What are the advantages and disadvantages of conglomerates?
One of the most significant advantages of forming a conglomerate is risk diversification. Companies that only operate in one industry are very vulnerable. If demand drops in that industry, there is little the company can do to grow.
However, a diversified conglomerate can weather a bad period in a single industry, since it relies on multiple areas for its income.
Conglomerates can also increase profits by reducing redundant positions. In some cases, subsidiaries can share resources, and reduce the number of jobs they need in-house to meet their needs.
Another advantage is that conglomerates can redirect profits from profitable companies to others that are less profitable or need capital for expansion or growth.
In a similar vein, the profits from a conglomerate can be used to expand the conglomerate. Since the holding company can leverage the assets of all its subsidiaries, it can get larger loans and purchase larger companies. Any of the subsidiaries on their own would typically not be able to make acquisitions as significant as those that the holding company can.
However, there are downsides to conglomerates. One problem that tends to grow larger as a conglomerate adds new businesses to its portfolio is the risk of being spread too thin. If the senior management cannot successfully focus on all its businesses, then some of the subsidiaries can suffer.
Conglomerates also run the risk of antitrust action. Antitrust action is a form of regulatory enforcement by the government to promote competitiveness in an industry. If the government determines that a company is behaving in an anti-competitive way, the government may impose monetary penalties, prevent a company from providing certain products or services, or even break the company up into smaller companies.
If a conglomerate become dominant in one of the industries in which it operates, antitrust action becomes even more likely.
Conglomerates are also associated with leveraged purchases. Holding companies use the assets they already own as leverage to get a loan to purchase new companies. Consequently, acquisitions that don’t turn out to be profitable can quickly put a conglomerate on shaky footing. If the newly purchased company doesn’t produce enough income, the debt acquired by the conglomerate to purchase the company can hurt the company’s bottom line.