Historically, Indian conglomerates have found that the synergy of housing individual businesses together has been greater than the dis-synergy associated with deconstruction. Does this logic still hold? Our previous article dealt with the logic of conglomerates globally and briefly touched upon Indian conglomerates. This article delves deeper into how Indian conglomerates have evolved and the current economic forces at play that make it imperative for Indian conglomerates to revisit their strategy.
Historically, Indian conglomerates came into existence because new businesses developed around diverse strategic assets (for example, licenses, natural resources, contracts) acquired by a set of business houses in India. Today, the Indian corporate environment has a rich mix of different conglomerates in all shapes and forms: completely integrated versus Holding Company, highly diversified versus adjacent multi-line businesses etc. Nonetheless, we found some common patterns regarding sources of competitive advantage and value creation as we studied different Indian conglomerates.
First, premium Indian conglomerates have been able to leverage their relatively larger balance sheets and stronger corporate brands to access capital for their individual businesses in larger quantities and at lower costs compared to what such business might have been able to achieve on a stand-alone basis. Access to greater capital allowed conglomerate to scale up businesses faster. Access to cheaper capital allowed conglomerates to gain pricing power and hence market share. The issue of efficient capital allocation was addressed by having a common corporate center to oversee business planning, performance monitoring and M&A activity.
Second, larger consolidated balance sheets also provided cover against hostile takeovers (takeover against promoter or management wishes). It is important to understand that stand alone businesses in India have tended to be sub-scale compared to their global counter parts. Consequently stand-alone they were more vulnerable to the threat of a hostile takeover. Through conglomerate structures, companies were able to ward off unwanted suitors.
Third, in several product or service markets balance sheet size is important for winning market share. For example, in many tenders/contracts, a certain balance sheet size is a qualification criterion. Because stand alone Indian businesses weren’t necessarily large enough, a conglomerate structure gave them the necessary asset salience.
Fourth, premium Indian conglomerates (like their global counterparts) also developed strong internal talent development platforms to compensate for paucity of readily available high-skilled talent locally. Promise of job stability, strong training programs supported by large budgets and prestige of association with a strong brand attracted high quality raw talent to the marquee conglomerates. Subsequently this raw talent pool was developed into business or functional leaders through a mix of experiential and classroom training programs. Such initiatives also helped develop a cadre of loyal business leaders. Further, because such a home grown leadership team tended to develop a holistic view of all businesses, it helped them drive synergies across group businesses.
Additionally, in our opinion, the dis-synergy of deconstruction for an Indian conglomerate was historically higher because of the relative labour to capital intensity ratio in Indian businesses. Unlike in developed markets, businesses in India tend to be more labour intensive than capital intensive. Redeploying capital after deconstruction is easier than redeploying labour. Therefore, Indian conglomerates had reason to maintain status-quo instead of actively rationalising their portfolios.
As a consequence, Indian capital markets have not historically ascribed the often touted ‘conglomerate discount’ to Indian conglomerates. In fact depending on the time horizon, timing in the economic cycle, peer set and type of valuation multiples considered, we can argue that the integrated Indian conglomerate has enjoyed anywhere between healthy double digit premium to a marginal single digit discount relative to sum-of-parts valuation of its individual businesses.
Many changing factors in the business environment however will compel Indian conglomerates to critically re-evaluate the rationale behind their corporate structure. For example, as Indian talent gets increasing access to global opportunities — both in terms of learning and career options — we have observed that it has become increasingly difficult to attract and retain quality talent for some large conglomerates where there is a perceived risk of getting lost in a gargantuan hierarchy. This is encouraging some conglomerates to consider deconstructing thereby devolving greater autonomy to individual businesses through independent boards, creation of more CXO positions and board seats. Many Indian conglomerates have considered the use of organisation overlays towards resolving some of these issues. For example, the creation of deemed company structures at a strategic business unit level as a means of attracting talent or the creation of conglomerate wide investment committees as a means of overcoming the obstacles to directing corporate funds into their most productive applications. These structures have had a mixed track record in fulfilling their objectives and have sometimes run the risk of several coordination challenges without active participation from promoters or CEOs as arbiters of what makes sense for the conglomerate as a whole.
Shareholder sophistication in pricing risk is rising as new investor classes such as private equity, large financial institutions etc. gain greater say in Indian capital markets. Many business units within several conglomerates have reached a scale where they can compete as stand-alone entities with the balance sheet support of sibling business units. As individual businesses globalise and become more complex, an integrated corporate form is seen to be a hindrance to being nimble in the pursuit of sharper strategies. However, the strategic response to such forces needs to be different for different conglomerates.
Our analysis at three different time periods in the last decade suggests some conglomerates have seen conglomerate premiums eroding faster than others. Almost always a common theme in such conglomerates is where emotions trump economic logic resulting in an unwillingness to take the appropriate portfolio calls to shed businesses pulling the conglomerate down. Those that have sustained stronger premiums share common themes of being able to preserve efficient internal capital markets.
So what next for Indian conglomerates? In the next article we will set out a model for Indian conglomerates to rethink their structure and examine if there is greater value release through equity deconstruction.
Ashish Iyer is partner and Asia-Pacific leader, strategy practice, BCG and Yashraj Erande is principal, BCG.
Views are personal.