There are two ways to achieve identical P/E multiple. First, Return on Invested Capital (ROIC) & other by achieving High Growth.
How to make trade-off between ROIC & GROWTH to create shareholders value?
Please follow below mentioned link to see my presentation on slideshare.net…..
What’s your opinion about cross-listing of shares in different stock exchanges? Do you think cross-listing provides higher shareholders value? Conventional wisdom has long held that companies cross-listing their shares on exchanges in London, Tokyo, and the United States buy access to more investors, greater liquidity, a higher share price, and a lower cost of capital.
In the eighties & nineties lots of companies in the developed world duly cross-listed their share and they achieved lot of advantages as at that time markets were not interrelated which provides less volatility and reduces risk. However in the recent years we have seen great decline in cross-listing of shares. Companies are delisting from exchanges and new cross-listing has also declined. In the recent years European company like Ahold, Air France, Bayer, British Airways, Danone, and Fiat, terminated their cross listings on stock exchanges in New York as the requirements for deregistering from US markets became less stringent.
In 1998 Foreign Listing of Developed Market companies on London International Main Market (IMM) was more than 500 however in the year 2007 it has declined to less then 400 companies.
What is the major reason for decline in cross-listing of shares?
Decline in Liquidity Benefit
As per the survey by top consulting firm European companies in the United States typically account for less than 3 percent of these companies’ total trading volumes. For Australian and Japanese companies, the percentage is even lower.
Broader Shareholder Base
In an age when electronic trading provides easy access to foreign markets, the argument that foreign listings can give companies a broader shareholder base no longer holds. Furthermore, a foreign listing is not even a condition, let alone a guarantee, for attracting foreign shareholders. It may improve access to private investors, but as capital markets become increasingly global, institutional investors typically invest in stocks they find attractive, no matter where those stocks are listed. One large US investor—CalPERS—has an international equity portfolio of around 2,400 companies, for example, but less than 10 percent of them have a US cross-listing. In fact, because of better trading liquidity in the home market, institutional investors often prefer to buy a stock there rather than the cross-listed security.
Better Corporate Governance
In 80’s and 90’s US & UK capital market have higher corporate governance as compare to other countries. Those higher standards enhances cross-listing benefits as companies applying for cross-listings in the United Kingdom or the United States would inevitably disclose more and better information, give shareholders greater influence, and protect minority shareholders — thereby improving these companies’ ability to create value for shareholders. However in the recent years other developed economies, such as the continental member states of the European Union, have radically improved their own corporate-governance requirements. As a result, the governance advantages once derived from a second listing in the United Kingdom or the United States hardly exist today for companies based in developed countries.
Increase in Volatility
In 80’s and 90’s global stock market was not interrelated and it provides an opportunity to shareholders to mitigate risk by investing in cross-listing shares as occurrence of event in one market makes very less impact on other market however in the age of internet it has become reverse as every markets are interrelated and small news in one market creates great impact on other market that makes shares more volatile and increases risk.
Access to Capital
Companies go for foreign listing when they can’t attract large amount of capital in their home country. Earlier it was true for European Union & Japanese companies to go for foreign listing in US and UK region to attract capital as they can’t generate huge capital in their home market but today situation has changed, local stock market in European Union & Japan has provided a sufficient supply of equity capital. Now US and UK listing is no more attractive for them.
Negative returns from Cross-listing
Maintaining an additional listing generates extra service costs—for example, fees for the stock exchanges—and additional reporting requirements, such as 20-F statements for ADRs. Although these service costs tend to be minor compared with the cost of compliance (particularly with US regulations such as Sarbanes–Oxley), they have grown enormously over the last few years. British Airways and Air France, which both recently announced their delisting from US exchanges, estimate that they will save around $20 million each in annual service and compliance costs.
However cross-listing doesn’t promote creation of value in any material way. As per analysis market doesn’t respond with -ve share price on announcement by companies opted for voluntary delisting. On the other hand when cross-listed companies were compared with comparable without foreign listing companies it was found that the key drivers of valuation are growth and return on invested capital (ROIC), together with sector and region. A cross-listing has no impact.
Situation is very different for Emerging Market as these markets require huge amount of capital to sustain their growth which is very difficult to generate in their home country. Foreign-listing provides solution for this. Lot of emerging market company in India & China has opted for foreign-listing to generate required capital.
Foreign-listing represents as a third of total trading volume of emerging market companies and compliance with more stringent UK or US corporate governance requirements and stock market regulations could generate real benefits for shareholders.
Conclusion
In the coming years emerging market will really benefit from foreign-listing but companies from developed economies with well-functioning, globalize capital markets have little to gain from cross-listings and they should reconsider their approach towards cross-listing.
When we talk about Emerging Market naturally our focus sights on “BRIC” countries Brazil, Russia, India & China but in reality there are other emerging market economy also that will grow very fast in the coming decade or so. Those countries are Czech Republic, Hungary, Indonesia, Lebanon, Mexico, Poland, Russia, Singapore, South Africa, South Korea, Venezuela, Vietnam, Malaysia, Saudi Arabia, Thailand, Turkey & Egypt.
At present we have two global power house Europe & America however after the emergence of emerging market economy we are going to have 3 global power house Europe, America & Emerging Market that will compete against each other, trade with each other and create partnership with each other to grow and serve the global economy.
Till the last decade there were only 20 emerging market multinational in Fortune 500 list but now more than 70 emerging market multinationals are in Fortune 500 list. This shows that emerging market multinationals are spreading their legs very fast and the emergence of IT has provided more impetus to it as world becomes flat and boundaries are narrowed.
Now the question arises how emerging market multinationals will compete with developed worlds multinationals. what are the challenges they have to face? What kind of operating model they have to develop in order to compete in global environment? Similarly after the acute financial crises & expected low GDP growth trajectory for long period of time what will be the business strategy of developed market multinationals to compete globally?
There is a great divergence between Emerging Market & Development Market. How they will compete in each others market? In the normal circumstances there is huge difference between operating models of both the economy. This makes us to think further, how they will achieve economies of scale? Does they require global operating model? Answer is yes…………
Yes both the economy requires global operating model. Then again question arises, Does development market & emerging market completely changes its operating model as per local models of a particular country/region?
In order to understand these issues we have to check existing operating model of both the economy & their advantages & disadvantages.
At present circumstances when developed market multinationals expand themselves to nearby region then normally they adopt their existing operating model as market condition, consumer behavior, regulatory concern, formal structure, Low risk & culture are almost similar to their home country so they have to make only minor changes in their model and the same is true for emerging market multinationals also.
We can call this “Minor Diversity” but the problem arises when developed country encroaches into emerging market economy where conditions are vastly different to their home country like market condition which caters more to lower pyramid, consumer tastes & preferences vary across regions because of developing nature, volatility of risk, Political uncertainty, lack of proper regulation, informal structure & diversity in culture etc.. These differences require major changes in their model and we can call this “Major Diversity”.
Now we are going to see existing operating model of both developed & emerging market multinationals.
Operating model of Developed Market & Emerging Market multinationals
Above mentioned picture shows that Developed market multinationals gives more emphasis to Process & Technology and Organizational Architecture. Their operating model is process & technology driven and results were judged on the basis of performance metrics. They give very less importance to Leadership skills & Inter-personal relationship between people however opposite is true for Emerging Market multinationals where more emphasis is given to Leadership & Inter-personal relationship between people and less importance is given to process & technology, organizational Architecture & metrics.
For Example: In the oil and gas industry, for instance, emerging-market NOCs do not seem to rely as systematically on the strict net-present-value metric that IOCs use in their decision-making process—which is consistent with a more-risk conscious leadership style. Rather than adopting this metric, NOCs change the game by creating deals that involve aid and infrastructure packages. This signals a market development mind-set as opposed to a market-exploitation mind-set.
Leadership in developed market multinational tends to be more institutionalized: the CEO’s personality surely counts, but decision influences employees’ collective thinking however there are always some exceptions like Apple’s Steve Jobs. In most developed-market multinationals, leaders’ personalities are not as important as rules, processes and organizational structure. Leadership in these companies revolve around planning and structured and formal decision making more than around direct interactions and personal contacts with employees. Leadership is not concentrated just at the very top but distributed throughout the hierarchy and the top-management team. In developed countries, stock market pressure leads leader/CEO to give more emphasis on the short term and more conservative attitude toward risk.
On the other hand Emerging Market multinationals strongly rely on the leadership component. Leadership at these companies is personalized and centralized; it is also more entrepreneurial and top executives make fast, bold decisions and are oriented toward long-term risk. Because many emerging-market multinationals are privately owned, they often have greater unity of ownership and control than developed-market multinationals. The CEO, who is often the owner, usually has more power than the CEO of developed-market multinationals. This results in individual-based leadership structures more than in team-based leadership structures where power is more distributed. The CEO is also highly visible throughout the company and top executives are often family members or members of the same political party (ownership-related) or clan (political clan); by contrast, in developed-market multinationals, the leadership is almost exclusively composed of professionals.
Emerging-market multinationals are state-owned or privately-held and don’t need to meet the short-term demands of shareholders, their top leaders are more comfortable with risks and look more to the long-term. The amount of red-tape and bureaucracy that emerging-market leaders have had to deal with in their home countries is also a sign of their leaders’ strong entrepreneurial spirit. It equipped them with a superior ability to create networking skills within their ecosystem and to deal with political stakeholders. They are much less politically naïve than their developed-market counterparts, and this can help them in their efforts to internationalization.
People
Emerging-market multinationals typically rely heavily on people skills. These companies excel at fostering and leveraging wide inter-personal and inter-organizational networks. It aligned with a leadership style based on highly personalized interactions; networking is deeply engrained in emerging-market multinationals corporate and national cultures. In emerging-market multinationals networks are based on reciprocal obligations, long-term commitments, kinship and trust.
On the other hand Developed-market multinationals emphasis on people means extensive, formal international human-resource management processes. In developed market multinationals, networks tend to be rational and calculated which limits trust due to the higher risk of free riding and opportunism.
Organizational Architecture
Emerging-market multinationals where CEOs and top managers seem to concentrate more on authority, organizational structures are more centralized and hierarchical than in developed-market multinationals. High power-distance acceptance and benevolent paternalism are common traits of emerging countries. It suggests that some emerging-market multinationals may lack the lateral structures necessary to formally coordinate international operations.
By contrast on the other hand developed-market multinationals tend to rely heavily on their organizational architecture to coordinate their international operations.
Process & Technology
Processes and technologies were given less importance in Emerging Market multinationals. This component is also less important than their leadership and people components. Emerging-market multinationals tend to subordinate processes to people.
By contrast, processes and technology in developed-market multinationals are an essential component of their operating model even when these multinationals operate in regions of similar economic development.
Metrics
Emerging-market multinationals use fewer metrics than developed-market multinationals since the former may have fewer tracking processes in place to generate the metrics. In emerging market multinationals, metrics used to measure individual performance and productivity do not seem to be as important as they are in developed market multinationals. Emerging-market multinationals appear to place more emphasis on loyalty, kinship and political connections for talent management.
Developed-market multinationals typically use metrics to assess the quality of human resources, innovation, supply chain effectiveness, knowledge management and leadership.
In order to internationalize business or encroaching in other countries/region, what shall be global operating model of Emerging & Developed Market? How to develop model so that they can retain advantages of existing model & improve on activity required as per other region/countries requirement?
Global Operating Model
Emerging Market Multinationals:
Leadership
Emerging-market CEOs centralize decision making—a possible flipside of their personalized leadership style—could be a handicap to their success in developed markets. The autonomy of subsidiaries might be stifled when they need it the most.
For example, Hyundai has suffered important setbacks in the United States (market share loss, high executive turnover) due to the feudal leadership style of its CEO. Evolving partially toward the more Western distributed-leadership model might then make sense.
Because family, cultural or political clan relationships matter for leadership selection and appointment, and because the clan is likely to be home country-based, leadership in emerging-market multinationals also needs to become more geographically diverse to manage a broad multi-power economy. More global emerging-market multinationals are beginning to understand this. Companies like Tata manage the career of future leaders with multiple foreign assignments, which creates more sensitivity to international markets.
Thus, emerging-market multinationals with a footprint in broad multi-power economy should embrace some of structural leadership attributes of their developed-market counterparts. They need to reconcile more structure and their current agility and speed of decision making. This will give them an added advantage as compare to developed market multinationals.
People
Emerging market multinational should converge towards more systematic international HR processes. In spite of progressive adoption of western human resource practices, the emerging market networking capability seems enduring. It influences both organizational and individual performance against expectations. More global emerging-market multinationals like Tata are using international networking extensively to leverage knowledge across borders. They not only keep the senior management of acquired foreign companies but also connect them with all employees in and outside India who hold valuable knowledge. These strong interpersonal networks have the added benefit of creating strong identifications with the company and of fostering the emerging-market entrepreneurial culture that helps employees become more comfortable with change. In the multi-power world multinationals are trying to emulate these networking capabilities.
Organizational Architecture
Tight hierarchy among emerging market multinationals with wide multi-power footprints is hindering integration and responsiveness. On the other hand, as the strong interpersonal networks of these companies may provide an advantage in helping them to manage the differentiated networks needed to manage successfully in broad multi-power economy.
Emerging market multinational should try to progressively converge towards developed market organizational architecture however they should continue using their soft skills advantages.
Process & Technology
Emerging-market multinationals may need to strengthen the role of processes and technologies in their configuration, they should also be wary of the rigidities that processes can create. In fact emerging- market multinationals should continue to subordinate processes to people. Although formal processes and technologies are important in a differentiated network, excessive reliance on them can inhibit the creation of interpersonal ties and thus, hinder the creation of customer intimacy, delay in decision making, opportunity loss, and the adaptation to local markets.
Metrics
Metrics help to determine whether the global operating model is performing well and whether each of the components is internally and externally aligned. Alignment of global operating model components will be increasingly important to emerging market multinationals performance. Emerging market whose footprint is more global may also need to employ more metrics.
Developed Market Multinationals:
Leadership
Developed-market multinationals have problems because of excessively structured leadership. They needs to move from an emphasis on management, in which good managers produce predictable results, to an emphasis on leadership, where leaders are charismatic, risk-taking, fast moving and far sighted.
If your strategy is to deliver breakthrough performance, you need a different type of leader to make that happen but the problem lies within existing workplace structures and business processes that are constructed not for breakthroughs, but for predictable performance. Simply put, successful leaders of the 21st century will not be cut from the cloth of managers of the old.
Developed market multinationals needs entrepreneurial leaders to get successful in multi-power economy.
People
Global developed-market shall try on developing networking skills.
Developed-market multinationals should realign their global operating model thoroughly by developing employee’s ability to network, by letting ties to be created by local people and not only by senior expatriates, by creating structure and performance metrics which allow foreign subsidiaries to lead more initiatives that go out from the corporate standard will provide impetus to develop inter-personal relation & networking skills.
Organizational Architecture
Developed market economy organizational architecture requires to reconfigure their global operating models so that more informal, soft components can play the necessary lubricating role. For example, it has been well documented that networks require intense inter-personal communication, a capability well found among emerging-market multinationals. This is where more global developed-market requires re-balance of their configuration and to include more of the soft components will gain.
Process & Technology
Developed-market multinationals with diverse footprints in multi-power economy should work to balance processes and people, in particular to succeed in emerging markets. The key for them might be to differentiate where standard processes work best (for efficiency maximization) and where they should rely more on people’s skills and networks. In other words, in some locations, human-based solutions might be the least expensive and most satisfying.
Metrics
Developed market multinationals are already metrics driven they should properly align metrics with increased importance of Leadership & People in their global operating model.
Global Operating model of Developed Market & Emerging Market Multinationals
Both Developed Market & Emerging Market multinationals make sure that all the components of global operating model should properly aligned with each other in order to provide Superior Business Performance.
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.
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.
Oil prices & Oil exporting countries are the major cause of high liquidity & leverage in global economy. Once liquidity overstretched then it creates asset bubble and, crash of financial market. We have seen the same in the last recession when oil price reached its highest level of $ 147.
What is the future of oil prices and how it is going to impact/shape global economy?
As I mentioned oil exporting countries plays a very important role in global capital flow. If oil prices rise then we see huge amount capital flow in global financial market. Apart from this lot depends upon these countries domestic investment strategy. In the past they have invested quite less as compare to emerging countries like China, India & Russia etc. If they increase investment domestically then we see less flow in global market which reduces liquidity globally and makes market to stabilize.
As per the survey conducted by top Consulting firm, exports of crude oil will earn Gulf Cooperation Council (GCC)/Petrodollar countries $5 trillion to $9 trillion from 2007 to 2020.
The GCC foreign-investment choices influence interest rates, liquidity, and financial markets around the world. And the domestic investments affect the region’s urban development, economic diversification, and ability to create jobs. Fortunately for the citizens of the GCC states and global policy makers, there will probably be enough petrodollars to satisfy both sets of needs.
Now the question arises how much of this capital will be deployed domestically by GCC countries?
Since 1993, GCC investment rates have averaged 20 percent of GDP, on par with European and US levels but almost one-quarter lower than the average investment rate of Brazil, China, India, and Russia combined. Petrodollars not invested locally will spill over into global capital markets. If oil lingers at around $100 a barrel and domestic investment stays at 20% level as mentioned above, the GCC would send $5.1 trillion in new funds into world markets and boosting these states’ total foreign wealth to $10.5 trillion by 2020. Domestic-investment rates as high as 28% combined with $70-a-barrel oil, would generate around $2.5 trillion of new funds for GCC investors to deploy in global capital markets until 2020. Only a major decline in oil prices-to less than $30 a barrel,-combined with high levels of domestic investment would make it difficult for the GCC to continue pumping significant liquidity into global capital markets which seems unlikely situation.
As oil prices continue to set new records, investors outside Europe and the United States are increasingly shaping trends in financial markets. Petrodollar investors have a newfound influence, and the more than tripling of oil prices since 2002 makes them the largest and fastest-growing component of a broad shift in global economic markets-a shift that also includes Asian central banks, private-equity firms, and hedge funds. High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting nations, which in 2006 became the world’s largest source of net global capital flows, surpassing Asia for the first time since the 1970s. A majority of these revenues have been recycled into global financial markets, making petrodollar investors increasingly powerful players.
Fueling liquidity—and creates asset bubble
Since 2002, oil prices have tripled, and much of the incremental increase has ended up in the investment funds and private portfolios of investors in oil-exporting countries. Most of the money is then recycled on global financial markets, whose liquidity is therefore rising.
In fixed-income markets, this added liquidity has significantly lowered interest rates. Estimated total foreign net purchases of US bonds have brought down long-term rates by about 130 basis points. Twenty-one of them can be attributed to purchases by the central banks of oil-exporting countries, and impact as large as that of the capital flows from financial hubs such as the Cayman Islands, Luxembourg, Switzerland, and the United Kingdom, though less than half the impact of Asia’s central banks on US interest rates. Petrodollars have added liquidity to international equity markets as well.
The story is different in global real-estate markets. According to research by the Economist Intelligence Unit, real-estate values in developed countries have increased by $30 trillion since 2000, reaching $70 trillion in 2005 and far outstripping GDP growth over the same period. This rise reflects not only the preference of petrodollar investors for global real estate but also the home-equity loans and larger mortgages that low interest rates and risk spreads have made possible.
Indeed, petrodollars have helped increase global leverage in many forms. Low interest rates and credit spreads have enabled the rise of hedge funds and the private-equity boom. Although low rates and spreads have created ample liquidity for consumer credit in the United Kingdom, the United States, and many other countries, a reassessed appetite for risk could burst this global credit bubble, causing pain to lenders and borrowers alike. In mid-2007 problems in the US sub-prime-mortgage market sparked a re-pricing of credit risk and a credit crunch.
Growing concerns
Despite the many beneficial effects of petrodollars in increasing global liquidity and spurring the growth of various financial-asset classes throughout the world, the rise of investors in oil-exporting countries has created concerns.
One worry is that the huge size of petrodollar sovereign wealth funds, coupled with their relatively high appetite for risk, could make global capital markets more volatile. The limited transparency of these funds amplifies the anxiety. Research, however, finds that their investment portfolios are widely diversified not only across asset classes and regions but also through a number of intermediaries and investors. Diversification reduces the risk that the funds could make financial markets more volatile. Moreover, petrodollar investors have a track record of sensitivity about the broader market impact of large flows and use derivatives and intermediaries to lessen it. ADIA, for instance, reportedly invests 70 percent of its funds through external asset managers—intermediaries who know they must move slowly in markets to avoid adverse price adjustments. Direct petrodollar investors tend to adopt a relatively low profile.
A second concern has also attracted growing attention among financial-market regulators in Europe and the United States; the prospect that sovereign wealth funds could use their growing financial heft for political or other non-economic motives. The rise of large government investors in financial markets is a new phenomenon-and one at odds with the shrinking role of state ownership in real economies. Given the limited transparency and enormous size of these investors, some observers question the motivations underlying their investment strategies. How will state investors behave as public shareholders or owners of companies in foreign markets? Will they seek to maximize value creation and long-term growth, or will their investments reflect the political objectives of their governments and the interests of businesses in their home countries? Financial markets require the free flow of information to function efficiently. The presence of huge, opaque players with non-economic motives could distort the pricing signals that other investors need. A growing number of economists and policy makers in Europe and the United States now support the creation of disclosure standards for government investors.
Final concern the long-term economic impact of higher oil prices. In the 1970s their rise sparked inflation in the major oil-consuming economies and sent global banks on a petrodollar-fueled lending spree in Latin America. Both developments inflicted significant economic pain on the countries involved. Today higher oil prices have been a boon for global financial markets, but, paradoxically, inflation hasn’t risen very much. Can higher oil prices really be good for the world economy? As we have seen, petrodollars are creating inflationary pressures in markets for illiquid investments, such as real estate, art, and companies. If the pressures move beyond those markets, the potential asset price bubbles could burst. So far the world economy has accommodated higher oil prices without a notable rise in inflation or a economic slowdown, but this may change in the future.
Conclusion
High oil prices will create more revenue for GCC countries and if domestic investment of these countries will not increase appropriately then more money will be available in global financial market which may cause high liquidity & emergence of more private equity & hedge fund players that increases global financial leverage and may create asset bubble & crash of financial market.
What’s your opinion about Top line & Bottom line growth of an organization?
Do you think organization that provides good top line growth always gives good total return to shareholder (TRS) or the organization which perform poorly in terms of both top line & bottom line growth doesn’t provides good return to shareholders or the organization which provides good bottom line growth however lacks in top line growth can deploy good TRS for a long period of time.
If you think yes then you are wrong. Top Line & Bottom Line growth are always a good indicator of high return to shareholder but this is not always true, there are certain number of companies that were not rewarded in terms of Total returns to shareholders (TRS) in spite of giving robust revenue & profit.
Survey conducted by a reputed company for US economic cycle of 1984-1993 shows that 20% companies in spite of being providing faster revenue growth than the median, could not generate good total returns to shareholders (TRS) however there are other 20% companies whose revenue growth were very slow but they have provided excellent total return to shareholders (TRS).
On the basis of TOP LINE & BOTTOM LINE growth we can divide companies into the following categories-
Growth Oriented
These types of organization always does breakthrough innovation & continuously invest in growing industry & segment and provides exceptional returns to shareholders for a very long period of time. These kinds of company’s top line growth outpaced GDP and TRS outperforms S & P 500. These companies grow continuously and provide GDP & market beat returns for more than one business cycle.
TRS (Total Return to Shareholders) Performer
These kinds of organization can’t grow their revenue however they provide very good return to shareholders. These companies compete in slow growth industry like consumer durable, engineering, construction & utilities etc. The keys to their ability to create value were of good execution, cost control and savvy portfolio management. Many of these companies sold or exited lower margin business or bought or enter high margin business. Majority of these kinds of company can’t survive for more than 1 business cycle and were acquired by other competitors however those weren’t acquired continue to struggle for Revenue & Growth unless they embarked on a successful acquisition program or shifting their business mix, they couldn’t survive or fetch enough gain from reducing cost or restructuring their existing business to compensate for the lack of top line growth.
Thus companies that don’t hit top line eventually hits TRS non-performer category and often becomes target of acquisition. Even largest company can’t delay it for very long period of time.
Unrewarded
Unrewarded companies are those that have increased their revenue faster but not rewarded in terms of Total return to shareholders (TRS) however in majority of cases these kinds of companies ultimately rewarded in another business cycle.
The Challenged
Challenged companies are those who underperformed in both increasing faster revenue & Total return to shareholders. These kinds of companies become major takeover target & could not survive for more than one business cycle.
However when same survey company conducted survey for another business cycles of 1994-2003 that shows 65% & 58% of “Growth Oriented” & “Unrewarded” category companies were survived from 1984-93 survey. On the other hand only 35% & 10% of “The Challenged” & “TRS” category companies were survived.
Conclusion:
TRS category result shows that companies need to give as much attention to top line growth as to increasing the bottom line. While cost improvement can drive earning & shareholder value in a near term however they have worst long term odd of survival.
Where to compete is more important than how to compete. The choices a large company makes today about its portfolio mix, and where to place its bets will shape its future growth trajectory for next 5-10 years. Unless the company enjoys the advantage of fast-growing pool of revenues and profit or has ample opportunity to consolidate, growth just with the pace of GDP will difficult to sustain, even though execution is great. Large organization should follow tailwind if they want to grow & provide market beat returns to shareholders. They need to identify industry & segment which out plays GDP growth rate.
When large companies faces headwind i.e. slow growing market and have few options to consolidation in their existing business, opportunity to change growth trajectory are limited then the best approach is to reposition the portfolio business, customers, products & geographies to create a mix with higher potential of growth.
Does your organization an international player and provides goods & services world wide? Are you competitive in foreign soil, if no then you need to restructure your global business strategy?
Lot of companies make mistake by following a single world wide strategy which make organization uncompetitive in foreign soil that impact their overall global business.
How to develop global business strategy? The best way is to regionalize strategy according to cultural, political, legal and economical condition.
Organizations like Toyota, GE & Wal-Mart have successfully created regionalize strategy to enhance growth & profitability.
Increasing cross-border integration has enhanced the prospect of regionalization. Data suggests that regionalized location attract more FDI and some difference between the reason can combined with similarity to expand the regions overall economic activity.
Defining your regions depends upon characteristic like geography, culture, administrative, political & economical condition.
There are 5 different ways to build regional strategy. Every regional strategy has its own strengths & weakness. It is upon an organization to choose strategy according to their business, products & benefits. Organization can use combination of any of these strategies. Toyota is the only organization that uses all the 5 combinations to built an overall global strategy.
Home Base Strategy:
In this type of strategy organization maintain R & D and manufacturing in the country of origin. This type of strategy is useful when economies of concentration outweigh those of dispersion. Bulk of the fortune 500 company still follows this type of strategy. Even organizations that move on globally followed home base strategy for a very long period of time.
Fore more than a decade Toyota serve their international clients through direct export. GE did the same for home appliances & Bayer in Pharmaceuticals.
This type of regional strategy is very effective for time-sensitive items to get to the market very quickly however these strategy cut down organizations future growth potential and it can put themselves in trouble once market matures or when there are some uncertain economic condition.
Spanish fashion company Zara faces the same problem when value of dollar depreciates again Euro. These makes Zara’s cost of production inflated against their competitors who relay more on dollar-denominated imports from Asia.
Portfolio Strategy:
The strategy involves setting up or acquiring business outside the home region that report directly to the home base. The advantage of this strategy is that it provides faster growth in non home region and the opportunity to average out economic shocks and cycles across region.
Though portfolio strategy is simple however it takes time to implement if organization wants to expand through organic growth. Even though if organization takes Merger & Acquisition route then also it takes some time.
Again Toyota is a very good example of this kind of strategy. Toyota applied its renowned production system (its distinct competitive advantage) to factories it built in the most important overseas market North America, however it took around 10 years to develop those facilities.
Hub Strategy:
Companies that wanted to add value to their regional level develops HUB strategy. Hub strategy provides shared service with in a region to different countries. This kind of strategy develops to create economy of scale because such resources may be hard for one country to justify.
In a purest form Hub strategy is a multiregional version of the home base strategy. Hub strategy often involves transforming a foreign operation in a stand-alone unit.
Toyota began producing a limited number of locally exclusive models in its principal foreign plants. Each plant has its own platform with products designed for sale within the region.
The challenging in executing a Hub strategy is achieving a right balance between customization & standardization. Companies too responsive to interregional variation risk adding too much cost or sacrificing too many opportunities to share cost across the regions. As a result, they may find themselves vulnerable to attacks from companies taking a more standardized approach. On the other hand, the companies that try to standardize across regional hub- and in so doing overestimate the degree of commonality from region to region-are vulnerable to competition from local players.
The Platform Strategy:
Hubs spread fixed cost across countries within a region. Interregional platforms go a step further by spreading fixed cost across the region. Most automaker tries to reduce the number of basic platform they offer worldwide in order to achieve economies of scale in design, engineering, administration, procurement and operations.
Toyota achieves economies of scale by reducing their platform from 11 to 6 and invested in global car brand such Camry and Corolla.
The idea behind reducing the number of platform is not to offer less varieties but to offer variety with cost effectiveness.
One drawback of platform strategy is that taking platform standardized too far can backfire if regional customization creates excessive disparity across regions.
Mandate Strategy:
It focuses on economies of specialization as well as scale. Companies that adopt this strategy award certain regions broad mandates to supply particular products or perform particular roles for the whole organization.
Toyota’s innovative international multi-purpose vehicle (IMV) fuel common engines and manual transmissions for pickup trucks, SUV’s and minivan from Asian plants to four assembly Hubs in Latin America & Africa. These parts are then forwarded on to major global markets except US, where vehicles are larger.
One drawback of this strategy is that it can’t handle variation in country, national or regional condition that’s why Toyota IMV excludes the US.
Toyota features in all the above mentioned five strategies. It provides perhaps the most compelling and complete example of how the effective application of regional strategies can develop a powerful global strategy and it makes Toyota number 1 automaker in the world.
Does your organization follows appropriate regional and global strategy? Please find out by clicking on below mentioned link.
In 2008 Indian economy becomes trillion $ economy, it took India 60 years since independence to reach the $ trillion status, now at present it is around $1.2 trillion and estimated that at the end of the year it will be around $1.3 trillion. If we take conservative real growth rate of 7% or nominal growth rate of 12% then by 2015 it will reach around $ 2.3 trillion and by 2020 it will cross $ 4 trillion. This calculation is based on conservative approach and if we take little aggressive approach then I think Indian economy will cross $ 6 trillion by 2025.
We can compare this pattern from Chinese Economy. China achieved the status of $1 trillion economy in the year 1998. For China also, it takes around 60 years to achieve that status. But after the first trillion, pattern of Chinese growth were very surprising. It took around another 6 years to reach $ 2 trillion mark however next trillion was achieved within 3 years but more surprising last trillion was achieved in just 1 year. At the end of 2008 Chinese economy was $ 4.2 trillion economy. In 10 years time China becomes $ 1 trillion to $4.2 trillion economy.
In 1985, 93% of Indian population was living in poverty which improved to 54% in 2005 and it is estimated that it will reduced to 22% by the end of 2025. It shows that there will be huge growth of middle class which will provide great impetus to consumption and further growth to Indian economy. As per the survey, by 2005-2025 Indian middle class will grow12 fold, from 50 million in 2005 to 583 million by 2025.
Graduation of Indian society & increased savings will lead Indian consumption to quadruple ($400 billion in 2005 to $1.6 trillion in 2025 approx. as per current exchange rate) and becomes 5th largest consumer in the world. During the period pattern of consumption will also change drastically. Presently majority of expenditure were made in necessary items like food, beverages, cloths, tobacco etc. however expenditure i.e. consumption on discretionary items like entertainment, healthcare, transportation, education, communication, housing and personal products etc. were very less but this pattern is going to change very drastically. As per survey conducted by a reputed firm it is estimated that Indian discretionary spends will increase from 52% to 70% (2005-25). It was around 39% in 1995.
India’s Savings and Capital grew substantially during the period 2004-2009. Savings grow from 30% of GDP to 39% of GDP and Fixed Capital Formation grows from 25% of GDP to 35% of GDP during that period. Saving boom spells opportunity for Financial Intermediary. Once Indian economy reaches $ 2.5 trillion and if we calculate the current rate of 40% saving then it comes around $ 1 trillion of investment opportunity. It will boost India’s Insurance & Healthcare, Banking & Stock broking Industry.
Rising capital formation is properly aligned with Indian govt. thrust on infrastructure development. Allocation of expenditure for eleventh five year plan is 2.3 times more than tenth five year plan. Rising capital formation will provide investment boom opportunity for turnkey services like engineering & construction, real estate like housing, construction inputs like cement, steel, iron, paints, electrical & capital good etc.
Boom in consumption, savings & investments will lead to boom in corporate profit. India’s top 100 listed corporates had continuously outperformed Indian GDP. During 1999-2004 India’s top 100 listed corporates registered 21% CAGR and the figure was around 18% during 2004-09. In both the cases it was more then 1.5 times of Indian nominal GDP growth rate.
However in the last few years Indian overall corporate profit to GDP ratio has declined.
In the FY 2008 Corporate Profits to GDP ratio was 7.1% which come down to 4.7% in 2009 and now it looks like that it is bottoming out and will rise to a sustainable level as India sees economic boom in near future.
Now the most important question arises. Which industry, sector or corporates will take full advantage of this boom?
First in order to become high growth corporate, a company has to outperform GDP growth rate. As there will be huge jump in Indian discretionary spending so companies that will cater to these kinds of products & industry will have access to high growth opportunity. In other words we can say that the organizations that will cater to mass market will come under high growth organization.
Example of discretionary product can be car instead of necessity products like motor cycle or bicycle.
Ultra modern housing rather then govt. housing.
Private banks than Public sector banks due to value added services proved by the former.
In order to come under high growth category, organization has to deliver J curve. J curve develops when product price matches the affordability to mass buyer. It occurs when income rises or product prices fall or both happen simultaneously. As organization attains scale, benefits get passed on to customers by way of lower prices, leading to demand J-curves.
We have a very good example of J-curve in a telecom Industry. As we see subscriber base in wireless telecom has increased drastically from 13 million subscribers in 2003 to 386 million in 2009 however on the other side there was huge reduction in tariff which reduced from Rs. 2.3 per minute to Rs. 0.60 per minute during the same period.
Organizations that will cater to industry which have the capability to become large in relation to the economy will come under high growth category. For instance, Construction activity accounts for a sizable 18% of Indian economy and continues to grow rapidly. Likewise, in India, barely 5% of total retailing is organized, In contrast, in the US, a single retailing company, WAL-MART has sales of about US $400b 3% of US GDP.
Consolidated industry will grow more as compare to fragment one. If an industry is highly fragmented, then even if it scales up, the benefits get diluted and are shared by a large number of players (e.g. Real estate). In contrast, industry which enjoys scale and are consolidated in nature gets more benefited as incremental growth is shared by few incumbent players. For instance, Oil marketing in India is US$125b industry, largely shared by just three players.
Organization that provides entry barrier or you can say sustainable competitive advantage will come under high growth category. An organization can attain sustainable advantage or entry barrier if it enjoys market stability & high return on capital.
Following are the ways through which entry barrier or sustainable competitive advantage can be achieved-
Value innovation- It does not make sense to other company’s conventional logic
Organization’s strategy may conflict with other company’s brand image.
Organization enjoys natural monopoly.
Patents or legal permit block imitation
High volume leads to rapid cost advantage for the value innovator, discouraging followers from entering the market.
Network externalities discourage imitation.
Significant political, operational and cultural barrier makes hindrance in imitation.
Companies that value-innovate earn brand buzz and loyal customers that tends to shun imitators.
The organization that enjoys these advantages naturally maintains market stability & high return on capital.
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