Considerations for acquiring another company

As every financial analyst say, the time is just right for acquiring companies overseas. The valuations are low and so the acquisition will be better for the acquiring company in terms of lower debt etc. The logic is correct, but I would like to put a fresh perspective on what kind of companies should be avoided.

Let us take the case of Tata Motors taking over JLR. This has all the proponents of turning out to be a disaster. There is no match. Tata Motors entire set up is to cater to mass base, its products and technology is low-end. On the other hand JLR is just the opposite, it caters to the high-end (probably the highest end) consumer and is of low volumes. Its technology is as its market, the highest end. What can TM hope to achieve? Improve its own mass base technology, or bring down JLR technology to reach out to a larger mass base? Neither is possible as little of the technology and the manufacturing philosophy of JLR can be transported to Tata Motors, the gap is too wide at both ends to migrate. If history is any indication, save an exception here or there (like Toyota – Lexus), no company has been able to straddle the entire gamut, not even when the gap has never been so wide. Even in the heydays the famed American trio could not produce a car with the technology of a Daimler Benz. Why so? Because the entire thinking within a company cannot handle the thinking required for the other end of the spectrum. I believe, in about a couple of years, Tata Motors will have to put JLR on the block, unable to handle the financial strains.

Or take the failed case of Reliance taking over Lyondell-Basel. Reliance is lucky they missed the opportunity, for the two companies are vitally different. While the focus of Reliance is manufacturing as the larger part of their website focus on that, Lyondell-Basel is more to reach out to customers and empowerment and development of new technologies. It is telling that Reliance contact is centralized in Mumbai, while Lyondell-Basel is worldwide. So, if Reliance was looking at enhancing their manufacturing facility and customer base, it is obvious they seem to have forgotten how to handle the culture, and they may have found it impossible to do so. It would have led to breakdown of the efficiencies that built the company and would have to resort to major financial restructuring to keep it afloat.

The key message I want to leave the reader with is that greater emphasis is required on the integration aspects of the two businesses, beyond the financials. These are never documented, but omnipresent within a company and shows up in its daily working, things that make a company tick. Within a company it is never discussed or articulated and dissent is never seen as positive thinking. Only an outsider is able to transcend and advice correctly. If not addressed, it leads to waste, both in terms of energy as well as resources as in the process of integration, the working values of the two entities come to the fore in greater obviousness. And the problem gets compounded when the two institutions in the integration process are equally large and influential. Don’t we remember the strain of integration and its breakdown when HP bought Compaq.

Ever so often the decision for a M&A is made on emotional or non-rational reasons. Reasons like we wish to be number one, we wish to be respected; we wish to be in a position where we can dominate and control and so on. There is nothing wrong with that but thereafter it needs to be thought thru dispassionately on what it will take. It is easier to buy a product, a facility etc., all which are inanimate, but a corporate M&A is not about acquiring inanimate assets, it is about integrating values and people; assets which work on beliefs in life principles. Only a honest and straight talking outsider can guide a company CEO thru this maze and before the damage is done. And this outsider needs to be trusted, not seen as a consultant who has been given an assignment to deliver.

The 1 Trillion Dollar Plan – will it work?

The G-20 pledged 1 trillion dollars to multilateral agencies to support poorer countries in getting bettwr access to credit. Will this help in speeding up the world economy to come out of recession. Te leaders think so, so i thought of putting together an alternate opinion that it may do just the opposite.

To start with, let’s trace back to where it started. Financial institutions, through complex instruments, raised the value of housing. Fuelled with speculation, the stock markets started to look good. While the real income did not grow, the opportunity to make money on the stock markets (including overseas) makes the consumer borrow more. This spiral was fine till it reached unsustainable position. That was the start of the fall. It spiralled out of control; people could not pay leading to a spate of foreclosures. The value of the assets started falling; leading to the financial institutions losing their ability to raise money to sustain themselves, and suddenly demand starts to shrink all around. The various governments starts to band-aid the institutions, but, as the fundamentals remain weak these bail-outs are not helping. GM continues to face bankruptcy, Citibank continues to remain iffy – the story is the same all over.

In the midst of these, many companies started “paying” bonuses to executives and that creates a hue and cry. Some back-off, others turn cautious while still others start playing to the gallery.

The first noises of protectionism is heard, the world starts getting divided, and all starts raising the pitch of the spectre of 1939, when protectionism apparently delayed the recovery. The countries in favour of protectionism starts backing down, but have not abandoned it.

Now comes the trillion dollar plan and not to forget the tighter international banking regulations.

There lies the problem. Will the trillion dollar (and all other bail-outs) help raise the value of assets to those levels when the institutions can continue to conduct business before the fall. The answer is no. The bail-out is like an extra cylinder when the patient is in ICU. Till such time the value of the assets does not start moving up, you are postponing the problem. In addition, you are creating a new problem, protectionism in another form. While earlier the institutions could raise funds internationally, now that route will become restrictive, so there will be less funds available or less free flow of money. I think the bad guy is not us, so I will make it difficult for the guy to take money from me.

All the bailout money is like water poured on sand, disappearing faster than you can give. Now somebody will have to cough up the bailout money as it is presumed gone forever. See the problem. It will only add to the woes quite reverse from what it should be doing.

So what will happen

Worst case:

You cannot bring interest rates down any further (unless you adopt Islamic Fundamentals), deflation will take place as people do not have the money to buy. Economies will shrink, for the moment unemployment will rise, salaries will decrease, parities between wages (developed and developing countries) will narrow, employment will start to rise again locally, and slowly (in about 5 - 7 years) things will start looking up. Credit card usage will fall, and so will easy loans. In the end, the world will be poorer in monetary terms but emotionally happier and mature. Industries worst hit will be “lifestyle” related industries. Earliest recovery will be seen by the “essential items” industries and generally unaffected the “luxury” industries.

Best Case:

The bailout money is used by the financial institutions to sell off the assets at a loss and using the bailout money to fund these losses. In parallel they start cutting down the cost of operations, not by removing people (and keeping the same lifestyle for the others), but by reducing salaries, bonuses etc. so that people survive with less. Recovery will take time

There is no place for GM here, they are far too out of phase with the reality to make it.

What would I prefer? The worst case as the recovery will be faster and the learning will be deeper. Yes the pain will be deeper, but the pain will be borne by more or less the same people who created it – that is fair.

The root cause of the current crisis is countries and individuals have gotten into the bad habit of living on debt. This is an opportunity to understand how to cut your coat according to the cloth and not to die with a debt burden. Carrying debt is a multi-life burden; you are born again and again till you are completely (debt) free as says the Hindu thought. Not a bad approach.

Organization's Purpose - To Make Money?

Since the early fifties, when management became an independent discipline on its own right, the only statement constant for consideration has been this. The consideration is correct, however a question remains – money for whom? Who is the company? The shareholders – who has put in their (or their representative’s) money?, employees- who have given in their careers?, senior management who have the maximum influence on the affairs of the company?. This question is pertinent as it somewhat determines the difficulties most companies suddenly face, and the angst among people against some sections of the company. Let us try and read between the lines at some of the incidents.

President Barack Obama of the US says that any debts given by the government would have a rider – maximum income is to be limited to USD 500,000. This implies that these people do not represent the true company, as it violates the basic tenet – purpose is to make money. Or take the case of Lehman Brothers. They invested (or created an artificial situation) into areas that was not quite the right thing to do, these investments turned toxic and the company folded up. Of course we have the advantage of hindsight, but during the process before the bankruptcy, we all knew that the actual earnings of the employees were based on a incentive pay. To increase their incentives, these people made the now wrong decisions for which the shareholders suffered. So the employees are also not the company. If they were then they did the right thing for themselves, and did not consider the others as the company. Or take another case. Reliance Industries Chairman considers it appropriate to construct for himself a USD 2 billion residence (as reported in the papers), and at the same time shuts down several plants and divisions, rendering many employees jobless. In other words, he does not consider these employees to be the company, for in his power he had a choice of continuing to allow these employees to make money or the shareholders (and him as senior management), he chose the latter. And finally, in the recent years (last ten years or so), the stock market (or the body of shareholders) so pressurise the senior management of companies to show profits (money) that it is a nightmare for these people (ask any MD/CEO/Chairman what is his biggest cause of stress). So the shareholders consider themselves to be more company than anyone else.

This dominant group syndrome is also the cause of one or more of the groups losing interest and no longer participating. In my years of consulting and observing companies in India, the employee participation in the progress is minimal. They prefer taking orders. On closer observation I have found ever so often a common thread. These people see themselves existing only to increase the coffers of the owners, while they have to fight for increments for themselves. I have seen that the gap in facilities (and resources) of the owners indecently wide between himself and his next line of people, and this gap continues to remain as we go down the hierarchy. The employees and the owners have fallen into a syndrome of mutual negativity.

Similar apathy is obvious between shareholders and the board of directors. A bad quarter has the investment bankers, financial reporters baying for blood. In Europe, where the unions still have some influence regularly take on the management. Examples abound on the definition of who is more of the company.

The definition of the company is therefore entirely dependent upon the dominant pressure group, and this is inherently flawed. The working of the company is subjected to constant pulls and pressures, and under artificial / incorrect pressure, wrong decisions are bound to happen.

Maybe it is right time to question the definition of basic purpose of a company used so far.

Money by nature is inherently a personal commodity. Yes many can argue that money is used to fund projects that would improve the standards of the society, or that money helps grow money (I remember Paul Samuelsson’s famous book – a bible for budding economists) and so on. But consider this, all these are but intermediate steps for individual’s final consumption. Money is and will remain fundamentally a personal instrument, used to meet the demands of that individuals psyche. Mark my words here; I do not use the word needs, as is commonly used, but the word psyche. This is because the psyche determines the extent of need and not what is required for keeping a dignified existence. (If only humans were like machines, it can only consume that much energy as it is built, then I would be happy to use the word need). Sometimes this psyche can overwhelm you, and make you commit drastic errors, as it has happened in the publicised Ramalingam Raju’s case in Satyam recently, or Kenneth Lay in Enron earlier. In both cases the requirements of the individual’s psyche exceeded his resources and being in power, used it to the detriment of the organization.

Since money is a personal commodity, it is obvious that a company that thrives on making money is in effect creating money for an individual or a set of individuals. A company is an entity in its own right, but is an entity which cannot think for itself. A company requires someone or somebody to think for it. In essence a company by itself has no need to make money except for the purpose of existing with dignity today and for tomorrow. So we come back to the original question, what is the purpose of a company?

It is because this dichotomy exists that people have segregated organizations into profit (commercial) and non-profit (including the Government). Because the conventional definition of the purpose of the company did not fit these alternate organizations into its mould, the convenience was sought. However whether it is commercial or not, any organization exists because it provides some facility to the community it works for, whether it is a organization engaged in commerce or not. Irrespective of the nature of the organization, business principles must apply uniformly.

I believe a change of definition to “A company exists for the purpose of serving the community with products and services it set out to do and ensure it is able to do so in the future as well”

Whether the organization is engaged in commerce or not, its goal is to provide those products or services it considers it capable of delivering, and one for which a community exists to accept those services. If tomorrow the phones as we know it today is no longer required, then the phone company (a commercial organization) will not require to exist. In the same vein, if poverty is completely eradicated then all the aid and Non-governmental organizations like Oxfam will no longer exist.

Incidentally, this definition of the purpose of a company given above is not quite new. A few years back, there was a wave in every company to write its “mission” statement. I have attended several of these mission statement creation sessions. People in the audience did create very lofty and well meaning purpose. Unfortunately they have all fallen by the wayside because in the process of implementing, they found that they (individuals) could not make money for themselves if they remained true to the mission statement. That wave is now over.

Is it not that company consider providing products and services as important, if so, then why focus on it now?. Of course it does otherwise it would not exist at all. But the context is about Management decision priorities. In that pecking order, the service is secondary to profits. If faced with a decision whether to go for service or profits, service is always thrown out of the window. Exceptions are in legal reasons or just bad publicity. The first is obvious, for the second it is indirectly a reflection of monies. It is rare, but examples exist, when a company seceded in favour of service and invariably these examples have concluded longer term stability and respect for these companies. I recall most of these examples were from the sixties era, a time when profits, income, shareholder values had taken a grip on the organization psyche.

Ok, we get the point, then so what? How can we change things?

This is probably the difficult and likely to be the most controversial part and the suggestions are likely to be commented upon the most. I am working on a few ideas, just like to have some comments from you folks so far.