The Hare and the Tortoise: The race is not to speedy (XIV). Racing for growth.
… “The tortoise meanwhile kept going slowly but steadily”…The hare and the tortoise, a fable by Aesop.
Have a beautiful first week of June.
When we raise the standards, that requires us to be prepared. The parameters of racing in terms of an organization existence, are not activated with the beginning of the race, but with the preparation before starting it. Last week we mentioned several pieces of evidence about preparation before the racing of our lifetime. We made an emphasis in excellent education as a differentiation factor to promote innovation, and this has to be under a long-term learning mode. The key to produce outstanding organizations is the continuum creation and maintenance of well-educated human capital. The more an organization engages in learning, the better competencies or capabilities of various kinds are flowing constantly in place for its racing particularities in corporate strategy.
Last week, we also elevated the importance of investigation, research and development within a framework of compliance pivotal to the ESG impact investing (environmental, social and governance standards), and in compliance with the SDGs (the United Nations sustainable development goals). When we raise the standards, that requires us to be prepared.
For those who are still on time to develop an outstanding educational background at a University, it is clever to pair your courses with other alternatives that could help you to accumulate experience in the industry of your preference. Nevertheless, for those who have limitations and have not been able or won’t be able to access a university (for whatever the reason), either because they can’t afford it or because they were not accepted to enter, or because in the middle of their studies, were not capable to fulfill the degree requirements, it is imperative to be open to continue searching for alternative long term education that could fill the gaps of the lack of a university degree. Particularly, if these individuals wish to continue developing their brains knowledge. Diplomas, practical equivalent degrees and certificates are very helpful. Reading my publications is also a blessing. Buying books and reading them daily is an aiding complementary tool. Moreover, it is commanding to learn at least another language, and leverage it to perfection to a B1/B2 level. The more languages you can acquire is a plus.
Racing for growth. As I have remarked it in previous posts, corporate strategy is all about decision making at three levels:
- Decisions about the growth positioning and the pace of progress of the entity.
- Decisions about how to perform a portfolio analysis.
- Decisions about corporate parenting.
Today is about commencing the subject number 1.
1. Decisions of growth positioning and the pace of progress of the entity.
Why should a company make decisions for growth?. Everyone of us who owns or has been hired to make decisions at the corporate level at an institution, is appointed to resolve about what to sell, who do we serve, how do we make it, where to do it, why and when is the correct time to achieve economic advancement, that is measured in terms of “profitable sustained growth” around three criterions:
- Revenues increase (compound annual growth rate > 5.5% over an extended period of time of at least 10 consecutive years)
- Net Profits rise (compound annual growth rate > 5.5% over an extended period of time of at least 10 consecutive years)
- Total Average Shareholders Returns (Share price appreciation plus dividends paid for each US$1 reinvestment) exceed the cost of capital, over the same extended period of time of at least 10 consecutive years.
These three criterions of sustained growth have to happen or be accomplished during an extended period of time, of at least 10 years. Again here we observe the variable “time”: growth is not to be measured in 2 years, neither in 5 years, but at least in one decade or 10 years. That is how continuum sustained growth measured in economic terms during a period of “time”. So we are talking about a “time span”, in which a corporation or institution has reached a state of continuing growth.
Continuing sustained growth happens because entities make and take the correct decisions at the corporate strategy level. Which by all means, only occurs, when decision makers adopt the “growth mood” to expand, in order not just to survive but to gain a sustained financial cushion to afford its present industry challenges, but also to be prepared for an uncertain future. Again, we observe the variable “time” in our words.
From this rationale, during the last century, the philosophy of “bigger is better” was coined. And the “bigger is better” proposition got immersed, into our corporate strategy dimension decisions. The “bigger is better” philosophy captured the corporate strategy so businesses could take advantage of its experience curve, be cost efficient, reach “critical mass· for large-scale production and become the influencers for their respective industries. With the advent of the disruptive technologies grouped under NAIQIs, nowadays the philosophy has changed to “quicker and bigger is better”. And this premise is far from being correct, reason why we decided to write this saga, as a reformulation for the next generations.
Let´s continue. In order to grow, the owners, a Board of Directors or top leaders of an organization, must decide how do they wish to expand, and basically at the moment there has been two major ways to do it, and a third one that is a hybrid one:
- Growing from and around the core business
- Growing by diversification
- Growing from the core and then with diversification
NUMBER ONE. Growing from and around the core business.
When deciding about growing from your core, I have already prepared a material about this theme. Please revisit the whole Leg 1 from our Strategic Regatta Volvo Ocean Race 2017-2018. There are at least 6 detailed publications about expanding your core business, and I would like you to read them all, before proceeding further.
What to do to grow from and around the core.
(1) Vertical Integration and (2) Geographic Expansion.
(1) Vertical Integration. When decisions for growth around the core business take in consideration the expansion backward or forward the value chain process, then we are facing a choice of vertical integration.
If the decision is to expand to upstream industries or going backwards by entering into producing own supplies of raw materials and provisions and all inputs, then we are in the case of a backward integration.
If the decision is to expand to downstream industries or going forward by entering into the distribution of its own products & services, then the entity is taking ownership and control of its own direct commerce with the consumers, and thus is assuming a function of a forward integration.
Vertical integration may be partial or full integration.
Vertical Integration seems to be logical for those entities with a strong competitive position in a highly attractive industry, particularly in the technological sector, where it is important to keep the secrets of the whole value chain in the same ownership. But there are some cases or specific industries, in which it is not feasible to do it because of transaction cost economics.
Transaction Cost Economics helps to explain why firms vertically integrate or outsource important activities of its value chain. Companies decide for vertically integrate, when it is more efficient in costs to do it inside the company, than contracting for goods and services of the suppliers and distributors in the marketplace. Companies decide for outsourcing when it is cheaper to purchase the needed goods externally. Keep this concept handy for next episodes, we will open a debate for a philosophic integral reflection beyond criticizing it accordingly.
Growing from and around the core through adjacencies. Now that we have covered how organizations can expand into backward or forward vertical integration of its production value chain processes, we also need to at least recall that in order to grow from and around the core, the range of products and services offered to current markets should related to the core, or usually reinforce the strength of the profitable core. These are called adjacencies, and I have described them in detail when racing the Strategic Innovation Paradigm, three years ago.
(2) Geographic expansion
We live in a world that has been globalized, regardless if we like it or not. Nowadays, there is an integration of national-regional-global commerce systems based on the NAIQIs (Nanotechnologies, Artificial Intelligence, Quantum Supremacy and the Internet). There are integrated processes of the value chain production of goods and services, which were settled into different countries (particularly Asia) based on reduction of costs (efficiency). There is an interconnectedness and interdependence between countries, that has been revealed with the nature of the COVID19 pandemic. In consequence there is not doubt that globalization is a fact that will continue to affect corporate strategy decision making. To a point in which globalization is considered one of the main decisions when it comes to establish new markets and product lines. In order to grow geographically, companies and entities are required to be prepared to understand other markets consumer behaviors, demographics, regulation and government policies, environment and natural resources and the technologies of those new markets. In addition, those new emerging markets which have been underserved are a potential for many companies which require to continue growing.
How to grow from and around the core?
When we land to answer the how to grow from the core, here we face different alternatives. We can consider to expand our organizations organically (by ourselves) or by internal development or externally through acquisitions, mergers, strategic alliances, etc. with other firms in the same industry.
Let´s revisit these concepts:
- Green-field development: Or starting from scratch. If an entity doesn´t want to purchase another company’s problems along with its assets, the green-field development gives the opportunity to do an organic growth. Usually entities with high resources and capabilities, opt to grow by this choice. Even though organic growth is more expensive than mergers/acquisitions it allows a company more freedom in designing their own value chain or adjacencies to the core.
- Strategic Alliances: According to researchers Prange & Mayrhofer, “Strategic alliances are cooperation agreements where firms decide to share resources (technological, production, marketing, etc.) while remaining independent. Often, the term strategic alliance is used as a generic term for different types of cooperative arrangements”, that may include some minority equity (which involve exchange or contribution of capital). Among the latter, we find arrangements which lead to the creation of a new entity (these are called joint ventures) and others which involve equity swaps. In addition, strategic alliances include traditional market based contracts like franchising, licensing and non-traditional contractual partnerships.
- Exporting: In order to minimize risks and experiment with a specific product expansion in other markets, the option of exporting is available. Basically this means to ship the products from the home country of the entity, to other countries. The corporation can handle to export itself, or hire an intermediary (an export management agency).
- Licensing: Under a licensing agreement the licensing firm grants rights to another one to produce and sell a product. In exchange, the licensee pays a compensation to the licensing firm, in return for technical expertise and accompaniment at the corporate strategy level.
- Franchising: Under a franchising agreement, the franchiser grants rights to another company to open a retail store using the franchiser´s name and operating system. In exchange, the franchisee pays the franchiser a percentage of its sales as a royalty.
- Joint Ventures: Within this framework, a joint venture (JV) is defined as “any form of cooperative arrangement between two or more independent companies which leads to the establishment of a third entity organizationally separate from the ‘parent’ companies”. Thus, every joint venture is an alliance but not every alliance is a JV.
- Mergers and Acquisitions (M&A): The whole idea to buy or purchase your competition is originated here. Acquiring another company already operating in your same core area or around the core happens because of synergistic benefits in terms of expansion of product lines, growth of customers base, strong complementary distribution, and other paybacks. Just to write about M&A will take me a new saga when it comes to a corporate strategy analysis, and we will consider to write about this topic in the future. For the time being, it is clever to realize that the term merger is not the same than an acquisition, and it is not the same than a takeover. A merger is when two companies agree to integrate their operations on a relatively coequal basis, because both have resources that, if combined, create a stronger competitive gain. In theory, in a merger there is alike power of negotiation, and decision making is balanced fairly equally between two parties. As a result, a new enterprise is likely to emerge as a consequence of the deal. Gains from mergers may reflect economies of scale, synergies of vertical integration, improved efficiency, full use of tax shields, etc. An acquisition is when one firm buys controlling (or 100%), and usually the management of the acquired firm reports to the one that buys it. Often the acquired firm becomes the new owned subsidiary. A takeover is an acquisition where the target firm did not want to be bought, and did not solicit the bid of the acquiring firm. If you study the M&A of the last 100 years, when the reason to merge, is because of financial troubles, and one party is near bankruptcy, this last weak firm will face very limited options and will play the role of a target, that later could be considered as an acquisition. There are plenty of reasons for M&A and takeovers: market power, to cause high entry barriers in the industry, to hide or mask management errors or flaws (as high debt, in order to make a turnaround or organization slacks) and because of speed in comparison to new green-field ventures.
- Production Sharing: Coined by Peter Drucker, the term production sharing means for entities to mix the higher labor skills and technology available in developed countries with the lower-cost available in developing countries. For example, many MNCs moved their value chain support activities as data programming, information processing, client service support (call centers) to locations in which they can reduce labor costs, because wages are lower. Eleonora Escalante Strategy doesn´t agree with this unequal production sharing, but also the rationale behind the digital giga economy is also founded in this premise. I do not agree about how business schools are igniting courses and executive education with topics as “How Digital Businesses Succeed in an Ever-Changing Global Marketplace”; when they know in advance that the digital giga economy is not promoting equal opportunities for everyone, and it is not designed to bear the imbalance of cheap prices coming from Asia. With production sharing as such, everyone loses. At the beginning, the digital model may be promising, but “with time” it is all a fallacy. The developed economies eliminate jobs in high cost locations, meanwhile the developing economies are underpaid, and living below the lower-middle income class status.
- Human Capital Management Contracts: The United Nations network of organizations and the Multinational Corporations (MNCs) usually utilize this concept to grow. Usually these entities have a large pool of experienced individuals, or management talent that can be transferred to assist their expansion endeavors for a specified fee and a period of time. Management contracts are of benefit when local personnel are not fully developed in place. The introduction of experienced talent (between 50 to 60 years old). human capital to train the local next cohort of managers or leaders is a method in which the next corporate strategy leaders can advance to learn on a day to day basis to strengthen capabilities, skills, knowledge, competencies and particularly effective values-driven expertise.
- Turnkey projects for certain industries: Turnkey projects are a type of collaborative arrangement in which a firm handles all operations and details in a specific location, mainly by building complete, ready-to-operate facilities. Turnkey operations are typically contracting for the construction of operating facilities. Mainly the clients of turnkey projects are governments or government agencies. But this expansion approach is also utilized by Multinational Corporations (MNCs) when they decide to grow assets abroad. Another example of a turnkey operation is the BOT (Build-Operate-Transfer) or BOOT (Build-Own-Operate-Transfer) or DBOT (Design-Build-Operate-Transfer). This concept is the trendy jetsetter solution used in public infrastructure sectors, as water and sanitation, transportation systems, maritime ports, airports, energy and power, petroleum extraction or full supply, land leases, solid waste facilities, and other utilities. BOT and BOOT projects are established for the company to build; (own); operate the facility for a fixed period of time, during which it earns back its investments plus a profit; and then returns the facility to the government. There are thousands of examples at each of these industries in every continent. More recently turnkey projects have been validated for public private partnerships in countries where the state is not able to pay for their infrastructure projects. Read more here: World Bank PPP reference guide
Where to grow from and around the core? To be continued…
Bibliography utilized to get some ideas when writing today.
Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY. Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine. I do not own any of the lovely photos or images posted unless otherwise stated.
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