Industry Aggregations A - ZThere are basically two ways to expand your business interests. First, there is the obvious way wherein you focus on building one company year after year and possibly decade after decade. This method frequently leads to early burn-out on the part of the entrepreneur. After all, how many times can anyone return to the same office to repeat the same basic day? Many of us have a low threshold for this type of routine.
The second way to expand your business interests is through deal-making. Specifically, this involves the purchasing, fattening up, and reselling of businesses and other appreciating assets. If you believe that variety is the spice of life, you should take a good look at this option. If you study the strategies of billionaires, you will see a common theme in how they succeeded: deal-making. Most built their empires through a series of deals involving the acquisition and flipping of various companies. Some they held onto for a long time while others were flipped in as short a time as a year.
A seeming benefit of this second approach is that it keeps them young. Most billionaires are active well into their 70s, 80s, and even 90s (e.g., Kirk Kerkorian).
So let's summarize various deal-making business models and introduce a new one as well.
ConglomerationConglomeration hasn’t been seen in any significant scale since the late 1960s conglomeration frenzy. Conglomeration is considered a failed strategy today because it involves aggregating companies from totally unrelated industries, thereby not affording any opportunities for economies of scale and other benefits which accrue to aggregated companies from the same industry. Perhaps the most high profile exception today is Warren Buffett’s holding company Berkshire Hathaway.
In my memory lingers a picture of an editorial cartoon from long ago that I saw as a child. It appeared in Newsweek or Businessweek and showed a cluster of old style smokestack factories. Each one had a sign on its roof displaying the name of the company. They read from left to right: Little Baby-Boo Baby Food Products, Little Baby-Boo Aerospace, Little Baby-Boo Fashions, Little Baby-Boo Pharmaceuticals. The names underscore why the conglomerate strategy proved unworkable. It was simply too diverse in its components to be manageable.
James Ling the Merger King of LTV fame was one of the most famous conglomerators of the 1960s, if you’re interested in reading up on this era.
Consolidation
In the post bubble phase of an industry cycle one will frequently observe consolidation activity. In a consolidation, the consolidator typically
acquires under-priced assets with its own particular industry. The goal
is to achieve various economies of scale. In contrast to the conglomerate, the consolidation is tightly focused around a theme.
RollupA rollup is performed by a platform company which intends to go public once it has achieved the critical mass necessary for an IPO. The bolt-on companies it acquires tend to be small businesses whose owners are interested in either cashing out or retiring. Oftentimes, the rollup is the only means possible for these owners to achieve a liquidity event because their businesses are usually small unattractive assets operating in mature industries. In the 1990s, rollup activity was high in the stationery and florist industries with rollup king Jonathan Ledecky’s platform companies swallowing up hundreds of mom & pop shops from both industries.
KeiretsuThis keiretsu is a Japanese variation of long-term, basically permanent, cross-industry aggregation for purposes of maximizing synergy and economies of scale.
From wiki:
The prototypical keiretsu are those which appeared in Japan during the "economic miracle" following World War II. Before Japan's surrender, Japanese industry was controlled by large conglomerates called zaibatsu. The Allies dismantled the zaibatsu in the late 1940s, but the companies formed from the dismantling of the zaibatsu re-interlinked through share purchases to form horizontally-integrated alliances across many industries. Where possible, keiretsu companies would also supply one another, making the alliances vertically integrated to some extent.
The major keiretsu were each centered around one bank, which lent money to the keiretsu's member companies and held equity positions in the companies. Each central bank had great control over the companies in the keiretsu and acted as a monitoring entity and as an emergency bail-out entity. One effect of this structure was to minimize the presence of hostile takeovers in Japan, because no entities could challenge the power of the banks.
Venture capital firm Kleiner Perkins began describing its portfolio companies as a “keiretsu” back in the 1990s. Other
top tier companies which claim to employ the keiretsu model include
Cisco Systems, Richard Branson's The Virgin Group, and Deutsche Bank.
Industry AggregationWhile aggregation strategies such as conglomerations, consolidations, and rollups, come in and out of fashion, the keiretsu model remains a stable long-term aggregation model. One can think of the industry aggregation model as a variation of the keiretsu fine-tuned for smaller companies with sales typically in the $2 million to $50 million range. Folding a number of successful companies of this size into a publicly traded vehicle then enables owners to “warehouse” their equity in a liquid form made possible by free trading shares. This concept begins to make all the more economic sense if we redefine what we mean by an “industry”. Traditionally, the term industry has been defined as the “aggregate of manufacturing or technically productive enterprises in a particular field, often named after its principal product: the automobile industry; the steel industry.” (From
www.dictionary.com)
The industry aggregation approach is to define industry by the demographic market the group serves. This allows the aggregation to include diverse companies from a variety of “industries” using the traditional definition. For example, a “hot” demographic market niche today is the rich and newly rich. (Read the book
Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich
by Robert Frank to get a sense of this market.) An industry aggregation can be created consisting of companies which provide everything to this market from luxury automobiles, private jets, and vacation homes, to high net worth financial planning services.
What makes the industry aggregation model work is retention of each member company’s management. Under the conglomeration model, the acquirer fires the managers of its portfolio companies and attempts to run all operations from head office. Under the rollup model, the owners of the bolt-on companies are expected to cash out and disappear. The industry aggregation, in contrast, prefers companies whose management is committed to staying on. The model also offers each member company a wide degree of autonomy to carry on its successful policies.
The main benefits of participation to businesses are threefold:
1. Increased revenues through various cross-marketing opportunities
2. Decreased operating costs via group purchasing power and preferred pricing for members. (In some cities there will be jointly owned business centers offering space and resources to members.)
3. Shared liquidity via a stock swap with a publicly-listed company.
Industry aggregation is the model for the 21st century. Expect to hear a great deal about it in the coming years.
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