In Search of Excellence June/July 2005

In Search of Excellence

Stick to what you are good at!

Peter Jansen
June/July 2005

One of the most telling characteristics of the companies featured in Peters and Waterman’s bestseller In Search of Excellence - Lessons from America’s Best-run Companies is their ability to stay relatively close to businesses they understand.

This contrasts markedly with Romania’s experience of the last decade or so, which has seen the rise of a number of diversified conglomerates – companies that are active in a wide range of fields, often with little or nothing in common besides the fact that that the owner perceived them as a business opportunity. Prominent examples include the Ion Tiriac, Ana, MediaPro, Tender, and European Drinks groups, each of which began with a core business with which the owner was familiar and which had some central strength or skill.

These core competences can be anything, from logistics or market knowledge to a specific technology. For example, a well-run American company such as 3M has its main competence in basic coating and bonding technology, which is applied to thousands of different products.

Once the company adopts a diversification strategy and starts to branch out into other areas, trouble usually sets in. First of all, it is a simple fact that most mergers and acquisitions are not successful. Not only are the operating or strategic synergies – usually mentioned as the main reason for the acquisition – seldom realised; more often than not the result is catastrophic. The typical diversification strategy reduces the core competence or central skill – in part because the acquired company undoubtedly has different competences and shared values. Management loses its feel and usually leaves the running of the new business up to people they know and trust – read: cronies – who are not necessarily the right people for the job. Furthermore acquisitions – even small ones – use up a lot of top management time, time taken away from the mainline businesses. As a result these companies – over time, as competition further increases – often start to lose the battle on all fronts, even in their core business area.

How then have well-run companies avoided these traps? As a general rule, the top performers moved out mainly through internally generated diversification, one manageable step at a time. They never leave their base. The principal finding is clear and simple. Organisations that do diversify (whether by acquisition or internal diversification) but stick very close to their base outperform the others. The most successful of all are those diversified around a single competence. A good example in Romania is the European Drinks, whose value system is mainly horizontally integrated. From downstream (basic ingredients like water or flour) to upstream (production and distribution of soft drinks and beer), their core competence is logistics. This allows them to manage the whole value chain from beginning to end. The start of National TV, on the other hand, does not fit into this strategy and can only be described as a vanity acquisition.
Another group comprises companies that diversify into related fields. An example in this category is MediaPro Group, which started out as an audiovisual (television and radio) production and broadcasting company, then branched out into other media, mainly print-related. Interestingly enough, the more the new activities deviated from the original core competences, the less successful they seem to become.

Least successful, as a general rule, are those companies that diversify into a wide variety of fields. Among this group acquisitions tend to render little return in the medium-to-long term. An example of such a company is the Ana Group, whose activities range from electric engines to tourism and bakeries. Also the Tender Group fits into this category with activities ranging from construction and industrial production to agriculture and security services.

In short, the best diversification strategies are based upon the concept of controlled diversity. These companies have strategies of only entering those businesses that build on, draw strength from, and enlarge some central strength or competence. While such firms frequently develop new products and enter new businesses, they avoid investing in areas that are unfamiliar to management. In other words, excellent companies do acquire; but they acquire and diversify in an experimental fashion. They buy a small company or start a new business. They do it in manageable steps, and clearly contain the risks by sticking to what they know. And are willing to get out if it doesn’t work.

There is still a way out for the over-diversified conglomerates in Romania: divestiture. Especially in this pre-EU accession period, chances are still good to sell non-core activities for a premium price to strategic investors. Once competition further intensifies after 2007, chances for survival will quickly dwindle.

Peter Jansen is the Managing Director of Sanoma Hearst Romania and writes these
articles on a personal basis.