Conglomeration

What Is Conglomeration?

Conglomeration describes the process by which a conglomerate is created, as when a parent company begins to acquire subsidiaries. Sometimes conglomeration can refer to a time period when many conglomerates are formed simultaneously. One of the chief advantages of conglomeration is the immunity that it provides the parent company from potential takeovers.

Understanding Conglomeration

A conglomerate is the combination of two or more business entities engaged in either entirely different or similar businesses that fall under one corporate group, usually involving a parent company and many subsidiaries. Often, a conglomerate is a multi-industry company and is often large and multinational.

Conglomeration started to become common in the 1950s because it was and still is a convenient way for parent companies to operate several related or complementary firms in conjunction with each other.

In theory, conglomerates offer economies of scale through greater access to capital markets and a cheaper source of funding. Conglomeration became increasingly popular in the 1960s due to a combination of low interest rates and a repeating bear-bull market, which allowed the conglomerates to buy companies in leveraged buyouts, sometimes at temporarily depressed values.

One of the main reasons for conglomeration is creating something new from the combined energies of multiple companies to produce independent goods and services under one parent company’s management.

Another reason for conglomeration is executing on the concept of diversification by combining two smaller firms. The union allows the larger, newly formed parent company to diversify its product offering, which helps it reach a new and wider base of customers. Ultimately, it all comes down to productivity and revenue.

Disadvantages of Conglomeration

One of the main knocks on conglomeration is the potential vulnerability that comes with the possibility of being spread too thin. When multiple companies are all independently producing goods and services that must then be bundled and distributed by one parent company, one weak link in the system can bring a conglomerate down.

The common criticism of conglomeration is the added layers of management, lack of transparency, corporate culture issues, mixed brand messaging, and moral hazard brought on by too big to fail businesses.

Ultimately, the management team is responsible for making sure this doesn't happen. Moreover, it is essential for management to prove to investors, shareholders, and the financial world at large that several diverse companies operating under one umbrella are better than they would be if they continued on as separate entities.

As mutual funds have come to dominate investment portfolios, diversification has been achieved for far cheaper than with corporate mergers and acquisitions (M&A), at least from an investors point of view, thus weakening the need for conglomerate business models.

How Conglomeration Occurs

Conglomeration occurs when one company decides to buy another company and possibly other companies after that. The reasons a company would buy another company are many.

The buying company may seek diversification in its business to reduce market risk, it may see a company not operating at its best capacity and believe that it could be managed better, or it buys a similar company that is different enough that will allow access to new customers and markets.

When a company buys another company it is known as a merger or an acquisition. A merger is considered as equal, when two companies come together, whereas an acquisition is when one company directly purchases another. When the company being acquired does not want to be purchased but is done so regardless, it is known as a hostile takeover.

There are three primary methods to pay for an acquisition. This can be done by paying cash, through the purchase of the stock of the company being acquired, or a combination of both. Stock purchases are the most common.

Real World Examples

Examples of conglomerates are Berkshire Hathaway, Amazon, Alphabet, Facebook, Procter & Gamble, Unilever, Diageo, Johnson & Johnson, and Warner Media.

All of these companies own many subsidiaries. Some own subsidiaries that are all within the same industry, such as Diageo focusing on beverage alcohol, while others are diversified, like Amazon, which owns the grocery store Whole Foods, Goodreads, a social cataloging site of books, Zappos, a shoe retailer, and many more other subsidiaries.