Are conglomerates still in style?

M.A.P. Insights
Jamil Paolo Francisco

Posted on March 01, 2016

In the early 1990s, when Serge Pun decided that the time had come to invest in his home country, Myanmar, he came armed with years of experience in doing real estate in Hong Kong, Thailand, China, and Malaysia.

But the business environment in Myanmar, having just recently opened up to private sector investment, was very different from the dynamic emerging markets he had previously operated in. His premier real estate development in Yangon was the first gated community in the capital. The exclusive village promised first class amenities and infrastructure, providing an oasis for expats and foreign diplomats making their way into Southeast Asia’s last frontier.

Early into the project, however, he realized that a basic but crucial service demanded by his exclusive village was not available in the young economy: security.

To plug the gap, Pun set up his own security agency. Shortly after, new office buildings, private factories, and embassies were seeking their services. To fill similar voids that undermined his real estate business, Pun soon invested in construction, landscaping, property management, and eventually ventured into banking, luxury tourism, and high-end retail, undoubtedly providing a strong competitive advantage for Pun’s Yoma Strategic Holdings from the synergies formed across subsidiaries.

Pun’s experience in Myanmar is simply a recent version of the same old story of how a conglomerate is born.

Business and economics literature typically explain the growth and success of conglomerates or heavily diversified business groups, as a second-best optimum where institutional voids or business/consumer needs gaps exist. Harvard Business School’s Tarun Khanna thinks that conglomerates in developing countries have thrived because businesses have needed to compensate for the underdeveloped nature of the local market.

But across the world, conglomerates continue to thrive even in relatively developed economies, particularly in Asia.

The Korean chaebols are of course the favorite example. According to McKinsey, conglomerates made up 80% of the largest 50 companies by revenue in Korea over the last decade to 2014, and their revenues grew by 11% per year on average.

This question had been asked before.

Are conglomerates a transient, second-best phenomenon that would or perhaps “should” grow obsolete as markets mature and institutions develop, or are they a sustainable, competitive business model? But this question is relevant once again as businesses and governments in our region ready themselves for the new normal of a single market and production base across the ASEAN Economic Community (AEC).

Is the conglomerate model a viable source of competitive advantage for local companies ambitious enough to go regional?

At AIM, we looked at the experiences of 58 top-performing companies based within ASEAN that enjoyed remarkable success in their local domains for years, even decades, in terms of sustaining growth and generating stockholder value.

Our selection process was particularly stringent as we incorporated multiple criteria of financial performance, market leadership, and expert opinion. All champion firms on our list had outperformed the average publicly listed company in their home country for the most number of years since 2001.

The strategies of these ASEAN Champions, as we collectively call them, are the subject of a forthcoming book of the same title. A key finding is that these ASEAN champions have had to quickly, creatively, and many times riskily, mobilize human, financial, and technological resources to provide solutions to institutional voids and market gaps that characterized most ASEAN economies.

As these champions ventured into their original lines of business, many of them soon encountered hurdles in an environment replete with market failures -- fragmented legal and regulatory frameworks, information asymmetry, inadequate physical and social infrastructure, costly financing, substandard support services, and a lack of technical expertise and managerial talent. The prevalence of these market failures kept transaction costs high, making some firms adopt a conglomerate strategy to take advantage of synergy across related activities while also spreading the risks of operating in a volatile and uncertain business environment across a diversified investment portfolio.

We define a conglomerate as a group of companies that operate in two or more unrelated industries based on the United Nations International Standard Industry Classification. Thirty of our 58 champions are part of conglomerates, supporting the notion of conglomerate success being an emerging market phenomenon.

Is the conglomerate strategy therefore key to high performance in Southeast Asia? We compared the number of years that conglomerate-affiliated and non-conglomerate-affiliated champions outperformed the average performance of publicly listed corporations in every ASEAN economy. We find that conglomerate-affiliated firms did not perform any better than non-conglomerate-affiliated ones in terms of return on assets. In terms of growth, non-conglomerate firms actually outperformed the average firm more often than their conglomerate-affiliated peers.

We also looked at the 12 top-performing firms among the champions also based on the number of years they had outperformed the average publicly listed company.

Only three of them were parts of conglomerates, although it must be noted majority of the 12 top-performing champions were in the extractive and real estate industries, both of which enjoyed industry-wide gains in the years before the global crisis of 2007 and 2008.

Although inconclusive, these results seem to suggest that conglomerates no longer have a comparative advantage over non-conglomerates with regard to sustained growth and profitability in their individual home economies across ASEAN.

As domestic institutions improve, infrastructure expands, barriers to entry disappear, and support systems emerge, transaction costs fall, and independent firms are able to compete directly with conglomerates, which begin to lose their advantages in an increasingly more competitive and mature market. But does the conglomerate model perhaps continue to provide a competitive advantage in the context of regional integration and pioneering business activities in the new single market and production base of the AEC? Out of 58 champion firms, only five are present in at least five other ASEAN economies. Among them, four are parts of conglomerates. The financial, operational, and organizational synergies that equipped conglomerate firms and their subsidiaries with a strong competitive advantage in their young domestic markets may prove useful once again as they venture into the greater regional market.

The “deep pockets of internal capital markets” described by Xavier Boutin of the European Commission that French business groups use to fend off foreign competitors or to penetrate new markets is something that ambitious ASEAN champion firms may also take full advantage of as they go regional. Firms seeking to establish themselves across ten integrated yet very different ASEAN economies will want to harness the benefits of scale and scope across business lines. Organizations seeking to harness the potential of ten widely diverse markets will want to learn through similar diverse offerings and structures.

Perhaps the days of the Asian conglomerate are yet to pass. Regional integration will put the model to the test.

(The article reflects the personal opinion of the authors and does not reflect the official stand of the Management Association of the Philippines or the M.A.P.)

Jamil Paolo Francisco is Associate Professor of Economics at the Asian Institute of Management or AIM, and Executive Director of the AIM Rizalino S. Navarro Policy Center for Competitiveness or AIM-RSN-PCC (formerly AIM Policy Center). His coauthor is Emmanuel Garcia, an Economist at the AIM-RSN-PCC.