Ready to grow?

Successful companies in general have strong balance sheets. The combination of a strong balance sheet with an entrepreneurial spirit, a favorable environment, money (access to it) and creativity is giving room to a more recent trend of expansion of large companies via horizontal or vertical integration and diversification.

This – the creation of large and sometime diversified groups - is something that is part of the development of the Capitalism, Brazilian included. Nevertheless at the rate that we see some companies doing deals (one after another) we suspect that there is a likely risk of “indigestion” after all, money is not the only resource necessary to properly run a business.
Growth is, without a doubt, the engine of capitalism. The absence of growth is an indication that something is not going well either at the company’s,  at the industry’s or country’s level.
 


Once a company has a proven management model, available financial and human resources and yet strong systems and processes (IT and internal controls) a logical step would grow faster via acquisition (or inorganically). Normally, first option would be to target a horizontal expansion by acquiring an existing competitor with the aim of serving new customers (new regions) or the same customers by being more representative (selling more to them) and / or offering new products. A natural second option would be that of a vertical integration. Basically it means moving up (stream) or down (stream) in the value chain (encompassing the production and distribution of their products). This move allows a company to either capture more margin or have more control over strategic elements or components of the chain. A third option is that of a diversification, moving into another industry. For its turn this could be a diversification towards related or non-related industries.
 
A “related industry” diversification example would be that of a retail company when it moves into Financial Services, Real Estate and even Food production. The logic behind involves: cross selling (to customers) in the case of financial services, having more control on one important element of the business, the real estate and in the case of food production (bakery, meat and dairy products) capture more margin and quality & productivity.  A “non-related industry” diversification example would be that adopted by an industrial group when it decides to enter in the investment area (private equity) or construction.
 
Cases are made for and against diversification through the formation of conglomerates, or of a corporation engaged in two or more unrelated businesses. In common one element used by both for and against is that of: not having all eggs in one basket. For those in favor of conglomerates it (the expression) means risk mitigation as when one business is suffering other(s) is (are) compensating for it. For those against conglomerates the lack of specialization means less efficiency, more complacency. To add more to this discussion even the mighty GE has recently recognized that specialization is necessary in order to manage a business.

One cannot fight facts thus a discussion of whether makes sense to build conglomerates or not is out of place. My point is more related to the elements necessary to run a more complex and diverse business. In an expansion towards a non-related industry what a strong new comer may bring is the combination of financial resources, good management and access to good people (being big and successful make this less challenging).

Thus, groups deciding for a diversification strategy should do the following:

icondestaqueBe very good in performing the traditional activities of a holding company: selecting and appointing the management of the operating companies, investment allocation (mechanisms to evaluate and approve), cash management (cash is king & means freedom!), and constantly evaluating the “portfolio” of companies (assessing their performance not only against their objective but also against the market).

icondestaqueHave implemented at the holding level a corporate governance structure. Having at the board specialists that can compensate for the lack of knowledge at the holding level.

icondestaqueSplit the management of the holding from the management of the companies.

icondestaqueBe committed to the holding performance & growth and not to any particular company. Meaning that any company that is putting in jeopardy the health of the holding or not contributing to it should be discarded (divested).

icondestaqueIn case there is a business or division which is yet responsible for a large chunk of results and cash generation, it should not be forgotten.