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Mergers need a sober approach

The world of business can learn a lot from beverage manufacturer SABMiller, a company that has been an acquisition machine in the world’s beer sector, writes Ted Black

A GOOD prophecy does not have to be right, but it should alert you. On these pages a year ago, we looked at the relationship between ROAM (return on assets managed) and market capitalisation —or value of the firm (VOF) — on the JSE.

It shows a clear, positive correlation between ROAM performance and the VOF. As ROAM rises, so does the perceived value of the sector and the companies in it. The drivers of ROAM are revenues, margins and asset productivity. They result in the three most important financial measures of operating management’s competence:

  • Profit margin (operating profit divided by sales multiplied by 100) multiplied by;
  • Asset productivity, or asset turnover (sales divided by assets), which give you; and
  • Return on assets managed (ROAM) — the total operating profitability of the business.

Managing revenue and margins are both critical tasks, but asset turnover is the most important one of the three. That is why we also took a peek at SABMiller through the asset turnover (ATO) and ROAM lenses last year.

We can learn a lot from a firm that has been an acquisition machine in the world’s beer sector.

First, what governs top management ’s behaviour? It has given up using EVA™ as a measure. It uses total shareholder return (TSR) instead. This combines share price growth and dividends over time.

However, there is a danger when you measure management with share price movements. The late Peter Drucker once said: “Stock option plans reward the executive for doing the wrong thing. Instead of asking, ‘Are we making the right decisions?’ he asks, ‘How did we close today?’ It is encouragement to loot the organisation.”

EVA™ is driven by productivity, but growth is one of the drivers of the share price and therefore TSR. That is why it makes sense for managers to go for mergers and acquisitions to accelerate growth and reward.

According to I-Net Bridge’s analysis, SABMiller directors’ remuneration in rand value has gone up 814% over a five-year period — not a bad return for their efforts.

SABMiller1SABMiller ’s market capitalisation has grown roughly in line with the growth of the asset base through 2004 to this year —about 190%. Exhibit 2 shows the effect of this over the past 10 years on asset productivity — a steady fall from right to left. You could call it “brewer’s droop” after SABMiller’s involvement in the consolidation “beer bust” of the past 10 years.

Mergers and acquisitions are management’s “Sun City” gamble —the big bet with high hopes that are seldom met. Statistically speaking, they seem doomed to mediocre economic performance. There is a reason for that: the sellers walk away with the value, leaving the buyer with a huge cost.

InBev is the latest example of that. It has offered $52bn for Anheuser-Busch’s asset base of $17bn —a premium of $35bn.

Accountants call it goodwill, but it does not generate a return and is bad for ROAM and the VOF. Today, Anheuser has aROAM of 17,3% on total assets. That means each year management will have to generate an additional $6bn operating profit out of the tangible assets to pay for the “opportunity cost”. It is the “winner’s curse”.

Few changes are as complex and challenging as acquisitions. The closing of the deal marks the end of a job well done. Top management celebrates victory and moves on. Making them work is someone else’s task.

That is when large numbers of people from two organisations plunge into the deep, cold waters of a new working environment. After the excitement of the courtship and consummation of the marriage, the offspring can be a big disappointment. The question becomes, how do we turn this unhappy product of a happy moment into a success? Miller is a case in point for SAB.

Despite some impressive productivity programmes described in annual reports, the acquisition seems to have put SAB management onto a permanent learning curve. You never, ever generate high productivity and cash when you learn.

Given the generally accepted 70%-80% failure rate of mergers, SABMiller ’s expansion through foreign acquisitions was seen as high risk at first. To lower the odds against it, the strategy, like all good ones, was simple and based on SABMiller’s strengths.

Its experience curve, a hugely profitable one, is anchored firmly in SA — especially Soweto. That’s not a good address by international standards. So to achieve the vision of becoming a major global player, the mission was clear and brilliantly simple: move the head office to London —a good address —and then: “Buy good beer firms at bad addresses.”

Like everything in life, it was not so simple to execute. Profitability fell steadily as the comp a ny grew in Eastern Europe, Africa, the Far East and Latin America, where it now has a big stake.

The share price languished for a while, but improved results changed capital market perceptions and doubled the VOF over a couple of years.

However, in 2002, management turned its successful formula on its head. It bought a bad beer firm at a good address — Miller in the US. In one move, it jumped onto a long, steep learning curve in a complex, highly fragmented market with a big, hostile gorilla in it.

The results since show that it cannot make the breakthrough onto a US experience curve even with highly competent operating management. The great lesson from SABMiller’s North American experience is to match opportunity with strength —not weakness.

Could that insight have prompted its decision to merge its US operation with Molson Coors and let them manage it?

The beer business is mostly a good one to be in —it has high operating margins and even the worst performers have a return on sales of about 10%. However, most of the well-known players who have been involved in the consolidation “beer bust” now have serious “hangovers ” – an intangible asset burden of around 50% of their total asset base. This causes low ATO and the effects are shown in Exhibit 2.

SABMiller2Low ATO companies rarely see good returns, but high margins compensate for it in the beer sector. The highest ROAM is Modelo’s 20,6% in Mexico — its return on sales is 28%. Unless you have “orderly market arrangements” as most big South African firms seem to, or you have a monopoly, low asset productivity means trouble.

Exhibit 3 shows what can happen. It looks at geographic market segments and InBev. First, compare SABMiller and Molson Coors with Anheuser- Busch’s US beer interests. It is like taking on SAB in SA.

SABMiller3Once the InBev deal is consummated, and $35bn is added to its asset base, Anheuser Busch will collapse in a heap in the left-hand corner along with its Chinese interests. Its ATO will be about 0,2.

That is what Bavaria’s was before SAB bought it, and why the Latin American segment also languishes down the bottom of the left-hand corner.

In last year’s article, the Molson Coors deal was being mooted. The warning given was to be wary of adding low productivity assets to low productivity assets. Rainbow Chickens tried it by acquiring Bonny Bird and Epol from Premier and took many years to recover. As Molson is already reporting poor results, will the US become SABMiller ’s Russian Front, or is this merger part of a withdrawal and regrouping strategy? In SA,Heineken ’s entry pulled SABMiller’s operating margin down to 24,3% from 27,3% and ROAM from 50% to 44%. Competition gets prices down. The very thought of it will change behaviour, which ra i s e s the final issue.

What should shareholders demand from SABMiller today? After the latest frenzy of acquisitions, they must stay sober. With rising input costs and the huge hangover of intangible assets, now is the time to focus on the VOF. The VOF is key to all management interventions. It is not growth, not revenues, not market share, not size; except to massage the VOF.

The VOF is governed by volatility and uncertainty. Volatility equals uncertainty, and uncertainty equals risk. To reduce risk, get managers to focus on economic profit and follow Warren Buffe tt’s advice. Build a crocodilefilled moat around the fortress: “Widen the moat: build enduring competitive advantage — delight your customers, and relentlessly fight costs.”

It means that productivity ratios become the only valid measures of management intent and results —not the share price. Productivity is units sold: resource units used. Improving productivity will reduce risk by influencing price recovery, which is the ratio sales price:resource price.

If you use a high selling price to make money without keeping product costs down, you increase the risk. This is price over recovery. It typically arises from sales price growing faster than resource price.

That is the basis of the information I would seek from management if I were a shareholder —or say Maria Ramos — who has just joined the board. Coupling a productivity focus to Heineken’s presence here would be good news indeed for long-suffering South African consumers. We seem to pay huge premiums for everything we buy, whether it is from the private or public sector.

Ted Black (jeblack@icon.co.za) coaches and conducts ROAM workshops that help managers design results-driven projects.

SA Inc should take less and make more

HR-Strategic-PartnerCOMPANIES and institutions are complex social systems and therefore difficult to manage. Consider the huge and rapid changes of recent decades, the even greater ones in years to come, and people become more important than ever to success.

Despite this challenge, and its diligent efforts over the years, the human resource (HR) function struggles to position itself in management ’s mainstream.

That’s probably one reason why the Boston Consulting Group (BCG) and the World Federation of Personnel Management Associations recently surveyed the views of nearly 5 000 executives in 83 countries and markets. They published a report of their findings and called it Creating People Advantage — How to Address HR Challenges Worldwide Through 2015. It covers 17 topics in human resources management and lists 194 action steps to compete better through people. The three main areas of focus that emerged were:

  • Keeping and developing the best employees;
  • Creating “learning organisations”; and
  • Anticipating change —for global companies this includes managing demographics and differing cultures.

Not surprisingly, the report concludes that the challenges are greater than ever before. That’s probably why transforming the HR function into “strategic partner” was one of the 17 topics raised. This is the “right to sit at the high table” with top management.

If HR managers want that, it seems they missed a DAZZGOTO — a dazzling glimpse of the obvious — during the survey. Productivity was not even raised. The closest to it was “performance management ” — usually this ends up as a more complex version of the dreaded, and mostly ineffectual, annual performance appraisal.

It highlights the problem HR people have. Operating managers see a need for what they do, but it tends to be a defensive one. It’s more a case of “keep us out of trouble” ( that ’s putting it politely), than anything else, and certainly not to help with productivity.

As to productivity improvement, within HR are the human resource development (HRD) specialists. These HRD people claim they already respond to the need through training, organisation development, selection, performance management programmes and incentive schemes. The belief is that improved results will follow these activities but the link is tenuous at best.

During the survey, executives in Africa identified the management of talent, work-life balance, globalisation and diversity as major issues —again nothing about productivity. The issues raised are important but the accompanying rand-dollar chart spells out the challenge and prime focus for South African managers — not least, HRD. Today, we don’t create wealth — we destroy it. The long decline in the buying power of the rand stopped in 2002 but seems about to resume its steady descent. T hat’s because it’s hard to swim against the tide of three numbers.

Our population growth is one of the world’s highest even if tempered by disease. Our inflation rate is higher than our major trading partners. Lastly, our productivity is low and falling compared with the rest of the world. That’s because a common driving value in government and corporations in SA is to “take ” money, not “make ” money.

Indeed, the way we pay people, especially managers, can even cause falling productivity. It’s all about pay and reward for size — size of the asset base, sales, costs, profit, numbers of people and growth —not productivity.

The rand-dollar chart’s wakeup call is loud and highlights a key economic principle —productivity equals wealth and is the most powerful weapon for fighting inflation.

Productivity gains allow companies to increase wages without increasing prices at the same rate. This keeps inflation below wage increase levels and grows real income and standards of living.

Moreover, HRD people with the talents they have are uniquely suited to contribute directly, significantly and measurably to productivity initiatives. However, they have to make a shift and bring meaningful metrics into play — simple ones that people at all levels can understand.

It is time for HRD to work with the finance department —another function that is largely irrelevant when it comes to productivity. If measures influence behaviour, then accountants are hugely ineffective. Most often, the numbers arrive far too late to make any difference and no one understands them anyway.

If you expect to find out if a company is improving productivity or not by reading the financials, you won’t. They mislead rather than inform. That’s why there is a flourishing trade in business school courses and finance workshops for non-financial managers. They achieve little.

In fact, accountants and HRD people share the same problem, but it is also a huge opportunity. They both battle to become genuine business partners and advisers. Their barrier is how to communicate — to present the numbers in plain, simple language for operating people with no formal training. If they did, then employees would think intelligently and suggest ways to improve them — just as they do in Toyota.

This year, in its neck-and-neck race with General Motors, it will probably take the lead and then widen the gap between the two companies. For good reason. Its employees generate one million suggestions a year. That’s around five per person. What’s more, they implement most of them — in many cases without even waiting for management approval.

Toyota has perfected a system that continually improves itself and creates huge profitability through productivity improvements. It is now the benchmark for world-class manufacturing — indeed for the profession of management. What the company shows us through its suggestions is that there is a vast, untapped reserve of potential in every organisation. The trouble is it stays hidden, and then simply fritters away because of historical accounting methods, policy and culture.

As one CEO of a major US company put it: “The three biggest barriers to continuous improvement are top management, middle management and supervisory management.” When anyone suggests a change for the better, typical reactions will be: “We’ve tried that before and it didn’t work so why don’t you go back to your workplace and get on with your job?” and: “No, that’s a silly suggestion. The savings will be too small.”

So what metrics should HRD people use to reposition themselves and help finance do the same? The first trait of the longlived companies that Arie de Geus described 10 years ago in his book, The Living Company, was that extraordinarily successful companies understand the meaning and value of cash in the bank. The second attribute was that no matter how diversified they were, people in long-lived companies felt they belonged. Case histories showed that a “sense of community” was essential for long-term survival.

This community includes not only the internal one, but those on whom the firm depends for its survival — its customers and suppliers. It means the company has to position itself to make it easy and worthwhile for customers and suppliers to do business with it. That’s the strategy part — designing your business to do that. Next is making it happen.

If you had only two measures to tell you about a firm’s health, the first is the length of the “cash-to-cash cycle” — the time it takes from paying your suppliers to the time your customers pay you.

The second measure is based on the classic sales prospecting question. You ask your customer: “Would you recommend us to your close friends and colleagues?” Trended “yes” replies tell you how well you are doing and whether or not you are going to grow.

These two measures — the cash-to-cash cycle and customer perceptions — drive productivity improvement and test the health of the firm. You can’t have many “yes” answers with high inventory turns and fast payment by customers if you aren’t doing a lot of things right.

PRODUCTIVITY is a much misunderstood and often misused concept. There is a physical and financial side to the equation. The physical side deals with quantity of input— resources and time — to quantity of output. The relationship between them defines “productivity ”. If you can get more output with the same level of input, that is a productivity gain. There are several other ways to do it.

Then there is the price of the input — what the resources and time cost — and the price of the output. This is about “price recovery”. If you increase salaries and wages by 10% but increase selling prices by less, the company suffers a price recovery loss. When you multiply the two elements (productivity and price recovery) you deal in rands. The relationship of rands input (costs) to rands output (sales) is profitability.

If your people understand these two elements, they can start to measure, analyse and make changes in the right way.

And the right thing to measure is the system, not people or processes in isolation. W Edwards Deming, father of the modern quality movement that found its genesis in Japan, saw that the typical employee worked in processes that have wasteful activity built into them. People don’t say: “I’ll go and do lots of wasteful things at work today.” Waste is already part of the system designed by management. This means HRD has to get managers to admit that all systems have waste built into them, put a process in place to identify it without blaming anybody and allow employees to eliminate it.

Eliminating waste isn’t the problem. Identifying it is. Only your people can do that—the people who actually execute the ser- SA Inc should take less and make more A great opportunity exists for HR to earn executive respect —by improving productivity, write Ted Black, Gerard van Hoek and Bazil van Loggerenberg A common driving value in government and corporations in SA is to take money, not make money vices or make the products.

Based on research by BCG and the Lean Thinking movement, the amount of time needed to execute a service, to order, to make and to deliver a product is only 5% or less of the time that the service or product spends in the system. That’s from the time you pay suppliers to being paid by the customer — the cash-to-cash-cycle. Attack the waste of time in the system — the cash cycle time — and you will gain remarkable improvements in results.

This brings us to the second trait of the long-lived company. You only get sustainable productivity when there is a strong sense of community — when all people feel they are in it together.

We take the positive view. A community is a group of people who are ready and willing to mould themselves into a close-knit team. They succeed because they:

  • Have a clear, “bottom- line ” goal;
  • Respect each other no matter how different they all are; and
  • Know the one thing they can never do is to let each other down. This is HRD’s prime task if it wants to “sit at the high table”—to help operating managers build communities for productivity. If they succeed in that, they will meet the prime growth needs of South African management. These are:
  • Vastly upgraded skills in the management of change;
  • The management of communication; and
  • The management of diversity and the conflict that comes with it.

You build communities of growing people most rapidly and sustainably when its members are “forced”, so to speak, to develop them under short-term, concrete, real-life challenges that are important to them. These challenges always lie at points of overlap between people along the value stream of activities, from supplier through to customers. That’s where you find the opportunities to lever up productivity and where you can design community-building projects.

THE question to ask that pinpoints opportunities is: “Would the customer be willing to pay for what we are doing here and now?” Answering that question means people can devote their efforts towards eliminating all the things that do not add value.

That is business acumen — being able to see and identify opportunities to make and save money.

The long-lived companies commit to people first, and physical and financial assets second. People are “the horse” and productivity is “the cart”. All it needs is to educate your people in what productivity is. As we all know, very few of them do, and that’s true from boardroom to the work place.

It is a wonderful message of opportunity for HRD people and it is how they can be part of the game of business. They will get onto the playing field as contributors to economic results. No longer will they be just observers while operating management does its thing. Moreover, they will address the prime areas of focus discussed earlier —attracting and retaining the best employees; managing change; and building a learning organisation.

Ted Black (jeblack@icon.co.za) conducts ROAM workshops. He and Gerard van Hoek are affiliates of Robert H Schaffer & Associates Bazil van Loggerenberg, from Loggic LLC, is a developer of analytics and mathematics for productivity control systems.

Time to get serious about productivity

“The future of the planet, and of SA, depends on effective management”

Focus on margins prevents managers from creating wealth, writes Ted Black


AFTER 1994, a rather arrogant, patronising, white, male old guard passed on to a new generation of inexperienced managers and owners some very sophisticated and complex organisations in both the private and public sectors.

Today, the new generation is discovering how difficult it is to run them. And the focus has not changed —it remains the same as the old guard: to maximise sales margins and redistribute wealth, not to create it. The prime lever for improving performance is not through improving productivity of resources but through the power to set and control prices. It is quick and relatively easy, but it is not sus tainable.

From a shareholder’s point of view, management still has only one legitimate purpose — to maximise the value of the firm. Mo r e – over, the value derives fundamentally from productivity. That is where the focus needs to be.

We cannot ignore the elephant sitting on our stoep

As we read of our steady slide down the world’s productivity rankings, then gaze north at Zimbabwe and elsewhere in Africa, we cannot ignore the elephant on our stoep. When are we going to stop taking money and start making money?

Peter Drucker described it in 1980 in Managing in Turbulent Times: “Only managers — not nature or laws of economics or governments — make resources productive.” I would add that you get sustainable productivity only when there is a sense of community — when all people feel they belong and are in it together.

Robert Mugabe has destroyed that in Zimbabwe. Where is SA heading? What are the omens?

Forget the hype about the need for leaders. The future of the planet, and of SA, depends on effective management.

Business literature swamps us with stories about leaders pointing the way and changing people with their visions. A lot of it is rubbish. throughout history, the reality is that few leaders have done that and four recent ones are Lenin, Stalin, Hitler and Mao.

Besides, how many of us want to be led anyway? We might like to be trained, coached, and developed by mentors we choose. We may even agree to be managed in the right way —but not led.

As to South Africa Inc, for this fledgling democracy to succeed we have two critical factors to address — make the poor productive and build a new generation of management. These issues should drive everything we do in the government and the private sector.

We need fiscal discipline, but the blunt instruments of free market monetary and interest-rate controls bludgeon the very people who have least influence over rising inflation—the poor. The negative effects on growth and job creation could damage us seriously and destroy the already fragile community and family structures in SA. The most fruitful way to tackle the thorny issues facing South Africa Inc is to lift productivity and create wealth that everyone can share.

During the previous century a small proportion of this country’s population prospered because of abundant mineral resources. Commodity exports were the lifeblood of the economy and still are. In effect, a mining camp spawned the industries we have today. Moreover, the government protected them with its political system, high tariff barriers and subsidies.

Judged by world standards, these hot-house conditions created highly profitable firms run by quite capable management.

In our Third World economy, with value based on limited beneficiation of exported commodities, corporate strategy was to gain preferential access to raw materials. This meant that productivity focused on low input costs and high pricing tactics in local markets. The aim was to maximise dividends, minimise equity holdings here and to shift money overseas.

Little has changed, except our management. After 1994, in the rush to meet affirmative action and black economic empowerment (BEE) quotas, a rather arrogant, patronising, white, male old guard passed on to a new generation of inexperienced managers and owners some very sophisticated and complex organisations in both private and public sectors.

Today, the new generation is discovering how difficult it is to run them. What is more, our focus is still to maximise sales margins and redistribute wealth — not to create it. The prime lever for improving performance, whether it be for municipalities, Eskom, or private firms, is not through improving productivity of resources but through the power to set and control prices. It is quick and relatively easy, but it is not sus tainable.

In the developing world a major barrier to improving productivity is financial illiteracy. Many of us have a phobia about numbers: we cannot do simple arithmetic and have only the vaguest notion of how business works.

Most people think that money cascades magically through an organisation into their bank accounts on the 25th of the month, whether they get the work done or not. Moreover, more employees are now shareholders with no clue as to what that it means for them.

To compound the problem we have a corporate governance movement that aims to influence boards and have companies compete and prosper in an ethical way —to make society a better place for everyone. However, it stresses social responsibility more than economic results and productivity.

“Business literature swamps us with stories about leaders pointing the way and changing people with their ‘visions’. A lot of it is rubbish”

Despite good intent, it’s hard to measure what it wants. A triple bottom line and balanced scorecards hold no-one to account.

From a shareholder’s point of view, management still has only one legitimate purpose — to maximise the value of the firm (VOF). Moreover, the value derives fundamentally from productivity.

By shareholders we do not include in-and-out traders looking for short-term gains. We mean investors who put their cash in a company expecting an economic return for a long time.

They see management as being ethical, competent and effective — people who do the right things in the right way because they think and act like owners. When that happens, shareholders become more than investors. They become long-term savers.

An example of a company that provides such opportunity is Berkshire Hathaway. As James O’Loughlin wrote in his revealing book, The Real Warren Buffett: “Buffett says he does not understand the CEO who wants lots of share activity: that can be achieved only if many of his owners are constantly exiting. At what other organisation —school, club, church — do leaders cheer when members leave? If this were the case, then Buffett would not be able to fulfil his function as corporate saver —the proper function of the stock market.”

In the 2007 annual report, Buffett says: “We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.”

He says they are not “faceless members of an ever-shifting crowd but rather co-venturers who have entrusted their funds to us for what may well turn out to be the rest of their lives”.

Contrast that view of management with former General Electric CEO Jack Welch who said: “Being a CEO is nuts! A whole jumble of thoughts comes to mind: Over the top. Wild. Fun. Outrageous. Crazy. Passion. Perpetual motion. The give-and-take. Meetings into the night. Incredible friendships. Fine wine. Celebrations. Great golf courses. Big decisions in the real game. Crises and pressure. Lots of swings. The thrill of winning. The pain of losing.”

Nice work if you can get it! Clearly, he was no corporate saver but he did manipulate Wall Street very skilfully, and that helped pump up the share price no end.

Whether he allocated capital very well is a moot point judging by General Electric’s relative economic performance over the years. Sorry to say he has become a model most modern managers want to emulate.

In stark contrast, Buffett and his colleague, Charlie Munger, see themselves as managing partners and see shareholders as owner partners. It is why today about 30 000 of them rock up for Berkshire’s annual meeting. At the end of one year the same investors who owned them at the start of the year held 97% of shares. That makes them savers, and for good reason.

The result of Buffett’s stewardship is a compounded gain on investment of 21,1% a year from 1965 to 2007. That’s a 400 863% gain over 43 years. The S&P 500 over the same period achieved 6 840%. The VOF today is more than $200bn. Apart from investments in companies, the firm has 76 operating businesses. It is a diversified conglomerate employing 233 000 people. Only 19 of them work at HQ.

There is no share option scheme — Buffett doesn’t believe in them. They violate the principle of rewarding people for their own efforts in their own units. However, most of the key managers of the operations are independently wealthy and none has left the group to work elsewhere.

Buffett delegates to the “point of abdication” as he puts it, and says that HQ has a twofold task. First, it is to “create a climate that encourages (key managers) to choose working with Berkshire over golfing or fishing. This leaves us needing to treat them fairly and in the manner that we would wish to be treated if our positions were reversed.” He rewards them handsomely for making an economic return on capital in their own companies and for sending all surplus cash back to HQ. That’s where he fulfils the second part of the “owner’s” task — to allocate capital for acquisitions or investment.

As he puts it, “our carefully crafted acquisition strategy is to wait for the phone to ring”. The bigger the company the greater his interest will be. He responds to an approach within five minutes if it grabs his attention. He never does an unfriendly takeover and his attitude to start-ups, auctions or turnarounds is, “When the phone don’t ring you’ll know it’s me.”

He looks for well-run businesses “with a fortress-like business franchise ” — a product or service that is needed and wanted, with no perceived close substitute and which is not subject to price regulation. Owners usually run the firms he buys and he keeps them doing it after he buys control. It is how he gets good management into Berkshire Hathaway.

He wants high levels of profitability from a low capital base and low operating costs. In other words, he seeks low risk, high return, cash fountains — not cash drains. Businesses like that don’t need reinvestment to sustain them. Another criterion he looks for is that they must be simple enough for an idiot to run because sooner, or later, one will. In other words, he sets out to minimise risk and maximise return through a simple agenda.


The chart in the illustration, In the shareholders’ shoes, shows how he might position an opportunity. Behind the four quadrants are 17 business safety ratings cases —they provide clear, unambiguous signals for shareholders to rate managerial per formance.

Most managers picture an entrepreneur as a hardened risktaker who shoots from the hip. This viewleads to the master myth of management: all things being equal, higher returns reward higher risks. Driven by the myth, corporate cowboys, egged on by greedy merchant bankers, lawyers and accountants, head for box one.

They might as well be going to a racetrack or casino. They end up in box four where you find the wreckage of corporate start-ups, mergers and acquisitions, the result of high-risk, low-return strategies. Winning firms achieve lowrisk, high-return positions. Only companies positioned in quadrant two will satisfy the long-term shareholder as Buffett sees it.

So, what does his simple agenda mean for the corporate governance movement, company boards and even the South African government? Giving management and employees share options, as so many firms are doing, won’t make them think and behave like owners. You have to do more than that.

“In reality most organisations operate in ways that switch off the brain”

Just as a firm has an external marketing programme to win the minds of investors, it needs an internal one for results. It is the only way to surmount what Buffett calls the “institutional imperative”. We paraphrase his description of it:

  • As if ruled by Newton’s First Law of Motion, institutions resist any change in direction;
  • Just as work expands to fill available time (Parkinson’s law), managers chase the big projects and acquisitions that drain cash;
  • Corporate troops (the bureaucrats) quickly support any business craving of their leader no matter how foolish it is; and
  • Firms mindlessly imitate peer companies, whether they are expanding, acquiring, or setting executive pay.

Buffett says that when he went to business school he got no hint of the imperative’s existence. If he went back to one today he probably still wouldn’t. He thought decent, intelligent and experienced managers would make rational business decisions and he learned that they do not. When the institutional imperative takes hold, and it does in government too, rationality wilts.

It wilts because managers reduce the fear of uncertainty by asserting control. They do it with plans, budgets, forecasts and they manage systems and people by decree. However, this approach triggers other needs —the need for survival and the pursuit of selfinterest. Improving productivity, and allocating capital and resources efficiently and effectively are not the priorities that the business safety ratings can reveal.

In Buffett’s view, the strategic plan creates the institutional imperative. That’s why he doesn’t have one. He believes it gives him his greatest advantage. It means he lets go of the bureaucratic controls that a corporate HQ exerts, the exact opposite of the typical manager. His leadership style conforms to Chinese philosopher Lao Tzu ’s description: “Intelligent control appears as no control or freedom. For that reason, it is genuinely intelligent control. Unintelligent control appears as external domination and that is why it is really unintelligent.”

The institutional imperative becomes a heavy blanket that stifles people’s potential. We talk of the value of human capital and business academics want it put on the balance sheet. However, in reality most organisations operate in ways that switch off the brain.

As to his operating companies, Buffett wants a crocodile-filled moat around the fortress. He urges his managers: “Widen the moat: build enduring competitive advantage —delight your customers, and relentlessly fight costs.”

Growth is not the aim. However, his productivity goals generate the cash returns he then uses for growth opportunities.

In summary, he gets his key managers to focus on productivity — the most powerful competitive weapon for a business and a country. He has no strategic plan and gives no forecasts. The world is too random for that.

This approach frees him and his managers to pursue the vision of thinking and acting like owners. He can allocate capital where, when and at a pace that suits him — not Wall Street.

Given this perspective, we wonder how a board that focuses on productivity would view South Africa Inc and some of its diversified portfolio of industries and companies. Using the ROAM model (return on assets managed) and operating margin (operating profit/sales%) on a small sample of big players, we compare the profitability of their domestic operations with their global ones.


You can draw your own conclusions from the accompanying charts. Four conclusions stand out in my view:

  • South Africa Inc is still seen as high risk and is not run by corporate savers;
  • This means South African citizens pay through their noses for the internationalisation strategies that follow from that perception;
  • South African management is not as good as it thinks it is when facing the heat of competition;
  • This is because the productivity focus overseas shifts from pricing tactics to the sales productivity of the asset base — the other prime measure within the ROAM model. This is the sales/assets ratio known as asset turnover (ATO).

South African management is not good at managing productivity because there has been no pressure to do so. It involves work on the entire supply chain through to customers. The goal is to drive out the wasteful activity that exists throughout the value/cost chain— to lift everyone’s productivity — and to speed up the time from paying to being paid. The benefits come through to the customer in more competitive pricing.

However, there is another conclusion that defines the elephant on the stoep even more clearly. The sanctions era under the National Party government entrenched a policy of import parity pricing that led to inefficient resource allocation. Its effects persist today. Even ANC government policies protect high-cost industries that are uncompetitive by world standards.

The long-term weakening of the rand creates huge price overrecovery. This is when a producer charges an excessive price — as most South African institutions seem to do. They extract an everincreasing price subsidy from consumers. This guarantees profit growth but management becomes complacent. With no competition it just becomes a case of cost-plus pricing that encourages waste and low productivity, all to our economy ’s detriment.

A nice example of this in our sample, apart from the obvious ones of Sasol and Mittal, is Sappi. With Mondi, it forms an oligopoly — a small group of typically very large firms that collude to exert power and control over pricing — as we have seen exposed in the steel and food industries.

At first glance, this firm’s low returns — it has an overall ROAM of only 6% — do not reflect the benefits of a monopolistic position. However, you can see from the chart how Sappi takes advantage of the South African consumer with a 19,4% ROS. It is even higher because that figure includes exports at a much lower selling price than its local customers pay.

There is a deep-seated problem with the paper industry. Pe ter Drucker wrote in 1974 in Management Tasks and Responsibilities that since the Second World War the paper industry “has substituted capital for labour on a massive scale. But the trade off was a thoroughly uneconomic one. In fact, the paper industry represents a massive triumph of engineering over economics and common sense.”

“If we are serious about productivity and increasing our national competitiveness we have to change behaviour”

Thirty-three years later in San Francisco on October 22 2007, Eugene van As, at the end of a long career with Sappi, 30 years of it as CEO, candidly endorsed Drucker’s view. “For the past 20 years the top 100 paper companies have collectively destroyed value consistently every year.”

As a wag in the South African paper industry put it: “So why was he there so long? He should have left long ago!” His remark was more colourful than that but it’s the gist of what he said. Many shareholders would probably agree. They have a low-return, relatively high-risk investment.

When it comes to risk, there are two key elements — productivity and price recovery. We define productivity as units sold divided by resources units used.

Improving this rate lowers product cost (all the costs of getting products ready for sale) and lifts profit. It also lifts business safety, because it lowers risk. A low product-cost firm deters competitors. Moreover, it is never that easy to copy what others do.

With ready-for-sale costs, because of the institutional imperative, the potential for improvement is huge. The lean-thinking movement proves that we add cost with value for a tenth or less of the time between paying suppliers and getting paid by customers. That means for 90% of the time or more we pile up costs without adding a cent of value.

Corporations such as Tiger Brands write about “continuous improvement” programmes in their annual reports. What do they mean? Continuous improvement is not about improving what you do well. It is about eliminating all the things that stop you from doing what you do well — all the headaches. That’s waste. It’s what you have to look for and eliminate.

Management — or we should say bureaucrats—design waste or fat into the systems and procedures that people have to follow. It exists everywhere you look. We don’t see it because we don’t look for it. The only people who do see it and live with it are the people doing the work. Rarely do we ask for their ideas on how to remove it. Even more rarely does management act on them. It means that their brains never get out of bed in the morning. They just have a job.

The second major factor is price recovery measured as sales price/resource price. If you use a high selling price to make money without keeping product cost down, you increase risk. We call this price over-recovery. Typically it arises from sales price growing faster than resource price. This lowers business safety.

Managers use price over-recovery to subsidise a company’s ine fficiencies. However, high selling prices linked with low productivity send a signal that provokes competitors to attack. They steal customers with lower prices and better service.

The safest way to make money is to generate high productivity and use some of it to keep selling prices down, which is price underrecovery. You charge less but operate more profitably off a lower cost base than your competitors.

Productivity and price recovery determine business safety. They qualify the sales productivity of the asset base — the most important measure of all. It enables you to measure the productivity of capital —the real capital cost per unit sold — and creates a focus on speeding up the time from paying to being paid. This is sales revenue/ marketing assets managed. It drives ROAM, economic profit and ultimately the VOF.

If we are serious about productivity and increasing our national competitiveness we have to change behaviour. As effective managers know, the best way of doing that is through measurement and feedback, not visions and pep talks.

You only have to tell people you will be measuring them. Even if you don’t give them the measure, the very thought of it will change their behaviour in some way. So, it makes sense to have ones that they believe in and trust.

In the late 1970s, during a severe drought in Clarens in the Free State, no matter how much the town fathers urged everyone to save water nothing happened until the doughty town clerk intervened. She published the names of every householder, showing how much water each used a month. Only then did behaviour change and consumption drop. That’s the power of public measurement.

We could have monthly publication of what we term business safety ratings (BSR). They would apply to all private and publicsector entities. They give clear signals on productivity and price recovery. Boards can use them as part of internal management development and performance improvement programmes and investors can use them as part of their risk-return evaluations.

An additional possibility is that government could apply tax incentives to companies which engage in price under-recovery because they would be lifting productivity to do it and remain viable. It can be done. It just remains for us to start doing it and we will.

In future articles, I will analyse companies to derive business safety ratings and see how big the elephants sitting on the corporate stoeps really are.

Ted Black (jeblack@icon.co.za) coaches and conductsROAM workshops that help managers design results-driven projects.

ROAMing through Rainbow’s prism

Ted Black and Frank Durand explain why Johann Rupert should have listened to his mum TRENDY theories that treat people as “human capital” or “intellectual property” and “brands” as assets, argue for new business metrics to measure and value talent. They are red herrings. What is important is to harness people’s brains with the numbers we already have.

There are only two critical factors in business. One is to make money. The other is to generate cash.

Most managers and staff don’t understand that their financial rewards and long-term security depend on doing those two things. Moreover, they don’t know how to do it. Imagine what could happen if they did. Without the big picture that the financial numbers give, they just have a job.

Bruce Henderson, the late founder of Boston Consulting Group, cut to the heart of the matter: “A business is a cash compounding machine or it is nothing, and sooner or later will be swept away.”

“Get back to basics” always becomes the management mantra when companies hit bad times. The recent Remgro offer of R16 a share to minorities of RainbowChickens presents us a timely reminder of them.

The bid puts Rainbow’s value-of-the-firm (VOF) measure today at R4,6bn (share price multiplied by issued shares). It hit a year-end low of R230m in 1998. Anyone who bought shares near the time, probably most of today’s minorities, has done very well indeed. But what about Remgro itself? What kind of investment has it been? Furthermore, what lessons can we take from the Rainbow saga? It’s a great story.

The first is that no manager can act intelligently, or with integrity, unless he thinks like an owner all the time. It is a state of mind. No-one tells owners what to do. They work it out for themselves.

Despite all other demands, management has one legitimate purpose. It is to maximise the VOF for its owners — the shareholders.

Fundamentally, the VOF derives from the productivity of the asset base, not the workforce. Managers make a return on assets. Owners make a return on investment.

That is why return on assets managed (ROAM) is still the best measure for operating management and a great lens to use to seek and pinpoint productivity opportunities for people to tackle together.

You cannot be a first-class manager unless you understand finance. The ROAM model helps build that understanding. It requires no more than Grade 6 arithmetic and can be used to teach everyone the “great game of business”.

Ignorance about the rules of the game is widespread — even at the highest levels. The first responsibility of any manager is to educate his or her people in business basics to give them the big picture — never mind specific job skills.

The only valid measures of management intent and results are “resource in: result out” ratios. The ROAM model provides many of them. If used in the right way — to develop people — it triggers innovation, collaboration, teamwork and learning. Improved, sustained productivity follows.


Exhibit 1, above, shows Rainbow’s ROAM performance over 25 years. It sends the message: “All roads lead to ROAM … or ruin!”

Sadly, that message did not re a c h the owner, Johann Rupert, until it was too late. People at the top are too often the last to know when things go badly wrong. The dour people he charged to watch over his investment typified those who Adam Smith described in The Wealth of Nations in 1771: “The directors, being the managers of other people’s money, cannot be expected to watch over it with the same anxious vigilance with which owners frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to detail as beneath them. Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company.”

A 15-year decline resulted in a loss of R150m in 1996 and near bankruptcy for Rainbow. Following a rights issue to rescue the company, a furious Rupert stuck in another R600m, pulled on his gumboots and trudged around his chicken farm to find out what was going on. Did he own a sh*t chicken business or was he in a chickensh*t” business? It looked like both.

Facing the truth seldom comforts us. It is why crises can be so valuable. They force us to confront reality and take action.

The first truth Remgro had to face was that it had made some huge blunders. Strategic planning’s great contribution, if done well, is to trigger managed change — change that exploits proven strengths and maximises opportunities.

However, neither Remgro, nor a reluctant HL&H, which ended up running Rainbow, knew anything about chicken farming. Seduced into a honey trap, they matched opportunity with weakness — the first blunder — and the numbers followed the weakness.

Soon after listing, the company acquired Bonny Bird/Epol from Premier Milling — a monumental bungle. This one doubled up the asset base and created a very different company from the one built by its founder — the late, legendary Stanley Methven.

The move was based on the false premise that high market share results in high ROAM — that it is a cause-effect relationship. It is not. It is a probability, but a most unlikely one when you add nonperforming assets to low-performing assets.

Methven knew this. Despite many approaches from Premier — a milling company that got into chickens by default — he did not want his company to be contaminated by it. The story goes that he even celebrated the end of a short, disastrous foray into feed milling. With his team gathered round him in Hammarsdale, he raised a glass of French Champagne, and said: “If I ever get the urge to buy a feed mill again, shoot me.”

That’s another important lesson. Celebrate the mistakes, savour them, and learn from them.

Over the years, Epol had performed little better than break-even and Bonny Bird made a profit once in its history. Market analysts thought it a great move both for Premier and Rainbow, whose share price doubled. The VOF went to R1,7bn in 1992.

The capital market’s vote of confidence confirmed the 6th Higher Law of Business: “You can sometimes fool the fans, but you never fool the players.”

The first loss followed and the VOF dropped to R848m. However, a small profit a year later in 1994 duped the fans again. They pushed the VOF back to R1,3bn, showing that managers in charge of a sick company can produce a big rise in the share price with second-rate financial performance.

The players — Rainbow’s people — were not fooled. From 1996 to 1999, the company lost nearly R600m, confirming the 9th Higher Law: “If nobody pays attention, people stop caring.”

It was a disaster, and all to get one good brand, Farmer Brown, the only Premier “asset” really worth having.

The move also destroyed HL&H — a once proud, 150-year-old company. The social and economic costs were grave, confirming the 10th Higher Law: “Sh*t rolls downhill.”

With acquisitions, the golden rule is: “Don’t buy a standalone company, especially if you don’t know the business.” You will pay far too much unless you can uncover and release hidden productivity opportunities. It is better to buy a parcel of companies, sell the ones you do not want and get the one you do for a knockdown price.

Corporate managers nearly always pay over the odds. In contrast, successful entrepreneurs bid “low”. Knowing how to allocate capital well, they buy at a discount; sometimes for nothing if the target company is in distress. Seldom do they pay a big premium.

Macsteel, owned by Eric Samson, is a good example. Reputed to be the biggest privately owned steel trading company in the world, it has acquired many companies but Samson has never paid more than net asset value — usually less, or in the end, sometimes nothing.

There are good reasons why corporations pay too much. First, top management uses other people’s money. Second, professional advisers’ commissions and fees are linked to the size of the deal — the bigger the better. Third, executive pay is based on size of company and responsibility, not economic productivity. This brings us to the next measure. It’s a cash one.

Rainbow has been profitable every year since 1999, achieving its highest ROAM since 1982 — 21%. But has the turnaround been good enough to justify owning it?

As Peter Drucker put it: “Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources. Until then it does not create wealth; it destroys it.”

Economic profit is a true measure of management competence and it is a tough one. You can manipulate the share price for quite a long time before capital markets catch on, which is why corporate management prefers it to economic profit.

Funding comes from owners, lenders and suppliers. The cash buys assets that operating managers have to manage. None of it comes free.

Rainbow’s interest charge has always been low except in the mid- 1990s when debt reached R500m. Supplier credit is interest free, but not cost free. Inventory takes up space, needs management and generates many hidden costs.

Owners’ cash is also not free. Until you charge for it, you do not know if the firm has made an economic profit or not. It must not be so high as to miss the creation of it, nor must it be too low or the company becomes a cash trap.

If you look at other, better alternatives for investment that Rupert had to give up, it seems reasonable and defensible for him to have “charged” Rainbow management 25% for his money and the risk he took. If he had, then Exhibit 2, below, is an indicator of how much wealth his management destroyed from 1989. It is not a pretty sight.


The calculation is based on Stern Stewart’s EVA™ measure (net operating profit after tax less the actual cost of capital). It took until 2003 to create an economic profit equal to or better than a 25% return on equity. From 1989 to 2003, Rainbow returned R195m to owners for average equity of about R750m. That’s a 26% return in total for a 15-year investment, or only R13m a year—an annual return of less than 2%.

As a self-deprecating Rupert humorously admitted at a shareholder AGM in 1998, his late mother had told him not to buy it. She was right. It was, and probably still is, a disastrous investment if you look at the 20-year opportunity cost.

However, it is rare indeed for a business leader to have the courage and integrity to do what he did. Facing harsh reality and taking full responsibility leads to “breakthrough” and another important lesson.

The corollary to the 9th Higher Law that the stuff rolls downhill is: “Change must start at the top.”

Rupert intervened, picked his own man to run the show, and the turnaround started.

Most organisations have huge potential for improvement but unlike Rainbow, few achieve major breakthroughs. The successful ones have leaders who grasp what has to be achieved — the goal is clear. They also confront their people with the clear belief that it will be done and that they can do it.

Finally, they know that simplicity drives productivity. If you want change you do it with one number.

Most managers “manage by the numbers” but with too many of them. Daily, a torrent of data swamps us. Most of it means little. Moreover, the numbers are random — random within the system.

Before looking at the random numbers, let’s look at the system.

Rainbow’s latest annual report gives a clear picture of the value stream of activities. If it attached asset values to each activity it would be even more interesting and revealing (see Exhibit 3 below). The business model determines if you make money. The key to economic productivity is concentration and focus. It raises two strategic questions: “What assets should we own?” and “How do we control the rest?”

The most toxic of all business designs is unfocused, vertical integration. That is when a company owns everything. Rainbow was highly integrated in 1996 and still is.

To make money, you must be the lowest-cost producer or you must have something no one else has. Unless you have a unique product or service that makes you different, you have to compete on price.

The first strategic decision taken was to have good genetic stock. It affects the cost and quality of the bird on the plate. Your birds must grow faster, resist disease and end up plumper after eating less. Rainbow management had neglected this issue but corrected it successfully.



The ROAM model poses two marketing questions to test a business model. They lead to input:output ratios. The first is: “For every rand of assets we have, how many rands of sales do we generate?” (Sales divided by total assets is the measure and is called asset turnover).

Asset turnover is the most important measure of operating management and the least used. For Rainbow, it determines the capital cost of every kilogram of chicken sold — the first competitive productivity barrier for any firm.

The slower your asset turn, the lower your ROAM is likely to be. Exhibit 4, below, shows how management improved asset turnover steadily through to 2002.

Rainbow2-2The first task was to undo much of the Bonny Bird/EPOL acquisition. Plants were closed and farms sold. As asset turnover accelerated from 1,3 in 1996 to 2,4 in 2002, it cranked up ROAM from -10,9% in 1998 to 12,5% in 2002.

Then as management started to reinvest in new plant from 2003, slowing asset turn down, the next ROAM marketing measure becomes more significant: “For every rand in sales, how many cents profit do we make?” This is return on sales (operating profit ÷ sales × 100). It improved steadily from 5,2% in 2002 to its highest level in 18 years— 14,1% last year. However, there are warning signs that today’s management is losing sight of the importance of asset turnover.

Watch out for marketing guys. They generate excitement and growth but have an Achilles heel. Asset productivity is not their strong suit. Because their mission is to please customers, give them the smallest gap and they expand and extend product lines, fill up warehouses with stock, discount it and then shy away from collecting money. This lowers the next ROAM productivity barrier: current asset turnover. It drives the measure that governs every company’s viability — the cash-to-cash cycle.

You must aim to have a lower level of stock and debtors per rand of sales than your competition. In Methven’s day, stock and debtors spun an average of 6,3 times a year — that is about a 58-day cycle.

Under HL&H it fell to an average of 3,9 — about 94 days — but reached a low of 3,5 (104 days) in 1997. Alarmingly, it is back there.

Rainbow2-3Rainbow2-5Exhibits 5 and 6, at right, use physical numbers to show what happened. The first shows sales in kilograms over a three-year period just before the crash started in 1996.

The pattern is typical for many companies. Although it shows random sales performance month on month, market demand was stable and predictable. It probably still is.

Reporting to the board, all the various Rainbow MDs could have truthfully said was: “Some months are better than others.” It would have not gone down well but would have been helpful.

Rainbow management could expect sales of about 3,5 tons of chicken a week for the foreseeable future. However, that is not how the organisation responded. Company plans often do not reflect market reality. Big, hairy, audacious goals set by gung-ho managers out to please their bosses can cause huge instability and distortion of information as it filters through people in the value stream.

Exhibit 6 shows what happened to inventory. It was “out of control”. At the end of this time series with stock leaping up, the company went on to record massive losses.

Not matching intent with reality is a common phenomenon. The dotcom bubble burst for a similar reason only a few years later.

“New economy” companies such as Solectron held $4,7bn inventory because of blue-sky forecasts from the likes of Cisco, Ericsson and Lucent. Cisco eventually “wrote off” $2,5bn inventory, axed 6 000 people and its VOF fell by $400bn.

With Rainbow, the velocity of current asset turnover increased from 3,5 in 1997 to 5,8 in 2002 and has slowed since then. At the 2006 yearend it was at 3,8 and wound down further to its 1997 level of 3,5 at end- September 2006.

To put the importance of competitive asset turn in perspective, compare Rainbow’s performance with Astral, the best-performing feed and poultry firm ( Exhibit 7 below).

Rainbow2-4Astral consistently outperforms Rainbow with an overall asset turn 30% faster on average over seven years; at year-end 2006 it was 60% faster. Astral’s current assets turn has averaged 6,1 for the past two years while Rainbow has slipped to average 4,1 — 50% slower and losing speed.

However, with the next productivity barrier, Rainbow’s cost of sales dropped from 75% to 63% in 2006 — a great achievement, probably due mainly to the low maize price and shrewd buying. Today, it could be the least-cost producer off the farm.

Then there’s the fourth productivity barrier: “How do you differentiate a dead chicken and charge more?” Rainbow’s “innovative solutions” do not seem to be working yet. Cost seems to have more influence on profit than the so-called “highmargin” products that analysts and financial pundits waffle about.

For every rand spent on administration, selling and distribution, Astral generated R8,98 of sales, and output is rising. Last year, every rand of expenses for Rainbow generated R4,62 in sales, but fell from R6,50 the previous year.

In summary, Rainbow lags Astral with these key productivity measures except cost-of-sales. However, this is a message of opportunity. It is no accident that Rainbow’s improved ROAM has generated an economic profit and improved the VOF.

Asset turnover and sales profitability drive ROAM. They are two of the four levers that create economic profit. The others are growth of a productive asset base, and gearing. When management achieves a ROAM result that beats the cost-ofcapital, you can expect the VOF to keep rising.

The “new”, much improved Rainbow has more, huge untapped potential waiting to be released, confirming another higher law from The Great Game of Business: “The more successful you are, the bigger the challenges you have to deal with.”

It is the same with every firm. However, because of fear, we do not educate people with the numbers. We fear they may fall into competitors’ hands. So what if they do?

We fear that employees will misunderstand and use them against management. They probably will if we do not educate them.

Give them the big picture and you appeal to a higher level of thinking. You knock down the barriers of ignorance that keep people apart. When you do that, it leads to higher levels of performance and results on your road to ROAM.

Ted Black (black@icon.co.za ) is an executive coach focusing on converting problems and opportunities into action projects. Frank Durand is a senior lecturer at the Wits Business School in the fields of finance and asset management.