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Guess, in today’s world which question is more important – Where to play or how to play.
The answer is ‘Choice of areas’ i.e. where to play (but the performances of individual
companies in opportune areas show variance i.e. companies show negative performance
and positive performances so shouldn’t the key question should be how to compete?)
More than half is about where to play? – Companies are not focusing on it. They are thinking
about innovating, marketing and product development, the develop their portfolio. Rather,
they could be much more active about changing portfolio and shifting where growth lies. But
they are very RIGID. They are very rigid in putting money. If brand is 50% then marketing
gets 50% of the budget if it is 10% then 10% (this makes shifting of portfolio, very difficult).
In a company, there are 2 divisions – older one which doesn’t perform (people will spend 4-5
years to turn in around) most of the budget will go to that division rather than fostering
innovations in other divisions. This prevents them in focusing on where the growth lies
(where to play). They compete on market share, where the growth does not lie (price wars,
competitors,)
Market Average Growth is the biggest contributor, the other two factors M&A 33% and
Market Share Gains 21%.
Summary of pie –
1. take a hard look at where the growth lies and then attack it, then do m&a, do not focus
on gaining market share
2. illustrate with example – telecom and financial services, market share gains are very small
As a strategist, if you are given aggressive goals then the first thing you do – look at their
portfolio to understand their growth prospects. (graph in class) all the existing resources are
concentrated in Europe and North America, but they should be shifted to Africa, Middle east
and Latin America because majority of the growth potential lies there.
Italian execs class example – APAC had 10% growth In year starting and 4% in year end
because their company was not ready to move resources to that region. They observed
more growth in Europe from 2% to 5% in that same period.
Power of choosing well of where to compete – it’s okay to give your employees , but if you
are giving them bad portfolio then then you are tying their hands. Eg L&T – they have
mantra of ‘moving towards asset light businesses’ it corresponds with their portfolio, they
sold their electrical components business, acquired Mindtree. asset light businesses -
business does not required major fixed assets. ROCE of the company was driven down to
15% from 20%+ you want to have significantly highly profitability. And it helps you in
reaching only a certain goal.
They company decided to evaluate where to play question to work on its ROCE which is
dependent on
- Operating profits
- Fixed assets
- Net working capital
If you want to correct ROCE overnight, you go to a company which has low fixed assets like
Mindtree (services company)
Ashok Leyland aggressive goals (already set the target industry - medium heavy trucks and
buses) q1 – what is the average industry growth? – you need a growth rate of 100% in an
industry which grows at 4% (to double its market share). It will concentrate on geographies
which are growing very well (q2). After that, evaluate how much growth you need in that
particular geography to achieve the target (q3). How likely is it to take hat market share –
(q4) could buy the next biggest player in market, but that’s difficult as competitors may not
want to sell and everybody else will come to India and china to capitalize on the lucrative
market potential. However, as a quick fix companies undergo m&a as they are able to reach
targets overnight, rather than investing in organic growth over a long period. Ashok Leyland
reached the goal 10 years after setting this goal as they didn’t have deep pockets. They had
planned on reaching it in 5 years, better not to do it, sends confusing message to
shareholders.
Organization:
- Decentralized – district level / plant level managers who reported directly to the CEO
Beatrice started changing its corporate strategy as it started showing signs of decay and
maturity. As the industry was being saturated, new regulations were passed that were
putting blocks on oligopolies. (Eg. Now, Zara is entering into new product lines, it cant keep
opening new stores and main 10% growth rate).
Corporate Strategy at the second stage (agricultural products, food service equipment, polymers,
specialty chemicals, bakery, recreational vehicles, graphic arts) – became a CONGLOMERATE
At this stage, Beatrice had become a less risky bank. It provided easy access to capital for
these companies as other money lending actors such as Banks and Stock exchange were not
evolved enough. And small companies were obligated to seek help from a big conglomerate
like Beatrice because of the absence of money lenders, at that time as Beatrice was the only
actor that had evolved to substitute these institutions. This is known as Institutional Voids
Theory – labor market is not very efficient; conglomerate acquires talent and distributes it
amongst its companies. For it, there was no value in acquiring publicly traded companies. It
identified companies in need to provide financial stability to them. The expiration date of
this strategy arrives with the evolution of external markets.
Synergies:
- Marketing
o Number of ad agencies
o Corporate brand $100 m Beatrice
- Distribution
o 400 centers -> 27 divisions
- Some r&d efforts
Organization:
- Centralization increases
- Too much too soon (the company changes its organizational structure changes 4
times in 5 years, the employees don’t do anything and waits for everything to settle
down. These disruptions evaporate the opportunities in conglomerate of exploiting
the potential of synergies. Beatrice spent a lot of money but not enough to be able
to leverage the value of it).
As long as the models are internally consistent and market consistent, the company is able
to create value, if there are discrepancies, the value is destroyed. Corporate strategy is
about choosing the right places, strategy in itself is about choosing the right places.
In this course, we will understand how to map portfolios, leverage synergies, organize the
company initiatives and main levers to align the company according to it.
Headquarter (conglomerate)
Conglomerates with very impressive portfolios always stand out but generally
conglomerates don’t do well. If we look at the 2003-2012, average shareholder returns were
32% for conglomerates in India and south east Asia. This means value is added, value is
more for companies in this structure as compared to the stand-alone pure play structure
where the average shareholder return is 28% in India and South East Asia. This is due to
following reasons -
- Access to capital (institutional voids)
- Awareness to regulations
- They attract good quality human capital which can be distributed amongst various
companies within the group
- Brand reliability i.e. trust for customers
- Conglomerate discount (30+20+10+20+20=100) / Diversification the idea that the
five businesses are part of the group having value 100 then its actual value to an
investor is 8 points less i.e. 92 (estimated by scholars). Investors punish
conglomerates in doing their valuation this way because they feel conglomerates
destroy value. Conglomerates got this reputation in 1980s and it still exists, that’s
why the share price doesn’t go up. ‘Difficult to justify value in a conglomerate’. In
today’s world it is important to justify that you are not following a conglomerate
strategy (GE’s CEO keeps telling the press that the company isn’t a conglomerate,
whenever the company does an acquisition it takes great pains to link it to the
company’s core business even if the acquisition is completely unrelated).
Now these factors are no longer present in the economy and conglomerates in India and
southeast Asia have started providing lesser shareholder value.
Portfolio Moves in news nowadays, L&T – becoming asset light; Tata Group – 7 verticals to
be created and every business to be reorganized into these 7 verticals which were to be
headed by independent directors. Firms should consider the fundamental question – Cost
versus implementation benefits before making their strategies.
Three frameworks in corporate strategy to map portfolio, measure it and make decisions
regarding it.
1. Portfolio Matrix
BCG matrix (oldest ones): Where to play? Making a graph to map our business with (X axis
Internal Analysis and Y axis External Analysis)
External Analysis - industry vital signs, industry structure (porter’s, value chain,
micro-economic features), global environment (PESTEL)
Internal Analysis – what are the company strengths and weaknesses (have necessary
resources to succeed in this industry, am I a leader or a marginal player, various
companies in my portfolio
In these tools we are always trading off simplicity and accuracy. At the time this matrix was
conceived, BCG was telling its clients that scale is important, and economies of learning will
give you an extra advantage. So they made this matrix based on scale. Best businesses were
the ones which were able to reach a higher scale. But nowadays, many times, Internal
Analysis is substituted by other parameters such as profitability, ROC and operating capital.
After a while McKinsey came up with its own matrix, they used an index rather than using
the market growth directly. They rated parameters on a scale of 0 to 10 and then took their
average, these parameters were – market growth, number of competitors, barriers of entry,
technological change, market share, synergies, etc. This was done for every company in the
business and then these companies were plotted on a graph where (X axis firm strengths
and Y axis market attractiveness).
Invest
Maintain
Divest
- Measures choice
- Threshold
- Investment Rules (what to do with the businesses which lie in each quadrant)
o ??? – seed or a weed – is it a good business and you don’t know how to
manage it or is it a bad business which cant be groomed
o Stars – pump in more money
o Dogs – divest
o Cash cows – maintain
Problems with the BCG matrix
- Noise in measurement
- Don’t see synergies
- Granularity = Detail
It is too simplistic e.g. If ‘Food’ business unit/division is plotted in a particular
quadrant for an entity like Unilever Group, then it isn’t entirely correct. The ‘Food’
business unit is composed of various companies, some of them would be extremely
profitable and lie in a different quadrant and some would be lesser profitable and lie
in another quadrant. To do actual business, investment decisions have to be price
and driven by sophisticated maps and graphs (granular view graph versus green area
graph) start with the first one and then go to the next one for getting the actual
picture and making strategies.
- Execution of reallocation
How will you sell the ‘dog’, it is a $5 Billion business the execution of moves is very
complicated, and it is not visible on that map. However, on the other map, it is easy
to identify the unprofitable firms due to high level of detail.
- Time Horizon - Short term picture of the company
3. The Three Horizon (Mckinsey) - Allows companies to see, care and put resources in
the long term.
Each business has to be managed differently depending upon its Horizon. For each horizon,
managers has different incentives
- CORE/Horizon 1: The key goal is efficiency by implementing cost reduction; planning
and measuring costs very accurately. Investments (88% - current; 70% - target)
- ADJACENT/Horizon 2: The key goal is to position and build. Investments (10% -
current; 20% - target)
- TRANSFORMATIONAL/Horizon 3: The key goal is to innovate (R&D spends).
Investments (2% - current; 10% - target)
For example, Facebook (slide on 10-year roadmap) and Unilever’s case study.
Path to growth plan of Unilever –
The growth declines from 1999 to 2004, a lot of targets were achieved other than growth.
Consequently, the plan was a failure.
Portfolio Strategy
1. Focus on FMCG, Divestment of non-FMCG
2. Focus on ‘foods’ – acquisition of BIG Brands like BESTFOODS, B&Jerry’s, etc.
3. Fewer Number of Brands – more focus on power brands and local jewels
Increase marketing budget
Market
From 11% to 13% Share
P&G’s = 15% (higher)
Generating $ Market
Average
Growth
(higher)
Growth
Why did Unilever’s strategy fail – They overinvested in marketing budget to gain more
market share.
- They were essentially selling soups and ice-creams in developed economies and
everyone knew about the existent of them already.
- Consumers are extremely brand loyal in the FMCG category.
- They had a market share of 30% to 40%, so gaining 4-5 points more should not have
been a priority. Plus, they had reduced their existing number of brands. This put a lot
of pressure of their exiting brands, like consumers of knorr can potentially get
confused because of ‘stretched’ brand positioning (is the brand Premium, middle,
value for money or cheap). In that process, market share is lost and not gained.
Session 3
HUL CASE
Knoor power brand, has equity, positioning cannot cover the whole market
If Market Equilibrium is distributed by external change or from one of the companies within,
leads to increased competition and an issue in the market
A market leader should not initiate price war. The more fragmented the market, more
aggressive will be the price war.
Nothing in the above plan screams High Growth or serious growth possibility. Every goal
focuses on profitability.
Organization
Culturally same and same language Belgium and Netherlands were very similar
When P&G bought Gillette, they organized by product – adopted Matrix Org structure
HQ
P&G was able to leverage the portfolio and get results, than HUL which still used local units.
If an organization has a portfolio of products which are a mix of global and local Matrix
Org structure.
If an org has portfolio of products which are more global then local
HUL should reduce portfolio and focus on power brands leading to Org centralization
An org should know What level of decentralization does the portfolio strategy require?
1. Cross-Subsidization
HQ
BU 1 BU 2 BU 3
Bad unit is getting more money than it deserves and good one is getting less money than it
should get.
Though there is difference in their future prospects, the conglomerate is diverting money
from the good one to bad one.
The conglomerate gives resources to the company that are bad, which are taken from the
good one Cross-subsidization
First had 4 options and then put a bad 5th option (more risk, low return) Then
people started putting money in all 5 options.
The conglomerate heads also have the bias, thus diversify the resources among
different businesses.
If structure changes
HQ
BU 1 BU2
b. Political
Size of Unit or Age of Unit or Power of Unit these units will benefit beyond than
they deserve. Managers will lobey the headquarters and they ensure to get the
resources and not get their resources cut.
Reason why Microsoft started so many growing businesses but dint become leader
at any time. There is one largest unit operating system this unit as higher
power and gets more resources. The large unit also decides the people and
resource’s which will be allocated to the other units.
Sum of the large unit will be bigger than the other units.
2. Escalation of Commitment No investment
Inability to divest at the right time
Diversified corporations are not good at selling or cutting investments.
Reason why?
Commitment to business to continue and invest more and try to turn around. Like
you don’t want to sell the stocks when they are low, and not selling lead to higher
loss in the future. Like in a casino, when someone losses, they still continue to play
and loose even more.
Cannot sell because we bought it, pet project, been with the company for very long
Sunk Cost bias amount of resources put into the project.
It is the project decision criteria
Example: you have already booked movie tickets for Saturday, a week prior and on
Friday you get to know of a party. If you go for the party, the ticket cost will be the
sunk cost
Managers hire consultants and go for Zero based budgeting instead of making
budget based on last year numbers, companies start making the budget from scratch
3. Personal Attachments
Samsung started a car business because the CEO loved cars.
Spencer bought Brooks brothers
Disney bought a TV network
Managers are borne to the bias of personal attachments but the plans have to get
approved by BOD.
Because of the 3 reasons, there is always a skeptical view of the markets at the
decision of conglomerates.
How does the private equity model create value? Private Equity Parenting
1. High powered incentives
2. Improved monitoring through separate boards
3. No cross-subsidization
4. Private ownership
5. Forced divestitures
Avoid Destroying value through governance
Add vertical synergy from HQ to the rest of the company
Managers in a PE are forced to put in their own money but the CEO of a diversified firm
does not have his wealth tied. In a PE, managers are playing with their own money and in a
conglomerate, managers are playing with SH’s money.
Divestitures are higher in a PE buy and sell within few years, PE puts a horizon to the
company. Max keep the company for 5-6 years.
PE high debt compared to Conglomerate. PE takes loan and finance the growth plan
through debt, so the company needs to generate cash flow soon as it has to repay the debt
and interest, so these companies have the pressure of performing and generating cash
flows.
What can a conglomerate do to perform like a PE? decisions based on numbers and
independent BOD for each business unit.
PE firms are seen as mechanism of the economy for achieving short term gains.
Companies which where under PE and then left are seen to be more profitable in the future,
they become more agile.
PARENTING VALUE
Can corporate HQ make the business units better?
More the company has vertical and horizontal synergies more is the added value
of the company
Low risk and high value adding are the best business / heartland businesses
Pirelli and the ways to “divest” a business for which you are not the best owner
PORTFOLIO + PARENTING