After decades of large conglomerates splitting into separate parts, there is a new trend of large companies diversifying into industries and investing in many different types of companies. But the drivers of this new wave of ‘conglomeration’ are different from those of the past, and provide some insight into the future of markets and business.
Observations
- In recent years, many large conglomerates have split into separate businesses, like Philips, Maersk, ON, RWE, ThyssenKrupp, Hewlett Packard, while large conglomerates like Siemens, DuwDuPont, GE and possibly even Berkshire Hathaway are looking to break up their businesses into so-called ‘pure play companies’.
- Tech giants, such as Amazon, Alphabet, Apple and Facebook, are taking over companies at record speed. However, these are generally not billion-dollar takeovers of mature companies in the same industry, but small companies with innovative technologies and scalable platforms in various industries.
- Many conglomerates trade at a so-called ‘conglomerate discount’ because of their inability to manage diverse and many separate business units. Recent decades saw increased shareholder pressure on conglomerates to let subsidiaries focus on their core business: the sum of the conglomerate is worth less than the individual parts.
- Alphabet recently missed its earnings expectations in the fourth quarter of 2017, as Google’s advertisement business is slowing down. However, it now suspects that its non-advertisement businesses, for example cloud computing and self-driving cars, will generate future growth.
Analysis
During the 1960s and 1970s, there was much enthusiasm for companies employing strategic diversification: a ‘parent’ company owning a large and diverse portfolio of other subsidiary companies. These business groups, which became the cornerstone of American capitalism, were established to use free cash flows to finance new businesses to hold a diversified portfolio to hedge against industry-specific risks.
They also made it possible to combine operational processes between business units that could yield efficiency gains (synergies). However, this trend of ‘conglomeration’ has gone out of fashion in the last three decades, and many of these conglomerates broke up and let the subsidiary business focus on their core business (a process called ‘starbursting’).
We should not understand the expansion of digital conglomerates as horizontal or vertical integration, as this still assumes different and distinct businesses and industries within an investment portfolio, while these digital conglomerates are building integrated and data-driven ecosystems
However, during this trend of ‘deconglomeration’, we see the emergence of a new type of conglomerate: the digital conglomerate, like Amazon, Apple, Facebook and Alphabet, and their Chinese peers Alibaba, Baidu and Tencent. Their conglomeration strategy has different drivers compared to ‘old conglomerates’. Their huge cash piles allow them to gobble up new companies at a record rate to sustain future growth rates and to deter new possible entrants in their markets.
However, looking at these companies’ portfolios, with subsidiaries in diverse industries, ranging from groceries, healthcare, autonomous driving to virtual reality, and gaming, it is clear that a more fundamental driver is at work: their belief that digital technology and the use of data will transform every industry.
Digital technology and data will not only be transformative within markets or verticals; data from their various businesses yields valuable intelligence for all kinds of activities and businesses. This implies that the data generated from individual businesses can yield additional advantages above merely synergies resulting from combined overhead processes and integrated free cash flows.
The integrated data will yield intelligence that is spread and used across the various industries and businesses, hence reinforce the network effects of these digital conglomerates. That is why autonomous driving becomes interesting for a search engine, or ‘offline retailers’ like supermarkets can yield additional data to online retailer platforms.
Following this line of thought, we should not understand the expansion of digital conglomerates as horizontal or vertical integration, as this still assumes different and distinct businesses and industries within an investment portfolio, while these digital conglomerates are building integrated and data-driven ecosystems.
With the establishment of these ecosystems with mutually reinforcing data businesses, digital conglomerates can tap into new sources of revenue that are not directly related to their core of their traditional business. For example, Apple now receives more revenue from its services division, which includes services like Apple TV, Apple Pay and Apple Music, than from its traditional ‘hardware’ division (i.e. iPods and MacBooks). And Amazon’s advertisement business might challenge Facebook’s and Google’s ad duopoly, as its retail platform has become the default search engine for consumer products.
Implications
- Aside from conglomerates that grow because of their sheer amount of cash and capital, a second type of conglomerate is directly driven by the introduction of new general-purpose technologies. The expansion GE’s and Philip’s businesses for example, was directly related to the electrification of our society and economy, and the conglomerate of General Motors to the introduction of the car. As we have written before about a new technological revolution that is in the making, we expect a new type of conglomerate to be formed on the basis of upcoming general purpose technologies.
- The expansion of digital conglomerates has a general pattern: in the first phase, a tech platform or business (smartphones, search engines, social media advertisements, online retail) generates a lot of free cash flows, which are invested in improving intelligence systems and acquiring different business to generate more and richer data in the second phase. In the third phase, they begin to invest in the core technologies to power their own digital ecosystems, reaching further down the Stack. Digital conglomerates are currently entering this third phase, as we see increasing efforts of these conglomerates to develop their own core technologies, for example computer chips or Artificial Intelligence systems.
- While previous conglomerates were sometimes legally dismantled because of antitrust issues, digital conglomerates rarely make the type of acquisitions that trigger antitrust actions, such as large acquisitions within the same industry. Moreover, most of their products seem – at least at first sight – beneficial to consumers (Amazon pushes down consumer prices, while Facebook and Google provide free services). Furthermore, the subsidiary businesses generally have little overlap with markets adjacent to their traditional core market (Apple’s smartphones and healthcare, Google’s search engine and autonomous driving).
