There seems to be a business news story just about every day concerning the latest global conglomerate under attack. This aggression is usually from an “activist investor” group trying to assert its will and influence on the strategy and shareholder value of what it terms as “undervalued” organizations. Pepsi, Baxter, and H-P are just a few of the organizations that have been or will be changed forever because an activist investor group intervened to “unlock potential.”But just a few years ago, many large companies were engaging in M&A strategies in order to grow, gobbling up companies and integrating them to create scale and efficiencies. So what’s really going on here?
Let’s take H-P, which is going to be split into two separate companies: personal computers & printers as one business, and servers, software, storage, and services as another. The PC & Printer business is the old commoditized business and the servers, software, and storage is the new growth business. This is a similar break up pattern for many organizations that are being pushed to break themselves up. In the case of Pepsi, the activist investor, Triad, has been driving to break up the snack food business from the beverage business and recently announced they will stop pushing it (at least for the time being) after Pepsi agreed to add a Triad partner to the Pepsi board of directors. Pepsi and all of their brands such as Gatorade and Frito-Lay are all premium, product-leading brands that create customer and shareholder value through a value proposition of innovation and the perception of premium quality. H-P tried very hard to create a value proposition of innovation and high quality first with printers and then with their personal computers, servers, software, and storage. The predicament that H-P finds itself in today is complicated, but clearly H-P leadership acknowledges that they did not execute their strategy very well while the markets they were competing in became more commoditized.
A significant challenge of the potential the H-P break up scenario, according to senior analyst for Stanford Bernstein Toni Sacconaghi, is that there is no compelling business reason to do it. Reading between the lines, it seems that the only reason the break up is being undertaken is to take advantage of H-P’s low market capitalization. The transaction and the excitement of a break up process artificially drive the share prices up for the two new company stocks through the perception of some sort of operational efficiencies with a “greater focus” on the core businesses. From our perspective, it seems like this is merely a manipulation of the stock price by implying there will be some sort of increased efficiencies and operational focus. Unfortunately, what these new corporate raiders don’t tell the shareholders – because they most likely will be long gone with their profits stuffed in their pockets – is that these sorts of break-ups can cause fewer efficiencies, not more.
In a recent business simulation workshop that Advantexe conducted with a group of 20 senior executives, we created a business simulation scenario where the executives were divided into teams of four running a global multibillion dollar organization in direct competition with other organizations in a model marketplace. Each team was responsible for setting a new business strategy and then executing that strategy through operational decisions while in competition with each other. In this specific simulation workshop, each multibillion dollar organization is comprised of three business units, each with a portfolio of products in various stages of their life cycles. Unbeknownst to the executives, we engaged in a role-play exercise where a fictional character, “Oscar Pultz,” approached their boards demanding either a break-up or some sort of payout to go away.
A typical Advantexe business simulation has thousands of different algorithmsand permutations related to company strategy, finances, decisions, and metrics, including drivers of shareholder value. In scenario after scenario, workshop after workshop, breaking up a company for the purpose of “unlocking potential” just doesn’t seem to work if there is no compelling value proposition to customers.
Ah, “customer.” Note that this is the first time in this blog - of almost 1,000 words so far - that the word customer has been used. It is truly amazing to read all of these stories of proposed breakups of large companies and notice that rarely is there mention of the customer and the value proposition that the company offers to its customers. But why should there be? These corporate raiders are only concerned about extracting short term profits and moving onto the next raid.
In our business simulation exercises, once the companies split up, each new company had to immediately re-create the core shared services and resources that they relied on previously from the pre-break up company including:
- Human Resources
- Marketing
- Sales
- Supply Chain
- Manufacturing
- R&D
- Distribution
- Warehousing
On closer review, the H-P breakup predicts a loss of about $1 billion in efficiencies. A similar thing happened to our companies in the simulation workshop as they also experienced losses of efficiencies simply because they now had to go out and hire people and build facilities to house and deliver the shared services.
But that wasn’t the worst loss in overall and business efficiency! The worst loss of efficiency was actually in the erosion of the value proposition to customers and the impact of the changes in terms of perception of brand and value.
All of a sudden, a global organization that had three business units selling to one customer organization with a unique portfolio of related products/services is now divided up into two business units selling to the same customer with two different global account managers with overlapping and undefined value propositions. The customers became confused quickly and the erosion of the brand and market share was almost as quick.
After several years of post-break-up simulated market dynamics, the market capitalization of the companies in the simulation that separated were significantly lower than their counterparts that stayed the same. In addition, their individual market performance suffered in terms of market share, product margin, and product contribution margin...
Click the following to read part ii of our discusion on What We Learn About Corporate Breakups from Business Simulation Workshops
