Conglomerate: Definition, Meaning, Creation, and Examples

What Is a Conglomerate?

A conglomerate is a corporation of several different, sometimes unrelated, businesses. In a conglomerate, one company owns a controlling stake in several smaller companies, conducting business separately and independently.

Conglomerates often diversify business risk by participating in many different markets, although some conglomerates, such as those in mining, elect to participate in a single sector industry. Economists, however, warn that large and far-flung conglomerates can become inefficient and costly to maintain, eroding value for shareholders.

Understanding Conglomerates

Conglomerates are large parent companies made up of smaller independent entities that may operate across multiple industries. Each of a conglomerate's subsidiary businesses runs independently of the other business divisions; but, the subsidiaries' managers report to the senior management of the parent company. Many conglomerates are thus multinational and multi-industry corporations.

Taking part in many different businesses can help a conglomerate company diversify the risks posed by being in a single market. Doing so may also help the parent lower total operating costs and require fewer resources. But, there are also times when such a company grows too large and loses efficiency. To deal with this, the conglomerate may divest. This is known as the conglomerate "curse of bigness."

There are many different types of more specialized conglomerates today, ranging from manufacturing to media to food. A media conglomerate may start out owning several newspapers, then purchase television and radio stations and book publishing companies. A food conglomerate may start by selling potato chips. The company may decide to diversify, buy a soda pop company, and then expand by purchasing other companies that make different food products.

Conglomeration is the term that describes the process by which a conglomerate is created when a parent company begins to acquire subsidiaries.

How Conglomerates Come to Exist

Companies can become conglomerates can be created in a variety of ways, and sometimes in a combination of ways.

Acquisitions

The most common way is via acquisitions: simply buying other companies. If a target firm is big enough, it might not become a mere subsidiary; instead, it and the acquiring company might actually merge, combining their talent, assets, resources, and personnel into one new legal entity. A conglomerate merger occurred when The Walt Disney Company merged with the American Broadcasting Company (ABC) in 1995, for example.

Expansions

Another approach is that of organic expansion. This strategy is more of corporate restructuring and reorganization, and sometimes the creation of a parent company to own various smaller ones. For example, in 2015, Google Inc. restructured. The corporate parent became known as Alphabet, and Google became a separate subsidiary within it, in a move intended to separate the company's core business—the well-known search engine—from a rapidly increasing array of other business ventures Alphabet was developing or acquiring.

Extensions

Yet another approach is that of an expansion of a family business or a historic, one-sector business into new industries or areas. Berkshire Hathaway (see "Real-World Examples of Conglomerates" below) can be considered an example of this. The company sprang from two 19th-century Massachusetts cotton mills that merged in 1955. When Warren Buffett gained control of it in 1965, he took it out of the textile business and turned Berkshire Hathaway into a holding company—one that existed to invest in other businesses, rather than manufacture products or provide services on its own.

Of course, there can be overlap among these approaches, and some conglomerates are the result of all three. Case in point: Moët Hennessy Louis Vuitton (LVMUY), commonly referred to as LVMH. This French luxury conglomerate began as a family business in 1854—a luggage and other leather goods maker named Louis Vuitton, after its founder. LVMH came into being over a century later, the result of a merger between Vuitton and wine/spirits company, Moët Hennessy.

LVMH itself acts as the holding company for 75 different subsidiaries, or "houses" as it calls them, in six different sectors. The original Louis Vuitton, Moët & Chandon, and Hennessy (the latter two owned by Moët Hennessy) are three of those houses. Most of the others LVMH has bought, and while they all tend to be producers of upscale, discretionary consumer goods, their fields range from jewelry (Tiffany & Co.) and cosmetics (Givenchy Parfums) to publications (Le Parisien) and designer clothing (Fendi).

Benefits of Conglomerates

For the management team of a conglomerate, a wide array of companies in different industries can be a real boon for their bottom line. Poorly performing companies or industries can be offset by other sectors and cyclical companies can be balanced by counter-cyclical or non-cyclicals. By participating in several unrelated businesses, the parent corporation is able to reduce costs by utilizing fewer inputs that may be shared across subsidiaries, and by diversifying business interests. As a result, the risks inherent in operating in a single market are mitigated.

In addition, companies owned by conglomerates have access to internal capital markets, enabling greater ability to grow as a company. A conglomerate can allocate capital for one of their companies if external capital markets aren’t offering as kind terms the company wants. One additional advantage of conglomeration is that it can provide immunity from the takeover of the parent company as it grows ever larger.

Disadvantages of Conglomerates

Economists have discovered that the size of conglomerates can hurt the value of their stock, a phenomenon known as the conglomerate discount. The sum of the values of the individual companies held by a conglomerate tends to be greater than the value of the conglomerate's stock by anywhere from 13% to 15%. 

History has shown that conglomerates can become so vastly diversified and complicated that they grow too challenging to manage efficiently. Layers of management add to the overhead of their businesses, and depending on how wide-ranging a conglomerate's interests are, management's attention can be drawn thin.

The financial health of a conglomerate is difficult to discern by investors, analysts, and regulators because the numbers are usually announced in a group, making it hard to discern the performance of any individual company held by a conglomerate. This lack of transparency may also dissuade some investors. Since the height of their popularity between the 1960s and the 1980s, many conglomerates have reduced the number of businesses under their management to a few choice subsidiaries through divestiture and spinoffs.

Examples of Conglomerates

Warren Buffet's Berkshire Hathaway (BRK.A) is a well-known conglomerate that has successfully managed companies involved in everything from plane manufacturing and textiles to insurance and real estate. Berkshire is well-respected and has become one of the world's largest and most influential companies. Buffet's approach is to manage the capital allocation and allow companies near-total discretion when managing the operations of their own business. Berkshire Hathaway has a majority stake in over 50 companies and minority holdings in dozens more. Still, the company has only a small headquarters office staffed with a relatively small number of people.

Another example is General Electric (GE). Initially founded by renowned inventor Thomas Edison as an electronics company and innovation lab, the company has expanded to own firms working in energy, real estate, finance, media, and healthcare. The company comprises several distinct arms that operate independently but are all interlinked. This inter-linkage lends itself to GE's initial mandate of extensive research and development (R&D) on technologies that can be applied to a broad range of products.

Conglomerates in the 1960s

The first significant conglomerate boom occurred in the 1960s, and these early conglomerates were initially deemed to be overvalued by the market. Low-interest rates at the time made it, so leveraged buyouts were easier for managers of big companies to justify because the money came relatively cheap. As long as company profits were more than the interest needing to be paid on loans, the conglomerate could be ensured a return on investment (ROI). Banks and capital markets were willing to lend companies money for these buyouts because they were generally seen as safe investments.

At the same time, the theory of synergy was becoming fashionable in business management and economic circles: the idea that the cross-combining of companies, products, and markets can enhance efficiency and profitability. This the-whole-is-greater-than-the-sum-of-its-parts concept helped justify mergers and acquisitions, even if the target firms were pretty far from the parent company's core business.

This optimism kept stock prices high and allowed companies to guarantee loans. The glow wore off of big conglomerates as interest rates were adjusted as a response to steadily rising inflation that ended up peaking in 1980.

It also became clear that the purchased companies weren't necessarily improving their performance, which disproved the popularly held idea that they would become more efficient after being acquired. In fact, mismanaged and misunderstood by the parent, they often performed worse and dragged down the entire corporation's bottom line. So much for synergy. In response to falling profits, the majority of conglomerates began divesting the companies they bought, downsizing and returning to their core businesses. A few continued on as shell corporations.

Foreign Conglomerates

Conglomerate companies take on slightly different forms in different countries. 

Japan’s conglomerate is called keiretsu, where companies own small shares in one another and are centered around a core bank. In some ways, this business structure is a defensive one, protecting companies from wild rises and falls in the stock market and hostile takeovers. Mitsubishi is an excellent example of a company engaged in a Keiretsu model.

Korea’s corollary when it comes to conglomerates is called chaebol, a type of family-owned company where the position of president is inherited by family members, who ultimately have more control over the company than shareholders or members of the board. Well-known Chaebol companies include Samsung, Hyundai, and LG.