Score Weightings are distributed:
Market position 8
Production/supply capability 4
Market support 4
Approximately 63 per cent of total weightings are applied to the provable elements of market position and relative profitability.
C H A P T E R 1 7
Strategic planning – a second look at the basic
options
This chapter aims to provide another way of looking at strategic options, which is related to the nature of the action instead of the source from which it is derived.
Seven major options are explored in some depth: divestment (including out- sourcing), obtaining licences, giving licences, various expansion methods, research and development, acquisition and merger, and strategic alliances. The value and difficulties of the approaches are explored. Practical guidance is given to help improve the chances of success if the option is chosen.
In Chapter 14 there was a considerable discussion of the matrix (Figure 14.3) into which most strategic alternatives could be fitted. Within each sector of this matrix there are many actions that can be initiated, and these may be classified under a second list of headings on which discussion should now be turned.
These are:
1 Divestment 2 Obtaining licences 3 Granting licences
4 A simple expansion approach – hiring staff partnership broking
‘piggy-backing’ operation contract production selling own services 5 Research and development
6 Acquisition and merger 7 Alliances.
Divestment
A decision to give up a particular sphere of activity may be very difficult to make.
There are often emotional or prestige reasons for wishing to continue: a dislike of admitting failure, an unpleasantly high loss to be faced in one year, problems of employee morale, and, above all, a sneaking feeling that someone else might pick up the divested area and make a success of it. For a chief executive this may be like advertising personal inadequacies. If it is a major divestment, the whole of the business world will observe it and will note the results if another chief executive does succeed where the first has failed.
The decision to divest can come in varying degrees of size. The dropping of a few minor products may cause no problems at all. In another case an entire activity area may be sold without having any noticeable effect on the day-to-day operations of the company. A decision to divest the company of a complete division or subsidiary may have a much greater impact.
Divestment may be a very important strategic decision to consider. Although my opening sentences on the subject hinted that failure could be the incentive to divestment, this is only one of the many possible causes. It is possible to divest from strength as well as from weakness.
A divestment decision might well arise from a tidying-up operation after the company has made its corporate appraisal or evaluated its portfolio. Perhaps the operation, although profitable, does not fit in with the company’s perception of what it should be doing. Here it may be sensible to apply the maxim of concentration of effort by attempting to withdraw from an operation which makes demands on top management time but which has no place in long-term strategic thinking.
A related divestment decision might arise because although the company might wish to remain in a business, it may be unable to afford the capital expenditures required to make that business a successful long-term competitor.
In these circumstances it is better to find a way to withdraw now, while the business is seen as successful, rather than waiting until it has lost competitive ground. It was this sort of circumstance that lay behind the reshaping of the Vickers portfolio over the three years following the merger with Rolls-Royce Motors.
Divestment may be the result of a desire to reduce risk. An assessment may suggest that the company is unwise to rely on profits from its subsidiary in an underdeveloped country because of the high probability of political unrest. It may be prudent to divest the company of all or part of its operations in that country in order to avoid a possible problem at a later date.
As we saw in the GI example in the previous chapter, the perception of risk may be related to the perception of the strategic requirements of this business, and it may be the combination of the two that brings the divestment decision to the fore.
Shareholder value has been discussed several times, and has provided a different motivation for divestment. This may take the form of reshaping the portfolio in the way already suggested, or of returning to the shareholders an
equity stake in an activity hived off from the current ownership. Argos was hived off in this way from BAT Industries, and now has nothing to do with its former parent, although no doubt it still has a number of shareholders in common.
Divestment may be forced for legal reasons. In the USA, anti-trust legislation has compelled many large organisations to divest part of their businesses. This has long been an element of US business history. For example, the break-up of the great Standard Oil Company in 1911 into thirty-eight state-centred oil companies ultimately led to a number of the mammoth world players of today.
There are many more recent examples, such as ITT. Monopoly legislation is not restricted to the USA, and the legislation of the EU and its component countries has made companies divest businesses that they would rather have kept, sometimes as the condition for allowing a merger to take place. In other countries, such as Malaysia, there has been legislation that has forced the sale of a major part of the shareholding to local people. This type of legislation may be the trigger that leads an organisation to withdraw from the particular country.
The final example is where the legal background to the competitive arena makes it impossible for the company to compete on level terms with its main rival. BP sold its downstream oil interests in Canada to the state-owned oil company. Not only was Petrocan in a preferred position through many government actions, but it became impossible for BP to expand to meet its challenge because of legislation which made it very difficult for a foreign-owned company to expand by acquisition in Canada.
A divestment decision from weakness might arise in order to improve the cash- flow position. The sale of a profitable activity might be the solution to a difficulty that cannot be resolved by other means. Alternatively, an activity may be divested now in order to avoid a major capital investment foreseen in the near future. In this way a potential problem is avoided, and the more favourable time (for the vendor) may be picked for the sale.
There are many divestment strategies. The simplest is to offer the business for sale, and here the skill is to do this in a way that gains the maximum price but does not cause a flight of customers or key staff. The need for what might be termed ‘confidential promotion’ has led to specialist acquisition broking businesses. When Vickers decided to divest the diesel division they approached it in a similar way to how they might have chosen a diesel company to acquire. In other words, which companies in the world would it best complement, in terms of development, product range, and geographical coverage. This resulted in a short list of target companies who could be approached with a carefully prepared proposition showing where the benefits were. The buyer was Perkins. The probability was that this approach brought a better price, and because it was handled by the top management of the division, may have maintained management morale and kept the key people together.
Another means of divestment is the management buy-out. This has long existed, and became particularly popular during the 1980s, often leading to businesses which prospered once they had thrown off the shackles of the head office. One well known example is the purchase of the National Freight Corporation from the British government by its management and other employees, a story which has been described by Thompson.1
Charterhouse in the 1970s was a combined industrial, merchant banking and financial services organisation in the UK. During the late 1970s it began to reduce its investment in the industrial holdings, and to use the funds to build the merchant banking operation, including the acquisition of another major player.
The divestment strategy applied to many of the strongest companies in the portfolio was to float them on the stock market, initially retaining a significant
Exhibit 17.1 Demerger
Increasingly divestment has taken the form of a demerger, with a large organisation splitting itself into discrete businesses, so that the shareholders then have shares in two quoted organisations instead on one. The reasons are usually defensive, to ward off an expected but unwanted acquirer, or in order to give more value to shareholders.
In 1993 ICI demerged into two companies, floating the pharmaceuticals and biotechnology businesses on the stock market under the name Zeneca.
Bulk chemicals, paints and explosives remained under the ICI name. One advantage for shareholders is that Zeneca, because of the standing of pharmaceuticals in the stock market, would find it easier to raise capital for expansion than if it remained a part of a larger company.
Through the 1980s ICI had followed a strategy of expansion by acquisition, following clear objectives to increase the organisation’s business in overseas markets, particularly the USA, and to build up its businesses in the most profitable segments of their industries. In the 1990s it began a further exercise in restructuring, selling businesses such as fertilisers, and dividing into seven core activities. It was apparent at this stage that there were two main groups of businesses, which were not synergistic with each other.
Hanson Group suddenly bought nearly 3 per cent of ICI shares in 1991.
Although no intention to bid for the whole company was ever announced, ICI acted as if it had, and mounted a vigorous defence strategy. Various internal studies had shown that there were really two major strategic business groupings in the company, and this was confirmed when the company’s merchant bank S. G. Warburg was invited to study the figures. The decision was made to follow the demerger option recommended by Warburgs.
In 1991, what was to become the Zeneca businesses had 32 per cent of the total turnover, but contributed 70 per cent of the trading profit. Apart for the strategic benefits to both businesses, flotation meant that shareholders would gain value as each business had its own share valuation, and full value could be obtained from the Zeneca portion of the shares. The move also made the organisation unattractive to a predator whose only aim was to release the locked-up value.
(Source:Kennedy, C. ‘The ICI Demerger: Unlocking Shareholder Value’. In Lloyd, B. (ed.), Creating Value Through Acquisitions, Demergers, Buy-outs, and Alliances, Pergamon, Oxford, 1977.)
shareholding which could be disposed of later. This was a neat way of divesting, in that it gained maximum realisation without it being necessary to find and negotiate with one particular buyer. Customer confidence was unaffected: it was after all a sign that the company had grown up, and it avoided the internal upheaval of an acquisition.
It is also worth stressing that divestment does not have to be total. It is sometimes worth removing some of the problems of risk and inability to fund growth by merging a subsidiary with that of another organisation. A stake may be retained, possibly for sale later. However, there can be risks here, particularly if one partner wants to slow investment and the other to increase it. Just such a situation is described by Friedman:2the joint company formed in the USA from the construction equipment interests of Allis Chalmers and Fiat. Allis Chalmers wanted to reduce their stake in this business: Fiat wanted to expand.
Consequently there was a clash every time Fiat called for new investment, which would in fact have increased the Allis Chalmers stake. Fiat had purchased 65 per cent of the construction equipment from Allis Chalmers. This attempt at reducing involvement in a business led to litigation and acrimony.
In all divestment decisions attention must be given to personnel, morale throughout the whole company (nothing spreads faster than a rumour that the ship is sinking), and to the public relations aspect. The divestment plan should deal specifically with these matters.
A divestment decision is based on forecasts and assumptions in much the same way as an investment decision. The main difference is the light of publicity. The outside world rarely knows when an investment opportunity is rejected or even – except in the case of large failures – where a decision to invest proves less successful than had been hoped. Divestment is a public act and calls for a higher degree of management courage. Despite this, it is an action which should be considered when a company evaluates its future strategy, for it may be the key to greater profits.
More recently there has been another form of divestment, the outsourcing of services which the organisation previously used to undertake for itself.
Sometimes this has included the transfer of employees to another organisation, which has happened frequently as IT activities have been outsourced. Another route has been helping employees in the area to be outsourced to set up their own business on the strength of an outsourcing contract.
The strategic rationale for this form of divestment is cost reduction, flexibility in times of expansion and contraction, a realisation that specialist organisations can often bring a better service, and a narrowing of focus to the core competency areas. Jennings3 argues that almost the whole value chain is open to an outsourcing decision. He gives a number of guidelines for use in the outsourcing decision, which include:
䊉 Ensure that decisions are taken in relation to the overall strategy, and in the context of a future-oriented view of the changes that are likely to take place in the industry.
䊉 Ensure that the service is fully defined when undertaking a cost analysis – it is easy to overlook frequent free advice that a unit may provide, which is peripheral to its main function.
䊉 Ensure that a careful costing exercise is undertaken, which means under- standing which of the indirect costs charged to a unit will truly disappear if the unit is closed.
䊉 Take great care to define the core activities, and to retain these in the organisation.
䊉 Ensure that the outsourcing decision does not create a competitive dis- advantage by leaking knowledge or technology so that it now becomes available to competitors.
Successful outsourcing decisions will often lead to forms of strategic alliance, an issue covered later in this chapter.
The virtual organisation
The combination of outsourcing, alliances, and, sometimes, the opportunities offered by modern information technologies has led to a new form of
organisation. The virtual organisation fulfils all the functions of the traditional form, but as many of them are not owned or performed in house, overheads are reduced, and suppliers are able to secure and pass on economies through specialisation. In fact the form is not as new as its name. For example, publishers have a tradition whereby they rarely employ authors, printing and book binding is outsourced, services such as copy-editing and proof reading are often performed by freelance specialists, and in some cases even sales and distribution are delegated to specialist organisations.
What is new is the greater number of organisations which have found value in treading this route, and the new opportunities that arise through the new technologies. So we have a virtual retail bank in First Direct, where telephone, hole-in-the-wall cash machines, and other computerised applications make it possible to eliminate the traditional branch offices: although, of course, there is nothing virtual about the back-office activities, where there is a very real bank.
The virtual form may reduce risks as well as reduce costs. Harbridge Consulting group Ltd established a virtual organisation to implement its strategy for Europe. Alliances were made with quality organisations in various countries, so that a service could be offered to multinational companies to run a tailored training programme in most European languages. In Germany, where there was a different strategy, a virtual office was created inside the premises of a non-competing consultancy. German-speaking London professionals were supported by contracts with quality self-employed German professionals. Had the firm not been acquired, a contact office would have been opened in Brussels in alliance with a number of firms from other European countries. What was achieved was a capability that would have taken more resources than were available to establish by traditional means, that was operational in months rather than years, and which almost eliminated risk.
Anyone considering this form should think carefully about the managerial implications, and should not underestimate the time that has to be spent with alliance partners to ensure a shared commitment to what is intended.
Obtaining licences
A decision to obtain licences may arise from a study of any of the boxes in the strategic matrix, although it is more likely to be associated with new products, whether for existing or new markets. It may be a logical decision in a situation where a licensed process can bring lower production costs for existing products or can upgrade the products so that they give a better market performance and in these situations can contribute to expansion under the two existing product boxes of the matrix.
The main drawbacks of obtaining licences are cost, continuity, security of information, legislation, and availability. A licensing agreement involves the payment of a fee, frequently on a royalty basis, over the life of the agreement.
This usually means a commitment of future margins, which can cause problems if the company ever moves into a situation where these are declining.
Continuity is another problem which depends on the type of agreement, the remaining patent life (if any), and the strategies of the licensee. Unless carefully considered a licensing policy brings the risk that what has become a major product area may disappear overnight if the agreement is cancelled or lapses, there is no control by the licensee over research and development, so he or she may not know whether product improvements are being carried out or how vulnerable it is to technological developments by competitors.
Security of information may not always be a disadvantage, or at least any disadvantage may be more emotional than real. But a licensee must provide information to the licensor and, in many cases, must give access to the books of account, marketing plans, and production processes. This may be a disadvantage if the venture proceeds well, giving the licensor full information about the market which might tempt him into it on his own account with this or the next improved version of the product. In this way the licensee may, in effect, be carrying out the expensive market development work on behalf of another company. This information problem can become more acute when company ownerships change:
what is quite sensible policy at the beginning may become much more of a problem if the licensor is acquired by a major competitor of the licensee.
Legislation may be a problem which has to be taken into account. For example, the payment of royalties may be prohibited by some governments. A change in legislation can be particularly difficult for both parties.
Perhaps the biggest problem of all is finding someone who wants to license a product or process. There are specialist agencies which can assist in bringing interested parties together, and it is possible to identify possibilities and make a direct approach to the company concerned. In many ways there may be similarities with identifying and negotiating with a suitable acquisition prospect.
Success cannot be guaranteed, and the company must always remain wide awake to the unexpected opportunity.
The difficulties and problems should not be overstressed, for cooperation is possible even among the most aggressive of competitors (e.g. the licensing arrangements in the world’s pharmaceuticals industry). There are very real benefits to a licensing agreement, and in most cases these outweigh the