A reader recommended this post by Jeff Carter.
The days of the one stop shop that Sandy Weil envisioned when he built Citigroup ($C) are gone.
I have always believed that there are diseconomies of scope. Companies with many lines of business are difficult to manage effectively, in my view.
In the case of banking, I thought that the “financial supermarket” fad of the 1980s was silly. Consumers are fine having separate vendors for credit cards, checking accounts, and stock portfolios.
I have to say, though, that it is not just banks that defy my prejudice against multiple business lines. Amazon has branched into all sorts of unexpected businesses, such as renting Web servers. Google is another example of a company that is not strictly bounded in what it businesses it will try.
Some possibilities:
1. I am correct, and whenever you see a company with many lines of business, whether it’s a bank or a tech firm, it represents the CEO’s ego gain and the shareholders’ wealth loss.
2. I am somewhat correct, but the diseconomies of scope are actually quite small. Six lines of business can be managed almost as effectively under one organization as under six totally separate entities.
3. I have it wrong. There actually are tremendous fixed costs to developing a good decision-making structure, and CEO talent is scarce. These super-managers, or management super-cultures, can handle a sixth line of business more effectively than other managers can handle a first.
It seems to me that tech firms with sudden, over-the-moon valuations are able to jump into all kinds of ‘cool’ businesses that their founders would like to play with, but these efforts seldom make money and are jettisoned in due course when times get tougher. Google has tried all kinds of things, but the money still comes from search advertising and a bit from YouTube and Android/Play Store. But Google profits are under a bit of pressure in the move from desktop to mobile. ‘Google Glass’ may have just been thrown overboard, and don’t look for Google to be a long-term player in the self-driving car business (even assuming there is such a business). For Amazon’s part, don’t expect their Kindle hardware business to last all that many more years. They’ve just taken a huge bath on the failure of the ‘Fire Phone’. They make no money on their tablets and eBook readers, and there’s not much reason to keep them around (as opposed to just providing Kindle apps for other manufacturers hardware):
http://www.forbes.com/sites/markrogowsky/2015/01/06/out-of-focus-amazons-hardware-obsession-is-distracting-bezos-from-the-big-picture/
So for tech companies at least, I’m voting on option #1 — Google and Amazon each have about 2 profitable lines of business, and they spin their wheels and lose money on pretty much everything else.
What about a different version of option
2: Economy of scope exists when a firm is able to use expertise or infrastructure developed in pursuit of an existing business, and expose it as a profitable line of business in it’s own right.
That would suggest that Amazon is going to have a much harder time with phones than they did with e-readers, but it also suggests that Amazon Web Services (which seem to be mostly an extension of the infrastructure that Amazon built for it’s own website) might be a good candidate.
When a large tech company launches a new product line that doesn’t stem from the stack their existing expertise is built on, I assume 1 applies. (Not all such moves actually fail to generate wealth, however, or CEOs wouldn’t be able to persuade shareholders.)
Arnold:
I’d like to suggest a bit different, more business management oriented, conceptual framework for you to apply in understanding and evaluating possible diseconomies of scope. As a lead-in example, I would have thought you might have listed Wal-Mart, as opposed to Amazon or Google, as an example of a large company that can succeed across multiple business lines.
The dimension to consider when evaluating whether a single firm can succeed is NOT how many business lines they take on. It IS whether (or not) any given business line they take on can be operated within their existing (proven effective) competitive strategy. And there are only two (generally) to keep in mind; a. Cost Leadership (as in Wal-Mart), and b. Product Differentiation (think Apple computers.)
Very often a (large) firm’s executive management fails, not due to having too many business lines to manage, but due to the fact they try to manage different business lines while trying to apply different competitive strategies to each.
@ ShayneCook – do you have a blog?
No, I don’t.
Oh, OK – well, can you start one – make it about investing – and then build up a dataset of firms that have either of those 2 competitive advantages (or both?) that you mentioned.
That would be great.
Thanks in advance.
PS – Obviously don’t feel the need to if you’re actually not that interested – but I suspect that you are.
I”m flattered. Gee, let me see if I can keep my ego in check here (I probably can’t).
I guess I might consider starting a blog if I actually believed I had, or could offer, some unique insight into a particular topic, such as investing. I’m not convinced I have any such unique insights. I’m flattered that you would suggest this though.
My comment here was to suggest that Arnold (a very smart man) just apply a different conceptual framework – one that he possibly hadn’t applied before – to evaluation of possible diseconomies of scope (or scale).
And as an aside, the 2 I alluded to are competitive strategies, not necessarily competitive advantages – with all the implications relating thereto.
Follow up: (couldn’t quite keep my ego in check)
I suppose lecturing is something like blogging, in the sense you suggested.
I taught business management, economics and information systems courses at several colleges – part-time and full-time – for over 15 years.
Now I’m generally content with continuing to be a student.
This sounds like Chris Zook/Profit from the Core. I don’t know that Walmart’s advantage is price, Walmart’s succeeded in solving the problem of regional distribution. Reducing the cost of distribution in turn afforded Walmart a huge price advantage. Zooks books give some good examples of when companies fail at “adjacencies” and when they typically succeed. It doesn’t have much to do with a management superculture. Google and Microsoft and Amazon have just invented new ways to decorate the corporate jet, but they make a ton of cash so they can get away with it.
Right, competitive strategy, not advantage. The perils of firing off quick blog comments.
google and Amazon both branched into highly specialized markets that their core businesses required them to be experts. Google’s market forays seem to be driven by 2 factors (with the exception of their moon shots) – getting eyeballs and trying to monetize the technology they have developed trying to get eyeballs. I think that is very different from banking, where starting a home loan division relies very little on any in house expertise and more on marketing.
Bitcoin and Lending Club are killing JP Morgan? Seriously?
I get the feeling that Google’s non-core businesses are real-world laboratories. “Will this application of something we know about work in the real world? Will it make us money? If not, will it at least be good advertising and thus worth the cost for a while?”
Seems to me it:
4. There are latent variables that lead to efficient clustering of seemingly disparate lines of business, but not all of them. Good mult-managers excel at the these variables.
This explains something Amazon’s digital marketplace and AWS well, the latent variable there is efficient use of computing at large scales. It also explains why Amazon Video Prime is a viable service, but their content production isn’t going to rock too many boats.
I think the strongest areas of innovation are those between lines and these are often insurance against existing lines being closed off by competitors on new business, similar to the way Apple took over the smartphone and tablet business locking Microsoft out of it and the way browsers and voice search could lock Google out of search, or Amazon getting locked out of their book and media business. It costs, but the risk from not doing so is great.
And you may not have to run faster than the bear just faster than the other people.
By the time a competitor figures out something Google has tried, Google can either focus on it or move on because they have already figured out it is unprofitable for them and the compet it or is likely to be worse at managing transitions.
To elaborate on Mb’s point, I believe the special cases of Amazon and Google are more homogenous than they may appear.
Both of them have had to develop unusually large data centers and unusually large distributed databases. C2 and AppEngine are ways for them to monetize the expertise they’ve developed in these areas.
Google’s free user applications are also more aligned than they might appear. Most directly, those apps provide a way to post ads, which in turn are Google’s main revenue source. As well, those free apps are a source of information about user behavior, and a way to boost the WWW on the whole.
A lot is simply brand name: You assume that if Google puts their valuable brand name on something new that it’s not an outright scam and that they’ve checked for viruses and the like.
Unless you count the NSA as a virus!
I agree with commentator Lupis42: it is industry- and firm-dependent.
Disney is the classic example where economies of scope work: once you have a great asset (in their case, IP on Mickey Mouse or X-Men or whatever), you want to deploy it widely: movies, rides, toys, video games, musicals, ice shows, and so on. In other areas, it doesn’t seem to work so well (e.g., Eastman Kodak thought it could use its knowledge of chemistry gained in photography to pursue opportunities in pharmaceuticals when it bought sterling drug in the 80’s. It was a miserable failure).