Most of Sri Lanka’s best-known corporate giants have a lot in common. They are heavily diversified across multiple industries. John Keells, Hayleys, Carson Cumberbatch, Softlogic and Hemas are just a few examples. To an outsider, it might seem that almost all these conglomerates are sustained by one or, at best, a few cash cow businesses that essentially make up for the lackluster performance of the other business units. When Expo Lanka – formerly a heavily diversified holding company – was acquired by new owners, a spate of divestments kicked-off with the aim of trimming the fat and bringing the focus back to its core logistics business. Should the other behemoths also consider jettisoning some of their peripheral business interests? More, importantly, are they being held back by the diversified structure of their businesses? After all, Sri Lanka’s best-known conglomerates are also some of our oldest and most successful companies.
A good starting point would be to consider why so many local firms have opted to diversify. The small size of the local consumer market is likely to have been a key influencing factor. A focused company that rapidly captured local market share in a particular industry would soon face marginally decreasing returns on further capital invested. At that point, they would face a choice between expanding overseas, doubling down on their core business with a vertical integration strategy or diversifying into an unrelated business. Diversification seems to have prevailed in most occasions. The psychological effect of the war years undoubtedly played a role in herding more managers towards this less risky option.
Another driving force behind rampant diversification in some holding companies seems to be a desire to limit outflows to external vendors. Before its fall from grace, Ceylinco Group was famous for having companies within the group that provided almost all conceivable services, ranging from software services to foliage rental, to each other. Some may recognise this as a clever way of setting up new business units with a captive internal clientele, but as Ceylinco’s experience suggests, such businesses are often uncompetitive in the wider market. The end result is a ‘house of cards’-like structure, where cash from a few thriving business are siphoned off by the rest. However, this remains a popular strategy locally among single owner and family owned businesses.
Has diversification held back some of our biggest companies? Local companies that had opportunities to diversify, but opted for a focused strategy, seem to have outperformed their peers. MAS Holdings and Brandix remained largely focused on the garments manufacturing business until recently. These firms had set their sights on capturing export market share and becoming dominant global players in their industry. They secured partnerships and made investments both locally and overseas to back up that vision. As a result, they are two of the country’s most valuable businesses today. Many conglomerates that have been operating for far longer produce far lower revenue. Hirdaramani Group, who has been a mainstay in the local garment manufacturing industry, but pursuing a relatively more diversified strategy, has arguably not enjoyed the same level of success.
Theoretically, diversification adds little value to shareholders, who are better off buying a diversified portfolio of equities. This optimizes the upside from winners (as they are not diluted by the results of the losers within the group) and is a better risk mitigation strategy – especially in markets such as Sri Lanka where there is heavy interdependence between business units of conglomerates.
Hence, it’s quite likely that we will see local conglomerates making more concerted efforts to link up their unwieldy structures around a more focused strategy in the near future. Business units that have become used to operating independently and managers wedded to the security of a highly diversified entity may need some prodding to buy into the idea. Coordinating the flow of information, particularly sharing customer information between the companies of the group to build richer customer profiles – a key strategic advantage of a well-coordinated strategy – is likely to run into both technological and political challenges. Some divestments are also likely to be necessary. But this is an essential transition if an entity in its whole is to be greater than the sum of its parts, which is after all the only viable reason for being a conglomerate in the first place.