Conglomerates Are Broken
In September 1967 the cover of Time magazine featured a grinning portrait of industrialist Harold Geneen underneath a banner headline declaring, “CONGLOMERATES: The New Business Giants.” It seemed appropriate for the era. During the ’60s, Geneen had used hundreds of acquisitions to build International Telephone & Telegraph Corp. into a dizzying collection of businesses—everything from Wonder Bread to Sheraton Hotels & Resorts to timberland giant Rayonier Inc., one of the largest private landowners in the U.S. ITT’s constituent parts had little in common beyond their parent. But after being heralded as the cutting-edge model of American business, the giant shrank. Over the next few decades, a series of splits and sales whittled away most traces of ITT, leaving what is today a smallish manufacturer of industrial and aerospace parts.
To Jerry Davis, a business professor at the University of Michigan who studies corporate organization, the decline of ITT wasn’t an anomaly. Conglomerates—aka multi-industry companies or business groups, if you prefer—once provided efficiencies that investors couldn’t get from unsophisticated capital markets. Sprawling outfits such as ITT, Litton Industries Inc., and Ling-Temco-Vought Inc. essentially operated partly as actively managed mutual funds and partly as private equity shops in an age before concepts such as “synergy” and “competitive advantage” chipped away at their raison d’être. Once investors started to question whether deal-savvy managers truly could manage everything from soup to nuts, their fall was swift. “We loved them in the ’60s and ’70s,” Davis says, “and then we hated them.”
General Electric Co. is belatedly learning that lesson. The quintessential American conglomerate was supposed to be the one that proved the expansive business structure could really work. The company that traces its history to Thomas Edison changed domestic life in the 20th century with the electric lamp and toaster, and formed the industrial backbone for America’s growth into a global superpower with its jet engines and power plants. Jack Welch, its sharp-penciled chief executive officer in the ’80s and ’90s, who became arguably the country’s most admired management guru, gave the myth of the conglomerate even more credibility when he built one of the nation’s largest financial-services companies alongside GE’s manufacturing operations.
That highflying reputation has come crashing down: GE’s stock price has fallen by half since December 2016, the company is considering ditching key units such as lighting and locomotives, and the U.S. Securities and Exchange Commission is investigating its past accounting practices. At the very least, GE seems headed for a dramatic reshaping, and its days as a megaconglomerate appear numbered.
GE isn’t the only outfit still sporting the conglomerate tag. There are industrial holdovers such as United Technologies Corp. and Honeywell International Inc., which were never as expansive as GE—and are often mentioned as candidates for breakups. The Digital Age also has emerging conglomerates such as Amazon.com Inc. and Alphabet Inc. (Berkshire Hathaway Inc. is often called a conglomerate, but it’s more akin to a holding company of independent businesses.)
The model still has particular resonance overseas—think India’s Tata Group, whose operations span from steel to hotels to beverages. Harvard Business School professors Tarun Khanna and Krishna Palepu proposed in 2010 an “institutional voids” theory—that the size and resources of multi-industry companies can make up for emerging markets’ lack of high-quality institutions. After all, someone needs to facilitate business transactions and relay market information—a role American conglomerates filled in the ’60s.
In the U.S., investors can still get behind a conglomerate: All it takes is a name. To Wall Street, Amazon’s Jeff Bezos can do no wrong. Ditto for Warren Buffett. “There’s nothing wrong with conglomerates in and of themselves,” says Richard Cook, a fund manager in Birmingham, Ala., who’s been a longtime investor in Buffett’s Berkshire Hathaway. “It’s just unusual to find a CEO with the skill set necessary to run one.”
Indeed, part of GE’s success was investors’ unshakable faith in Welch, who seemed to hit quarterly numbers like clockwork. The model faltered under successor Jeffrey Immelt, particularly after the 2008 financial crisis exposed the risk in the increasingly bloated financial operations Welch had built. Immelt tried to reinvent GE again—as a digital company—but his luck was running out. He stepped down in mid-2017 under pressure from shareholders.
New CEO John Flannery has tried to right the ship by cutting costs and changing management, but it hasn’t worked: The stock fell 45 percent last year, even as the broader market hit record highs. With few options left, Flannery said he’d consider a once-unthinkable breakup of the company. He’s already shedding $20 billion in assets and could separate the remaining businesses into publicly traded companies. “The question is not, Why is GE possibly being split up now,” says Davis, “but, Why did it take so damn long?”
There was a time when it made sense for a company simply to buy the earnings of another, as a low-cost way to grow in an era of low interest rates. The conglomerate structure also let companies smooth out earnings among volatile industries. For GE, another justification was its ability to turn out world-class leaders. At its legendary Crotonville, N.Y., management training center, promising executives endured boot camps to learn how to lead large organizations, honing skills that were widely applicable whether they ran a business making microwaves or trains or TV shows. Its graduates and other GE veterans went on to run major companies including Boeing, Honeywell, and Home Depot.
Today, many corporations have their own management training programs. But more significantly, questions have emerged over the universality of leadership skills. Is knowing how to structure an organization and read a balance sheet enough reason to put, say, a retail CEO in charge of an aerospace manufacturer instead of someone who’s spent his entire career in the field?
Technological change and the increasing specialization of businesses make it harder for executives schooled in general management to effectively allocate resources, says Paul Elie, chief of U.S. industrial deals for consultant PwC. “We’re seeing management teams really evaluate what their core strengths are and where they think they can really generate a return on their capital,” he says. “It’s very difficult to do that across a vast portfolio of businesses.”
Investors are asking if GE’s problems were exacerbated by sprawl, letting small issues grow unnoticed. If so, maybe a breakup is needed. Some investors seem to think so: When Flannery said on a recent conference call that “there will be a GE in the future, but it will look different than it does today,” the stock price surged 6 percent within minutes.
GE no doubt will continue to exist in some form. The question is whether it will exist the way ITT still does. “The conglomerate is dead,” says Michael Useem, a management professor at the University of Pennsylvania’s Wharton School. “Long live the conglomerate.” —With Noah Buhayar and Thomas Black