Tech Firms Become Conglomerates ... Unsuccessfully

My colleague Michael Hickins wrote an illuminating post yesterday about big business ignoring Cisco’s united computing system, which is supposed to be a data center platform that could rival those of IBM and HP. That got me thinking about a number of news items and thoughts that have been kicking around, with tech vendors missing big success in all sorts of “additional” business lines. Once again I find myself wondering whether a major mistake companies are making is diversification. Not in avoiding the strategy, but in going about it the wrong way? If you watch business history, you see similar themes reoccurring over time. The current flailing about by so many tech vendors smells a lot like the conglomeration fiasco of a few decades past.

Last year I wrote about e-conglomeration, or the trend of such companies as Google, Amazon, and Microsoft to enter wildly divergent areas of business. I’ll repeat something from that post.

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.

Clearly not all of this is a fit. For example, many of the current tech corporate powers have exceptionally strong balance sheets, with lots of cash in the bank and a reasonable amount of debt. Many are handsomely profitable.

But consider some of the other points. Many big tech companies match the characteristics. And, the most important one, is that plenty either have or are jumping into a range of businesses that are outside their core experiences:

• As Michael pointed out, Cisco’s UCS is an attempt to get into the server space has not taken off strongly — not surprising, given that it is attempting to enter an already crowded and consolidated field.
• Cisco also bought Pure Digital Technologies, maker of the Flip video camera, for $590 million. Networking for the home? Maybe. Video conferencing as a network service? Maybe. Consumer video camera? Uh … no.
• Microsoft finally beat a sluggish retreat from the personal finance software market, which makes you wonder if, when all was said and done, given their market share, whether they made a reasonable return for the total corporate cost of the investment.
• Oracle decided to buy Sun. Although I still think the strategy has potential strength, it is still an example of a company going far afield, from software to hardware. The channel, support, cost, and sales issues are quite different.
• Amazon has gone into cloud computing, trying to leverage the large and expensive infrastructure it had to build for its main line of business. It might seem like a natural until you realize that being a mass retailer and providing hosted computing services to large corporations have virtually nothing in common, other than some physical/virtual tools.
• EMC is pushing to get into the home storage market. Well, at least it’s storage, but getting to consumers is a far different set of channel issues and a significantly different financial model.
• Google’s push into the apps market is hardly a natural extension of its core expertise of ad-supported search. (And apparently, according to one commenter on a thread of Michael’s, the enterprise support, critical to this sort of offering, ”sucks”, and the offerings are “99% betas”.)

I’d argue that each of these moves — whether it pans out or not – is an example of strategically questionable radical business diversification. And I’d argue that all of them have a few characteristics in common:

1. They require investment of time and energy in a significantly different type of business.
2. By entering new markets, the initiatives force the companies to develop new skills and new organizations that can deal with a different set of design issues, customer requirements and preferences, and support and service delivery issues.
3. Because of the change needed in internal abilities, focus, and market knowledge, each is to some significant degree or other a gamble. And they can leave you scratching your head.
4. Some of the product or service areas may generate relatively significant revenue and appear successful. But business extensions aren’t autonomous and must work within corporate strategy and managerial focus, or there is a cost to the overall corporation.

Certainly some conglomerates worked. Look at General Electric and Berkshire-Hathaway. However, most have vanished. And even a GE regularly drops entire lines of business because they are not a true fit for the company. (Jack Welch divested 117 business units in his first four years, or about 20 percent of the company’s assets.)

To the degree that there are some scary similarities between the tech e-conglomerates and the older conglomerates, it might be well for executives to remember some other characteristics that Rozeff mentions:

• They pay big premiums over market value. (Can you say Web 2.0?)
• The economies of scale that formed the raison d’être of the conglomerate were often impossible to achieve because of the premiums paid.
• Company heads were building personal empires, because they were paid based on the revenue they managed.
• A rising stock market (or apparent total revenue) make many strategies look intelligent because the damage is masked.
• Management with experience in one industry didn’t necessarily know how to intelligently run a company in another.

Eventually investors wrote down the value of the stocks in a bear market. Given that we are in one again, perhaps it’s time for tech executives to reflect on whether their grand plans actually build stronger companies with more value for investors, or simply assemble houses of cards ready to topple, no matter how grand they look.

Image via stock.xchng user CraigPJ, site standard license.