In my previous blog, I had argued for why faculty at the leading business schools in the world tend to be researchers with PhDs rather than executives. Some of the responses that I received made me realize that a segment of readers had misunderstood my point on two fronts.
First, I was not claiming that all schools should have research as a mission, and therefore, be populated by research faculty. In fact, except for the top 50 or 100 business schools in the world, the rest of the degree awarding institutions should focus on delivering great classroom experience. The reality is that research is an elitist pursuit.
Second, teaching a semester long course requires strong theoretical and conceptual frameworks. This does not imply that executives do not have great knowledge and experiences to share. Their “war stories” can lead to valuable insights and should be plugged into these frameworks.
The best executive stories are rather nuanced, with an elaboration of the conditions that led to success or failure. I would like to share two such anecdotes that were told in my class around a decade ago which I have used repeatedly.
Acquisitions at Reckitt Benckiser
Mergers and acquisitions (M&A), as those who follow the academic literature, know is fraught with high failure rates. The usual number given is that 70% of deals, on average, do not create value from the perspective of the shareholders of the acquiring company. Yet acquirers like Cisco or the more successful private equity players have demonstrated that acquisitions can be an effective strategy. Nor surprisingly, as an academic, I have always sought the secret of those companies that have been serial acquirers and still created value for their owners.
A presenter from Reckitt Benckiser, a company that I admire and now led by my friend Rakesh Kapoor, once elaborated the acquisition strategy of the company. As a caveat, please note that this was more than a decade ago, so their acquisition strategy may have changed. He went on to say that before Reckitt acquires a company they look for the following three conditions to be fulfilled:
- The potential target company is in the space where the basis of competition is more on “functional” and “rational” criteria rather than purely “emotional” or “symbolic” attributes. For whatever reason, Reckitt management believed that they had not mastered managing the latter types of businesses. Clearly, this implied stick to your competences and what you know how to manage.
- The margins in the target company were higher than the margins at Reckitt Benckiser. This ensured that the acquisition did not dilute their overall earnings quality. As a result, applying Reckitt’s pre-acquisition PE (price earnings) ratio should support a higher overall post-acquisition valuation.
- Reckitt could see a clear path for the target company that would enhance the current growth rate of the acquired company. This meant that there was the potential for Reckitt to add value to the acquired company.
For me, such an anecdote is insightful as it leads me to provoke the audience to reflect on their own acquisition strategy considering the 70% base failure rate. No wonder, a recent Financial Times article demonstrated that the operating margins for 2016 at Reckitt Benckiser were almost twice those of Danone, Nestle, or Unilever. While strategies must change over time, it remains a well-managed company with a focus on earnings.
Exits at Vodafone
The second anecdote comes from Arun Sarin, who was the former CEO of Vodafone. Presenting to a class of mine, he recounted the sale of Vodafone Japan. Vodafone was struggling in Japan when it received an offer in excess of $15 billion from Softbank for Vodafone’s Japanese unit. Arun asked his Chief Financial Officer (CFO) to run the numbers. The CFO reverted that for this valuation to be justified, Vodafone’s margins had to expand by X% and its market share had to increase to Y% (I cannot recall the actual numbers or whether Arun shared those with my class). Given the almost monopoly status of DoCoMo in Japan, Arun knew neither of these two assumptions were likely to happen. The result, he sold Vodafone Japan.
The resulting cash from the exit of Vodafone Japan was useful. A large part of it was returned to the restive shareholders who were unhappy at Vodafone’s recent lacklustre performance as well as the large losses in Germany and Italy. The remaining cash helped Vodafone acquire its way into India, which was then one of the most exciting mobile telephony markets. This Indian entry did run into some well-known challenges, but that is another story.
But, Arun’s story became better. Subsequent to the sale of Japan, Arun received an offer from a private equity firm for the assets of Vodafone New Zealand. Once again, the CFO was asked to run the numbers. The results were similar. The assumptions needed to justify the offer from a financial perspective were aggressive. As a result, like in the case of the Japanese unit, the net present value for Vodafone for the New Zealand business was less than the offer on the table.
This time Arun refused to sell. His logic was that the New Zealand business was one of the smallest of the forty or so countries that Vodafone operated in. The sale or retention of the New Zealand business would have no financial impact on the overall fortunes of Vodafone. However, from a management perspective, a small operation such as New Zealand or Ireland were important to have in the Vodafone portfolio.
These small countries could be viewed as laboratories for high potential talent. By assigning people there, one could observe their performance in low risk environment for Vodafone. Even if they failed, it would not impact the global Vodafone results. Yet, performance of top executives in these small countries helped evaluate and develop top management talent for future roles in larger countries.
So, the best executive stories have learnings that make our conceptual frameworks come alive.
Great teachers combine the two.
The stunning UNESCO world heritage sites of central Java that I was privileged to visit last week.