How to avoid using tax payers’ money and maintain optimum capital structure to maximize shareholders value?

Every organization or banks main aim or motto is to maximize shareholders value. However shareholders were always concern about financial distress situation where they have to dilute their share to pay debt holders or govt. need to step in and use taxpayers’ money to bail out banks/institutions.

We have faced these kind of similar situation during 2008 financial crisis where billion of $ i.e. tax payers money were used to bail out several banks. How to undo this kind of financial distress situation & avoid using tax payers’ money? One answer to this question is adding contingent capital (coco bonds) in capital structure.

What is contingent capital? Contingent capital is a debt that converts automatically to equity after some triggering event like decline in the market value of equity or capital below threshold limit. Contingent capital is likely to play a very important role in new BASEL III agreement. As per estimate banks need to issue $ 1 trillion of contingent capital to replace existing security that no longer qualified as regulatory capital.

However generally contingent capital (coco bonds) are tied with certain regulatory ratio like capital ratio (core Tier 1 capital), once the banks breaches the ratio then the debt automatically gets converted into equity to avoid financial distress situation. However problem with this concept is that it is regulatory based not market based and it transfers wealth from shareholders to bondholders and kills the main motto maximizing shareholders value (Creating value for shareholders means creating value for all the stakeholders) as conversion takes place at predefined price or at current market rate.

Capital ratios are calculated on quarterly basis and doesn’t provide true market impact of current situation & can’t handle market manipulation properly.

 Mean & Median (Core Tier-1 Ratio in 2008) of 50 major banks (%) 

	March 31	June 30	Sept. 30	Dec. 31
Mean	8.07	8.14	8.16	9.12
Median	7.88	7.92	7.89	9.14

By comparing September 30 ratio with March 31 and June 30 ratio we can hardly make out occurrence of any financial distress situation but market reality was totally different as we saw during the crisis.

COCO bond seems ideal instrument to maximize shareholders value however they are not. In February 2011 Credit Suisse issued a coco bond that gets converted into equity whenever bank’s core tier 1 capital falls below 7%. However regulator can also force conversion if it sees that credit Suisse will need public fund to avoid insolvency. The conversion price was fixed at minimum of $ 20. As per these characteristics this bond seems risky.

First, trigger is based on capital ratio which is an accounting number therefore will be different from the market based measure of financial leverage, especially during financial crisis. Hence, there is no way to predict stock price at the time of conversion.

Second, if the stock price at the time of conversion is less than $ 20 then bondholders will incur significant loss.

Third, the possibility that regulators can force conversion before the trigger is reached creates an additional risk which is difficult to price. Though the bond was successful among retail investor but its base was very limited due to its riskiness.

Better contingent capital should be linked to current market situation and triggers are based on current stock price / market value of asset.

Generally market based trigger are criticized as they create instability. Bondholders has incentive to short sell shares to trigger conversion and at the same time fear of huge dilution makes shareholders sell their share and create death-spiral for a company.

What’s the challenge?

Main challenge in issuing these kinds of debt instrument is that instruments should carry minimum risk so that it can be catered to mass risk-averse investors and simultaneously protecting the motto of maximizing shareholders value. In normal convertible bonds wealth gets transferred from equity holders to debt holders. Shareholders don’t prefer these instruments in company’s capital structure.

What will be the ideal instrument that avoid share dilution, protect the money of contingent bondholders and handle market manipulation or panic perfectly?

CALL OPTION MARKET TRIGGER CONVERTIBLE (COMTC) BOND can be ideal contingent bond that can be issued above 20-30 basis point of risk-free bond and caters to mass risk-averse investors who know they will be paid at the time of financial distress situation.

How does COMTC works?  

COMTC bonds target to risk-averse investors and provides return above normal risk free bond. This instrument carry forced right to get paid at the time of financial distress situation. It carries a conversion trigger point which is less than then current market price. However in order to avoid market manipulation & panic shareholders got pre-emptive rights to buy-back shares from bondholders so that they can avoid any conversion that results from market manipulation or panic. At the same time in order to avoid huge dilution shareholders got the right to issue share (right issue) at the same conversion price and pay back the bondholders and maintain proper capital structure.  As bondholders will be paid back they have no incentive to hedge their investment by shorting the stock when the leverage ratio approaches the trigger point.

Why conversion trigger price is lower to current market price?

Conversion price of COMTC bond should be less than the trigger price. Suppose the market price of $ 10 share will come down to $ 5 during financial distress situation. In this case conversion price of the bond should be fixed at below trigger price say $ 1. We can understand this with an example.

Example:      Senior Debt    –     $ 1000

Equity Capital –   $ 10*7 = $ 70 (7 share with face value of $ 10)

COMTC          –        $ 30

Scenario 1    (Financial Distress Situation) = Market Price $ 5

Conversion Price = $ 5 (Conversion price = Market Price)

New diluted Share price = (6*5+7*5)/13 or (30+35)/13 or 65/13 = $ 5 per share

(Assume that repayment will be made after conversion)

Total Value of Assets = 1000+65 = $ 1065

Shareholders will exercise his option of right issue & pay back bondholder at its par value till the time value of assets is $ 1065. If value goes below $ 1065 shareholders will not exercise his call option and all the value above $ 1000 will be shared between bondholders & shareholders at the time financial distress or bankruptcy.

Scenario 2    (Financial Distress Situation) = Market Price $ 5

Conversion Price = $ 1

New diluted Share price = (7*5+30*1)/ (7+30) or (35+30)/37 or 65/37 = $ 1.76 per share (Assume that repayment will be made after conversion)

Total Value of Assets = 1000+65 = $ 1065

Shareholders will exercise his option of right issue & pay back bondholder till the time value of assets is $ 1037 or market value of share is $1. If the market value goes below $1 or total assets value becomes less than 1037 shareholders will not exercise his call option and all the value above $ 1000 will be shared between bondholders & shareholders.

Thus with $ 1 conversion price, bondholders become shareholder when value falls below $ 1037. With $ 5 conversion they become shareholders when value falls below $ 1065. Lower conversion price clearly reduces riskiness of convertible debt which lowers financial distress and makes the security more marketable among fixed income investor.

How COMTC bonds are different from COCO bonds?

COMTC BONDS	COCO BONDS
COMTC bonds are market triggered bonds that provides true financial leverage	Normally COCO bonds are regulatory triggered bond i.e. capital ratio. Such mechanism are accounting measure and  doesn’t work when company’s capital structure deteriorate rapidly
Regulators can’t intervene as it is totally market based	Regulators are aware that capital ratios are stale, they may be tempted to intervene and pull the trigger themselves and this regulatory risk may difficult to asses, even for major credit rating agency.
COMTC bonds are risk-averse bond, it can easily marketable & cater to mass market.	COCO bonds are difficult to market as investors know that capital ratio doesn’t provide true picture so in order to mitigate risk they demand higher spread however issuer thinks firms financial distress risk is lower and reluctant to pay higher risk premium.

Conclusion

COMTC bonds are risk-averse bond that can be targeted to mass market as it provides assurance that bondholders will be paid at the time of financial distress. These are market related bonds triggered at certain market price or market value of assets. It considers current financial leverage and provides absence of regulatory intervention. All the normal bonds carry tax deductible interest rate and in order to make COMTC bonds attractive it should also be tax deductible. These bonds can be issued by any institutions apart from bank to prevent financial distress situation and maintain optimal capital structure.

COMTC bonds are superior to COCO bonds and one of the best debt instruments to be part of organizations/banks capital structure.

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Shareholders Value Creation

How to create value for your organization? Why TSR (Total Shareholders Return) is the best metric for value creation? Why is it difficult to create sustainable value? How to build sustainable value creation strategy? Why CSR & brand value change not consider as a part of TSR? Why multiple compressions are so difficult to beat? Why investors & analyst discounts valuation multiple? How to transit majority investors without eroding TSR? How to create value in low growth economy? How to play your strategy with sustainable TSR matrix as per investors eye? Why investors communication is so important for value creation? Which strategy you should use for value creation? How to use value creation scenarios? Why cash strategy is so important in low growth economy?

If all these questions bother you before developing your company’s corporate strategy/value creation strategy then you must see New Year’s complimentary presentation

Shareholders Value Creation – “A handy e-book on how to create sustainable shareholders value”

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Granular Business Portfolio Matrix

GE developed 9-box matrix strategy to manage portfolio of business when business grows to more than 150 business units.

In today’s global environment where world is flat, global economy, workforce & businesses are integrated, boundaries are narrowed traditional 9-box matrix is not very useful for managing portfolio of business. It requires more granular approach towards business portfolio.

This presentation is an advanced version of “traditional matrix (9-box) business portfolio strategy”.

Manage business portfolio in new multi-power economy with (2-way 9-box) matrix strategy

Organization Vision & Corporate Strategy

Every organization has a vision & in order to achieve that vision organization develops corporate strategy.

How to develop an optimal corporate strategy that carries both Blue Ocean & Red Ocean products?

Organization Vision & Corporate Strategy

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Strategy Control Map (Market Capitalization Dynamics)

Strategic Control Map (Matrix) is based on market capitalization dynamics to help companies identify their biggest opportunities and threats and boost their odds of hunting for acquisition targets rather than being hunted themselves.

Please follow the below mentioned link to see 1 slide presentation on my slideshare account.

Strategy Control Map Matrix

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Shareholders Value Creation through Strategic Market Positioning (SVC-2)

What is market share? Does market share mean share of product, share of category, share of channel, share of customer, share of region or share of something else? How does your company define market share? Companies that cannot answer this very important question cannot effectively engage in Strategic Market Positioning (SMP) and in the long term, will find it difficult to invest successfully for growth.

What is Strategic Market Positioning (SMP)? For a business or product line that competes in only one strategic segment, SMP is simply the market share of the business in its strategic market segment. For a company competing in multiple strategic segments, its overall SMP is the average of its SMPs in each strategic segment, weighted by the business’s sales or investment in each strategic segment.

Achieving effective SMP involves analyzing an industry to determine strategic market segments and then making investments in those segments that will lead to increased returns.

Does SMP = Market Segmentation? Normally market positioning is considered as market segmentation. This is totally a marketing technique that involves breaking down market into smaller segments in order to better understand consumer behavior & identify opportunities to increase overall market share.

However on the other hand SMP is different because it creates shareholders return. It brings together the disciplines of strategy and finance to help shape a company’s approach to value creation. Organizations that fail to differentiate between market segmentation and Strategic Market Position may be at risk because the definition of market share often does not correlate with company profitability, returns and strategic potential.

Do you think larger market share provides superior return? As per research by one of the top consulting, larger market share even provides low return in comparison to companies having smaller market share with Strategic Market Positioning. There are several reasons supporting to this finding. The smaller, more profitable company may avoid going head-to-head with larger, more powerful competitors. It may deploy its investments into segments where (among other things) the dominant players simply do not compete. In essence, it positions itself in its industry strategically and allocates more assets in fewer, carefully selected ways. As a result, it has a much higher market share in its chosen segments.

How to create Value through Strategic Market Positioning (SMP)

Following 3 approaches should be followed to create value through SMP-

Be Creative & think Broad: To maximize the chances of identifying successful strategies, think beyond the current business offerings. Apply the Blue Ocean Strategy principle “Reconstruct Market Boundaries” & “Reaching Beyond Existing Demand”. Evaluate other businesses that share the same customers or leverage the same technologies. Consider services as well as product offerings. Identify the range of organic or acquisition initiatives that could be used to pursue potential growth strategies.

Conduct SMP Test: Identify the growth strategies that have the greatest potential to increase the company’s weighted average relative market share, as measured across all strategic segments impacted by the strategy. This will identify strategies that have the potential to improve the company’s overall position on the most important drivers of profitability. Conduct SMP test quantitatively to specific initiatives to see whether market share, appropriately defined, increases or decreases.

Conduct Value Creation Test: “Strategic value” is defined as the net present value of cash flows from higher revenues, lower costs and lower capital requirements that will accrue from the growth opportunity and the existing business being run together versus separately.

We will see an example of Southwest Airline & America West Airline to know how SMP creates higher value.

Southwest Airline & America West Airline started in roughly the same position, but ended in very different places. Both formed as low-cost, low-fare regional carriers, both airlines grew their operations and profits on roughly parallel tracks through the early 1990s.

America West followed a traditional hub-and-spoke design for its flights and became well known for its expansionist strategy. Southwest, on the other hand, grew at a slower pace, taking the time to build up strong positions in specific markets before penetrating additional markets. Southwest’s emerging strategy was creative in that it focused on short haul, high frequency flights in city pairs where the airline could secure a strong market share position, often flying to a secondary, lower-cost airport. In addition, its costs were controlled as a result of the corporate decision to use (and therefore maintain) only one type of aircraft: the Boeing 737.

By contrast, America West’s expansionist strategy called for international routes, which in turn called for a heterogeneous and expensive-to maintain fleet. America West did not base its strategy on the core tenet of SMP: build the type of market share that maximizes high-impact growth and leverages economies to the greatest extent possible.

  Summarize two Airlines positions & Strategies

Summary Stats ( 1990)	South West	American West
Revenue	$1186 M	$ 1315 M
Number of Aircraft	106	104
Types of Aircraft	1	4
Flight Design	Point-to-Point Short Haul	Hub & Spoke

Figure 1: Compares the two airlines in terms of traditional market share and Strategic Market Position to reveal the true impact of their different strategies

 Source: Bloomberg 

Although America West and Southwest had similar US total market shares in 1990, this measure obscures their relative competitive strengths.

In the airline business, pricing power and operating costs are driven more by share of flights between states or, more precisely, by share of flights between specific city pairs. Travelers prefer to fly an airline that has several daily flights between two points because it gives them more flexibility in the event of a missed or delayed flight. This is better for airlines because they are likely to have larger scale and more efficient operations at each end.

Southwest Airlines recognized this as a critical factor and was careful to enter a new market only when it felt it could achieve substantial strategic share in that market. By contrast, America West assumed that, by entering larger and increasingly international markets, it was strengthening its overall position in the airline market. In fact, it was neglecting its core franchise and spending limited resources to enter new market segments where it had little to offer against strong competitors.

Figure: 2 illustrates the value creation outcome of these two Airlines while adopting different strategies

As America West’s emergence from Chapter 11 in 1994, its stock has declined at a CAGR of -4.9 percent, while Southwest’s stock has grown at a CAGR of 9.9 percent.

Conclusion

Strategic Market Positioning (SMP) is a proven and highly effective tool for creating value. It is founded on the assumption that not all growth is good – in fact, that some growth actually destroys value. SMP helps companies identify the difference and respond accordingly. By being creative and thinking broad to maximize the chances of identifying successful strategies, and by conducting the SMP and value-creation tests, an organization’s leadership can gain valuable insight into organic growth ,acquisitions and other growth investments and be better able to formulate strategies that have the potential to improve the company’s overall performance.

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How Divestiture helps in restructuring corporate portfolio of business?

In order to achieve growth organizations give more importance to Merger & Acquisition. Merger & Acquisition plays pivotal role in organizations Corporate Strategy & maintaining portfolio of business to achieve high return on capital & growth. However situation arises once organization diversify itself into various businesses and its corporate portfolio becomes so huge that it is very difficult to maximize return on capital & take advantage of new growth opportunities.

Divestitures and carve-out plays a very important role in restructuring organizations corporate portfolio to maximize return & growth.

Normally organization doesn’t give as much importance to divestitures as to M & A however if Divestiture/Carve-out activity carried out timely & sequencely then it can provide huge benefit in terms of shareholders value, future growth and cash flow.

Why organizations do Divestiture

The reasons to divest a business are wide-ranging, from short-term cash generation to a desire to restructure the business portfolio by spinning off non-core or low-performing assets. And regardless of the driving force behind a divestiture, the overall objective of most companies is to get the best possible return—i.e., the highest price.

In order to get optimum return from divestiture organizations should do it in an accelerated time frame. Best practice is to make sure that to-be-divested units are configured for maximum appeal to potential buyer, and putting effective program management in place to manage the complexity of divestiture.

Divestiture Strategy

In order to develop its divestiture strategy, a company should comprehensively assess its corporate portfolio to identify opportunities for value creation. This entails four basic steps:

• Aligning assets with the business’ best opportunities
• Developing a timing and sequencing strategy for separation & divestiture  transaction
• Define boundaries of assets being considered for divestiture
• Packaging the divestiture assets for maximum value

Aligning assets with the business’ best opportunities

Organization should carefully study the overall business’ growth opportunities, and the capital required for each business in the portfolio to take advantage of those opportunities. This perspective then must be paired with an understanding of the potential value of each business to an external owner compared to its worth to the divesting company.

Timing & Sequencing Strategy

Parent company should determine the most advantageous timing  & sequencing strategy for the divestiture and its execution. In most instances, it is best to start with carving-out of a business unit before the sale process. Following are the benefits of carve-out.

     Transparency

Potential buyers require full transparency of an asset’s tangible and intangible value, contracts, service relationships and, of course, revenues and costs. Transparency will be easier to achieve if the divestiture target is a separate legal or organizational entity (which includes having its own accounting systems and boundaries).

      Avoid Uncovering Bad News

The second reason to begin the carve-out process early is that having a concrete and defined divestiture target helps to avoid uncovering any bad news during the sale process that would be an obstacle to negotiations with potential buyers. Furthermore, having already executed the carving out of the asset to be sold enables the selling company to quickly capitalize on emerging sales opportunities—such as a sudden recovery of M&A markets or the appearance of an unexpected potential buyer.

Define Boundaries of Divestiture Target

Once the timing and sequencing of the divestiture are determined, a company must carefully define the boundaries of the divestiture target, taking into consideration the strategic fit of the business unit as a whole and its constituent parts within the parent company. For example, one business function of a to-be-divested business unit might provide research services to the rest of the parent company, or possess valuable technical knowledge.

In addition, the future intended scope of the parent business after the divestiture should be considered to ensure potentially valuable assets are not jettisoned.

Packaging the divestiture assets for maximum value

The final step is to make the divestment target as attractive as possible to the most likely acquirers. Stopping at the prior step and focusing strictly on the to-be-divested business unit’s boundaries from an internal viewpoint likely would not result in the most attractive asset from a buyer’s perspective. For example, some investors desire complete, operationally functioning entities.

To facilitate a transaction the divesting company would need to provide a unit meeting that description from the buyer’s perspective and further adjust the boundaries of the to-be-divested organization if needed.

Divestiture Strategy Execution

Once it is clear which assets to divest and how it should be packaged, a number of best practices can help ensure successful execution.

Effective program management should be put in place to avoid underestimating the impact of divestiture on daily business.

Second, a company must plan for the future success of the divestiture target, and make sure accountability between the parent company and the to-be-divested organization is clearly defined.

Finally, it is vital for a divesting company to maintain an open dialogue and stay flexible as the transaction unfolds.

British Petroleum’s master carve-out & divestiture strategy

BP captured $9 billion in cash by divesting its petrochemicals units—up to $2 billion more than Wall Street analysts had expected. In crafting the divestiture program, BP’s corporate development experts defined the major steps needed to separate and sell the $25 billion-a year petrochemicals business. First, the unit was carved out as a standalone business under its own name—Innovene—so it could float on the New York Stock Exchange.

The carve-out, making Innovene the world’s fifth largest petrochemical and polymer company. BP’s dedicated corporate development team determined the key phases, major milestones, work streams and project teams needed to deliver the complex divestment. The whole process involved a detailed assessment of the path to a rapid separation, accelerating the process by two months and greatly enhancing BP’s chances of obtaining the best possible valuation in an IPO. As soon as Innovene was legally a separate entity, the priority turned to IPO preparation, developing the necessary sales presentations for the underwriters and preparing the flotation prospectus. Then the BP team made its move to woo potential buyers, which meant getting ready for the prospective acquirers’ due diligence procedures—a major work stream in it. The multiple options strategy paid off brilliantly, sparking a successful bid from specialty chemicals producer INEOS. The $9 billion deal represented one of the largest-ever leveraged buyouts and instantly made INEOS one of the world’s largest chemical companies. BP had completed a huge divestiture only a year after declaring its intent to sell.

It is generally easier to pursue divestiture in robust economy than during a downturn. Companies should use divestitures to enable much more substantial and long-lasting change. Success in the current economic environment can hinge on effective portfolio rebalancing and efficient divestiture execution. Companies that configure business units for maximum value, manage the complexity, ensure accountability and embrace flexibility throughout the divestiture process improve their likelihood of success. For many companies, there is no better time than the present to pursue divestitures to position themselves for high performance when economic conditions ultimately improve.

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MNCs Dilemma on China’s “Good-Enough” market Segment

Chinese economy is growing very fast. It is estimated that it will grow nearly 10% for the next 2 years and by 2030, 36% of world’s Incremental GDP will come from China. China is taking huge advantage of its cost efficiency & leverage manufacturing to serve other regions also. Chinese growth depends upon emergence & fast growing segment of middle group or we can say “good-enough” market segment.

Majority of MNCs provide goods & services in high margin premium segment facing huge dilemma and competition from “good-enough” market segment.

Dilemma in the sense that company is not sure whether to jump into “good-enough” segment or continue with the premium segment. If they jump into good-enough then it can cannibalize their premium segment sales or in other case if they can’t enter “good-enough” segment then other local competitors will take some of the market share locally- Chinese people gives more importance to good-enough market segment where they buy almost same quality of products at lesser price.

Good-enough segments are growing and changing very fast and it becomes more than ½ of the total Chinese market segment.

What should be MNC Company’s strategy regarding good-enough segment? How to determine whether they need to jump into this segment or not? What should be their approach in catering to this segment?

DECISION TO ENTER INTO GOOD-ENOUGH SEGMENT

It can be very tough decision for any MNCs providing services in premium segment to get attracted & involve in catering to 62% market share of good-enough segment.

They have to do their homework properly before jumping into this segment. They need to find out few question i.e. Are the premium segment is still attractive? Is it growing? Are companies still achieving high returns or returns are eroding? What is your position in a current market? Are you a market leader or niche player?

If the company finds that growth of the premium segment is slowing down & returns are eroding and there is future threat from local competitors to capture some premium segment market. In this circumstances company has to take a call to enter into good-enough segment market however they should clearly strategize their approach, how they are going to enter, whether they expand organically or acquire an existing player. How to capitalize on strong geographic distinction so that new offering couldn’t cannibalize premium offering?

However one more important reason that justifies MNCs to get into this segment is that if they don’t enter into this segment then they will face tough competition from local Chinese company not only in the local Chinese market but also in their own backyard.

HOW TO ENTER INTO GOOD-ENOUGH SEGMENT

The goal for the organization is to lower their manufacturing costs, introduce simplified product & services & broaden their network while maintaining reasonable quantity. There are 2 ways through which companies can enter into good-enough segment-

Attacking From Above

MNCs providing goods & services in premium segment should employ and offensive-defensive approach to enter middle market/good-enough  segment. They should enter good-enough segment to defend against the rise of local competitors and erosion of premium segment.

GE Healthcare strategy to enter into good-enough segment and simultaneously protect its premium segment is a very good example of attack from above.

GE Healthcare employed to expand sales of its MRI equipment in China. The company created a line of simplified machines targeted at hospitals in China’s remote and financially constrained second and third-tier cities where other MNCs rarely ventured. That good enough territory has all the right conditions. It was a fast-growing market whose customers purchasing criteria weren’t likely to change soon. GE’s cost structure allowed it to compete with other middle market players in the industry. And there was little risk that the company would cannibalize its premium line of diagnostic machines; large city hospitals were not keen on downgrading their MRI equipment.

GE Healthcare was able to defend its position against local upstarts. The company is trying to develop the optimal product portfolio and is addressing such issues as how best to service the equipment. GE captured 52% of $238 million market in 2004 generating roughly $120 million in sales. GE is replicating the same strategy in other developing countries including India.

Buying way In 

MNCs that can’t alter their cost or process quickly enough to compete with local players should use break-through approach to enter good-enough segment market by way of merger & acquisition.  

Gillette is a very good example of entering into good-enough segment by way of merger & acquisition.

Gillette’s Duracell division throughout the 1990s was losing market share to lower- price competitors like Nanfu who controlled more then 50% of the market. By 2002 Gillette’s Duracell share of the Chinese domestic battery market was mere 6.5%.

Gillette management team recognized that its Duracell unit was at a cost disadvantage compared with its rivals and concluded that it will be difficult to broaden the brand’s market penetration. Facing with such an odd Gillette decided to buy into good-enough segment market by acquiring a majority stake in Nanfu but Gillette was extremely careful to protect Duracell’s & Nanfu’s brand in their respective segment. Gillette continues to sell premium batteries in China under the Duracell brand and has maintained Nanfu as the leading national brand for the mass market. The dual branding, cost synergies, sales growth, broadened product portfolio, economies of scale, and distribution to more than 3 million outlets in China have paid off for Gillette, Which has seen significant increase in its operating margin in China.   

Finally entering into good-enough segment in China can be double bonanza for MNCs. Just like Chinese good-enough segment market Indian good-enough segment market is also very big & growing very fast. MNCs can use experience of Chinese good-enough market and replicate the same in Indian market. In order to achieve cost efficiency or economies of scale MNCs can make a hub in South-East Asia region to cater both India & China’s good-enough market segment.

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How to use “Business Portfolio Matrix” strategy to get maximum out of diversified business units?

When large organization diversify themselves into different business units then after sometime it becomes very difficult for an organization to take decision where to put more cash and where less. Lots of large organization find themselves in this kind of situation where they need to take decision of providing cash to different businesses in order to get maximum result. GE is one of the organizations which find itself in this kind of situation when their business grows to 150 separate business units.

It is very difficult for an organization to allocate cash just on the basis of projected future results. This can be very dicey as each individual makes projection differently as per his thinking. Apart from this, there are different kinds of businesses some are capital intensive, others give more impetus to advertisement or brand etc.

How to solve this kind situation? How to allocate cash so that a particular business gets required cash?

Business Portfolio Matrix is one of the ways to solve this kind of situation. GE used Matrix to make decision on their diversified business portfolio.

In order to use matrix we need to know Industry Attractiveness of business units and organization’s Business Position in a particular business unit. This provides real position of a company in an industry.

Industry Attractiveness

Industry size
Growth Rate (substitute industries growth rate, capability & expansion should be considered before identify growth of the industry)
Number of Competitors
Current Profitability
Entry Barrier
Industry’s future Expansion potential / Govt. Regulation
Industry approach towards social responsibility
Customer outlook towards industry

Industry attractiveness can be identified by getting information of all the above mentioned points. Industry size is very important, how much players can an industry accommodate? What’s the future expansion potential of a particular industry, for example if you are in Outsourcing (BPO/KPO) industry then there is huge opportunity because BPO/KPO industry is growing very fast and will grow for a very long period of time and it can expand itself in other areas also like initially when BPO was started it was used mainly for call center or transaction processing work but now today all the high-end services like business analysis etc. are served by outsourcing industry. On the other hand, industry like Textile which is growing but growth rate is not very fast and there future expansion depends upon govt. regulation and consumer behavior.

Industry’s attractiveness depends upon growth rate of industry. Organization should find out industry’s past, current & future growth rate. While identifying industry growth rate- substitute industries growth rate, capability & future expansion should also be considered.

Business Position

Company’s business position as compare to competitors (competitive sustainable advantage)
Core competencies
Financial position
Market share / Brand equity
Use of technology in business
Bargaining power over supplier
Customer loyalty towards business (Corporate Social Responsibility)
Is the company natural owner of business?

What is the company’s business position as compare to competitors? Does business unit has sustainable competitive advantage as compare to its competitors?

 “Business Portfolio Matrix” Strategy

In “Business Portfolio Matrix” strategy, the major hurdle for any organization is to know how to plot businesses in these 9 columns.

In the above mentioned Matrix X-axis shows Industry Attractiveness however Y-axis shows Organization’s Business Position. As we see all top right corners are marked in green and these are the business that will provide good returns and has huge growth potential. These businesses require more cash. Organization should try to fulfill cash requirement of this segment so that business units can obtain business advantages before their competitors. It should not happen that organization couldn’t grow business due to lack of resources. These are the highly attractive industry categories where organization’s business units position is also high-medium category.

After putting cash in high-growth business if there are any cash left then it should be used selectively in business units marked in yellow. These are the business units where Industry Attractiveness is high but company’s position is low or company’s position is high as compare to its competitors but industry attractiveness is low. In between them there is a category where industry attractiveness and business position both are in medium category. Organization should first put money in this category of businesses afterwards if there is any money left then it should be used in other two extreme categories on the basis of selective investment.

Investing in these two categories are very critical decision, this need to analyze properly before making any decision. Is it viable to continue business in this category even though company’s position is good? An organization should try to make selective investment in these kinds of businesses and once when they find some other attractive business opportunities that require cash in highly attractive industry then they should harvest/divest investment in existing business and put cash in attractive growth oriented industry.

Other selective category where company’s position is low but industry attractiveness is high. This is another critical decision, first it should be analyzed whether business unit is showing poor performance due to lack of resources or any other reason. Can business units will grow if additional resources will be allocated? If poor performance is due to some other reason then it should be analyzed properly before taking any cash allocation decision.

It is always better to put money in a high growth oriented industry rather than in low growth oriented industry even though company’s performance is better as compare to its competitor in low growth industry.

Other 3 lower category of matrix marked in orange should be harvest/divested immediately and generated cash shall be allocated in upper & middle category of business units as per their requirement.

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Managing Portfolio of business for Consistent growth

Traditionally organization that doesn’t maintain portfolio of business appropriately faces natural life cycle of corporate life i.e. start-up, growing, mature & decline phase however if corporate would like to grow consistently throughout their life cycle then they have to chose & update portfolio of business strategy continuously & appropriately.

It is easy to make business strategy for a foreseeable future based on reasonable assumption about development in markets, technologies, regulation & predictable economic situation however after the latest financial crisis & recession, future is very unpredictable & uncertain, so classic business strategy approach doesn’t works in an uncertain environment.

In order to counter uncertain environment & to grow consistently, organization need to follow business strategy “Portfolio for Consistent growth” (PFCG) approach.

PFCG approach is based on risk & reward on time basis. How organization select portfolio of business depends upon its familiarity & knowledge about the business. If organization has thorough knowledge about the industry & its attractiveness, markets, technology, geography, pool of talent etc. then it means they are familiar with the risk and they can provide an initiative to deploy abundance of resources and reap the benefit of knowledgeable risk in the short term.

Organization should spend huge amount of resources in this category of business to get maximum return on short time normally 18-24 months. These businesses are core business and most readily identified with the company name and those that provide the greatest profits and cash flow. Here the focus is on improving performance to maximize the value of business. These types of businesses are run by business maintainence managers within fully installed capability platform to earn maximum return on investment.

However there are certain businesses where organization doesn’t have adequate knowledge, they need to acquire knowledge to develop business. These kinds of businesses come in unfamiliar category where risk is very high at the present situation because organization doesn’t have adequate knowledge about the business, and capabilities were developed or acquired during a period of time. These businesses were developed over a medium-long term time horizon of 5-6 years. These businesses require initial capital which generates future cash-flow over a period of time and they are handled by entrepreneur talent. These businesses are valued not on the basis of profitability but on the basis of NPV and growth. They are the future cash-cow for an organization.

Third category of business that come in PFCG strategy are businesses where future is uncertain & organization can’t predict it during a short period time. These kinds of business were developed considering long term perspective whose benefit can be achieved over a longer period of time. These types of businesses are like research work where organization is using its foreseeable talent to predict future requirement of industry. Here organizations are not very clear about future but there is a vision which drives them.

Normally companies should never invest in uncertain business for short-term benefit however there are exceptions where organization invest in uncertain business for example investing in an industry whose fate depends upon election results and future govt. Opposite is true for familiarity risk category where normally companies don’t invest considering long-term view because maximum benefits can be reaped during the short period of time however here also exception are there like for example a company finds a reservoir of oil but it is not investing because it is not sure how petroleum industry prices will shape up in the future.

The most important part of PFCG is that organization should know when they have to move business from category 2 ( unfamiliar) to Category 1 (familiar) and Category 3 (Uncertain) to category 2 ( Unfamiliar). This is a continuous process where companies must take three steps: undertake a disciplined search for a number of initiatives that provide high rewards for the risks taken; monitor the resulting portfolio rigorously, reinvesting in successes and terminating failures; and take a flexible, evolutionary approach that allows for midcourse corrections. The resulting strategy, like a conscious form of natural selection, identifies the strongest initiatives and sheds the rest. The increasing uncertainty of today’s business environment and the importance of balancing risks with rewards make the Portfolio-of-Consistent-Growth strategy more relevant than ever.

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