Corporate beasts are their own enemy; Managers blessed with a great business have been known to embark on destructive adventures

September 24, 2013 4:48 pm

Corporate beasts are their own enemy

By Luke Johnson

Managers blessed with a great business have been known to embark on destructive adventures

In some ways winning can be almost as bad as losing. When companies become very successful, they frequently fall prey to a variety of diseases. These undermine the very reasons why a business achieved success in the first place. For example, hugely profitable businesses tend to allow bureaucracy to proliferate like a virus. And it does not just increase expense; it inhibits change and becomes an end in itself.General Motors was the world’s biggest carmaker for decades. It had huge market share which enabled it to enjoy massive margins and vast cash flow thanks to rising demand. So layer after layer of management crept into the system, all justifying their existence and adding to cost and inflexibility. Only after bankruptcy has the carmaker truly started to become lean. Time will tell if the culture has changed sufficiently to permit GM to prosper in the long run.

Dominant companies often think they can exploit customers, and sometimes even forget them. Monopolistic transport providers – national airlines and rail operators, for example – typically get captured by managers and staff, and almost ignore passenger welfare. The only consistently profitable and growing airlines in the world are low-cost, disruptive models such as RyanaireasyJet and Southwest. Despite all their apparent advantages, national carriers generally cannot compete economically against such efficient, entrepreneurial rivals. The same logic holds for any industry.

Massive profitability can be a dangerous addiction. Organisations become habituated to such conditions and fail to realise that their returns are excessive and unsustainable.

Two leaders of British industry, GlaxoSmithKline, the drugs company, and BP, the energy group, have been battered in recent years by US regulators. Both have suffered enormous financial and reputational damage, allegedly because they took inappropriate risks or broke rules. They are not alone, of course. Both of these industries have enjoyed super margins and returns for many years, which can breed arrogance and complacency. But the era of exceptional profits may well be over.

Hollywood has over-rewarded its bosses and stars grotesquely, and allowed unions to ramp up costs, because it has made so much money from DVDs. But that cash well is drying up, and on-demand video will not prove such a gusher.

The studios are scrambling, hoping international sales, special effects and endless sequels will solve their challenges. But onscreen creativity is at a low ebb, and I predict the sector will suffer in the coming years.

Triumph in one segment can lead executives into delusions of grandeur, and a belief that they can run anything brilliantly. EMI was the world’s leading recorded music business: but the board squandered its fantastic cash flows and catalogues in a myriad of other activities through mergers and acquisitions, from CAT scanners to microchips to domestic appliances to television rental.

Rather than concentrating on a core competence, management teams spoilt with a great business can become bored and self-indulgent, leading to diversifications which destroy value.

A related sickness is the well-known edifice complex, where tycoons build monuments to themselves. A classic example was the 50-storey headquarters of
Enron, an oval glass tower in downtown Houston. After Enron’s bankruptcy, the building was sold for about a fifth of its previous valuation.

Office politics is a syndrome which afflicts all organisations: it tends to be worst in those which have highly lucrative franchises, because they can afford such decadence.

Perhaps the finest expose of how harmful it can be was described by Dick Brass, a former Microsoft vice-president, in a New York Times article in 2010. He explained how the technology group could have launched a tablet device 10 years before Apple but internecine warfare killed the project. Other, established divisions withinMicrosoft resented the diversion of resources and so sabotaged the innovation.

Taking customers for granted, bureaucracy, office politics, wasteful diversification, management self-indulgence and greed, regulatory complacency – the many perils of success mean no companies stay great for ever.

lukej@riskcapitalpartners.co.uk

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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