Last November, three major conglomerates – General Electric, Johnson & Johnson, and Toshiba – all revealed plans to break themselves up in an effort to maximize shareholder value. They won’t be the last to do it.
Conglomerates are large parent companies made up of smaller business units that operate across multiple markets in an effort to diversify the risk of being in a single market. The financial health of a conglomerate is difficult to discern, as the parent company reports results on a consolidated basis. Recall the key role GE Capital played for many years as the catalyst for growth and profitability at General Electric.
Johnson & Johnson (J&J), the biggest pharmaceutical company in the U.S. based on market cap of $435 billion, announced its intent to break off its consumer health division in the next 18 to 24 months. J&J is the 36th largest company in the U.S. based on total revenue, according to the 2021 Fortune 500 list.
It will spin off its consumer business, which includes such brands as Band-Aid, Tylenol, Nicorette, and Neutrogena, into a new publicly traded company by November 2023. Its prescription drug and medical device businesses will continue to operate under its banner.
What is behind these break-ups? There is an argument that these firms have all become too diversified, complicated and grown too challenging to manage efficiently.
The recent history of all three has also been tumultuous. General Electric was nearly taken down during the financial meltdown in 2008. J&J is facing over 20,000 lawsuits related to claims that its baby powder causes cancer and for its role in the opioid crisis. The firm took a hit when the Centers for Disease Control and Prevention recommended that Americans not receive its COVID vaccine because of adverse side effects. Toshiba is still trying to recover from a massive 2015 accounting scandal.
A different approach for Amazon, Facebook, Microsoft and Apple
At first blush it would appear that the era of the conglomerate and the notion that brilliant management can successfully run businesses in varied industries is over. While traditional industrial corporate conglomerates may be pushing up daises, the success of tech giants such as Amazon, Facebook (parent Meta), Microsoft, Apple, and Alphabet as modern-day conglomerates should be noted.
These firms are not throwbacks to the traditional conglomerate model whose main purpose was to allocate financial capital across various businesses and rebalance the portfolio through acquisitions and divestments.
Take Amazon for example. While the company does not describe itself as a conglomerate, it operates online and brick-and-mortar retail stores, sells outsourced computing services, runs global logistics operation, produces movies, and the beat goes on.
These tech conglomerates do differ from traditional industrial conglomerates. They have created platforms that knit together and support the varied businesses. Put differently, the businesses in these companies rely on a common infrastructure to provide the unifying thread.
A platform is essentially a marketplace that connects the supply side and the demand side. Amazon links shoppers and sellers, producers and consumers in high value exchanges. The company enables Prime members to order Whole Food deliveries on the Amazon website.
The spectacular growth of these businesses has been explained by network effects. The value of a platform depends in large part on the number of users on either side of the exchange. The more users a platform has, the more attractive it becomes, leading even more people to use it. This allows business to scale up quickly and creates a competitive advantage. The tech companies are exploiting the power of platforms and the relatively low capital investment they require. These network effects are the driving force behind every successful platform.