The news that Google is reorganising as a holding company called Alphabet didn’t surprise me. Google has long existed in an untraditional strategic form with business interests as diverse as driverless cars and search to venture capital and the provision of wifi. Certainly in branding terms, if not governance, the single company model was starting to become a little forced.
That the comparison was made by some commentators to Warren Buffett and Berkshire Hathaway particularly interested me though, as I’d only just read some of Warren Buffett’s letters to shareholders on the holding company issue (as an aside, Jeff Bezos’ letters to Amazon shareholders are of a very very similar form and content – it’s interesting to see an idea travel). Warren Buffett addresses the typical issues that arise with conglomerates about half way down this letter last year. To my mind it is a very robust defence of why holding companies can add value in a world in which capital does not flow freely, a defence of a legal form which isn’t surrounded by much robust analysis.
“One of the heralded virtues of capitalism is that it efficiently allocates funds. The argument is that markets will direct investment to promising businesses and deny it to those destined to wither. That is true: With all its excesses, market-driven allocation of capital is usually far superior to any alternative. Nevertheless, there are often obstacles to the rational movement of capital. As those 1954 Berkshire minutes made clear, capital withdrawals within the textile industry that should have been obvious were delayed for decades because of the vain hopes and self-interest of managements. Indeed, I myself delayed abandoning our obsolete textile mills for far too long…
At the shareholder level, taxes and frictional costs weigh heavily on individual investors when they attempt to reallocate capital among businesses and industries. Even tax-free institutional investors face major costs as they move capital because they usually need intermediaries to do this job. A lot of mouths with expensive tastes then clamor to be fed – among them investment bankers, accountants, consultants, lawyers and such capital-reallocators as leveraged buyout operators. Money-shufflers don’t come cheap.
In contrast, a conglomerate such as Berkshire is perfectly positioned to allocate capital rationally and at minimal cost. Of course, form itself is no guarantee of success: We have made plenty of mistakes, and we will make more. Our structural advantages, however, are formidable.”
This raises an interesting question for the social sectors. If in traditional capital markets, where as Buffett says it might be argued capital flows relatively freely, there is value in holding companies, then might there be an argument even more so in social sector markets where capital doesn’t flow freely at all? Dan Pallotta’s TED talk is an easy start to the literature here.
So, with the collapse of Kids Company lingering in the background, which to my mind was mostly about the inefficiencies of capital allocation in the social sectors, all this brought me back to a question about holding companies in the social sectors, especially as in essence Hub Ventures itself is a holding company so we have particular interest in working out if this organisational model has value.
Last year I was really pleased to see thinking from Big Society Capital about how holding companies like the extraordinary Groupe SOS could be one mechanism to facilitate exits for social entrepreneurs. Since though we haven’t seen much progress in development of holding company models. It looks like Big Society Capital’s Business Impact Challenge may put something out there with the inclusion of Interserve amongst the short-list. But the next Google/Berkshire Hathaway/Groupe SOS of the social sectors is clearly not in development around the corner.
I think the Big Society Capital paper sums up the issues under consideration better than anything else, so will leave the thoughts at that. My only question for now, having seen Warren Buffett’s arguments for conglomerates and the news about Google this morning, is whether we are barking up the wrong tree or whether this seriously needs looking at?