What it is:
A conglomerate is a corporation made up of several smaller, independently-run companies which may operate across several sectors and industries.
How it works (Example):
Conglomerates are generally formed for two reasons: to diversify risk by participating in unrelated businesses or to expand a business within an industry to include suppliers and product purchasers.
Despite the possible benefits, conglomerates face the challenge of becoming so large that they are difficult to manage efficiently. This can lead to a lack of focus, which exacerbates managerial problems and reduces shareholder returns. This reason is why conglomerates often "spin off" subsidiaries into stand-alone entities. Corporations may also fail to realize the anticipated cost savings associated with acquisitions.
Why it Matters:
The motto "the parts are worth more than the whole" is the idea behind conglomerates. They are typically very diversified businesses (although some conglomerates stick to one or two industries). This diversification and the efficiencies brought about by shared or reduced costs often make conglomerates less risky than those operating in a single market or niche. Many well-run conglomerates like Berkshire Hathaway and General Electric are much like funds in that they offer diversification and are less sensitive to general business cycles than more focused companies.