Conglomerate

What is a Conglomerate?

A conglomerate is one very large corporation or company, composed of several combined companies, that is formed by either takeovers or mergers. In most cases, a conglomerate supplies a variety of goods and services that are not necessarily related to one another.

The newly-formed conglomerate becomes known as the parent company, while the smaller firms that compose it are known as subsidiaries. Each acts independently of one another but reports back to the management of the parent company.

Example of a Conglomerate

Berkshire Hathaway Inc. is a good example, being one of the largest conglomerates in the world. Formed through years of acquisitions and mergers, Berkshire Hathaway is responsible for the ownership of companies that provide utilities, retail goods, transportation, and other services, as well as the insurance and other financial services it is perhaps most well known for.

The Issue of Synergy

One of the primary arguments for the formation of conglomerates is something known as “synergy” – the combined energies of multiple companies coming together to produce independent goods and services under one parent company’s management.

A related reason for creating a conglomerate is the concept of diversification through the combination of two or more smaller firms, each independently producing its goods and services. The union allows the larger, newly formed parent company to diversify its product offering and therefore enables it, potentially, to reach new and wider consumer bases than each company could individually. Ultimately, it all comes down to productivity and revenue. Many shareholders are willing to bet on diversification to hedge their risk.

Inherent Vulnerability

The major potential drawback to conglomerates is the inherent vulnerability that stems from such wide exposure. When many diverse companies are producing goods and services, the danger of the conglomerate becoming spread too thin is a potential weak link that can bring the conglomerate down.

The ultimate responsibility ends up falling on the management team, making it essential for the team to be able to smartly manage all the various subsidiaries in a way that ultimately improves profitability for the whole enterprise.

Keys to Success

Every successful conglomerate – Berkshire Hathaway, General Electric, etc. – needs to master the art of bringing diverse companies together and establishing a form of cohesion that enables the group of companies to act as one successful entity that can wear multiple hats.

While cohesion can be brought about in many ways, one of the most solid ways to establish cohesion is to institute a set of operating standards and expectations that are the same for each smaller firm within the conglomerate. Because the exact production schedule, scale, specifics, and needs of each smaller firm are likely different from one another, this can be a difficult proposition. However, if certain aspects – such as the level of quality for both goods and services – is set at the same level for each firm, each can work to meet its independent needs as well as meeting the expectations of the parent company.

Conglomerates come with both risks and rewards. For some firms, the formation of a conglomerate enables them to stay afloat and increase profitability by being able to lean on the combined efforts and resources of multiple companies. For others, too much diversity proves to be a ticket to disaster. Finding the sweet spot that lies between a profitable addition or two and taking on too much to manage is what makes for a successful conglomerate.

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• Financial Synergy
• Horizontal Merger
• Mergers and Acquisitions M&A Process
• Vertical Integration
• See all valuation resources
• See all equities resources