Bangladesh has several large conglomerates with diverse sets of holdings across multiple sectors.
Such large companies can be assets for Bangladesh, especially as we strive to address the economic challenges that lie ahead, the challenges of export diversification and productivity improvement, and expansion of industry to create good jobs for the millions that enter the labor force each year.
But these companies can be liabilities too. Large companies, especially conglomerates, have strong economic power, which may translate into influence over policy making.
That influence may go either way. It may lead to policies that help us address challenges mentioned above.
But it could also lead to policies that create privileges for few and not jobs for the many that foster investment in political connections rather than productivity improvements that encourage rent-seeking rather than market creation.
At this crucial juncture in our economy, as we ponder over the implications of being a middle-income country, we need to take a closer look at the Bangladeshi conglomerates - their nature, capabilities, incentive structures and internal dynamics.
At first glance, these conglomerates appear to be all over the place.
Their expansion into very diverse sets of activities appears to defy logic.
However, a closer look reveals some patterns that may make sense.
Consider the following charts which show the long-term trajectories of two large conglomerates of the country.
The information embodied in the charts is public knowledge, derived from the company websites.
It may not be 100 per cent comprehensive but enough to provide clues to what is going on in the world of Bangladeshi conglomerates.
In the charts below, I show time periods on the horizontal axis and sectors on the vertical, starting from relatively simple activities to more complex ones.
Details
The first chart illustrates a conglomerate whose founder started his entrepreneurial journey a couple of months after Bangladesh’s independence by setting up a mustard oil plant in old Dhaka employing 25 people.
Conglomerate journeys: Staying close to core competence This remained his main business through the 1970s and 1980s. In the 1990s, he expanded by setting up plants to make soybean oil and semolina, as well as a packaging plant to serve the needs of his other plants – a modest case of vertical integration.
The most significant diversification happened after 2000 when the conglomerate ventured into several new areas.
Nonetheless, it did not stray far from its core competence.
As we can see from the following chart, much of the diversification happened in food related activities, the only exceptions being investments in lighterage vehicles, polypropylene woven bags and a private economic zone.
So, this is a case of horizontal diversification, largely into activities at a similar level in the food products value-chain.
Conglomerate journeys: expanding into several value-chainsThe second chart relates to a more diversified conglomerate and provides not one, but three examples of investments along a value chain.
An early venture of this Group was a silk mill, set up in 1962.
Its most popular product was a saree catering to the needs of middle-income and low-income families who could not afford expensive wedding sarees for their women.
This hugely popular saree acquired a somewhat iconic status and provided the primary capital that was used for subsequent investments in the textile value chain.
This included a dyeing and printing mill in 1984, a textile mill in 1992, a cotton spinning mill in 1996 and a jute yarn mill in 1998.
This is a clear case of progressively moving into backward linkage industries within the clothing value-chain.
Like several other conglomerates, the Group has also gone into the construction value-chain, but its entry was earlier compared to most.
It set up an iron and steel mill in 1978 (making iron bars), followed by additional steel mills in 1987, 1995 and 2004, cement mills in 2002 and 2014, and a real-estate business in 2001.
It has thus diversified both forward and backward within the construction value-chain.
The third value-chain where the group has invested is finance.
The founder of the Group was one of the first to have set up a bank after a policy change in 1982 allowed private banks to operate in Bangladesh.
It is perhaps not surprising to see one of the pioneers in the banking industry later branching into other areas in the financial sector.
The Group went onto insurance in 1998 and a lease finance venture in 1999.
These were followed by a stock brokerage and a merchant bank in 2011 and a second commercial bank in 2013.
Meanwhile, in 2004, the Group invested in fisheries and poultry, and in sustainable (agro-processing). This could be the beginning of a fourth value-chain expansion for the Group.
These are just two examples.
If such portraits are created for other conglomerates, these may reveal similar patterns or uncover additional features.
But in all cases, we are likely to see substantial diversity of activities.
Abundant diversity
There are several possible explanations for such huge diversity.
I discuss some below.
None of these by itself would explain the observed diversity but together they may explain most of it.
The first is the classic explanation put forward by Ronald Coase in his “Theory of the Firm”.
Coase, who won the Nobel Prize for Economics in 1991, explained why firms sometimes produce goods or services in-house, i.e., within the company, instead of purchasing it from the market.
This happens when the transaction cost of purchasing these inputs from the marketplace exceeds the coordination costs involved in producing these within the firm.
The same argument can be put forward about selling the output, i.e., under certain circumstances, a firm may prefer to sell a product in-house than in the market.
Both these considerations lead to greater vertical integration, with the first leading to an expansion into a backward-linkage activity and the latter to a forward-linkage industry.
Such a tendency may be stronger in Bangladesh because a strong culture of delivering on commitments has not yet developed.
Entrepreneurs thus want to have control to avoid possible risk of un-reliable supply sources.
A second factor is the size of the domestic market, which may limit how much an existing activity can be expanded. In the case of a tradable product, this constraint may be relaxed by exporting.
But exporting requires firms to be globally competitive.
For a variety of reasons, companies may lack the capacity or incentive to acquire such competitiveness. Unable or unwilling to expand a line of business by exporting the company expands into other activities targeting the domestic market.
This is a reason why highly successful RMG entrepreneurs tend to be less involved in other sectors, given the opportunities to expand in a global market.
On the other hand, large domestic conglomerates tend to focus on service, construction or import substituting manufacturing activities perhaps because they have not achieved the level of productivity to compete in global markets.
This is a common phenomenon in developing countries, especially those who tend to be relatively more inward-looking.
This is particularly true if the company has extra cash flow in a slow-growing market.
Here, diversification allows the company to make use of surplus cash flows.
A third factor is risk mitigation. Diversification may reduce overall risk if there is a downturn in some activities.
It may be argued that diversification of economic activities within a conglomerate is not the same as diversifying a stock portfolio.
In the case of stocks, expected return and risk (as measured by variance of returns) are exogenous to the investor.
Thus, if the covariance is low, the more diverse the stock portfolio the less risky it is.
The logic of diversifying stock market portfolios does not necessarily extend to diversification of economic activities within a company or conglomerate.
Here, both expected return and risk depend significantly on managerial quality and attention, which is an endogenous variable.
Diversification could lead to scarce managerial resources being spread too thinly thus adversely affecting productivity.
It is possible that within Bangladeshi conglomerates, some firms are doing well and cross-subsidizing those that are performing poorly, in which case it may be asked why the latter companies are not being closed.
However, under some circumstances, diversity may support productivity growth by creating synergies, i.e., by helping the company take advantage of economies of scope.
The large conglomerates of Bangladesh have acquired experience in building industrial enterprises and other businesses.
They have shown an ability to identify and exploit new opportunities.
Many have acquired state-of-the-art technologies and are operating at significant scale.
All these are useful attributes which may prove invaluable as Bangladesh strives to meet the challenges of the future.
Nonetheless, there are some important questions that need to be asked about the conglomerates.
Have these companies invested in merely increasing capacity or also in improving productivity? In the markets in which they operate, what has been their attitude to competition?
Having done well in the protected domestic markets, are they ready to venture into the more challenging and competitive global markets?
To what extent has their growth been due to efficiency, and not the result of protection and privileged treatment by the state?
These are important questions to ask.
As I said on the outside, the large conglomerates are big assets for the country.
We want to make sure we get the best returns from these assets, not just for their owners but for the economy and society.
Answers to the above questions will tell us whether we are getting such returns and, if not, what needs to be done in terms of policy intervention.
The author is an economist, previously with an international development agency