A Brief History of Conglomerates

Dealbreaker.com just linked to this this outstanding piece by Michael Rozeff, a finance professor at the University at Buffalo. In it, Rozeff traces the history of the conglomerate corporate form from it's heyday in the 60s to its' subsequent decline in the 80s.

If you're a student of finance or management, it's a must read. Professor Rozeff outlines some of the reasons that were given at the time (and still are) for why buying and combining unrelated companies might possibly create shareholder value. These include:

• Debt capacity
• Economies of scale/synergies
• Cost savings
  
• Internal capital markets (managers could allocate capital from division to divisionTthe managers of)
• Lower risk through diversification
  

He then promptly shoots the arguments thoroughly full of holes one by one.

You can read the whole thing here.

I know of one professor already (a new colleague of mine with the office two doors down) who'll be giving it to his advanced corporate finance class next semester before covering acquisitions and restructuring.

The piece is worth reading for a couple of reasons: It's always good to look at a longer span of time than just the last few years. History tends to repeat itself, and those who don't learn from its lessons get to enjoy them all over again. It's also interesting to see how conglomeratization led to deconglomeratization and to the eventual rise of private equity (at least the LBO variety). Finally, it's always good to remind ourselves that today's hot idea becomes tomorrow' lecture on failed ideas. As Rozeff puts so well,

It suggests that nothing in business is a slam-dunk. How to lower costs will never be reduced to a formula found in a book. How to create incentives that motivate managers and employees to work together is an open book. The opportunities to finance enterprises in the internet world will produce many innovations. The ways in which companies produce and market products will evolve in unexpected ways. Entrepreneurs will continue to experiment with organizational forms in order to find the most efficient forms. The issue of how to organize human business activity will remain very subtle, involving information, valuation, agency costs, business operations, etc. What is inside a firm and what is outside a firm, where market prices stop and where they start are open matters. One wonders what a firm is. However firms evolve, those of us who made our first forays into the stock market in the sixties will fondly remember the almost daily excitement of a new conglomerate acquisition.

HT: Going Private