We have been writing a bit about innovation strategy lately. While innovation and strategy are often poorly connected in the literature and in organisations, a real connecting point between the two is taking an evolutionary approach to both. In other words, if we manage both strategy and evolution as evolutionary processes of variation, selection and amplification (Eric Beinhocker’s equivalent word for ‘reproduction’ in the biological model of evolution), then they become very compatible activities. As I have said earlier in a talk to the Brisbane Innovation Network, innovation can become a means for executing strategy as part of a dynamic evolutionary process.

I’ve been thinking more about the consequences of adopting an evolution model for strategy and it has led me to some conclusions about a possible return to the conglomerate business model.

Conglomerates, or highly diversified portfolios of businesses, were once very common in developed economies. GE is probably the world’s best known conglomerate. In Australia, many people would not have heard of Wesfarmers but they own a wide variety of businesses including Coles and Bunnings (retail), insurance, gas distribution and coal mining. Since the Coles acquisition, Wesfarmers has around 90% of its business in retailing and has arguably lost its conglomerate status.

The paradox with Wesfarmers is that the business text books all say that conglomerates are bad and will eventually die out as a relic of bad business practices from the last century. Businesses don’t need to diversify to manage risk because shareholders can do it themselves. What shareholders really want is for businesses to ‘stick to the knitting’ and focus on the core competence of the firm. This is an easy mantra to follow until we look at Wesfarmers success as a diversified portfolio of businesses.

A lot of books were written about the mystical powers of Jack Welch during his tenure as GE’s CEO. It’s a pity that there aren’t books written about Michael Chaney, the CEO of Wesfarmers, who outperformed Welch in terms of returns to sahreholders during the 1990s until 2007, when he resigned to become chairman of the National Australia Bank.

Now Wesfarmers success couldn’t just be a result of chance. They actively managed the portfolio and acquired and sold many businesses over a number of decades. Even with the current ructions in the international economy and the difficulties of turning around the Coles business, Wesfarmers still has a 17% annualized total shareholder return over the past 10 years.

So what makes Wesfarmers work? I’ve got to admit to struggling with this question over the past 10 years of using it as a case study in my strategy lectures on business diversification. However, if we look at the Wesfarmers model through the lens of evolution, things start to make sense. Much has been written on Wesfarmers in the Australian business media but I’d like to focus on three activities that were central to their corporate business process.

The first of these is that there was always a large group of analysts in the corporate office looking at new business opportunities. It really didn’t matter what business they were in, as long as it fitted with the goal of providing sustainable returns to shareholders. This is really a process that generates variety in the business – the first step in evolutionary strategy.

Many of the old, failed conglomerates produced variety in the business portfolio, but Wesfarmers is highly disciplined in the selection phase of the evolutionary model. The benchmark for performance was 18% return on capital employed. If the business unit fell to 16% this was cause for remedial action and 14% could signal the divestment of the business. It is probably the adherence to this selection discipline that has set Wesfarmers apart from other conglomerates that have faded into business history. Finally, Wesfarmers would move capital to growing businesses to support expansion (amplification).

Business fashions are like clothing fashions. They come and go, and then come back again. I’m not saying that the conglomerate is about to make a rapid comeback but there is a lot we can learn from Wesfarmers. The dominant logic in business schools is that only the strongest survive and this comes through focus and effort to build on existing strengths. It’s worth quoting Charles Darwin here:

“It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change”

A changing environment demands much from strategy. Out the the top 100 firms publicly listed in the US in 1900, only two continue to survive today. Maybe it’s time to take another look at the conglomerate business model.