capital markets advisory, and financial consulting services. Transactions have included leveraged buyouts, restructures, mergers, acquisitions, capital raising, and direct investments. The clients Mr. Hoelscher has assisted operate in a variety of industries including financial services, food & beverage, lodging & hospitality, manufacturing, industrial services, commercial real estate, oil & gas, and healthcare. Mr. Hoelscher received his MBA from Texas Christian University and earned his BBA in Finance from the University of Texas – Arlington.
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