By Jim Hagemann Snabe, Co-Founder of Idonea
For well over a century, diversified companies – or conglomerates – have been a powerful vehicle for economic growth and competitive advantage. In our times, however, the world is changing so fundamentally that conglomerates are losing this “magic power.” To stay relevant, the concept of the conglomerate has to be reinvented.
The conglomerate was a marvelous economic invention. The word “conglomerate” comes from a Latin verb meaning to “roll together in a ball.” A more flattering explanation of the modern noun would be that conglomerates are large companies that address more than just one specific market with their products and services – say, for example, cosmetics as well as foods, energy as well as mobility, or automotive parts as well as machine engineering. Conventional conglomerates span industries. They’re horizontal organizations.
The Heyday of the Conglomerate
In the First, Second and Third Industrial Revolutions, conglomerates derived competitive advantage from their sheer size. They drove down costs through economies of scale and mass production. As marginal production costs went down, profits went up and conglomerates thrived. Their “bigness” was also an advantage when they entered adjacent industries. In fact, company leaders perceived diversification as a way to make conglomerates more stable and ensure long-term success. If one particular business was languishing, other businesses could compensate.
The conglomerates themselves, however, have not been the only ones to benefit from size: Mass production and lower product prices brought higher living standards to more and more people. Over the past two centuries, poverty rates and infant mortality fell dramatically around the world, while life expectancy has increased. Compared with 1950, for instance, people today live over 10 years longer in the U.S., over 20 years longer in Brazil, and over 30 years longer in China. Conglomerates played a big role in making this socio-economic miracle happen.
In Comes the Fourth Industrial Revolution
Conventional conglomerates had a great run. However, things changed quite drastically with the Fourth Industrial Revolution. This Revolution started with the invention of the World Wide Web in 1989, I would say, and greatly accelerated in the 2010s.
A look at the Fortune 500 – a list of America’s largest companies by revenue – gives us an important clue of what the Fourth Industrial Revolution means for big companies. Between 1965 and 1990, the top 10 of this list included one group of eight firms each year: General Motors, Exxon Mobile, Ford Motor, General Electric, Mobil, Chrysler, Texaco and IBM. It’s a picture of continuity. Scale through size was a sustainable competitive advantage.
By contrast, when we compare the top 10 of 1989 with today’s top 10, we see a picture of drastic change. Only one company (Exxon) has managed to remain in the top group.
Researchers have found that, overall, the turnover rate in the Fortune 500 – that is, the speed at which fast companies drop off the list – has constantly increased. Size no longer guarantees survival. Compared to the two centuries before, that’s nothing less than a shift of economic paradigms.
Speed Trumps Size
In the Fourth Industrial Revolution, the logic of the conglomerate is being challenged in a profound way. Digital platforms basically reduce the marginal costs to zero and enable infinite reach and scale at zero cost. With 3D printing and intelligent robots, a single product that is produced at a location near the customer and is based on re-usable materials could potentially become cheaper than a mass-produced product from a “low cost” location. With a marginal cost of zero, the optimal lot size is one. In addition, digital platforms offer unlimited reach to any market and any customer at close to zero cost. This logic could soon also apply to legal advice, lending, medical recommendations and education.
In this new world, scale still matters. However, it’s no longer about the scale of the organization or the scale of production runs. What matters is the scale of the platform that empowers every aspect of a company’s business.
When it comes to exponential growth due to network effects, platform companies profit much more than any other type of business. As a result, it’s only logical that seven out of the world’s ten most valuable companies today are platform companies.
Digital platform companies grew up in a fast-changing environment. Their organizational structures, processes and cultures were shaped in the crucible of the Fourth Industrial Revolution. Speed is part of their DNA. And precisely that speed – speed of decisions, speed of execution, speed of adaptation – is the key virtue in today’s economic world.
Reinventing Large Companies
The leaders of conventional conglomerates should carefully study and understand these shifts. Most of all, they should draw the right conclusions and act on them.
At its heart, the reinvention of any company – including large ones – is about challenging current business activities to make sure the company stays relevant. We are all familiar with the concept of the S-curve in business lifecycles. It starts with a great idea that is brought to market in the infancy phase. If the idea is valuable and differentiating, it goes through the growth phase for maximum scale.
Eventually, it reaches the maturity phase where the business is optimized. Sooner or later, all businesses, even the most successful, run out of room to grow and enter a negative growth phase. This happens when new ideas challenge the fundamentals of the business. Andy Grove, one of Intel’s founders, called this point an “inflection point.”
When facing an inflection point, a company has three options: It can re-invent that part of the business. It can drive consolidation in the market. Or it can exit that part of the business and re‑invest the money in other new opportunities.
The ability to pull this off — to predict inflection points and manage the portfolio in a proactive way by jumping from the maturity stage of one business to the growth stage of the next — is what separates high performers from those whose time at the top is all too brief.
Clayton Christensen observed that large successful companies are often unable to re-invent themselves because they stick to their old business too long. He called this circumstance the “Innovator’s Dilemma.”
I agree with Clayton Christensen that reinvention is hard – in particular when the company is doing well. But when a company’s leaders act decisively, reinvention is surely possible. It requires two key elements: On the one hand, constant re-invention of the portfolio. On the other hand, the ability to sense the rise of new trends and execute at high speed.
An outside-in strategic approach to portfolio reinvention begins with the challenging question: “What will the world look like in five to ten years?” This approach pays attention to future competitors – not just current competitors. It challenges current assumptions and looks for ways to disrupt and re-invent our current business.
Three simple principles can guide this approach:
- First, a constant search for growth markets. It’s dramatically easier to grow a business if it operates in growth markets.
- Second, being average is obviously not enough. In order to win in a growth market, a company needs the ability to address the “profit pools” within that market. This is largely a question of being able to develop relevant differentiation while maintaining focus.
- Third, you need to be among the leaders within the market – which means being #1 or #2. This is a question of being ambitious – of having a clear intent and the means to win.
Making the right portfolio decisions is key to re-invention, but it is not enough by itself. You have to adapt organizational structures, too.
The conventional organization of conglomerates consists of a matrix of global business areas, regional sales organizations and corporate functions. Complex matrix structures were successful for many decades because they helped manage size. Today, however, they slow companies down and prevent them from adapting quickly.
There’s certainly no standard recipe. Yet, the way Siemens AG answered the question of reinvention may be of interest to others, too. Siemens is one of the most successful industrial conglomerates and has 172 years of history – a longevity unimaginable without adaptation and reinvention.
The company’s Vision 2020+ strategy concept, launched in 2018, gives all Siemens businesses greater entrepreneurial freedom, focus, and responsibility. They can shape their own future in their respective markets – and above all be closer to their customers, sense new trends and execute rapidly.
Siemens will comprise three companies going forward. These companies will have the necessary speed – but also the necessary size – to lead the transformation of their respective businesses. The first company is Siemens’ industrial core, which consists of Digital Industries, Smart Infrastructure and Mobility. The second is the healthcare technology provider Siemens Healthineers. And the third is the future energy company Siemens Energy, which will be spun off and publicly listed in 2020 as an independent company that can shape and drive the energy transition worldwide. All three companies are positioned to lead the digital transformation within their respective industries.
Vision 2020+ aims at creating the conglomerate of the future: dynamic, focused and flexible businesses with the ability to adapt to market conditions and inflection points quickly and on a case-by-case basis – while leveraging the benefits of an open, connected ecosystem.
In the end, reinventing the conglomerate is about adding value – for customers, employees and shareholders as well as for society. Conglomerates that are able to make this leap will stay relevant – and they will regain the “magic power” to shape a more sustainable future.