An RBV Approach to Conglomerate Diversification
| Peter Klein |
The resource-based view of the firm has spawned a vast literature on corporate diversification. Inspired by Penrose (1959) and Rumelt (1974), this literature has emphasized the benefits of related diversification over expansion into industries that are not good fits for the firm’s current portfolio of resources. Unrelated or conglomerate diversification is typically viewed, within the RBV, as an anomaly, either a mistake (as in the conglomerate merger wave of the 1960s) or pure luck (those few conglomerates, such as GE, that are consistently high performers). Of course, relatedness is difficult to define and measure consistently, and the kinds of relatedness that presumably matter for firm performance are not captured well by conventional measures of inter-industry relatedness (see this paper for details). There is evidence that conglomerate diversification can add value by creating internal capital markets (see here and here), but this approach has little to do with resources and capabilities.
John Matsusaka’s “Corporate Diversification, Value Maximization, and Organizational Capabilities” (Journal of Business, 2001) develops a model in which firm capabilities are unknown ex ante, but must be discovered over time as entrepreneurs experiment with different combinations of business units. Hence in a cross-sectional analysis diversified firms may appear to underperform more focused firms, but the unrelated diversification is a necessary step toward the discovery of future capabilities, and is thus value creating.
Now comes a new paper by Oliver Gottschalg, “What Does It Take to Be a Good Parent? Opening the Black Box of Value Creation in the Unrelated Multibusiness Firm,” arguing that unrelated diversification may occur when firms possess excess capacity in “headquarter services.” The conglomerate’s central office, like a consulting firm, provides specialized support and advising services to its portfolio companies, creating value even when there are no operational synergies among the operating units. Gottschalg applies the theory to a sample of European LBO associations, viewing them as “private conglomerates” to which the same principles apply. An advantage of using LBO associations is that they are typically forbidden (by the terms of their debt covenants) from reallocating cash flows among portfolio companies, so the findings cannot be driven by internal capital markets. Gottschalg finds some support for the hypothesis that conglomeration adds value when the parent possesses specific headquarter resources that the target company lacks. These resources are measured using survey data on the parent and target firms’ expertise in operations, finance, management recruiting, and strategy. (The dependent variable, firm performance, was also measured subjectively.) Worth a read. (And thanks to John Chapman for the pointer.)