To understand the conglomerates that grew up in post-war America, it would be useful to visit the corporate strategy framework called the BCG matrix, or sometimes the BCGGE matrix because it was developed by the Boston Consulting Group for its client, GE, General Electric, perhaps the most well-known conglomerate of this era. The central idea in the BCG matrix, is that a corporation needs to be active in different businesses, that are at various stages of their industry life-cycle. Some late in the life cycle, where the industry is mature, and the market is growing very slowly, and others early where the industry is young and the market is growing very fast. This market growth is graphed along the vertical axis. Graphed on the horizontal axis is market share, sometimes graphed as relative market share. That is the market share of the focal company relative to its largest competitor. More generally, the two axis can be interpreted as market or industry attractiveness on the vertical axis, and company's strength on the horizontal axis. Mapped on the BCG matrix are the company's businesses, also called Strategic Business Units or SBUs, whose needs and performance will evolve over time. The strategic goal of using this tool is to create a portfolio of SBUs, that is well-balanced between current and future success, and between resource availability and resource needs. So conglomerates manage portfolios of businesses in this way, and the question is, how it all made sense? How did conglomerates create value from this assortment of businesses? One key source of value was a set of management tools, based primarily in accounting and financial analysis, and even some frameworks from strategy like the BCG matrix. These tools allowed conglomerates to manage businesses professionally, at a time when there was less management knowledge available to other companies. So despite some bureaucracy and inefficiency, conglomerates were able to extract more value from the businesses they managed by applying these management tools. The other source of value which is what we will focus on now, is the redeployment or transfer of resources between a company's businesses. In particular, the BCG matrix emphasize the redeployment of cash, from businesses that had too much of it to others that needed it. The bubbles in this BCG matrix illustrate the business units or SBUs of a company with the larger bubbles representing larger businesses by revenue. These SBUs are then categorized into four types: Dogs, question marks, stars, and cash cows, based on where they are in the matrix. Dogs are businesses that are neither in growing industries nor an area of strength for the company. Generally, the expectation was that these businesses would be divested to raise cash. At the opposite end, stars are SBUs with fast-growing markets, and strong market share. These businesses are the future of the company which it should be investing in. So cash is put into these SBUs. Cash cows are typically yesterday stars. Businesses in which the company has a strong presence but in markets that aren't growing as quickly. So there's less need to invest in these businesses and they will likely be yielding excess cash due to the company strong position and that cash can be redeployed elsewhere. Finally, there are the question marks, which are in fast-growing markets, but where the company is yet to establish a strong presence. Here the company has to make a choice. Should it invest and strengthen its position by investing more cash or give up and divest the business? Thus the name question marks. All in all, the idea with the BCG matrix is to either divest businesses or invest in fast-growing ones in order to build strong positions in them. Eventually, these star businesses would mature, and become cash cows and throw off cash for the company to invest in the next generation of stars. So effectively, conglomerates acted as their own bankers, which was quite effective in an era when US financial markets were much less developed, which is something you still see today in other countries. So what happened to these conglomerates? Let's answer that question by looking at a specific conglomerate of this era, ITT. ITT started out as International Telephone and Telegraph, and as the name suggests, the company was in the telecom business in many countries, selling both telecom equipment and telecom services. Starting in the 1950s, and particularly under CEO Harold Geneen, ITT undertook an aggressive strategy of diversification into many unrelated businesses. In other words, it became a conglomerate. ITT entered into insurance, Hartford was a major ITT insurance company, into hotels with the Sheraton group, which eventually became Starwood, and even in training Services and car rentals. For a time ITT owned Evans rental car. Geneen's motto was simple, that all these businesses were the same. That it was all about managing by the numbers. In other words, by analyzing the financials, you could manage any business. This goes back to the idea of professional management being a key capability that these conglomerates brought to their portfolio of companies. The other idea of course, was that companies like ITT were able to transfer resources between their many businesses, which was not available to specialized non conglomerate companies. However, over time, conglomerates like ITT began to find that general management knowledge was not enough to manage businesses well. They needed more specialized knowledge. They found that hotels was actually a much different business than insurance or telecom, or engineered products. Also, management capabilities were becoming more common in business, and conglomerates were not effective in creating value from unrelated businesses. The corporate headquarters staff was getting too bloated, and not really adding much value to manage these businesses, which is also what Gordon Gekko railed about in the movie Wall Street. Then by having so many businesses under one umbrella, the focused incentive to maximize performance in each business was also getting muted overtime. All in all, the conglomerate model began to lose its shine. So ITT began to sell off businesses starting in the early 1980s, after Geneen stepped down as CEO and chairman. By the late 1990s, the company had even sold off its insurance and hotel businesses. The rump ITT that remained, didn't stop there. In 2011, the company was again split into three parts: A water business called Xylem, a defense business called Exelis, and the remaining ITT business that was mainly in the engineered parts. Xylem and Exelis were spun out into separate companies. Interestingly, engineered parts had been a star SBU within ITT, and the other two businesses, were cash cows. So what was ITT doing here? Giving up its cash cow businesses, and staying with the business that required cash to grow? In fact, ITT's former CEO, Geneen had a real aversion to losing sources of cash. He's noted as saying, "The only unforgivable sin in business is to run out of cash." Also interesting, is the stock market reaction to the news that ITT were splitting up in 2011. ITT starved, zoomed up almost 20 percent. This is real money we're talking about. It created a few billion dollars of wealth here. So what's going on? Why is the stock market so happy about this news and if we put on our BCG matrix hat, how will ITT now meet the cash it needs to grow? Offers cash cow businesses have been divested. Think about this and write down your answers. To understand what went on with ITT's breakup, we need to bring back our familiar toolkit of comparative organization. Generally, we can think of two modes for ITT's businesses or strategic business units to operate. In the first mode, they operate as one company, with internal cash transfers from cash cows to stars to fund their growth. In the other mode, ITT's businesses operate as separate companies, like they did after the breakup, using financial markets for investing surplus cash, or raising cash as needed. So the question is, which one is more efficient, and why? From the reaction of the stock market, it seems like the internal transfers of cash using the BCG matrix approach is less efficient. Instead, modern financial markets may be quite efficient at allocating cash. If ITT star business needs money, it can simply go to the equity markets, the bond markets, or to a bank. Keep in mind that we're talking about the situation in the United States in 2011, which may be different from the 1960s or in other countries, and of course, general management principles were widely used in business by 2011. So they would not add any significant value to managing these three unrelated businesses in a single company. On the flip side, by combining these businesses into a single, possibly more bureaucratic entity, pre 2011 ITT, may have been adding inefficiencies, and suppressing the value they could potentially create. So when the company announced the split, investors felt that the separate companies would be able to do much better by focusing on their respective businesses and therefore bid up the company's stock price.
