The 1998 merger of Citicorp and Travelers into Citigroup created an institution with more than $700 billion in assets and operations in some 100 nations, providing commercial banking, wholesale and retail investment banking, life and property-liability insurance, in addition to other financial services. Liberalization of product restrictions in other nations has led to similar mergers and acquisitions, as well as to the creation of financial service firms of unprecedented size and scope. The economic and systemic concerns raised by these new “universal banks” are at the center of current policy debate. On the level of business strategy, however, this trend begs the question of whether or not integrating lines of business is ultimately more profitable than remaining specialized in one area—that is, whether joint producers (conglomerates) or specialists are more economically viable in the long-run.

In a paper titled, “Conglomeration versus Strategic Focus: Evidence from the Insurance Industry,” four researchers set out to answer precisely that question. Written by Allen N. Berger of the Wharton Financial Institutions Center and the Board of the Federal Reserve System in Washington, D. C., J. David Cummins of the University of Pennsylvania’s Wharton School (who is also the executive director of the S. S. Huebner Foundation for Insurance Education), Mary A. Weiss of Temple University, and Hongmin Zi of Korea-based Sejong University, the study focuses specifically on the insurance industry and provides some conclusions through the use of a concept called “profit-scope economies.”

While traditional studies tend to focus exclusively on production cost, profit scope economies measures efficiency by taking both costs and revenues into account. According to the researchers, this concept sets the study apart from others in its ability to account for differences in methods of production that can generate skewed information about cost. For example, joint producers might need to spend more on technology to provide “one-stop shopping” convenience for customers, but they might ultimately regain that cost through increased revenue. According to the traditional cost scope economies measurement, these producers would be viewed as having cost diseconomies; when they are evaluated using profit scope economies, however, the results are more accurately positive.

Another innovative feature of the study is its exclusive focus on the insurance industry. Although the study aims to provide answers for the finance industry, the authors have specific reasons for their choice of insurance as a subject. Like the financial industry, the insurance industry is experiencing a surge in mergers and acquisitions. Moreover, the existence of true “specialist” firms in the industry—those that focus exclusively on property-liability or life insurance—allows the researches to rely on actual data, as opposed to the kinds of hypothetical models used for studies of the financial industry. Of equal importance is the historical lack of restrictions on joint production in the insurance industry: As a result, the industry offers many examples of mature firms that joint produce, as well as those that specialize.

Interestingly, both joint producers and specialized firms have remained competitively viable in the insurance marketplace over time—an empirical puzzle that the study addresses. Drawing from a debate in the finance literature, the researchers define the problem in terms of two competing hypotheses: the “conglomeration” hypothesis and the “strategic focus” hypothesis. The conglomeration hypothesis holds that owning and operating a broad range of businesses allows firms to exploit shared resources for production, to generate revenue from one-stop shopping, to create internal markets, and to diversify risk. The strategic focus hypothesis, on the other hand, argues that maximum value comes from focusing on core businesses and competencies, and that conglomeration leads to management problems and a lack of market discipline. As the authors note, neither hypothesis alone seems to account for the success of both joint producers and specialists in the insurance industry.

The researchers approach this puzzle by estimating profit scope economies using data from 111 insurance firms that produce both life and property-liability (P-L) insurance, 293 firms specializing in life insurance, and 280 firms specializing in P-L insurance over the period 1988-1992. To account for what seems to be the competitive success of both the joint producers and specialists, the researchers also develop several hypotheses regarding firm size, product mix, distribution systems, and organizational form. They conclude that, indeed, both hypotheses hold—that joint and specialized producers are competitively viable. The catch is that the two hypotheses—conglomeration and strategic focus—seem to dominate for very specific types of firms. The authors break this down according to the following criteria:

  • The conglomeration hypothesis mainly applies to insurers that are large, to insurers that emphasize personal lines of business, and to those that use vertically integrated distribution systems (i.e., in which the company controls the agency).
  • The strategic focus hypothesis seems to hold for small insurers that emphasize commercial lines and for insurers that use non-integrated distribution systems.

These results underscore the importance of remaining focused on consumers’ needs when the question of conglomeration vs. specialization arises. For example, most commercial consumers have internal resources devoted to shopping around for a tailored product, and they purchase in a high enough volume to demand good value. Therefore, firms that cater to commercial consumers should remain focused on value and quality—or, in other words, maintain strategic focus. Likewise, if a firm caters to personal consumers, who often lack time to shop and depend on the firms themselves for information, it can more easily exploit the ideals of “convenience” and “one-stop shopping” while offering different product lines.