E-Conglomerates: Smart Strategy or Future Problem?

Tinker Toy ComputerIf you wait long enough, not only does history repeat itself in broad brushes and themes, but even through specific crazes. Lately I've been noticing one business fashion, conglomeration, which seems to be returning in a new form: the e-conglomerate.

An e-conglomerate is a high tech company whose lines of business move increasingly further afield of each other. Microsoft makes money with desktop operating system, server, and office productivity software -- and loses it in the online and entertainment/gaming divisions.

Amazon makes 97.4 percent of its net sales from media, electronics, and other general merchandise. And yet, the company is investigating other arenas, such as becoming an online payment service provider for other companies, selling its own hardware in the form of the Kindle e-book reader, offering a marketplace for outsourcing software development, and cloud-computing services. Amazon doesn't provide as clear a break-out of its income as Microsoft, in terms of investors understanding exactly the return on the range of ventures, but that's one wide range of activities.

Then there's Google, with search engines and advertising, mobile phone design (that doesn't seem to be impress much of anyone), user productivity software, enterprise software, rumored efforts in creating at some level its own media content, and clean energy technologies. The company does say that it devotes 70 percent of its resources to search and advertising, 20 percent to "related businesses" that include the apps, and ten percent to "areas that are farther afield but have huge potential, such as Android," though no hint on how revenue breaks out by operating segment.

Traditionally, high tech companies haven't been shy about diversification. HP has enterprise storage, services, software, personal systems, imaging and printing, and financial services. IBM might have been the prototypical e-conglomerate, before Lou Gerstner started to change the focus to services and the company began to shed many of its non-core activities.

But Google, Amazon, and Microsoft are all examples of companies with wildly diverging sets of businesses that might have been more noticeable if they weren't largely home-grown, or acquired at very early stages. The reason to call them e-conglomerates is to avoid high tech's general lack of business memory, which can lead to needlessly repeating the mistakes of others.

The original conglomerates were all the rage in the 1950s and 60s, as University of Buffalo finance professor Michael Rozeff notes, with a single corporation owning dozens of separate companies whose markets and operations had nothing to do with one another. By and large, they had a number of common characteristics:

  • They sold at premiums;
  • Operations were not particularly profitable or safe;
  • They carried more debt than the average company;
  • They seemed over-valued;
  • Analysts had difficult times understanding the wildly diverse operations;
  • They were "glamorous";
  • The men -- they were all white men at the time -- running them were broadly admired in business, though today few remember them.
A conglomerate could literally have interests in movies, book publishing, mining, auto parts, clothing, financial services, agricultural products, and home furnishings -- and in fact, that's pretty much exactly what the former Gulf and Western had.

In the 1970s, the stock market ceased to treat these behemoths as kindly. Although conglomeration allows a company to grow quickly, it is inherently inefficient. Running one company well -- let alone 20, 30, or 40 -- is difficult.

The corporations had compensation plans that benefited individual units but failed to optimize overall results. There was little to no economy of scale because the various entities were largely independent of one another. No one could effectively integrate all the accounting and operational systems, so getting the necessary information to manage the overall business coherently was impossible. Politics, not cold examination of finances, governed internal distribution of capital. As management turned over, corporations realized that they could make even more money by breaking things up again, and so they did.

Shunning a direction because it didn't work in the past is short-sighted; there might be an important difference in the current situation. However, to ignore history, as we've all heard, is chance repeating it. Consider some of the characteristics our e-conglomerates share with their predecessors:

  • Stocks that often demand premium pricing;
  • Many operations provide no profit, just vague promise;
  • Operations require teams of industry analysts to adequately understand;
  • They are "glamorous" (well, Google and Amazon are).
E-conglomeration is possible because the technology needs of so many business areas are similar, lowering the cost of adding a new one. However, the markets, customers, needs, and practices can completely differ. Just as the dot-coms failed to redefine the basic rules of business, e-conglomerates are not necessarily good for business and shareholders.

Money isn't the issue so much as distraction. Softening management focus, politics and bureaucracy, and an unproven assumption of competency in new areas causes poor forecasting and planning. I think Microsoft has demonstrated these signs for some time, and Google and Amazon are beginning to as well. Because these companies are so respected, there's a good chance that others, emulating them, could also start to diversify beyond their ability to control the results. At such times, there's nothing like a little dose of historic reality to remind us all that the most important rule of success is keeping your nose to that same grindstone.

Tinker toy computer image (c) 2000 Erik Sherman, all rights reserved.