When talking about business organisations, you must have often heard that there is usually one parent organisation that handles various small companies that operate separate businesses. This is often achieved by the parent company by holding considerable stakes in the small companies. This parent organisation or company is often referred to as a conglomerate. There are a number of reasons as to why corporations form conglomerates and these conglomerates have their own advantages as well as disadvantages. To understand these reasons and to get more familiar with the term, let us go through the basic concepts of the term Conglomerate.
What is a Conglomerate?
The term conglomerate refers to a corporation that runs several different and seemingly unrelated businesses. The basic concept behind a conglomerate is that one company or organisation controls various other small businesses that run separate businesses. The main company or parent organisation, as it is commonly called achieves this control by holding a controlling stake in these small companies.
The purpose behind the formation of a conglomerate is varied and the biggest conglomerates diversify the business risk by engaging in many different markets. There are also some conglomerates like mining that choose to participate in a single industry.
Conglomerates are essentially large companies that consist of individual entities that function in multiple industries. A lot of conglomerates are multi-industry corporations that have international operations. Every small business that the conglomerate controls, runs independently of the other businesses. However, all these small businesses or subsidiaries, as they are commonly called, report about all their business activities to the conglomerate or parent company.
The parent company in a conglomerate plays an essential part and it may reduce the risk in the business by taking part in various small businesses rather than sticking to a single market. This move also proves helpful for the holding company and helps it to reduce costs and consume fewer resources. One of the main reasons behind forming a conglomerate is that if a single company becomes too big, it may lead to inefficiency.
There are various types of conglomerates all around the globe including media, manufacturing, food and many more. All these are engaged in different business practices and gain through investing in different markets. A manufacturer, for instance, begins with manufacturing and selling goods and products. This company may then decide to enter some other market and start a different business industry like financing. A media conglomerate will generally start by owning newspapers and then go on to own television stations, radio stations and even book publishing industries. A food conglomerate can start its business as small as selling snacks or other basic food products and then go on to buying a large food company or soda pop company.
Why is a Conglomerate formed?
Now that we have seen the basic concept behind a conglomerate and how it works in the business industry, let us try to understand the reasons why a conglomerate is formed in the first place. There may be various reasons as to why a corporation decides to form a conglomerate. Some of these reasons are listed below:
- One of the main reasons for forming a conglomerate is to satisfy the desire to become involved in business which is different from the company’s main focus or main business operation.
- As already discussed above, another reason for the formation of a conglomerate is the desire to diversify in an effort to reduce risk in a business and with a goal that a loss in one business may be offsetted by the profits or gains in another business.
- A conglomerate can also be formed with a desire to transition a company towards a new area of business.
- The company or corporation may seek attractive revenues after the formation of the conglomerate, either historical or projected from the prospective subsidiary.
- A conglomerate is often formed as a protection against the risk associated with the subsidiary business.
Due to the above reasons, many large corporations have opted to form a conglomerate by holding a controlling stake in its subsidiary businesses. In a situation where a conglomerate owns less than a controlling percentage of another company’s voting stock, the second company can be referred to as an associate or an affiliate company.
Advantages and Disadvantages of a Conglomerate
As with any business corporation or business strategy, even conglomerates have their own advantages as well as disadvantages. These advantages and disadvantages are as follows:
Advantages of a Conglomerate
The following are the advantages of forming a conglomerate:
- As, one of the main features of a conglomerate is having a wide array of companies in different industries; this may prove to be beneficial for the main company as poorly performing companies and industries can be offset by other sectors or companies that are performing better and achieving large profits and gains.
- The act of participating in various small unrelated businesses by the parent company or organisation helps this parent organisation reduce costs by optimally using the resources and diversifying the business interests. This also reduces the risks that are associated with investing or operating in a single market.
- All the companies owned by the conglomerates can access the internal capital markets that enable a greater ability for the company’s growth. A conglomerate can mark capital of companies in case the external capital markets are not offering the terms that the company wants.
Disadvantages of a Conglomerate
Although we have seen a number of advantages that come with the formation of a conglomerate, it also comes with its share of disadvantages which the businesses should be aware of before making a decision about forming a conglomerate. The following are the disadvantages are as follows:
- The size of the conglomerate can hurt the stick value. This is a condition which is referred to as conglomerate discount.
- The total market value of the companies in a conglomerate is higher than the stock value of the conglomerate by 13% to 15%.
- Along with the above disadvantages, there are also some issues related to the financial transparency and management which makes the conglomerate stock valued at a discount.
Examples of Conglomerates based in India
Here is a well-known list of Conglomerates in India:
- Aditya Birla Group
- Hinduja Group
- ITC Limited
- JSW Group
- Bajaj Group
- Godrej Group
- United Breweries Group
- Tata Group
- Reliance Group
