Why this time Government intervention should work

Five reasons why this time it should work:

• Western govts have been forced into ownership unlike previously where owning commercial enterprises was an integral part of governing philosophy. In the US and UK, govt officials have repeatedly proclaimed that they are reluctant stakeholders and have pledged to manage their stakes in a commercial manner.
• The US and UK govts insist that they will seek to sell their stakes asap. The desire to sell their stakes to private investors at a profit means that the govt must pay close attention to its interventions.
• A limited no. of capital injections, makes its easier for the public to measure the value created or lost and to hold govts accountable for their performance.
• With record budget deficits looming, govts can ill afford to engage in wasteful spending at bailed out firms.
• Retaining a public float enables these firms to maintain their stock exchange listings which carry mandatory reporting requirements that compel govts to explore the impact of their actions on stockholders.

As a first step to success, govts must establish a baseline for evaluating their own performance. Another way in which govts can show their commitment, is by defining an exit timeline and strategy.

The American Recovery and Reinvestment Act (ARRA): Implications

The total cost of this act comes to 5.4 percent of GDP. More than 70 percent of the money is to be spent by the end of fiscal year 2010.

Investing in energy efficiency ($97 billion) : The Obama admin has set three sweeping goals:

• Create millions of clean energy jobs over the next decade
• Cut oil imports by two million barrels a day over the same period
• Slash greenhouse gas emissions by 80 percent

Investing in High tech ($200 billion incl indirect govt tech outlays) : Various projects are envisaged from airport security installations, software for tracking student performance, systems integration work in federal agencies, and optical fiber for new rural broadband networks. Every major construction project funded by the ARRA will need computers, s/w, IT services.

Investing in healthcare : The govt will spend $40 billion to subsidize the use of electronic medical records. Govt spending should increase the adoption of electronic records from 5 percent of doctors now to 90 percent of doctors by 2019.

Competitive strategy tips

• Rare is the company that truly understands what its competitors care about most. A company with such insights could reverse engineer the moves of their competitors and predict what they were likely to do.
• If you want to anticipate rather than react to strategic moves, you must analyze a competitor at two levels: organizational and individual.
• At the organizational level, you have to think like the strategist of your competitor by searching for the perfect strategic fit between its endowments and its changing market environment. At the individual level, you have to think like the decision makers of the competitor, identifying who among them makes which decisions and the influences and incentives giuding their choices.
• One of the keys to predicting a competitor's future strategies is to understand how much or how little it resembles your company.
• Companies can determine whether they face symmetric or asymmetric competition by using the resource-based view of strategy: the idea that they should protect, leverage, extend, build, or acquire resources and capabilities that are valuable, rare, and inimitable and that can be successfully exploited. Resources come in three categories: tangible assets, intangible assets, and current market positions. Capabilities come in two categories: the ability both to identify and exploit opportunities better than others do. (Eg of McD Vs Burger King ; Microsoft, Sony Vs. Nintendo Wii )
• The objectives of the person or group with a controlling interest in your competitor probably have a major influence on its strategy.
• The importance of non-owner stakeholders in driving a companies' strategy varies by country of origin too. If you compete with a Chinese co, the Chinese govt is often a critical stakeholder. In Europe, environmental orgs and other non govt stakeholders exert more power over corporate decision making then they do elsewhere.

The importance of politics in today's economic situation

• Today political battles weigh on economic policy making even in the world's richest economies.
• Both, the growth of emerging markets and the determination of political officials around the world to avoid the social upheaval that the global financial crisis might generate have injected politics and political motivations into the performance of global markets on a major scale.
• Post cold war, the belief that governments could micromanage national economies and generate prosperity seemed dead. Globalization became a household word with the emergence of massive private corporations in Japan, America, and Western europe.
• Over the past several years, an era of state capitalism has dawned, on in which govts are again directing huge flows of capital with profound implications.
• State capitalism : economic system is which governments manipulate market outcomes for political purposes.
• But state capitalism also stems the rise of globalization, because it hampers the flow of ideas, information, people, money, goods and services across international borders.
• The world's 13 largest oil companies are now controlled by govts : Saudi Aramco, Gazprom, China National Petroleum Co., National Iranian Oil Co, etc.
• State corporate activity is fueled in part by the emergence of a new class of SWFs.
• Because political factors unique to each state will determine the response to each domestic economic slowdown, countries with relatively strong political fundamentals will have a better shot at a quick recovery.

Latest US consumption patterns

• US consumers have reduced spending acting more or less on choice rather than necessity.
• More than half the respondents in a recent McK survey said that they planned to keep their expenditures down after the recession. This finding suggests that companies must develop a deep understanding of how such profound behavioural change will affect strategies fundamental to value creation.
• The vast majority of US consumers are not only reducing their expenditures but also borrowing less, agressively paying down debt, and saving more.
• Personal savings rate reached a 14 year high, 5.7 percent of disposable income in March 2009. (But this is not even two thirds of the post WWII avg of 9 percent)

Strategy in a "Structural Break" - Richard Rumelt

• Strategy is a cohesive response to a challenge. The most important element is a coherent viewpoint about the forces at work, not a plan.
• Leverage lies at the heart of most crisis. The current crisis is about kickback from leverage in two places: households and financial services. Leverage spreads the pain in ever-widening waves.
• US houshold debt started rising in the early 1980s and its growth accelerated in 2001. Leverage among the five largest broker-dealers rose dramatically after 2004, when the SEC exempted these firms from the long standing 12 to 1 leverage ratio limit. From 1990 to 2007 the whole financial services sector expanded 2.5 times faster than overall GDP, and its profits rose from their 1947-96 average of 0.75 percent of GDP to 2.5 percent in 2007. Then falling home prices led to an unanticipated rise in foreclosure rates and a drop in the value of mortgage backed securities. US consumer spending continued at a high level through the first half of 2008 but by the third quarter had dropped at a 3.1 percent annualized rate. Recession had arrived.
• Structural break : Moment in time-series data when trends and the patterns of associations among variables change.
• The first order of the day is to survive any downturns but the second is to benefit from new patterns.
• In several industry sectors, the most recent structural break occurred in the 1980s, with the development of microprocessors, which lead to cheaper computing, personal and desktop computers, and the rise of a new kind of s/w industry. These innovations begat the Internet and e-commerce.
• Many aspects of structural changes will depend upon the government's policy response. Today, nuclear power, infrastructure repair, and fiber to the home are on the list of possible stimuli.
• The wrong way forward in a structural break during hard times is to try more of the same.
• Another pattern that may generate diminished or negative returns is the complexity of our business and management systems.
• In structural breaks, cutting costs isnt enough. Things have to be done differently, and on two levels: reducing the complexity of corporate structures and transforming business models.

Lessons from the Crisis: Lowell Bryan & Richard Rumelt

Management Lessons:

• Smooth Sailing fallacy: The fallacy is the idea that you can predict disaster risk by looking at the bumps and wiggles in current results. Competent management always looks deeper than the numbers, deeper than the current numbers.
• This focus on meter readings rather than on a deeper understanding of the forces at work is what gets one into trouble. The Fed for eg, managed its policies around the Consumer Price Index (CPI). The CPI doesnt really measure inflation, it measures a bundle of prices. It doesnt measure wages, it doesnt measure asset prices. Of course if they took their eyes off the meter reading, they'd realize that they were creating a giant credit/asset bubble.

Policy response:

• We dont know whether the response is going to be effective or not. There's one of two outcomes for this: One is that the quick fix will work but not fix the fundamentals. In that case we wont have a foundation for good sound growth. The other result is, no matter what we do we'll have a deep recession, which will give us time to actually fix the problems. We will get leverage down to good levels.
• The real economy boils down to what work people do. We are now in a structural break and that mix of work being done has to change. The worst policy is to prop up people in jobs that are no longer necessary.

Corporate Strategy:

• What would be interesting coming out of this economic shock is that all the industry structures and rules and value chains and customer segments in industry after industry are in flux. And no one's yet figured out how to make money at it. That's the opportunity !
• Pinning these structural shifts down and seeing the second order effects - the second wave in each one of them - is the strategists job. The money is made in the second order effect. The money is made on the rebound from that inital proposition.

M&A strategy in a downturn

• Organic growth is hard to come by and profit margins are constantly under pressure.
• A carefully designed M&A transaction can accelerate growth by providing access to new markets, customer segments, technologies, human resources, and economies of scale.
• Indian M&A volumes have dropped from USD 42 bn in 2007 to USD 33bn in 2008 and just USD 3.7 bn in Q1 2009. Global volumes are down to USD 427 bn in Q1 2009 from USD 2498 bn in 2008 and USD 4058 bn in 2007.
• Reasons range from a shift in focus from growth to survival, higher risk aversion, poor or no availability of capital, reduced PE appetite etc.
• However, valuations are modest and an increasing no. of companies are looking to consolidate by divesting non-core/non-performing assets.
• Further, market uncertainty has resulted in a widening of the bid/ask spread, where bridging the gap between buyer and seller expectations has made deal closures difficult.
• With lower leveraging opportunities, promotoer contribution has become important. This will significantly reduce highly leveraged buyouts. Max debt levels are likely to be between 2.5-3 x EBITDA (post acquisition) vis a vis levels of 4-5 x EBITDA, structured through multiple levels of senior, subordinate, quasi, and unsecured debt instruments.
• Some solutions that can be considered include cashless transactions via the share swap and asset swap route, delayed payment schemes, "earn out" strategies, upside sharing, and minority sales.
• Also, SWFs who continue to be more optimistic can be considered a source.
• Global research has shown that downturn mergers generate about 15% more value (total shareholder return) as compared to bottomline transactions.

Strat Talk

"To be world class, Indian companies have to focus, they can't be in 25 businesses" - Michael Porter, 2004

"If you think, standardisation is wonderful in a manufacturing process, when you start to standardise mindsets then innovation and thinking dies" - Gary Hamel, 2006

"Before the crisis struck, your company's indicators of success were increasing earnings per share and growing revenues ... The most critical metric now is cash" - Ram Charan, 2009

The "normal" of tomorrow

How will the new normal of tomorrow look like ? The new normal will be shaped by a confluence of powerful forces—some arising directly from the financial crisis and some that were at work long before it began. Lets look at some features that could probably define the new normal: 

• There will be lesser financial leverage in the system. This reduction in leverage has been fueled by two factors : increase in debt due to financial innovation & the credit bubble fueled by irresponsible risk taking.  Business models that rely on high leverage will suffer reduced returns. Companies that boost returns to equity the old fashioned way—through real productivity gains—will be rewarded.
• Another defining feature would be the expanded role for government. A good outcome of the crisis would be greater global financial coordination and transparency. A bad outcome would be protectionist policies that make it harder for companies to move capital to the most productive places and that dampen economic growth, particularly in the developing world.

It was clear much before the crisis that US consumption could not continue to be the engine of global growth. Consumption depends on income growth, and US income growth since 1985 had been boosted by a series of one-time factors—such as the entry of women into the workforce, an increase in the number of college graduates—that have now played themselves out.

Companies seeking high rates of income and consumption growth will increasingly look to Asia. Through it all, technological innovation will continue, and the value of increasing human knowledge will remain undiminished. For talented contrarians and technologists, the next few years may prove especially fruitful as investors looking for high-risk, high-reward opportunities shift their attention from financial engineering to genetic engineering, software, and clean energy.

McKinsey Strategy Classics: 4 phase planning, Nine box matrix, MACS

• A company should make sure that it is the best possible owner of each of its business units - not simply hold on to units that are strong in themselves.
  
• Strategy : An integrated set of actions designed to create a sustainable advantage over competitors.
  
• Planning routinely progresses through four discrete phases of development. The first phase, financial planning, is the most basic and can be found at all companies. It is simply the process of setting annual budgets and using them to monitor progress. As financial planners extend their time horizons beyond the current year, they often cross into forecast-based planning, which is the second phase. A few companies have advanced beyond forecast-based planning by entering the third phase, which entails a profound leap forward in the effectiveness of strategic planning. We call this phase externally oriented planning, since it derives many of its advantages from more thorough and creative analyses of market trends, customers, and the competition. Only phase four—which is really a systematic, company-wide embodiment of externally oriented planning—earns the appellation strategic management, and its practitioners are very few indeed.
• McKinsey’s standard portfolio analysis tool is the nine-box matrix, in which each business unit is plotted along two dimensions: the attractiveness of the relevant industry and the unit’s competitive strength within that industry. Units below the diagonal of the matrix are sold, liquidated, or run purely for cash, and they are allowed to consume little in the way of new capital. Those on the diagonal—marked "Selectivity, earnings"—can be candidates for selective investment. And business units above the diagonal, as the label suggests, should pursue strategies of either selective or aggressive investment and growth.
• MACS (Market Activated Corporate Strategy framework): MACS represents much of McKinsey’s most recent thinking in strategy and finance. Like the old nine-box matrix, MACS includes a measure of each business unit’s stand-alone value within the corporation, but it adds a measure of a business unit’s fitness for sale to other companies. This new measure is what makes MACS especially useful. The key insight of MACS is that a corporation’s ability to extract value from a business unit relative to other potential owners should determine whether the corporation ought to hold onto the unit in question. In the MACS matrix, the axes from the old nine-box framework measuring the industry’s attractiveness and the business unit’s ability to compete have been collapsed into a single horizontal axis, representing a business unit’s potential for creating value as a stand-alone enterprise. The vertical axis in MACS represents a parent company’s ability, relative to other potential owners, to extract value from a business unit. And it is this second measure that makes MACS unique.

Global sourcing : Factors at play

Globalization is not a very recent phenomenon. Since 1914 itself, people could make use of the advantages of globalization to pursue their needs. In terms of charting out their global sourcing strategies companies need to keep three aspects in mind-

• Low cost off-shoring as a concept will remain and is probably here to stay. Even though labor costs between China and America having been closing in, the gap is still expected to increase to $26 per hour in 2013 from $17 currently. What would happen is that low cost destinations would compete against each other for various off-shoring projects.
• Within these low cost destinations itself, internal locations would compete for business due to cost arbitrages between various locations. Going forward, it would make sense for companies to understand the dynamics within these low cost countries in order to gain maximum leverage from these locations. This would involve substantial investment in research and manpower.
• Politics and public policy will play an important role in the coming years in shaping global forces. Companies would need to carefully understand these policies and their implications. Whether or not countries will agree to play by common rules in international trade or pursue their own nationalist or regional policies will be critical.

The ability to understand these global forces at play would be crucial for companies to succeed in the coming decade.