TCS Daily


Conglomerate Cannibalism

By Stephen Bainbridge - March 24, 2006 12:00 AM

Press reports alleged that Comedy Central's decided not to run the South Park episode making fun of Tom Cruise's sexuality and Scientology after Tom Cruise threatened not to promote his upcoming Paramount film "Mission: Impossible III."

Cruise denied having made any such threats and Comedy Central eventually decided to run the episode anyway, but the incident tells us something very interesting about the enduring popularity among corporate CEOs of the conglomerate business model.

Around the middle of the 20th Century, the idea grew up that good managers could manage anything. This view was operationalized via conglomerate mergers, in which companies intentionally sought to diversify their product lines and business activities horizontally across a wide array of unrelated businesses. The theory was that a cyclical manufacturer could buy a noncyclical business, making the combined company stronger because some division would always be doing well.

The problem, of course, was that diversification necessarily reduced the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well.

To be sure, diversification reduced the conglomerate's exposure to unsystematic risk. But so what? Investors can diversify their portfolios more cheaply than can a company, not least because the investor need not pay a control premium.

Intra-firm diversification may make management better off, because their employer is subject to less risk, but the empirical evidence is compelling that intra-firm diversification reduces shareholder wealth. (GE being the exception that proves the rule.)

The self-correcting nature of free markets is demonstrated by what happened next: during the 1980s there was a wave of so-called "bust-up" takeovers in which conglomerates were acquired and broken up into their constituent pieces, which were then sold off. The process resulted in a sort of reverse synergy: the whole was worth less than the sum of its parts.

Ironically, just as the takeover market finished dismantling conglomerates in most industry sectors, a brand new wave of conglomerate mergers began in the entertainment industry. Mass media executives decided that their firms needed to bring distribution and content within a single entity, prompting mergers of TV networks, cable networks, movie studios, book and magazine publishers, music labels, and, eventually, ISPs.

Unlike the older multi-line conglomerates, the new entertainment conglomerates were motivated neither by the belief that good managers can manage anything or that intra-firm diversification benefited shareholders. Instead, the logic behind creating massive media conglomerates (like Time-Warner and Viacom) was the potential for cross-platform synergies. As a simple example, AOL would put ads for a new Warner movie on its welcome screen. As another, Tom Cruise might go on The Daily Show to plug a new Paramount release. And so on.

Just as the old conglomerates performed poorly relative to more narrowly focused firms, so have the new media conglomerates. As the Hollywood Reporter noted, the media conglomerates' "stocks continue to woefully underperform while they wrestle with unprecedented business and economic turmoil."

Why? Several of the problems that plagued old-style conglomerates turned out to apply to the new media versions, as well. Numerous disparate lines of business create span of control issues. In any organization, ranging from army divisions to corporations, administrators cannot effectively supervise more than 3-5 immediate subordinates. Yet, in many media conglomerates, top management faced far broader spans of control and, as a result, lost control.

Even in firms whose organizational charts imposed less exacting demands on top managers, they faced the old problem of trying to develop expertise in multiple lines of business. Just as firms like IT&T eventually learned that folks who are good at managing telephone companies may not be equally effective when it comes to supervising bakeries and cruise lines, firms like Time-Warner have learned that even the best managers may have a hard time supervising ISPs, cable networks, movie studios, and the like. Even though they're all media firms, the differences caused top management to struggle to develop the expertise to supervise them all.

Just as underperforming business lines dragged down the overall performance of old-style conglomerates, slow-growing old media lines held back faster growing segments of the new media conglomerates. CBS famously dragged down Viacom's performance, ultimately forcing the firm to spin-off CBS into a separate firm.

Most importantly, however, the promised cross-platform synergies never materialized. To the contrary, as the Cruise-South Park kerfuffle illustrates, the media conglomerates were just as likely to face negative as positive synergies. Problems in one business line regularly spilt over to adversely affect all lines. The problems Time-Warner suffered after its music division released Ice-T's "Cop Killer," for example, dwarf the minor fall out from the Cruise-South Park fight.

Once again, the conglomerate business model has proven to be a loser. Once again, as the Viacom split and Carl Icahn's effort to force a similar split at Time-Warner illustrate, the market is demanding a round of deconglomerization. The $64,000 question is why managers can't seem to learn this very simple lesson.

Steve Bainbridge is a professor of law at UCLA. His blog ProfessorBainbridge.com is a popular law and politics blog, while his wine blog ProfessorBainbridgeOnWine.com offers wine reviews and commentary.

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2 Comments

This line of thinking
never made any sense to me.

If you want to place an ad on AOL, just buy the ad, you don't have to buy AOL.

If you want Tom Cruise to appear on a talk show, just make him available. You don't have to buy the company that airs the talk show.

Where do customers benefit?
The supposed example of comglomerate power in cross-platform content is fallacious when viewed in terms of customer needs. It has the same business-killing ramifications as liberal bias in MSM in general.

The customers of media pay for independent, factual information. If I'm on one end of a media stream and it suddenly biases its content to benefit another branch of the same owners, I've lost value. When AOL offers only positive reviews of Warner Bros. films, why do I need them. When I realize that, they've lost a customer.

They no longer are serving me in fair exchange for my subscriptions, tickets, and/or eyeball time.

A company that doesn't serve my needs doesn't get my attention nor my money.

Didn't the comglomerate managers who put this together realize we're smart enough to figure this out?

Call it hubris and we know how that ends.

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