The authors, who studied Indian business groups for five years, believe that the key to these organizations’ success is their structure. Unlike corporate divisions, a group’s affiliate companies are legally independent. That allows them to raise capital, set strategies, and create incentives more effectively. Affiliates don’t report directly to the leaders of the business group but are overseen by the group center, a management layer in the group chairperson’s office. It coordinates the identity work that unites and inspires affiliates’ employees, and helps affiliates spot and seize opportunities, share resources and talent, and collaborate on strategic activities. Business groups using this model are not only profitable; they also outperform other companies in their markets.
Conglomerates once dominated the U.S. business world. But by the 1980s, they’d been laid low by poor performance, inspiring the belief that focused corporations created more shareholder value. Today conglomerates are largely considered dinosaurs—except, that is, in emerging markets, where diversified business groups, comprising numerous unrelated enterprises, are flourishing.
Conglomerates may be regarded as dinosaurs in the developed world, but in emerging markets, diversified business groups continue to thrive. Despite the recent global economic slowdown, their sales rose rapidly during the past decade: by over 23% a year in China and India, and by 11% in South Korea. Business groups accounted for 45, 40, and 20 of the 50 biggest companies (excluding state-owned enterprises) in India, South Korea, and China, respectively, according to a recent McKinsey study.
They may be called different things in different countries—qiye jituan in China, business houses in India, grupos económicos in Latin America, chaebol in South Korea, and holdings in Turkey. But no matter where they are, business groups are becoming increasingly diversified. On average, they set up a new company every 18 months, more than half the time in a sector unrelated to their existing operations. Most of them are profitable. In India, they deliver above-average performance: Companies belonging to the largest Indian business groups generated higher returns on assets from 1997 to 2011 than the rest of the companies listed on the Bombay Stock Exchange, according to a study we conducted, and more than 60% of those groups generated better returns than a comparable portfolio of standalone companies did.
The success of the business group—a network of independent companies, held together by a core owner—in most emerging markets is remarkable for several reasons. First, it defies history. Conglomerates were all the rage in the United States and Europe for decades, but hardly two dozen of them survive there today. By the early 1980s, they had been laid low by their poor performance, which led to the idea that focused enterprises were better at creating shareholder value than diversified companies were. Most conglomerates shrank into smaller, more specialized entities.
The multidivisional company is the dominant structure for managing multiple business lines in the West today. But it, too, faces challenges. Pioneered by DuPont and General Motors in the 1920s, the divisional structure was supposed to improve the parent’s ability to deal with diversification. But the problems associated with the structure—extra layers of senior executives, opaque accounting, the inability of headquarters to cope with different businesses, and so on—have often made the whole less valuable than the sum of its parts. If that isn’t happening with business groups, they must be more effective in some way—and it’s important for executives to understand how.
Second, the unbridled expansion of business groups challenges the conventional wisdom that they have succeeded in developing countries mostly because they’ve been able to compensate for institutional voids there and, in the process, catalyzed their own growth. Since the early 1990s, however, economic reforms in those nations have led to the creation of new institutions modeled along Anglo-American lines: Legal infrastructures and corporate governance requirements have been strengthened, and sophisticated market intermediaries have emerged. Although institutional voids have contracted, and markets have become relatively more efficient, business groups haven’t imploded, suggesting that making up for institutional inadequacies may not be their only raison d’être.
Of course, countries take generations to develop efficient markets and institutions, so it may be too early to conclude that. However, business groups are neither a temporary phenomenon nor found only in developing countries; many, such as the Tata Group in India (which dates back to 1868), Jardine Matheson in Hong Kong (1832), Doosan in South Korea (1896), and Mitsubishi in Japan (1870), were born over a century ago.
Third, business groups in developing countries have grown mainly through diversification, even though U.S. investors believe that diversification destroys value. On Wall Street the typical conglomerate discount ranges from 6% to 12%. That makes the structural choices today rather stark: If a CEO can convince Wall Street that a new business relates to the current one, it can be accommodated in the form of a division. Otherwise, the CEO will be compelled to divest or let go of the opportunity, regardless of its promise, in order to retain the benefits of a focused enterprise. Not surprisingly, in recent times conglomerates such as Fortune Brands, ITT, McGraw-Hill, and Tyco have all broken up into more focused entities.
U.S. investors think diversification destroys value. On Wall Street the conglomerate discount ranges from 6% to 12%.
Business groups represent an alternative to this “divisionalize or divest” approach. We’ve done five years of research on them in India, and we’ve found that, because of the way they are structured, they can manage a portfolio of enterprises better than multidivisional companies can. Another major factor in their effectiveness, we’ve observed, is that their leaders have stopped relying on family members and associates to oversee companies and created a formal management layer, called the group center, which is organized around the office of the group chairperson. That mechanism is helping smart business groups spot more opportunities and capitalize on them while retaining their identity and values.
Two Ways to Structure Diversified Enterprises
The Multidivisional Company (M Form)
A listed parent company directly manages all the divisions.
The Business Group (G Form)
A holding company, often unlisted, holds equity stakes in several independently listed affiliates.
How Business Groups Are Different
Business groups are distinct from multidivisional organizations in two ways. One, unlike corporate divisions, the companies (or affiliates) of a business group are legally independent entities. The Tata Group, for instance, comprises around 100 listed and unlisted entities (some of which have more than one division). Each affiliate has a separate board of directors, is answerable to its own shareholders, raises capital from investors on its own, independently develops and executes strategies, and creates its own incentives for managers. To borrow a term that Anand Mahindra, the chairperson of India’s Mahindra Group, likes to use, a business group is a “federation” of companies.
Two, in business groups, there’s a high level of involvement between ownership and management. In some groups, the core owners, who may hold large equity interests in affiliate companies, directly participate in overseeing them—as CEOs, functional heads, or board members. An investment committee, composed of representatives of the core owner and the top management of the key affiliates, usually reviews and approves all major investment decisions of the group and its affiliates.
These features help business groups better navigate the challenges of operating diverse businesses in three critical areas:
In multidivisional organizations, the top management teams of divisions are empowered to make decisions—in theory. In practice, corporate headquarters casts a long shadow over divisional management. And that destroys value. Michael Goold, Andrew Campbell, and Marcus Alexander of the Ashridge Strategic Management Centre summed the reason up when they asked: “Why should the parent’s managers, in 10% of their time, be able to improve on the decisions being made by competent managers who are giving 100% of their efforts to the business?”
By contrast, the structure of a business group—especially the presence of separate boards of directors with distinct fiduciary responsibilities—affords the affiliates’ top management greater autonomy. The legal separation of each business also ensures that it’s affected less by the parent’s dominant logic than the divisions in a company would be.
While multidivisional organizations can base their incentives on the performance of each business, the task is not without challenges. After all, a single corporate entity can tolerate only so much variation in incentives. Moreover, it’s impossible to create a separate market-based measure of performance for each division.
Because each affiliate in a business group is legally independent, it has greater latitude to tailor its performance measurement systems to its distinctive needs. Its stock price also provides an accurate market-based measure of performance. The combination of greater autonomy in making decisions and more-appropriate rewards increases managers’ psychological ownership of the affiliates, inspiring greater entrepreneurship.
In a multidivisional structure, business divisions allocate capital more efficiently than external capital markets could, because their executives have better information. At the same time, divisions have only limited control over free cash flows; surplus cash usually flows to headquarters, which makes the call on redistributing it. This centralized system is susceptible to supply-and-demand mismatches, bureaucratic delays, and favoritism. In business groups, however, each affiliate retains the capital it raises and the cash it generates, largely mitigating those problems. Further, the affiliate can raise capital directly from the financial markets, which usually ensures better valuations.
In addition, membership in a business group provides access to the highly diverse resources of sister companies, and that allows affiliates to tap greater growth opportunities. Our statistical analysis of a large sample of Indian companies from 1994 to 2010 suggests that affiliates of the biggest business groups had greater access to business opportunities than standalone companies did. And the affiliates of more diversified groups had access to even more opportunities than those belonging to less diversified groups.
A group’s core owners often play a critical role in exploiting these opportunities. Because their associations with affiliates are long-term (whereas the average CEO tenure in the United States is now just six or seven years), they have a rich understanding of all the affiliates’ capabilities, knowledge, and assets. And their shareholdings give them the influence to coordinate those resources in novel combinations. For these reasons, business groups often spot—and seize—opportunities that multidivisional organizations can’t. (See the sidebar “How Tata’s Group Center Drove Cross-Business Innovation.”)
How Tata’s Group Center Drove Cross-Business Innovation
Although household water purifiers were widely available in India for many years, they were unaffordable to the poor, who didn’t have access to clean drinking water. Then in 2009, Tata Swach, a low-cost water purifier, was launched. The result of years of work among three Tata companies—TCS, Tata Chemicals, and the Titan Company—this purifier is based on natural ingredients and nanotechnology.
Tata Swach’s origins lie in research first carried out by TCS, a software services company. The company developed an early prototype but declared it unviable and not a fit with its software business, and shelved the project. In 2006, R. Gopalakrishnan, a senior member of Tata’s group executive office, stumbled across the prototype at TCS and became intrigued by it. He revived the project, suggesting that Tata Chemicals, with its expertise in chemical-processing technologies, take the lead. The chemical company and the software service provider started working together on it; later the group’s watchmaker, the Titan Company, which had developed precision engineering capabilities, joined in. Today Tata Swach provides potable water that meets the stringent standards of the U.S. Environmental Protection Agency at a cost of less than one paisa a person a day. But without the interventions of the group center, that collaboration among the three businesses would not have been possible, and Tata Swach would never have come to market.
Given these capabilities, it’s not surprising that the portfolio of most groups consists of many unrelated businesses. The Tata Group, for instance, comprises affiliates operating in a wide range of sectors including automotive, chemicals, communications, consumer products, energy, engineering services, financial services, hospitality, information technology, and steel. Similarly, the Aditya Birla Group comprises 56 companies running businesses as diverse as cement, textiles, telecommunications, financial services, and retailing.
The Role of the Group Center
Business groups may be positioned to pursue opportunities in unrelated industries, but the coordination of strategies across affiliates is still difficult. The affiliates’ legal independence, industry specialization, and autonomous resource allocation processes can set off centrifugal forces that reduce a group to little more than a portfolio of stocks. What’s more, the heads of groups don’t have the same hierarchical authority over affiliates that the CEOs of multidivisional firms do: Though the leaders of the affiliates do answer to the core owners, they don’t report to them; they report to their own boards of directors. In fact, group heads sometimes have to deal with affiliates that want to chart out destinies independent of the parent group.
Yet, as we have said, the unique value creation potential of business groups lies in coordinating the activities of affiliates. In India in particular, that task was traditionally handled by an inner circle of trusted managers and relied heavily on the group head’s personal charisma, as well as on complex holding structures, interlocking directorates, and informal mechanisms, such as family loyalties. However, the effectiveness and legitimacy of the informal coordination methods were constrained after the Indian economy opened up to local and foreign competition, and global corporate governance standards became the norm.
Several Indian groups imploded, but the progressive ones chose to increase their capacity to manage new businesses. As the policy environment became less restrictive, the owners shifted their role from helping their affiliates gain access to the corridors of government to helping them formulate strategic goals, build organizational capabilities, find resources, and achieve their growth aspirations. Over time, the process led to the development of the group center—a formal management layer at group headquarters.
Business Group Affiliates Outperform Other Enterprises
From 1997 to 2011, companies belonging to the 50 biggest Indian business groups had higher returns on assets than the rest of the corporations listed on the Bombay Stock Exchange.
In 1998, for instance, the Tata Group announced the creation of a group executive office that would strengthen its relationship with its affiliates and review strategy issues. Soon after, several groups, such as the Aditya Birla Group, the Murugappa Group, and the Mahindra Group, announced the formation of group centers that would explore synergies between businesses and forge strategic plans. The job of coordination in the business group has shifted to the group center, which acts as a centripetal counter to the forces of fragmentation.
How the Group Center Adds Value
To add value, group centers guide activities along two dimensions: strategy and identity.
The group center helps affiliate companies develop and reshape their strategic frames. From its vantage point, the group center can challenge the assumptions that affiliates hold and spur them to set their sights higher. Typically, the center drives a three-part agenda:
Sensing distant opportunities.
Most multidivisional companies find it tough to manage opportunities across varying time horizons; they often require different kinds of resources, mind-sets, skills, planning and budgeting systems, and performance measurement processes. Unlike multidivisional companies, though, business groups can create different systems for different horizons. When a group center identifies a promising nascent business, it can incubate that business in an affiliate, in a specialized entity, or by setting up a new company, where it won’t distract other affiliates from focusing on their existing businesses.
In the 1990s, Anand Mahindra asked a number of people at his headquarters to scout for opportunities beyond his group’s tractor and utility-vehicle businesses. Among the pitches he received was one for a time-share-based hospitality business. Back then, time shares in India were associated with shady operators and had a bad name. Mahindra sensed an opportunity to leverage his group’s impeccable reputation and invested some $5 million in the business. By 2012, Mahindra Holidays & Resorts had become the market leader, with a stock market valuation of over $500 million when it first went public. It has built a base of more than 150,000 members today, delivered high levels of service—and wiped away the sector’s unsavory image in the country.
Pursuing stretch opportunities.
Often the group center induces affiliates to look beyond their current environment and resources and develop more-audacious strategies. Because its executives work closely with decision makers across the group—sometimes as directors on boards, sometimes as mentors to the affiliates’ CEOs—they generally gain valuable expertise and experience in nonroutine events, such as M&A. By sharing those capabilities with affiliates, the group center can assist them in achieving ambitious goals.
In 2007, the Aditya Birla Group’s flagship, Hindalco, India’s largest integrated aluminum producer, bid for Atlanta-based Novelis, the world’s leading producer of rolled aluminum. Although it was not performing well, Novelis was four times the size of Hindalco, and many believed that the Indian company was overreaching. The bid had unqualified support, however, from the group center, which thought that the acquisition would give Hindalco global scale, a portfolio of premium products, and technological expertise. Hindalco eventually bought Novelis for $6 billion and turned it around. Executives at the group center played a crucial role in the cross-border acquisition and in teasing superior performance out of it. They deployed key personnel to integrate the American and Indian operations and help rework Hindalco’s strategic plans to take advantage of Novelis’s distinctive capabilities.
Executives in the group center played a key role in Hindalco’s $6 billion acquisition of Novelis and its integration and turnaround.
To ensure that affiliates are constantly thinking about stretch goals, the group center must engage with the affiliates’ teams on an ongoing basis. For instance, every major Tata company has a business review committee—made up of that affiliate’s top leaders and key members of the group center—that works with it to redraw its horizons.
Shepherding cross-business opportunities.
Some opportunities call for creative collaboration among affiliates. The group center can identify potential synergies that typically wouldn’t be apparent to individual affiliates and set up initiatives that foster the exchange of capabilities and ideas. The Tata Group Innovation Forum, for example, sponsors five innovation clusters in the areas of engineering, information technology, nanotechnology, plastics and composites, and water. These clusters bring together managers and experts from companies across the group to share research and technology road maps and identify joint innovation projects.
A business group’s brand, motto, reputation, and organizational identity are important sources of value. That’s why identity work—a lever for shaping the beliefs, perceptions, and motivations of customers, business partners, employees, and talent—is usually an integral part of the group center’s activities.
Because the affiliates are autonomous and have different aspirations, the center’s first challenge is to manage the presence of multiple identities. The creation of a robust and meaningful überidentity that can help executives “think like one group” is crucial to cohesion. The überidentity will lend stability and continuity to the group as the environment changes and provide the boundaries within which affiliates can articulate their individual identities. The Murugappa Group, for instance, has built a corporate brand around the core values of moderation and helping the community. The group believes that the brand has kept it in good stead even as it diversified away from its traditional businesses of manufacturing abrasives and bicycles to making fertilizers and pesticides and, more recently, providing financial services.
A second challenge is that the group’s intangible resources, particularly the parent brand, can be devalued by affiliates’ actions. Such problems can be prevented only if the intangibles have a guardian.
The group center’s identity work has three objectives:
The center must periodically rejuvenate the group identity and brand. Five years ago the Godrej Group embarked on a complete makeover of its corporate brand after research determined that consumers associated it with the image of a frumpy old woman. After studying the group’s heritage and key business lines, consultants helped articulate a unifying aspirational proposition—“Brighter Living”—and revamped the Godrej logo to incorporate vibrant colors and contemporary motifs. This repositioning also led to a new brand architecture, which distinguished between businesses that were master branded (such as Godrej Properties), platform branded (Godrej Interio furniture), and endorsed (Real Good Chicken). The Godrej name dominated the master brands but was used as a prefix to the platform brands and was not part of the endorsed brands. The platform and endorsed brands are allowed to embody values other than Brighter Living. That new architecture, the group center felt, was essential to transform the Godrej brand into a strategic asset.
The center should reaffirm the group’s identity in day-to-day workings and manage that identity’s alignment with key strategic decisions. But the center’s paramount role is to act as the custodian of values, as Anand Mahindra said in an HBR interview several years ago. (See “Finding a Higher Gear,” July–August 2008.)
In the late 1990s, the Tata group executive office received a proposal from an affiliate that wished to produce movies. Senior executives were concerned that movie production, then tainted by the financial ties some producers had to organized crime, was incompatible with the group’s purpose of “improving the quality of life of local communities.” Ultimately, the group executive office decided to turn down the proposal.
Systems that ensure proper communication of the group’s identity and values are critical. The Tata Group has codified the values that it stands for in the Tata Code of Conduct, which it expects its affiliates to abide by. R. Gopalakrishnan, a key member of the group executive office, refers to it as the group’s bible; it provides guidance on the dilemmas and questions that crop up in the course of business every day.
The Tata Code of Conduct provides guidance on the dilemmas that crop up in business every day.
A particularly potent way of embedding values across affiliates is to develop a cadre of key executives who can be transferred among them. At the Tata Group, a program known as TAS (formerly Tata Administrative Services) has been nurturing talent since 1956. TAS trains managers centrally, assigns them to affiliates in keeping with the latter’s needs, and helps them move up and across companies as their careers progress. Similarly, the Mahindra Group has a cadre of managers, many of them graduates of India’s leading business schools, that it rotates through the various companies in the group.
Systematically channeling resources for socially responsible activities through a group center increases their impact. A centralized agency that guides and coordinates social initiatives can generate enormous economies of scope. Take the Aditya Birla Centre for Community Initiatives and Rural Development. Headed by Rajashree Birla, the matriarch of the Birla family, it focuses on education, health care, sustainable living, and rural infrastructure development. The center is setting up a vocational training facility in the state of Kerala, which will begin operating in early 2014. The 23rd facility run by the Aditya Birla Centre, it will provide skills development in careers such as tailoring, carpentry, construction, and plumbing to around 10,000 people every year.
Leveraging the Group Center
Business groups in developing nations may be flourishing now, but they could face greater challenges as the institutional environments in which they operate become more like those in the United States. Outperforming standalone companies in more-efficient markets will be tougher, as will retaining a group identity in a global marketplace. To keep groups competitive, group centers will need to focus intensely on both strategy and identity.
But not all group centers are ready to handle that task. We believe that centers fall into four basic categories (see the exhibit “How to Assess Your Group Center”). Some pay no attention to either identity or strategy work; they belong in the absentee landlord category. In our experience, the long-term survival of groups with this kind of center is endangered unless a charismatic owner and his or her top management can miraculously compensate for the center’s lack of initiative. A center that is a clan leader, on the other hand, pays attention to identity work but neglects strategy work. It sustains the identity that binds the affiliates together and protects the group’s reputation but shows little concern for coordinating the pursuit of growth opportunities. Lacking a common strategic vision and unable to get affiliates to work together on new projects, this kind of center frequently fails to demonstrate the value of belonging to the group. That often raises questions about the legitimacy of the owner’s control.
A venture capitalist group center conscientiously shapes the group’s strategy, identifying opportunities and assisting affiliates with resource and leadership challenges. This type of center doesn’t cultivate and communicate a common identity, however, so it doesn’t energize affiliates with a collective purpose or support them with a group brand. The fourth category of center is the evangelical architect—which is committed to both identity and strategy work. Such centers undertake initiatives that enhance the groups’ performance as well as their longevity.
How to Assess Your Group Center
1. Identify Your Center’s Strengths and Weaknesses
Group centers, which oversee all the affiliates in business groups, often have different focuses. To find out what kind of center you have, rate your organization on the traits listed below, on a scale from 1 to 6, and then calculate the average score for each column.
1 = Strongly disagree
6 = Strongly agree
2. Determine Which Category Your Center Belongs To
Plot your two scores on the x and y axes and see which quadrant your center lands in. Absentee landlords don’t appear to add much value; groups with this type of center could be under pressure. Clan leaders and venture capitalists may not be leveraging their full potential. If your center falls into one of these categories, consider broadening the scope to include both strategy and identity activities. The most effective centers are evangelical architects; they help deliver the best performance and ensure a group’s long-term survival.
Attention to Identity Work
___ 1. Employees of our affiliate companies value membership in the group.
___ 2. Employees of our affiliates always carry business cards with the group logo.
___ 3. A set of guiding principles for employees of all affiliates has been developed and articulated.
___ 4. Senior managers in our affiliates refer to group principles whenever they confront ethical or strategic choices.
___ 5. Our group systematically recruits managerial talent that can be shared by affiliates, in addition to the recruitment that the affiliates conduct.
___ 6. We conduct group-level competitions for process excellence, product innovation, and business creativity.
___ 7. Customers pay a premium in the marketplace for our group brand.
___ 8. Our group’s reputation carries significant weight in the talent market.
___ 9. We make substantial, recurring investments in developing, communicating, and protecting our group identity.
___ 10. Group representatives work with affiliates’ executives to manage any significant engagement with external stakeholders, such as the government, the media, or business partners.
___ Identity work average score
Attention to Strategy Work
___ 1. Senior managers in our affiliate companies habitually consider the consequences their strategic initiatives will have for the group.
___ 2. We’ve designated a number of senior group executives to identify new long-term opportunities for the group.
___ 3. In the past three years, we’ve identified at least one new long-term opportunity that wasn’t being pursued by any affiliate.
___ 4. Our group center has specialized management expertise that it makes available to affiliates.
___ 5. We’ve instituted structural mechanisms to provide mentoring to senior managers at our affiliates.
___ 6. In the past year, we’ve made up for the financial shortfall of at least one affiliate by pursuing a new strategic initiative.
___ 7. We’ve created groupwide platforms to disseminate best business practices and processes to affiliates.
___ 8. Directors of all our affiliates interact on a regular basis in formal and informal settings.
___ 9. We have created mechanisms for developing new strategic initiatives that involve partnerships among our affiliates.
___ 10. In the past year we’ve launched at least one new product or service that synthesized the resources and capabilities of multiple affiliates.
___ Strategy work average score
As the business environment and leadership priorities change, group centers must evolve, moving from one category to another before they achieve the right balance. For example, between 1938 and 1991, chairman J.R.D. Tata held the Tata Group together by sheer dint of personality. When Ratan Tata took over as chairman, in 1991, Tata Sons, the holding company, was a passive shareholder that exercised little influence over the affiliate companies.
After rejuvenating the group’s flagship companies, Tata Steel and Tata Motors, Ratan Tata spent the next few years strengthening the group’s identity. His initiatives—the Tata Code of Conduct, the Brand Equity and Brand Promotion Agreement, the Tata Business Excellence Model, and the makeover of Tata Administrative Services—embedded a core set of values in everyday work throughout the affiliates. This task was coordinated by the newly formed group executive office.
Later, Ratan Tata and the group executive office complemented the identity work by building new capabilities for strategy execution: They developed expertise in cross-border acquisitions, formed a business review committee in every major affiliate, created the Tata Group Innovation Forum, and launched other initiatives. Thus, the group executive office became an evangelical architect.CEOs in North America and Europe who are managing business portfolios should take a close look at how their counterparts in India, China, and other emerging markets are tackling this challenge. There’s already at least one sign that the latter’s approach is spreading. In 2011 the Agnelli family, major shareholders in Fiat SpA, implemented a new plan for accelerating growth: It would break Fiat into two legally independent entities, a car company and an industrial unit consisting of its agricultural equipment, construction machinery, and Iveco truck operations. Fiat is in the process of transforming itself from a multidivisional company into a business group. In order to generate long-term value, the Agnellis will probably have to create a group center—just as business groups in emerging markets have done.
In a sense, the business group liberates strategy from structure. Though structure is supposed to follow strategy, the former’s limitations seem to have decided strategy until now. Too often the need to pass up opportunities in order to satisfy shareholders’ expectations has inhibited companies’ growth. A business group, particularly one led by a dynamic group center, enables the pursuit of shareholder value at the affiliate level as well as strategic value at the group level. That makes the business group a winning organizational structure even if it isn’t popular in North America—yet.
A version of this article appeared in the December 2013 issue of Harvard Business Review.