1. business and industrial

Agenda
Issue 7 / April/May 2011
Insights into growth, performance and governance
“India has
showed the
world how
to manage
an economy’’
Infrastructure king GM Rao
on why the West gets
governance wrong
p8 M&A
Making deals
that deliver
value, not
headlines
p17 Growth
Are you
selecting the
wrong kind
of CEOs?
p26 Power
Why it’s time
to rethink
your energy
supply
p22 China
Understanding
the world’s
first economic
superpower
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
Business is complex. Our goal
is to help you cut through that.
By cutting through complexity, we believe
we can help you preserve and create value
for your investors in the long run.
What do we mean by this? We certainly
don’t mean simplifying things. Robust
businesses have a clear, coherent strategy.
But that strategy must be validated by
your experience of the real world. That experience can take
many forms: sales data, market analysis or gut instinct. But
especially in times of uncertainty, even good companies can
make piecemeal changes and lose sight of the big picture.
The CEO or CFO of a global company headquartered in
North America or Europe may be less optimistic than their
counterpart with a head office in Delhi or Shanghai. If you can
see past the famous twin impostors – triumph and disaster –
and keep the bigger picture in mind, you will be better placed
to take advantage of the upswing.
The most startling global economic shift is the growth of China
and India – an issue explored in detail in this edition of Agenda.
China is already the world’s second-largest economy. In the
next year, it will again become the world’s largest manufacturer
– a position it last held in 1830. So to refer to China and India as
“emerging markets” is nonsensical. They have emerged. We
are too quick, today, to hail every trend as revolutionary, but this
Alan Buckle
magnitude
of change is experienced once in a lifetime. Our aim
Global Head of Advisory, KPMG
in this issue is to help you understand the implications for
your business today and in the future.
Alan Buckle
Global Head of Advisory, KPMG
2
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Agenda April/May 2011
Contents
26
12
Unclear power
With the future so uncertain, CEOs
who don’t rethink their energy
strategy may find their business
model becomes obsolete
Inside
18
04 Foresight
Why location-based technology
could revolutionize finance
06 Ones to watch
Their records are impeccable – but
these five leaders face challenges
08 Best practice
Redefining capital
The Dark Ages decimated the
global banking system. Will Basel III
have a similar effect on the way
multinationals raise money?
22
You’ve spotted the synergies, so
why does M&A often fail to deliver?
12 Keys to success
GM Rao on powering India’s growth
– and his recipe for the future
16 Acumen
The wind power giant conquering
China one turbine at a time
17 Learning curve
Why it’s time to look beyond
finance for your next CEO
18 The great debate
Business in China
Forget the stereotypes about
quality – Chinese companies have
their sights set on being more than
just the world’s assembly line
Where will capital come from in
future? Three specialists explain
21 Competitive edge
The Japanese retail maverick
inspired by JFK and James Cagney
22 Ten issues
What you don’t understand
about Chinese business
26 The big issue
Cover photos: Atul Loke, Prisma Bildagentur/Alamy. This page: Bloomberg/Getty Images, The Bridgeman Art Library
Agenda: Insights into growth, performance and governance is published by Haymarket Network, Teddington
Studios, Broom Road, Teddington, Middlesex TW11 9BE, UK on behalf of KPMG International. Editor Paul Simpson
Managing Editor Robert Jeffery Production Editor Sarah Dyson Art Editor Jo Jennings Senior Designer Paul Frost
Sub Editors Ben Beasley-Murray, Peter Bradley Staff Writer Katie Jacobs Picture Editors Dominique Campbell,
Jenny Quiggin Group Production Manager Jane Grist Production Manager Hannah Pettifor Senior Account
Manager Caroline Watson Group Art Director Martin Tullett Editorial Director Simon Kanter Managing Director,
Haymarket Network Andrew Taplin Reproduction Haymarket Prepress. No part of this publication may be copied
or reproduced without the prior permission of KPMG International and the publisher. Every care has been taken
in the preparation of this magazine but Haymarket Network cannot be held responsible for the accuracy of the
information herein or any consequence arising from it. Views expressed by contributors may not reflect the views
of Haymarket Network or KPMG International or KPMG member firms.
Why every business must review
its energy costs, use and supplies
30 Left field
How Trotsky’s winter of discontent
can help you manage change
31 AOB
Forensic: bringing CSI skills into
the boardroom
3
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
Agenda April/May 2011
Foresight
Dialling up a
new global
currency
T
hey may not have built it on
rock ’n’ roll, but most people
consider their city or neck
of the woods to be theirs –
a place they know. But what if the
reverse were true? What if people lived
in a place that knows them?
We’re careering towards intelligent
urban ecosystems that sense our
movement, detect our passage and will
recognize patterns of movement, even
predicting where we’re going. A skin
of sensors laid over a city will inform
itself wirelessly, collecting metrics that
profile people’s behavior through their
smartphones. Researchers such as
Sense Networks are harbingers of a
trend called ‘reality mining’, a budding
area of business intelligence. R&D and
legal departments at Google and Apple
are exploring such developments.
Thorny privacy issues intrude here.
But hundreds of millions of users of
platforms such as Facebook, Twitter
and Foursquare are already advertising
their location when they’re out and
about. It’s all in their phones.
Smartphones such as Apple’s
iPhone incorporate global positioning
Smart companies can use
business intelligence to
target high-yield customers
precisely and at little cost
technology. When a user of Foursquare
arrives at a particular location such as
a restaurant and launches the app, the
phone’s GPS locates them. The user checks
in to see if friends are around, to read tips
and comments left by others, and discover
if the venue has any special offers.
An app called ShopKick aligns these
gaming mechanics more closely with a
mercantile experience. ShopKick works with
retailers to provide in-store rewards when
the user checks in at a store (confirmed by
sensors as GPS is not available indoors).
These ‘shopbucks’ can be exchanged for gift
cards or Facebook credits.
Social media are increasingly driven by
games, transactions, loyalty and rewards,
which has obvious ramifications for digitally
savvy businesses. For bricks and mortar
retailers the smartphone is a portal to closer
customer relationships based on real-time
interaction. ShopKick’s hard-wiring of
venues – so far, partners include Macy’s,
Best Buy and shopping malls in US
capitals – has put it in the forefront.
This new world won’t just favor
retail giants. Suresh Sood, a social media
expert at the University of Technology,
Sydney, says the splintering of businessconsumer communication according to the
device being used (smartphone or tablet,
for example) will create a ‘splinternet’.
Any smart company can use rich business
intelligence to target high-yield customers
precisely and at little cost.
Location is the holy grail of targeted
advertising. Businesses that understand the
contradictions of simultaneous individual/
social statuses can analyze consumer
behavior and build communities.
Sood says there is a snag: sheer clutter.
He foresees the day when myriad reward
schemes, points and ersatz currencies will
evolve into a globally recognized currency
that will bring real benefits to consumers
tired of dealing with so many scattered
and discrete value artefacts.
Now there’s a winner-takes-all business
waiting for someone to exploit.
Ian Berry/Magnum, Joel Saget/Getty Images, Minnesota Historical Society/Corbis
For digitally savvy businesses, using technology to track customers is just the start…
4
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Leading
Edge
Opening gambit
We are what we repeatedly
do. Excellence, therefore,
is not an act but a habit.
Aristotle
by Swaminathan
S. Anklesaria Aiyar
G-20: why it’s India’s
turn to lecture
its global rivals
The end of CSR?
Shared value, not charity, is the new fashion –
and that starts with a US$300 home for the poor
S
ending staff to help in homeless
shelters. Ploughing profits into
the rainforest. The list of corporate
social responsibility (CSR)
initiatives is inventive. But many companies
are belatedly deciding that being nice for
the sake of it has its limits.
University of Michigan Professor Aneel
Karnani has sounded the death knell for
CSR, declaring: “The idea that companies
have a responsibility to act in the public
interest and will profit from doing so is
fundamentally flawed.“
The new buzz is around “creating shared
value” (CSV) – the idea that embedding
commercial capabilities in emerging
economies lifts communities out of poverty
and creates new markets.
Vijay Govindarajan, Professor of
International Business at Tuck School of
Business, says a US$300 (€207) house
holds the key to CSV. He wants to turn
slums into liveable residential areas with
cheap, mass-produced homes. Aside from
transforming run-down areas, this could
create a new market, rather like the
ultra-cheap, compact Tata Nano car.
“It’s a challenge for commerce,“ says
Govindarajan. “The world’s poor represent
the fastest-growing customer segment.”
CSV is already paying off. Hindustan
Unilever‘s Project Shakti, a direct-to-home
distribution system, run by 45,000
entrepreneurs in Indian villages, accounts
for 5% of the company‘s revenues in
India. Mexican food giant Grupo Bimbo
has helped thousands of shops train staff
and upgrade facilities – and benefits
from their expertise. In Japan, Hitachi
is to invest around US$11bn
(€7.6bn) in social innovation in
the next three years.
New
Rules
No.1 Kanter's Law
Will a flat-pack
house help beat
poverty – and
boost profits?
At last, some good
news for embattled
French president
Nicolas Sarkozy.
“Everything can
look like a failure in
the middle,” says
Harvard Business
School’s Rosabeth
Moss Kanter. Her
theory is that
change can often
feel wretched when
you’re halfway
through, where new
projects can stall
and workers flag.
“Everyone loves
inspiring beginnings
and endings,” says
Kanter. “But the
middles need hard
work.” So if an idea
still inspires you
– like Sarkozy’s
much-maligned
change program
– stick with it.
What does G-20 membership mean
to India? A seat at the high table and a
pulpit from which to lecture those who
have long lectured India. While it has
no illusions about its influence, a stellar
economic performance in the past
decade has given India confidence to
plough its own furrow and introduce
a development angle to G-20 debate.
India would like the G-20 to be a
deliberative body that sets directions
and incubates ideas, not a hard decisionmaking group backed by financial
sanctions. So India opposes quantitative
targets such as the proposed 4% ceiling
on current account surpluses and deficits.
The country runs a current account deficit
of 3.5-4%, and regards the notion that
a 4% deficit is alarming enough to be
penalized as simply ridiculous. Indeed,
it believes the deficit helps ameliorate
global imbalances, enabling it to absorb
the global flood of dollars that has so
discomfited other emerging markets.
Unlike Brazil and some Asian
countries, India does not see itself facing
currency wars or destabilizing dollar
inflows. Far from imposing capital
controls on inflows (as Brazil, South
Korea and others have done), India has
relaxed its capital controls on foreign
investment in bonds.
After India became independent in
1947, its inward-looking socialist policies
made it a chronic underachiever. But
today the country is accepted as a
serious policy guru, averaging 9%
GDP growth between 2005 and 2008.
At the G-20 in Seoul, Prime Minister
Manmohan Singh brought development
to the fore, saying surplus-rich countries,
notably China, should invest in building
infrastructure, not just at home but in the
Third World. This, he said, would ensure
a better use of surpluses than endlessly
increasing foreign exchange reserves.
Whether or not such constructive
initiatives will fly remains to be seen.
Swaminathan S. Anklesaria Aiyar is
a research fellow at the Cato Institute’s
Center for Global Liberty and Prosperity.
5
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Agenda April/May 2011
Ones to watch
45, CFO, Alliant Credit Union (Chicago)
With assets of over US$7bn (€4.9bn),
Alliant is the sixth-largest credit union
in the US. The not-for-profit financial
group has weathered the global
recession, but CFO Mona Leung is
convinced cutting-edge analytics can
ensure it stays better informed in future.
The story so far Credit unions – essentially
member-owned banks offering credit and
banking facilities at reasonable rates – are
used by 43% of Americans. Their profile
soared during the financial crisis, as their
losses were often proportionally lower
than their Wall Street rivals, thanks to their
smaller size and lower reliance on risky
loans. During 2008, lending by credit unions
rose 7% as banks cut back. In 2010, Alliant’s
membership rose to 255,000, assets were
up 8% to nearly US$7.6bn (€5.3bn) and net
income soared 93% to US$50.9m (€35.3m).
What’s next? Leung, who came to Alliant
after working her way up at the likes of
PepsiCo and Sears, believes analytics aren’t
just for corporate giants. She is upgrading
Alliant’s ERM system, incorporating tools
that will help it rapidly model risk scenarios
using real-time information. The aim, she
says, is to serve members better, keep
abreast of vital indicators of credit problems
and model extreme-worst-case scenarios.
“We don’t just ask: ‘Are we going to be in a
recession?’,” says Leung. “We ask: ‘What if
we’re in recession for five or ten years?’”
She adds: “You can have the right tools and
the right talent, but if the culture isn’t ready,
none of it will matter.” Alliant has revamped
its website and says 70% of transactions
now occur over the internet.
She’ll succeed if… Software integration
is seamless and embraced by staff.
Consumers stick with credit unions as
banks recapitalize. Leung’s scenarios serve
Alliant in a crisis and her focus on efficiency
cushions the group against uncertainty.
These five leaders work in
very different sectors and
parts of the globe but they
all face career-defining
challenges in 2011
Gee-Sung Choi
59, Vice Chairman and CEO, Samsung
Gee-Sung Choi secured top spot in the
global TV market and helped Samsung
become No.2 in cellphones. This South
Korean titan is now the world’s largest
technology firm by sales. Choi plans
a huge investment in R&D and green
technology to change the company’s
image and bring in new business.
The story so far One of the runners on the
Olympic torch relay through New York in
2004, Choi’s 30-year career at Samsung has
been a professional marathon. Appointed
CEO in 2009 as a new generation of
managers took charge, Choi admits that
historically Samsung succeeded by doing
things better and faster: annual revenues
quadrupled to US$116bn (€80.4bn) in the
ten years to 2009. He sees the speed of
technology as an opportunity and a threat.
What’s next? In 2010, Samsung invested
US$23bn (€16bn) to increase capacity in
its chip, display and phone units. Green
technology is one R&D focus: Samsung
has a solar-powered smartphone and wants
to make domestic solar cells. “The global list
of top companies is being replaced by
Apple, Google and Facebook. Our job is to
prepare Samsung for the next generation,
so it can keep evolving into a great
company,” he says. Expect services of the
kind that make iTunes so successful.
He’ll succeed if… Samsung focuses on
innovation, not imitation, and cracks the
smartphone market. Its tablet device,
Galaxy Tab, finds a profitable niche.
Paulo Fridman, Bobby Yip/Reuters/Corbis, Bloomberg/Getty Images
Mona Leung
What
is on
their
to do
list?
6
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Zhang Qingwei
49, Chairman of Comac
José Sergio
Gabrielli
61, CEO, Petrobras
Brazil’s part-state-owned energy
multinational smashed records in 2010
with a US$70bn (€48.5bn) IPO – double
the next-largest float of the past 20
years. With Petrobras’s value matching
Qatar’s annual GDP, investors expect the
scholarly José Sergio Gabrielli to ramp
up growth as Petrobras aims to be the
world’s largest oil producer by 2015.
The story so far Brazil used to rely on
renewables, with 80% of domestic energy
coming from hydroelectricity. That all
changed in 2007, with a string of offshore
oil finds by Petrobras that should make
Brazil a net exporter of oil in 2011 and a
global top-ten producer soon after. Profits
in 2009 of US$28.9bn (€20bn) were strong
in a troubled climate. Gabrielli, a professor
of macroeconomics before he became the
company’s finance director in 2003 (and
CEO in 2005), is admired for his evenhanded stewardship and financial smarts,
but must deliver strong results.
What’s next? Critics say Petrobras spends
too much time on ‘political’ investments
and should focus on profiting from its
offshore finds. That illustrates Gabrielli’s
dilemma: the government is a minority
shareholder with majority voting rights and
he can’t determine the price he sells oil
at domestically. Still, Petrobras reckons its
Libra and Tupi fields may hold 15bn barrels
of crude, which could be a game-changer.
It already has 11.2bn barrels in reserve.
A planned US$224bn (€155bn) investment
before 2015 could double output.
He’ll succeed if… The oil market stays
buoyant (Petrobras anticipates the average
price will be above US$80 a barrel over five
years). The government allows Petrobras to
expand globally and invest in growth. The
Libra and Tupi fields meet expectations.
Breaking the Boeing-Airbus duopoly
that dominates commercial aircraft is
a daunting task that has defeated many
– but if Chinese aerospace manufacturer
Comac’s planned launch of a flagship
jetliner in 2016 takes off, the rewards
would be enormous.
The story so far In 1997, Boeing acquired
US rival McDonnell Douglas, which ran
a fledgling production line in Shanghai,
spelling the end for the Chinese airline
industry. Comac, founded in 2008, is a
valiant attempt at resurrection. One-third
state-owned, it agreed to a US$7.5bn
(€5.2bn) facility in 2010 with China
Construction Bank for its C919 aircraft,
linchpin of its expansion plans, targeting
the Boeing 737 and Airbus A320. Zhang
heads the State Commission of Science,
Technology and Industry for National
Defense, and is deputy chief of China’s
manned space programme.
What’s next? Putting Chinese astronauts
on the moon could prove easier than
meeting a test-flight target of 2014.
Progress has been uneven, but Comac is
now taking orders from China’s big three
airlines. Zhang’s target is to produce 150
C919s a year for 12 years, meeting
30%-40% of domestic demand in its class
and winning 10% of the global market.
He’ll succeed if… Comac minimizes
costs without compromising safety and
sustainability. The state forgoes returns
on development capital and offers
incentives for foreign countries to buy its
airliners. Zhang’s other roles don’t distract
him from running Comac.
Giorgos
Papaconstantinou
49, Finance Minister of Greece
He has lectured in economics, spent
ten years at the OECD and has been
advising Greek governments and
ministers since 1998, so Giorgos
Papaconstantinou is well-placed to take
on one of the biggest challenges faced
by any finance minister in the world.
The story so far When Greece’s budget
crisis triggered a loss of faith in its sovereign
debt in spring 2010, Papaconstantinou
negotiated a lifesaving US$146bn (€101bn)
bailout with the IMF, European Central Bank
and EC. Although he had spent much of
his adult life outside Greece, he sensed
the national mood, accepting an immediate
wage cut. The debt-to-GDP ratio reached
142.5% in 2010 and Greece has effectively
been locked out of long-term debt markets
since the crisis began.
What’s next? Papaconstantinou expects
the government’s program of fiscal
consolidation, structural reforms and
privatization to boost investor confidence
and lead to a return to long-term debt
markets by 2012. Austerity measures –
including landmark reforms to public sector
pay and pensions, and VAT hikes – were the
EU’s deepest in 2010. But Papaconstantinou
is also targeting tax revenues and
management practices in public institutions:
he estimates that 1.2m businesses are
unaudited and 1.3m Greeks are in arrears.
He’ll succeed if… His measures
consolidate public finances and stimulate
investment. European leaders are able to
restore wider confidence in the Eurozone.
“The global list of top companies is being replaced by
Apple, Google and Facebook. Our job is to prepare
for the next generation so we can keep evolving”
7
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Agenda April/May 2011
Best practice by Paul Simpson
M&A: How to
create value,
not headlines
Even though eight out of ten acquisitions fail, many firms still
look to them for growth. Here are eight steps to getting it right
P
atrick Bateman, the anti-hero of
American Psycho, Bret Easton
Ellis’s cult novel, works in
mergers and acquisitions on
Wall Street or, as he jokingly
calls them, “murders and
executions”.The gag is far from accidental.
Ever since a group of wealthy American
entrepreneurs, including oil magnate John
D. Rockefeller, went on the acquisition trail
in the late 19th century – earning collective
infamy as the “robber barons” – the media
and public perception has been that the
M&A business is driven by greed, selfaggrandizement and chicanery.
CEOs haven’t always helped their
cause. For every Rupert Murdoch and Bill
Gates, whose acquisitions seem driven
by strategic vision, there are many other
bosses – such as the late tycoon Robert
Maxwell – who seem to live for the deal
or use takeovers in a smoke-and-mirrors
show designed to mask their business’s
underlying underperformance.
Economic historians talk of five
waves of acquisitions, starting with deals
between monopolies in the 1980s and
ending with the equity-driven deals of the
2000s that were fueled by globalization,
deregulation and booming stock markets.
But two themes recur throughout: the
varying attitude of governments (which
have been supportive or hostile and almost
every nuance in between) and a concern
about whether these deals deliver value.
The last stock market bubble killed or
stalled many deals. For Laurence Capron,
The Paul Desmarais Chaired Professor
of Partnership and Active Ownership at
INSEAD Business School, that is no bad
thing: “This is the perfect opportunity for
companies to rethink their M&A strategy
and the process they have been using to
buy companies. M&A deals in past decades
have, on average, destroyed value for the
acquirer’s shareholders. Now is a good
time to step back to better understand
the market for corporate control.”
John Kelly, Head of Transaction Services
at KPMG in the UK, echoes Capron’s call
for boards to take a reality check: “In 2006
and early 2007, with cheap money and
markets encouraging management to be
aggressive, acquisitive companies were
given the benefit of the doubt – even
when they didn’t deserve it. Nobody
was pointing out that, in many cases,
the emperor had no clothes on.” There
is another way – as these eight steps
to rethinking deal-making demonstrate.
However intensive the planning,
innovative the financing or
watertight the contract, people
are the key to extracting value
8
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
John D. Rockefeller was
fêted and hated for his
deal-making acumen.
Today’s acquirers tread
more carefully
Pictorial Press/Alamy
1 Don’t start with the deal
With every acquisition in the balance until
it’s completed, the temptation is not to
risk wasting resources by deferring any
study of how you will extract value from
a deal until the last minute. Yet most
managers, analyzing their purchases in
KPMG’s 2010 M&A study, wished they’d
started their integration planning sooner.
If the bidder doesn’t understand what
and where value can be obtained, how can
they be sure they are not paying over the
odds? And how can they decide how best
to unlock the value they acquire?
This planning process goes far beyond
crunching data. The bidder needs to
understand the mechanics of how
synergies can be obtained, what cultural
challenges they face and how compatible
their IT and reporting systems are.
KPMG research suggests that acquirers
have a 100-day honeymoon period to take
hold of a business and start delivering
benefits. Unless they can make the hard
changes necessary in that period, they will
lose value. The sooner they start planning
integration, the easier it will be to focus
on the initiatives that help extract value,
mitigate risk and maintain momentum.
2 Define your strategy
Why are you trying to buy? Cisco
Systems, which has bought 145
companies since 1993, divides its
potential acquisitions into three
categories: those that expand the market,
take it into new markets or accelerate the
market. For every company it buys, it has
researched 100 and entered into serious
conversation with ten.
Yet even Cisco’s M&A specialists say
acquisitions are as much art as science.
And sometimes, Kelly suggests, a deal
makes sense even if the rationale sounds
unspectacular. United Biscuits, he points
out, beat Golden Wonder to acquire
Jacob’s Biscuits from Danone in 2004.
Within two years, Golden Wonder was in
receivership and United had bought two
of its rival’s core brands. (The Golden
Wonder brand is now owned by Northern
Irish group Tayto.) “The difference
between a number two and a distant
three is a big deal,” says Kelly.
Sometimes, the simplest rationale –
this purchase protects our position
in the market – is the best.
9
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Agenda April/May 2011
Best practice
Overreliance on acquisition adds to risk.
You can always grow your business
through acquisition. But that growth can
destroy value rather than enhance it
M&A by numbers
2,100
The number of acquisitions in the US in 1984,
the peak year for M&A activity.
250,000
Copies of the novel American Psycho – with
M&A specialist Patrick Bateman (above) as its
central anti-hero – sold in one week in 1991.
83%
Proportion of mergers and acquisitions that fail
to deliver value, according to a KPMG survey
in 2010. Many deals failed because of bad
project management by the acquirer.
9 months
Time it takes a typical company to feel it has
post-merger issues under control, according
to KPMG research.
20%
Proportion of US GDP accounted for by the
value of firms acquired in M&A deals in 1900.
2,333
Cross-border acquisitions in 1997.
50%
Proportion of top executives who leave an
acquired company within the first year after
the deal, according to KPMG figures.
US$172bn
The value of the largest M&A deal ever: the
1999 purchase of Mannesmann by Vodafone.
18,800
Google results for “diworsification”, a term
invented by financial guru Peter Lynch to
describe companies whose performance
deteriorates after they diversify through M&A.
US$262m
The 2010 profits for Kohlberg Kravis Roberts’
core private equity business. The company’s
private equity assets under management
were worth US$46.2bn (€32bn) in 2010.
3 Don’t just focus on costs
If you are to convince investors one
and one won’t equal less than two, you
need, Kelly says, to broaden your focus:
“Companies often give very bland
statements about the potential revenue
synergies, but they need to quantify
what those might be if they are to
give investors the best opportunity to
understand the value of a transaction.
“Markets don’t value revenue
synergies and people tend to focus on
cost so suddenly, instead of being a
strategic, value-enhancing deal, you start
slashing and burning.”
Buyers often invoke the millions to be
gained from synergies in R&D, product
development and cross-selling but find it
easier to cut cost. There’s a bizarre paradox
at work here. Because investors are
sceptical about revenue synergies,
businesses put less effort into them – yet
investors, though they have more faith in
cost reductions, are more excited by deals
that deliver new revenues. CFOs need
to talk credibly, in detail, about revenue
synergies, giving a fully rounded view that
may increase valuations.
4 Give diligence its due
Traditionally, due diligence was largely a
study of the target company’s past. That
is changing as CFOs realize the true value
of a deal cannot be gauged by analyzing
historical data and projecting forward
relatively conservative cost synergies.
As the last three years show, the past
can be a catastrophically imperfect guide
to the future. Kelly uses an extreme
example to make his point: “Let’s say you
were trying to sell a building materials
company in Ireland at the moment. The
historical data would cover three of the
worst years in the history of the Celtic
Tiger economy. Seller and buyer would
need to ask such questions as: where is
the bottom of this market? And what are
the macro-economic factors that could
get this market moving again?”
In his view, acquirers need to “diligence
the future by, for example, taking a
discounted view of future cash flows”. If
CFOs don’t do that, they risk walking away
from a bargain or wildly misjudging the
future and destroying value.
5 Is acquisition the right answer?
More than half the executives Capron
spoke to for research undertaken with
Professor Will Mitchell of Duke University
blamed implementation problems –
“lack of people skills” and a “poor ability to
integrate acquired businesses” – for their
failed strategic shifts. Yet maybe the fault
lies in the strategy, not the execution.
In aggressively pursuing M&A to the
exclusion of all other tools to deliver
growth, they might have been “doggedly
applying the wrong approach”.
“Companies become committed
to acquisition very quickly,” she says.
“Especially if competitors are in an
acquisitive mood. But acquisitions
might not be the right tool to reach your
objective.” Her research suggests that
companies which consider every means of
developing new resources – joint venture,
partnerships, internal launches, alliances,
licensing agreements – are 26% more likely
to survive over a five-year period than those
focusing entirely on M&A.
Kelly says joint ventures are attractive as
the global economy rebalances. “In many
emerging markets, where you don’t have
the licence to operate without a joint
venture, you’d be mad not to consider
them. Some joint ventures are born out
of risk. They’re not what companies might
want to do in an ideal world but, the cost
involved in an acquisition is a burden
many are reluctant to bear at the moment.
With lower premiums to claw back, joint
ventures are often at a considerable
advantage from day one.”
Successful joint ventures and alliances,
Capron suggests, keep it simple, requiring
only a few people or units to work together
to succeed. Eli Lilly has even created an
10
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
Find out the secrets behind Rupert
Murdoch, the world’s top deal-maker:
www.kpmg.com/agendaonline
Everett Collection/Rex Features, Mike Goldwater, Celebrity/Alamy, Ed Kashi/Getty Images
Deal-makers: Rupert
Murdoch (left) and Bill
Gates used acquisition
to fuel strategic growth,
in marked contrast to
Robert Maxwell (below)
Office of Alliance Management to identify
alliances, but the US pharmaceutical
giant will buy when necessary (half the
companies it acquires have been partners),
paying US$2.3bn (€1.6bn) for ICOS in
2004 to commercialize Cialis, a drug the
companies developed in a joint venture.
6 The hard truths about soft issues
With 45% of Fortune 500 CFOs blaming
post-M&A failure on “unexpected people
problems”, Kelly says acquirers cannot
afford to “concentrate primarily on the
hard mechanics of extracting value.
However intensive the planning, however
innovative the financing, and however
watertight the contract, people are the
key to extracting value – and these softer
issues cannot be left to chance.”
The three soft issues on which
many deals founder are: selecting the
management team; cultural differences
between buyer and target company; and
communication. Management shouldn’t,
Kelly warns, define communication purely
in terms of PR and investor relations: “Poor
communication to employees is likely to
have a more detrimental effect than to
shareholders, suppliers or customers.”
7 One size does not fit all
Some deals go wrong at the start, others
in the middle but many go awry after the
paperwork is signed. “I’m always surprised
at the lack of sophistication in post-M&A
integration. Very few executives have
a good model in mind,” says Capron.
One question too few boards think
through is the degree of autonomy an
acquisition is allowed. There is no simple,
right answer. “You have to ask what makes
sense for the specific deal,” says Capron.
“If you’re acquiring an entrepreneurial
firm, you need the entrepreneurs to
remain committed if you are to deliver
value. And yet to avoid replication of effort,
and internal inconsistency, you need to
have some degree of centralization.”
KPMG research suggests that, while it
might be useful to replace managers when
buying a bolt-on business, successful
acquirers retain key leaders at companies
being fully integrated. This approach helped
Johnson & Johnson commercialize such
valuable products as Tylenol.
One overlooked aspect of successful
integration is divestment. As Capron points
out: “Acquirers must be disciplined about
selling resources they don’t need, lest they
become overloaded with excess baggage.
General Electric divests as often as it
purchases, after reconfiguring its targets.”
8 Balance risk and reward
In the acquisition business, activity is too
often confused with achievement. Capron
cautions: “Keep in mind that overreliance
on acquisition adds to your overall risk.
You can always grow your business
through acquisition. But that growth can
destroy value, rather than enhance it.”
It sounds obvious but, as Kelly says,
many companies have ignored this simple
truth. In the heyday of M&A, while the
champagne glasses clinked, you would
often see “an ashen-faced figure in the
corner” – the operations director, whose
job it was to make it work.
And yet, Kelly says, acquisitions will
still attract many. “If you’re a European
conglomerate, in a mature market, and
you’re projecting forward three to five
years, you’re probably realistically looking
at single-digit growth in a hard, mature
market. That isn’t going to excite investors.
If you plan early, pay the right price, and
deliver the cost and revenue synergies, you
can deliver value for shareholders.”
11
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
Agenda April/May 2011
Keys to success by Robert Jeffery
“My father told
me not to enter
the family
business
“
GM Rao, founder of Asian infrastructure titan GMR, gambled
an assured career in gold trading to go it alone. Now, he tells
Agenda, the West should heed the lessons of India’s success
i
n pure ambush marketing
terms, GMR has India sewn up. Taxi
along the runway at Delhi International
Airport and the first thing you see is
the infrastructure giant’s assertive royal
blue logo, emblazoned on the steps that
take you from your plane. As you whizz
through immigration, GMR pops up again,
wishing you a pleasant stay. The highway
to Delhi’s city center is one long stream
of cranes and diggers.
“This,” says the cab driver, gesturing,
it seems, towards everything around us
at once, “is GMR.”
Many of the company’s rivals would be
content to keep a low profile, reasoning
that if they do their job well, the public
needn’t be aware of their existence. But
in a country where things don’t always
come together, GMR is justifiably proud
of the efficiency it has built into an airport
that houses the world’s fifth-largest
passenger terminal.
India’s infrastructure has simply failed
to keep up with an economy growing by
9% a year. The government has pledged
to spend US$1 trillion (€690bn) between
2012 and 2017 to bring it up to scratch, but
central bank governor Duvvuri Subbarao
says India needs a “quantum step” in
investment to reach the next level of
growth. GMR, as the largest player in
the market, has been the driving force
behind airports, roads and other urban
infrastructure projects across the nation.
Grandhi Mallikarjuna (or GM) Rao,
the group’s founder and chairman, is
understandably hungry for more. “The
government needs a strategy on this very
quickly,” he says. “What’s been done so
far is very minimal. If you look at other
countries, they built infrastructure before
they developed the economy, but we
have done it the other way round. The
government understands the scale of the
problem, but in many cases the long-term
funds aren’t available right now.”
That is unlikely to assuage Jeff Immelt,
General Electric CEO, who recently
rebuked Indian authorities and investors,
12
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Portraits: Atul Loke
13
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Agenda April/May 2011
Keys to success
From Rajam
to riches
1950 Born in
Rajam, Andhra
Pradesh, son of
a gold trader
1974 Graduates
with engineering
degree from
Andhra University
1978 Founds
GMR, a group that
starts nearly 30
businesses, from
sugar refining to
power and roads
1994 Buys stake
in Vysya Bank,
which he later
sells to ING
2003 Wins contract
for GMR to build
Hyderabad Airport
2007 Named
‘Entrepreneur of
the Year’ by the
Economic Times
2009 Reports link
GMR (which owns
IPL cricket team
the Delhi Devils)
with a takeover of
Liverpool Football
Club. Rao says the
deal was never on
the cards
GMR Group net
revenue by year
Source: Annual report 2009-10
1bn
800
600
2010
2009
0
2008
200
2007
400
2006
US$m
telling them: “There’s billions of dollars
needed on infrastructure spending and it’s
not happening… you guys aren’t keeping
your side of the bargain.” Foreign
companies, he said, weren’t given a fair
shot at larger projects.
In the company’s bunker-like
boardroom within the Delhi airport
complex, Rao predictably disagrees.
He has worked with foreign partners on
many projects, he says. “But in a country
like India, you need local companies to
lead projects because they understand
the landscape.”
Few have as much local knowledge
as GMR. With 2,000 employees and
a 2009/10 pre-tax profit of US$42.4m
(€29.4m) on revenues of US$1bn
(€693m), the privately owned, Bangaloreheadquartered company derives around
40% of its income from airports, but is
also involved in roads, energy (including
power plants and renewables projects
across the developing world) and property.
Rao’s route to prosperity (he is said
to be India’s 14th-richest man) has been
far from linear. The son of a gold trader
from Rajam, a remote town in the
south-eastern state of Andhra Pradesh,
he failed his high school examinations
before eventually returning to academia,
gaining an engineering degree. “As the
first engineer in my family, my father
urged me not to enter the family business
and I started my career with the State
Public Works Department,” he recalls. The
role didn’t excite him and after his father’s
death he took up trading again before
starting a series of businesses – 28 in
20 years – ranging from brewing to sugar
refining. In 1994, he bought a stake in the
failing regional Vysya Bank which he later
sold to ING, the first foreign acquisition of
an Indian financial institution.
By 2003, GMR had a growing
reputation in highway construction,
power plants and agri-business. But it still
came as something of a shock when Rao
persuaded Andhra Pradesh’s government
to award him the contract to build and
run Hyderabad International Airport.
“Everything was new to us,” he says.
“We set out to learn everything we could
about airports. We spoke to the best
consultants and experts worldwide.
I travelled the world, looking at the
best airports.” GMR also hired key
employees from airport operators in the
UK, US and Singapore to head divisions.
Six years later, the Airport Council International rated
Hyderabad the fifth-best airport in the world. By then GMR
was busy revamping Delhi International Airport on a US$3bn
(€2.1bn), 30-year contract. “It was already a working airport,
so we had to minimize disruption. It was six times bigger
than Hyderabad Airport. It was like running a marathon then
performing heart surgery at the end.”
Terminal 3, the flagship international terminal, was completed
in just 37 months, with a peak workforce of 30,000. Rao
compares it proudly with Heathrow’s troubled Terminal 5,
which took 60 months and handles 25% fewer passengers.
A hands-on manager, Rao was onsite the day 3,000
dummy passengers stress-tested the terminal before its grand
opening. Such attention to detail – he remembers meeting our
photographer years previously, and even recalls the location
– sounds stereotypical for an Indian business leader, but not
everything about the 60-year-old is so predictable.
Take his attitude to divestment, something some Indian
businesses struggle with. When Delhi Airport was completed,
GMR quit agri-business to focus solely on infrastructure. “Agribusiness was dear to me because it changed the village I came
from. I went back and saw what it did. But you can’t form
attachments. It is painful, but necessary,” says Rao.
Humble beginnings
GMR’s corporate values are unorthodox. Humility (defined as
“intellectual modesty” and a dislike of “false pride”) ranks
above teamwork or entrepreneurship. Rao is puzzled when
I mention this. It isn’t, I suggest, a value most Western businesses
would give such prominence. “But if you lose humility,” he says,
“when success comes along it will breed arrogance.”
GMR stays grounded by spending 3-5% of profits on CSR.
But while he admires the philanthropy of Bill Gates and Warren
Buffett, many of Rao’s management influences are more
focused on the bottom line. He was impressed by The Science
of Success, by the ultra-libertarian Tea Party funder Charles
Koch. When he read Jim Collins’ How The Mighty Fall –
which details lessons from failing enterprises – he gave his
management team three days to immerse themselves in it
before sharing their insights.
Understanding where things go wrong, he says, was an
obsession that began at Vysya Bank, where many customers
were defaulting on loans and needed strategic analysis and
advice. Today, all GMR’s senior leaders critically evaluate their
business every six months. “If you don’t do that, people will
just tell you “yes, it’s all fine, don’t worry,’” he says.
As a self-professed “baby of liberalization”, Rao is among the
vanguard of Indian entrepreneurs seeking closer relationships
with the West and watching with interest as the country’s
economy gradually opens to outside investment. As he puts
it, echoing the famous phrase by JFK: “Before liberalization,
a Western businessman would come and ask ‘What can I do
for India?’. Today, they ask ‘What can India do for me?’”
Adrian Mowat, J.P.Morgan’s chief emerging markets strategist,
believes the Indian economy could grow faster than China’s,
if it focuses on investment-led growth. India, says Rao, has
“moved beyond IT capabilities”, mentioning leaders in banking and
manufacturing to prove his point. “But people still don’t recognize
the quality of Indian leadership.” He names Tata and Reliance
14
© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
After two decades of debate, India has
given clearance for a second airport in
Mumbai. GMR is likely to bid for it.
Shutterstock
For GM Rao,
succession
planning is
never left
to chance
Industries as Indian companies making
major acquisitions abroad.
“India isn’t about being cheap,” says
Rao. “Two hundred of the Fortune 500
are in India today, and they’re not just here
for back office functions. They have R&D
centres and knowledge centres.”
The global recession, says Rao, “didn’t
affect us… We acquired a stake in [USbased power generation company]
InterGen during the crisis and were able
to raise US$1bn (€690m) easily. We raised
US$3bn (€2.1bn) from local banks to build
Delhi Airport. The Indian banking system is
robust and we have strong regulation.
“The Indian economy is based around
domestic savings, so it didn’t have a great
deal of exposure outside the country.
“Divestment
is painful but
necessary.
You can’t form
attachments”
India was one of very few countries that showed how to
manage its economy. One of the main reasons for that is our
savings culture, and the way domestic consumption has kept
pace with growth.”
Rao points to India’s “demographic dividend”. By 2020, the
country’s average age will be 29, which gives it a significant edge
financially and as an exporter of intellectual capital, over other
economies that have ageing populations. Many analysts believe
these demographics make India a better long-term prospect for
investment than China but Rao downplays talk of any rivalry
between Asia’s emerging economic superpowers.
“We’re not in competition. Most of our power equipment
comes from China. If China develops technology, we will buy it.
It is low-cost and we can leverage it to help us compete globally.
The development of China is actually helping India to compete.”
GMR is unlikely to compete in China, but Rao sees “organic
growth in developing economies” as the central plank of the 2020
strategy he is developing to prepare for his own retirement at 70.
GMR’s 2010 sale of its InterGen stake to China’s Huaneng Group
fits this vision. The group has won airport business in Turkey and
the Maldives, and owns a major energy provider in Singapore.
The next big thing
GMR is likely to bid for a second airport in Mumbai, which the
Indian government has indicated will be among the last to be
privatized in the current wave, but sees growth in providing
services to airport owners in India and abroad. Rao is an eloquent
advocate of the “aerotropolis” model of basing new business and
social developments around airport development, which is why
GMR often buys and develops land adjacent to its projects.
GMR’s next moves will form part of Rao’s meticulous
succession planning. The companies he saw floundering when
he was at Vysya Bank were often torn apart by family rivalries.
More than 70% of Indian businesses are family-owned, he
points out, and their evolution into international institutions will
be crucial to the country’s development. He brought in a family
succession expert in 2007 to draw up a Family Business Board,
backed by a code of conduct and a “deadlock trustee” who will
rule on any disagreements once responsibility for GMR’s
divisions is shared between his two sons and son-in-law.
“A family works with passion,” he says. “Family members
are more focused on value because they can’t just walk away
from the business. But the risk is how that affects governance,
and how you approach conflict resolution. If you can align
governance across all family members, it can bring great value.”
Rao and GMR are leaving nothing to chance. Family members
aside, all senior executives are assigned short-term and longterm successors, while key positions have emergency “red
dot” succession plans for unforeseen crises. That might sound
inflexible but it is symptomatic of Rao’s safety-first approach.
Risk, not opportunity, is the first thing he considers in an
acquisition, he says. Erring on the side of caution, he likes to
point out, has not been detrimental to the Indian economy.
India needs leaders like Rao, who pursue progress while
keeping an eye on risk. But can the country’s cautious growth
do enough, fast enough, to heal India’s social divisions?
Heading away from the airport, we pass a business college
with motivational aphorisms on its walls. One reads: “Keep good
company.” It is a lesson Rao, and India, are putting into action.
15
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Agenda April/May 2011
Acumen by Robert Jeffery
Vestas in China: the
government has invested
twice as much in wind
generation as the US
Wisdom
of the East
Vestas
Vestas lessons for
success in China
1 Relationships
matter Trust from
officials safeguards
investment
2 Quality sells Low
cost doesn’t always
succeed in a rapidly
shifting market
3 Economies of scale
Multinationals’
bigger solutions give
them an edge
4 Embrace change
Reacting fast to new
developments is key
Chinese takeaway
A Danish wind turbine giant proves you don’t have to
enter a joint venture to run a flourishing business in China
H
ohhot in Inner Mongolia is only 250 miles from Beijing, but
seems like another world. Travel writer Paul Theroux called
Hohhot – population 2.5 million – “a garrison plunked down
in the Mongolian prairie”. One resource the city can rely on is the
wind whipping in from the Gobi desert. For Danish firm Vestas,
the world’s largest wind turbine maker, it is an ideal home for
a new Chinese factory which, with its 600 staff, is tangible
evidence of China’s deepening commitment to sustainability.
“We believed in China and renewable energy from an early
stage,” says Jens Tommerup, President of Vestas China. That faith
is paying off – in 2010, the government installed an estimated
18GW of wind energy generation capacity, double the US figure,
part of a US$47bn (€32.6bn) stimulus for green energy initiatives.
In an era when every CEO needs a China strategy, Vestas’s
experiences are pertinent. It derives 8% of its US$9.1bn (€6.3bn)
revenue from China, having installed its first turbine there in 1986.
“We built up a customer base and local understanding before we
went into production in 2006,” says Tommerup. “We’ve built
relationships with local authorities and the government.”
Those relationships helped Vestas gain a foothold without
joint ventures. In October 2010, GE, Vestas’s biggest global rival,
formed a partnership with Harbin Power. In contrast, Hohhot is
Vestas’s fifth Chinese factory and more than 90% of the parts in
its tailor-made V60-850kW model are sourced locally.
Tommerup, 54, has worked in China for 14 years, learning the
value of diplomacy and reliability. He says 120 staff focus on the
quality of Vestas’s local supply chain, although “there are still areas
we can’t outsource… we are committed to delivering products
of Vestas’s worldwide quality”. He is reasonably pleased with the
Chinese graduates – “skilled technically, but if you measure them
on innovation and creative thinking, there is still some way to go”.
16
It’s a hint at the challenges foreign
firms face in a huge, growing yet complex
domestic market. Spending on green
energy is soaring, yet Bloomberg
estimates that multinationals only had
14% of the Chinese market in 2009.
Globally, Vestas may eventually face
tough competition from Chinese rivals,
but the domestic market continues to
grow at unprecedented rates and the
company won 18 deals in China in 2010.
Vestas’s early insistence on a localized
supply chain prefigured a 1990s
government directive that 70% of
wind turbine components be sourced
domestically. Experts say this policy
helped Chinese companies undercut
multinationals. Tommerup is more
upbeat: “China is one of the largest
markets for renewables, so we will
develop things here that will become
important to the global organization.
There are over 100 players in the turbine
market in China and the government
has to create a sustainable industry.
It must make some tough decisions,
but I see progress.”
Because “everyone in China has
seen the impact of pollution and that is
recognized in government”, Tommerup
is confident of growth.
Other multinationals, tempted by
a quick profit in a vast market, should
remember the exchange between
President Nixon and Zhou Enlai, China’s
first premier, in 1972. Nixon asked Zhou
to assess the French Revolution’s impact.
Zhou replied: “It is too soon to tell.”
16
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Agenda April/May 2011
Learning curve by Paul Simpson
Back to the
drawing board
Companies focused on innovation and growth need visionary leaders.
Could a designer, R&D guru or engineer be best for the top job?
AFP/Getty Images
A
nyone looking over the shoulder
of Mark Parker during a meeting
may be in for a shock. The CEO
of sportswear giant Nike is a relentless
doodler, but his scribblings are far from
meaningless spirals: the 54-year-old
sketches training shoes, his first and most
abiding business passion, and his drawings
are often the prototypes for new ranges.
As a teenager, Parker modified his
sneakers so he could run faster. Today, he
has an entire company shifting into a higher
gear: Q3 FY2010 results showed a 9.9%
leap in global revenues. Parker has made
China Nike’s second-largest market and
reorganized the business “so we’re not
some big, fat, dumb company.”
The cliché says that creatives lack the
ruthlessness required for the boardroom
and find it hard to focus on the figures.
When a business is driven by innovation,
however, a more relevant question might
be: “What does a number-cruncher know
about R&D?” Parker says: “Designers are
by nature more connected. They dig deeper
in terms of insights, and they turn those
insights into innovations.”
As companies position themselves for
growth, some are turning to leaders with
“softer” skills. A stint as a designer or
engineer may one day be more important
for aspiring CEOs than an MBA or a spell
in the finance department.
In 2009, Honda Motors reacted to
suggestions that it had lost the spirit
of adventure that had characterized its
trailblazing days in the 1990s by appointing
Takanobu Ito, the 55-year-old head of R&D
(who had designed the chassis for the
company’s iconic NSX sports car) as CEO.
The move surprised many, but maybe
it shouldn’t have. Ito’s predecessor, Takeo
Fukui, had started in engineering. Ito had
joined the company in 1978, held senior
operational posts and spent almost
two years as Chief Operating Officer of
automobile operations. His involvement in
the NSX suggested that the company was
serious about regaining its maverick streak.
As if to underline the point, Ito started telling
the media about the three joys – of creating,
Designer chic:
Mark Parker still
comes up with
fresh ideas
buying and selling – and famously rode a
new monocycle for the TV cameras. Rex
Tillerson, who become CEO of Exxon Mobil
in 2006, joined the company in 1975 as an
engineer and never worked a day in finance.
Boards usually play it safe when picking
a new CEO. Studies consistently show that
around 20-25% of leaders in the US and UK
were formerly CFOs. Heads of marketing
and operations are only slightly less likely
to make it to the top job.
It is clear, however, that boards
increasingly expect potential CEOs to
have worked in different disciplines. In
2000, one quarter of the CEOs of the
top 500 companies on the Standard
& Poor’s (S&P) index had risen through a
single department. By 2005, that had fallen
to 9%. That trend has accelerated since.
In 2009, 21% of S&P 500 CEOs had
an engineering degree. One explanation
is that, as one study of 150 high-tech
companies discovered, most were founded
by engineer-entrepreneurs such as Bill
Gates (Microsoft), Steve Jobs (Apple) and
Larry Page (Google).
There may be some aspects of
an engineer’s training that may make
them better-suited to the top job. James
Heskett, a Professor at Harvard Business
School, identified the core skills required of
a potential CEO of an organization as large
as General Electric: “They include stamina,
the ability to listen, learn and teach, a
vision of the future and the ability to
inspire confidence”. Jack Welch, arguably
the most admired American CEO of the
last 30 years, started at General Electric
as a junior engineer. At 32, he was the
youngest manager in the company’s
history to run his own department.
Business schools are encouraging future
leaders to embrace diverse disciplines.
Cambridge’s Judge Business School is
running a Philosophy in Business elective
where Kierkegaard rubs shoulders with
Keynes. A head for figures and a stomach
for tough calls will always be pre-requisites
for CEO success. But the ability to think
creatively needn’t be restricted to the
design studio any more.
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Agenda April/May 2011
The great debate by Robert Jeffery
Capital: a love story
c.9000bc
c.3100bc
Cattle class
Domestication of livestock and cultivation of crops
(particularly grain) means surpluses of both –
which lead to them being used as currency.
The bottom line
Writing is invented
in Mesapotamia,
motivated by the
need to keep records
of accounts. The
cuneiform script, on
clay tablets, is used
by merchants to track
goods – nascent IOUs.
400-600ad
687bc
Cash economy
The first rudimentary
coins, made of leather,
appear in Lydia, Asia
Minor, according to
historian Herodotus.
Roughly 50 years later,
the Lydians invent the
first true coins, made
of electrum.
Dark times
After Rome falls, the Dark Ages wreck Europe’s
finance system. Banks disappear for six centuries.
Britain doesn’t use coins for nearly 200 years.
Has capital
changed
for ever?
New global regulations will hit banks hard, and private equity
coffers are low. Where can large businesses turn for liquidity?
The panel
1 Jitendra Sharma
KPMG’s Global Risk
Management Leader and
a Partner in the US firm
2 Adam Gilbert
Head of Regulatory
Policy in J.P.Morgan’s
Corporate Risk
Management group
3 Steven Kaplan
Professor of
Entrepreneurship
at University of
Chicago Booth
School of Business
Y
ou could argue that big
companies have never
had it so good. The media may
seem full of bad news, but
equities markets have bounced
back far faster than other parts
of the economy, US multinationals are
sitting on a cash mountain worth US$2
trillion (€1.4 trillion) and profit margins in
many parts of the world are healthier than
ever, with net earnings for the world’s 25
largest companies up 63% in 2010.
Yet when they have spent their hefty
reserves, multinationals may face
a more credit-constrained future. The
implementation of Basel III rules from 2012
will compel banks to keep bigger reserves,
of capital, impacting their profitability and
return on equity. Research company Preqin
says private equity fundraising was at its
lowest level for six years in 2010. And
while large companies may be flourishing,
their suppliers and customers complain
about recalcitrant lenders – electronics giant
Siemens has even applied for a banking
licence so it can lend to customers in the
green energy sector.
Global net financial wealth is predicted
to fall 36% by 2024, with a drop in saving
further lessening cash available to banks.
Access to capital may soon look very
different. Are multinationals prepared for
this? Agenda took three views from the
market: Jitendra Sharma, KPMG’s Global
21
18
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Global M&A will top $3 trillion (€2.2
trillion) this year, up more than 25%,
according to Thomson Reuters
1200s
The Tulip Folly by Jean Leon Gerome/Walters Art Museum & The Legions of Attila Descending from Heaven by Maurice Berty/Archives Charmet/The Bridgeman Art Library
Chequeing in
Banks in Persia – which
arise from temples
– first issue letters of
credit, or Sakks, in 410
AD. As the Mongol
empire grows, under
leaders such as Kublai
Khan, these letters
evolve into cheques.
1634-1637
1946
1694
Flower power
Prices for Dutch tulips skyrocket as buyers pile
into them. A wild futures market arises and they
are a valuable currency – until the bubble bursts.
Risk Management Leader; Adam Gilbert,
Head of Regulatory Policy in J.P.Morgan’s
Corporate Risk Management Group;
and Steven Kaplan, Professor of
Entrepreneurship at University of Chicago
Booth School of Business.
Would it be fair to say multinationals
have had too much easy access to
capital for their own good in the past?
Sharma There’s no doubt there has been
too much credit. Excess liquidity in global
capital markets reduced the cost of
borrowing. But I don’t think multinationals
having access to relatively cheap funding
was a major contributory factor to the
recession. There were many factors, but
on the corporate front, excess liquidity led
to highly leveraged M&A and that market
came to a standstill in the summer of 2008.
Kaplan The untold story is that
multinationals, particularly non-financials,
have been spectacularly successful lately.
They have US$2 trillion (€1.4 trillion) of
cash on their balance sheets – which
means they have come out of the worst
downturn since the Great Depression in
marvellous shape. It’s part of the reason
that stock markets have recovered so
strongly, and that things aren’t worse all
round for everybody. Businesses have
been prudent. They have cut quickly for
the downturn and they are coming out
of it healthily. That’s very different to
something like the downturn of the late
1980s/early 1990s, when multinationals
came off very badly.
London calling
In under two weeks,
£1.2 million is raised
from private funds
to start the Bank of
England. The first
central bank was
founded in Sweden in
1668 and managed by
the parliament.
Why do multinationals have so much
cash, and how long do you expect
them to hold on to it?
Kaplan Three things are happening. One,
which affects US multinationals, is the tax
disadvantage of bringing cash back to the
US. The second is that companies may
have been more successful than they
anticipated. They have really tightened up
and got more efficient. Thirdly, there is a
sense in which multinationals’ baseline is a
little higher than normal, for precautionary
reasons. When we went into the crisis,
they wanted to reduce their bank debt and
make sure they had a reasonable amount
of cash. Now they’re waiting to see
whether there’s a recovery, and they’re
keeping the cash there until they do.
Gilbert There’s a bit of a chicken and egg
thing going on here. The economy won’t
get going until companies start investing
in things and generating household
income, but they won’t do that until they
start seeing income from households. It’s
hard to see what will break that. We’re
in an exceptionally low interest rate
environment and companies would rather
have cash than invest in new equipment.
Sharma Keeping cash isn’t a new
development – cash reserves at
multinationals have been steadily increasing
as they have found ways to reduce costs
and increase profits by finding new
markets. Twenty years ago, they were
converting assets to cash because they
were looking to emerging markets for
expansion. Right now, there’s a lot of
Going private
Two academics found ARDC, the first private
equity firm. Its initial investment is a US$2m loan
to DEC, a forerunner of Compaq.
uncertainty about what part of the cycle
we’re in. Companies are very cautious
about what sort of multiples they are willing
to pay. And countries like China are trying to
increase domestic consumption, albeit with
protectionist undertones.
What effect will Basel III have on banks
and, by extension, large businesses?
Gilbert Basel III is an appropriate move. It
will increase risk weights in certain
activities and will increase the calibration
of capital that’s required even if banks just
want to stand still. It strikes at the heart of
bank activity, which is capital liquidity. Banks
can respond in a few different ways. They
can front it up and lower their return on
equity, they can change product offerings
to clients to become more capital-neutral
or they can pass costs along. You’d expect
a net increase in cost to banks of any given
asset, but it’s not clear to what extent.
Sharma Banks will have to tighten their
belts and be a lot more efficient. They will
need to be more disciplined about who
they do business with and how they
maximize returns on capital. It won’t affect
the Procter & Gambles of this world, but
mid-market companies rely much more on
the sort of capital that banks provide.
Kaplan Any time you increase capital
requirements, you make capital more
expensive and see less of it. Banks will
have less to lend. How big will the effect
be? I’m not sure it will be that large. Large
corporates operate in capital markets, and
they have plenty available.
22
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Agenda April/May 2011
The great debate
1988
1971
The Art Archive, Alamy, Bloomberg, Rex Features, Corbis, Getty Images, Shutterstock
Another dollar...
The US government
announces that the
dollar can no longer
be converted into
gold, bringing an end
to the Bretton Woods
system of currency
being backed by
physical assets.
Capital concern
Central bankers in
Basel agree on minimal
capital requirements
for banks, put into law
by G-10 states in 1992.
(Basel II would lay out
regulatory practice.
Basel III, addressing
liquidity, is on its way.)
Private equity took a major hit during
the recession. Will it ever recover?
Kaplan Reports of private equity’s demise
were premature. Two years ago, a report
claimed that a large fraction of private-equity
funded companies would default. But that
assumed the deals were imprudent, which
they weren’t. Debt structures in the recent
boom were more conservative than in the
1980s, one reason why a large number of
defaults have not materialized. Private equity
will be smaller than 2007, but it isn’t going
away. BlackRock has raised a US$15bn
(€10.4bn) fund – that’s not the US$21bn+
(€14.5bn+) it was several years ago, but
it shows the interest is still there.
Sharma Private equity often comes in
when companies are restructuring, and
that is driven more by the business cycle.
PE firms might be taking a look at their
own funding as a result of the crisis, and
it’s not yet clear how that will shake out.
Gilbert Private equity has always been
important, and it always will be.
Is Siemens’ move into providing
capital for customers a positive
development, and will other large
companies follow suit?
Sharma It could work, depending on your
strategy. There’s a fundamental business
logic to it for many companies. Banks have
retreated from certain sectors that might be
central to your business model, so it makes
sense to fund them directly, although they
would need to be prepared to deal with the
infrastructure, governance and compliance
costs of getting into that space.
1997
Rock star finds spare ch-ch-change
David Bowie securitizes revenues from his back
catalogue, raising US$55m and showing the
versatility of the asset-backed securities market.
2007
Prime cuts
Banks overly exposed
to high-risk mortgages
in the US are undone
when property slumps.
The shock sends banks
into a global freefall,
leading to a three-year
financial crisis and
massive bailouts.
Kaplan Chinese companies already
provide very attractive finance to their
customers. But on the flip side, this
has been tried before in the late 1990s,
particularly among telecoms companies,
and it ended up causing a lot of trouble.
Gilbert There’s a pretty strong strain against
mixing banking and commerce. Regulation
may make a lot of people, including banks,
skittish about the lending environment. And
if banks are eschewing activity because it
isn’t economic for them any more, that may
open the door to innovation. But the
barriers for companies entering markets like
this are quite high, and they need to be
prepared for the scrutiny that comes with it.
What would your priorities be if you
were a CFO, and how optimistic would
you be about the future of capital?
Gilbert I’d be broadly optimistic about
access to capital. The question is: at what
price? I have great faith in the ability of
financial markets to come up with new
vehicles, and it may be that CFOs look
increasingly to non-bank providers.
Kaplan The bank markets will get better,
so I would be optimistic. Debt markets and
high yield markets are holding up. Obviously,
the wild card right now is the Middle East.
Sharma In many ways, for credit-worthy
multinationals, 2010 was a great year, with
plenty of access to low-cost funding. Yes,
there are problems, and there may be
bigger worries on the horizon such as issues
with the Eurozone and sovereign risk. In the
medium term, I would be examining my
funding mix quite carefully.
Capital
games
Unusual approaches
to raising funds
Best Buy
The US retail giant
launched its own
venture capital arm
in 2008, focusing
on “disruptive
opportunities”.
Investments include
electric motorcycle
manufacturer
Brammo and Zeo,
which markets
sleep aids.
FedEx
Today, the logistics
giant has annual
profits of US$2bn
(€1.4bn). But in
1973, founder Fred
Smith feared he
couldn’t pay staff.
Flying to Las Vegas,
he won US$27,000
(€18,700) on the
blackjack tables, and
wired his winnings
back to HQ.
Fest Films
The movie company
funded its Starving
Artists by ensuring
that the name of
every investor,
however small,
appeared on screen.
“Regulation
may make
banks skittish
about lending
and open
the door to
innovation but
the barriers
to entry are
quite high”
IKEA
Ingvar Kamprad
started reselling
matches he bought
in bulk to his
schoolmates. When
he passed his high
school exams, his
father gave him
a lump sum as a
reward – which he
used to start IKEA.
The Body Shop
When Anita Roddick
sought money to
expand her beauty
products chain in
1976, she sold 22%
to the boyfriend of a
friend for US$6,200
(€4,300). He held on
to his shares until
the business was
sold to L’Oréal in
2006, netting him
US$227m (€157m).
20
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Agenda April/May 2011
Competitive edge by Robert Jeffery
Stuart Isett/Polaris/Eyevine, AFP/Getty Images
That’ll be the Daiei:
the famous retailer is
one of Japan’s largest
supermarket chains
Maverick, prophet, genius
Isao Nakauchi was all these. A king
of cost containment and lean supply chains, this retail
tycoon foresaw Japan’s lost decade
I
American idols: JFK
and Jimmy Cagney
inspired Nakauchi
n a life full of hyperbolic anecdotes, Isao Nakauchi’s favorite
story dates from his time as a teenage infantryman in World
War II. Cut adrift from his platoon in the Philippine jungle, he
was surviving on insects and leather peeled from his boots when
a shell landed next to him. “Luckily for me, the American shells
were manufactured in a slipshod way, like American autos, and
did not explode,” he said.
Once Japan’s most successful and outspoken entrepreneur,
Nakauchi, the Osaka-born son of a pharmacist, held no grudge
against the US. Aside from Mao Zedong (to whom he often
likened himself), America provided much of his inspiration. The
James Cagney movie Angels with Dirty Faces (1938) introduced
him, he said, to the concept of department stores. Then,
at a 1960s retail conference, he heard JFK talk about how
supermarkets were extending prosperity and was inspired to
expand his Daiei empire.
Daiei pioneered mass retailing in Japan, taking the US
hypermarket model and allying it to a super-lean supply chain and
aggressive promotion. But, by the time he died in 2005, Nakauchi
had been forced to sell most of his assets. His rise and fall is
a reminder that the availability of credit in a growing economy
doesn’t necessarily mean its business models are sustainable.
In 1957, when Nakauchi opened his first store in Osaka, Japan
was enjoying unprecedented growth. He began confronting
entrenched supply chains. When he sold beef at 39 yen for 100
grams, he received death threats. When he couldn’t find cheap
suits, he imported them from North Korea. Rivals accused him of
irresponsible price cutting, but he saw himself as “an agent of the
consumer”, empowered by Peter Drucker’s belief that demand,
not cost of production, should set pricing policy.
Nakauchi instinctively understood that
cost containment drove sales growth.
He made customer service training a
consistent priority, but he focused on
spending in minute detail. When he
realized customers were sampling Daiei’s
confectionery before buying it by weight,
he pre-packaged it. This could have
backfired, but Nakauchi portrayed it as
a revolution in customer convenience.
Within six months, Daiei’s sales
exceeded a million yen per day. By 1994,
the company was Japan’s most profitable
retailer with more than 400 stores.
Drucker, with whom Nakauchi wrote
the 1995 book Drucker and Nakauchi On
Asia, said Daiei’s creation of a modern
distribution system was part of “the
greatest social achievement in any country
of the last 40 years” and revolutionized
Japanese retail.
But Nakauchi’s authoritarian style (he
even wrote a musical about his business
acumen) deterred scrutiny and masked
the fact that his retail miracle was built
on cheap credit. Daiei reinvested profits in
a terrifyingly diverse array of businesses,
from language schools to the Daiei Hawks
baseball team, who played in a new
US$1bn (€693m) stadium. These ventures
were seldom as profitable as the core
stores, and when Japanese banks started
reining in risky loans, Daiei unravelled.
With a debt-to-equity ratio of 9:1, but
96,000 employees, the group was too big
to fail. The assets were bought cheaply by
investors before the state-run Industrial
Revitalization Corporation took over the
store business.
Nakauchi saw the end coming, was one
of the first business leaders to understand
the importance of the knowledge economy
and predicted Japan’s ‘Lost Decade’ of
negative growth: “If we are to learn, we
need to make the transition from studying
the outcome of innovation to… ways
to produce it.” And a true innovator he
certainly was: his ‘super-lean’ supply chain
prefigured Toyota’s ‘just-in-time’ method,
a cost-saver adopted by car makers the
world over (and especially in Detroit).
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Agenda April/May 2011
Ten issues
What you
don’t know
about...
Chinese business
Almost every major company sees the world’s second largest economy as key to profitable
growth. But being ‘in China’ is no longer enough. These ten factors could help you stand out
1
Return to an old world order
The new Confucius
(551BC- 479BC) cult
is a symbol of China’s
return to the top
China is not a new global economic
superpower. By 2030, if it does become
the world’s largest economy, this will be
a return to business as usual. If you take
the long view, China’s pre-eminence – not
the West’s – is the historic norm.
As William Kirby, Professor of China
studies at Harvard University, has pointed
out: “China was the world’s largest
economy in 1800. Its empire was the
strongest, richest and perhaps best
governed on earth. The wealthiest men
on the planet were Chinese.”
But the industrial revolution – and
misrule (especially in Mao Zedong’s
25-year reign) – rebalanced the global
economy. Although some analysts have
predicted China’s renaissance for almost
100 years, only in the past 40 have such
forecasts been taken seriously.
Now, Kirby says, the West has
finally realized that “a place that values
entrepreneurship, education, engineering,
internationalization and a government
strong enough (sometimes too strong) to
get things done can be a powerful partner
and a formidable competitor.”
After rebalancing the global economy
in its favor, China now needs to rethink
its own: its GDP may be growing by 9%
a year but, with the IMF predicting global
economic growth of only 4.4% in 2011,
how long can it maintain that pace?
Some estimates suggest a 10% decline
in export growth could cut GDP growth by
two percentage points. The government’s
bid to reduce reliance on exports by
stimulating the consumer economy has
pushed inflation to nearly 5%. A perilous
property bubble has developed. As Simon
Gleave, Partner, KPMG in China, puts
it: “Large GDP growth tends to hide a
multitude of problems. But the state is
learning to handle them.”
China’s renewed confidence is reflected
in a campaign to bolster its ‘soft power’ by
promoting Confucius. The 250 institutes
devoted to the philosopher across the
globe are a powerful reminder of China’s
early days as a global superpower.
22
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2
The Ivy League of the East
If the 21st-century global economy is
truly to become a knowledge-based
one, countries would do well to invest
in learning. And China is doing just that –
on a scale that budget-conscious rival
governments must envy.
Peking University, the most highly
regarded academic establishment in
China, is ranked only 37th on the list of the
world’s best universities. But Professor
Richard Levin, president of Yale University,
says: “In 25 years – only a generation’s
time – China’s universities could rival the
Ivy League.”
In October 2009, nine universities
formed the C9 League, the country’s Ivy
League-in-waiting. Some – particularly
Peking and Tsinghua – are renowned
already. Others have noted specialisms:
Harbin Institute of Technology is linked to
the space program, while Shanghai’s Jiao
Tong has a strong engineering reputation.
By tripling the percentage of GDP spent
on higher education to 1.5%, China has
quintupled its university student population
since 1997. In 2007, 5.5 million Chinese
were studying at universities and colleges.
There have been problems, though:
student-to-teacher ratios have soared
and the quality of education has in some
locations been questioned.
Levin says that building a world-class
university isn’t easy – “It took centuries
for Harvard and Yale to achieve parity with
Oxford and Cambridge” – but insists that
China “has the will and resources to make
this ambitious agenda feasible”.
The biggest challenge may be
modernizing teaching itself. In 2001, Peking
University started a pilot program that
offered a select group of students a liberal
arts environment. The goal, Levin says, was
“to encourage students to be more than
recipients of information and
to learn to think for themselves”. But such
developments will take time. “Changing
pedagogy is much more difficult than
changing curriculum,” Levin says.
3
APIC/Getty Images, ChinaFotoPress, Rainer Dittrich/Getty Images
Made (surprisingly well) in China
Would you be prepared to pay 50% less for a smartphone that is
80% as good? It’s the sort of proposition that could provide China
with an enduring competitive edge in the next decade.
The ‘Made in China’ label used to suggest low cost but
reasonable quality. However, a series of product recalls (wellpublicized by the Western media) has tarnished China’s reputation.
Since then, the government – and business leaders – have been
determined to close the quality gap, imposing stiffer regulation,
improving storage and shipping and trying to emulate the sort
of best practice found in Japan. With China’s middle class set to
treble in size over the next decade, there is a compelling domestic
incentive for companies to compete on quality.
Azim Premji, who runs India’s IT giant Wipro, says: “Don’t
underestimate China. It has done some incredible work in electric
cars, is very innovative in fundamental R&D for solar energy and is
developing automobiles, software and renewable energy as part of
a national program.”
But that’s only part of the story. During 2010, KPMG’s Global
Business Outlook Survey estimates, China surpassed India as
the favored outsourcing destination for the Asia-Pacific region.
In 2009, the Chinese government identified 17 policies that would
stimulate outsourcing and, by 2010, the industry was worth
US$10bn (€6.9bn). Many of the 3,000 outsourcing companies are
cash-rich and the ministry of trade and commerce is encouraging
them to make the right mergers and acquisitions abroad.
Heavy investment is
making China a world
leader in solar energy
4
The Tencent solution
“Pony” Ma Huateng is not the
stereotypical Chinese business leader.
But then his business, Tencent, is far from
run-of-the-mill. While it has not yet moved
out of the domestic market, it is the
third-largest internet company in the world
by market capitalization. And despite
having a charismatic founder, its
management team is genuinely democratic
and can say ‘no’ to the chief executive.
Tencent proves that Chinese businesses
can compete on more than just cost,
as well as how different the domestic
customer experience can be from that in
the typical Western business model.
The story began when Shenzhen
software engineer Ma (above) built an
instant messaging system called QQ. It
quickly became China’s most popular
real-time web communication service and
at the end of 2010 was the world’s largest
online community, with more than 630
million active users.
But Ma also did something Facebook
and Twitter have so far only dreamt of –
he monetized social media usage. Tencent
expanded into mobile apps, gaming, dating
and most recently e-commerce. Ma styles
himself as “chief product experience
officer” and has brought in managers from
external companies to stop him and other
founders dominating decision-making.
The result is a virtual goldmine.
Tencent’s margins are estimated at around
70%, and it announced first-half profits for
2010 of more than US$500m (€347m).
“QQ arose at a time when many
internet companies tried to slap Western
business models on the China market and
failed,” says Jack Ma, founder of Chinese
e-commerce giant Alibaba. Rivals may be
playing catch-up for years to come.
23
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Agenda April/May 2011
Ten issues
5
Many Chinese
supply chains
remain outdated
Entrepreneurial spirit
Analysis of China’s economic rise is often
skewed by talk of just a few big brands such
as Tsingtao beer or NCPC pharmaceuticals.
But China is the world’s largest – and
fastest-growing – source of start-ups.
Running a private business was illegal
in China until the late 1970s when Deng
Xiaoping liberalized the economy, assuring
the population in the 1990s that “to get rich
is glorious”.
There are now more than 10 million
small and medium enterprises in China,
accounting for 60% of the economy, 80%
of jobs and, the Ministry of Science and
Technology estimates, 65% of high-tech
patents filed since 1990.
Small businesses have often clustered
together to reduce start-up costs, ease the
financing burden and attract customers.
The far eastern town of Zhili focuses on
textiles, for example, while nearby Huzhou
is famed for bamboo products.
Such a model worked better when labor
was cheap and plentiful, but the one-child
policy has brought wage inflation as
businesses compete for a shrinking labor
pool, driving up costs.
Small businesses can also be
extraordinarily sensitive to exchange-rate
fluctuations. A 5-10% appreciation in the
yuan would wipe out the cost advantage
of many small exporting companies, one
reason the state has done what it can to
stave off such a rise. Less contentiously,
officials are trying to encourage banks to
lend more to small businesses.
7
Reforming rural banks
Modernizing China’s rural banks has been
good news for the country’s SMEs. A lack
of land ownership and tangible assets
meant that many found it a challenge to
extract funding from large, city-based
commercial banks. But now rural banks
have been consolidated into newer, more
flexible institutions, fewer SMEs will have
to pay the high rates that underground
banks or trust companies demand.
“China is trying to spread financial
services into areas where it’s been lacking,”
says Simon Gleave, Partner, KPMG in China.
6
The logistics challenge
Online retailers are being drawn to China’s
increasingly wealthy 420 million internet
users. Although credit card penetration in
China is low, it is expected to double by
2013 and there are third-party payment
systems available. The problem for online
pioneers, however, is moving goods around
such a vast landmass.
Logistics accounts for 18% of China’s
GDP – US$920bn (€640bn) in 2009 –
twice the rate of most developed
countries. KPMG’s China Logistics Report
points to inefficiencies in connections
between transportation, storage and
stock control functions. The country’s
underdeveloped infrastructure produces
“The regulator is concerned about the
market share of the biggest banks. Secondtier banks are being encouraged to step up,
along with co-operatives and village and
town banks (VTBs). To grow market share,
these types of institutions know they have
to be quite aggressive and innovative.”
The inevitable concern is how many
facilities may become non-performing loans
– especially those handed out over the past
three years atop a wave of optimism. The
outlook for defaults will depend on GDP
growth, fiscal revenues and property prices.
A lack of risk management experience in
China opens up opportunities for foreign
institutions. By 2009, the China Banking
Regulatory Commission had identified
more than 1,000 sites for new rural finance
institutions, and some foreign banks have
transportation bottlenecks and there are
tough regulatory constraints and local
barriers to entry.
For many companies, it is prohibitively
expensive to reach consumers outside the
more developed eastern seaboard cities.
Things are looking up, though. The civil
aviation sector has grown on average by
17.5% per year over the past decade and
there are plans to build 97 new airports by
2020. The government is also forecast to
spend US$93bn (€64bn) on rail links across
15 cities over the next decade.
State-owned businesses still dominate,
but private competition in the logistics
sector is growing fiercer as regulators allow
foreign players to enter. FedEx has bought a
domestic delivery business for US$400m
(€277m) and UPS has applied to operate.
The pair are chasing a market of up to five
million packages a day – and the chance to
seriously stimulate the economy.
“Second-tier banks know
they have to be innovative
and aggressive to build
their market share”
already taken advantage of relaxed market
entry requirements. HSBC now has eight
rural banks with 13 outlets, offering greater
flexibility on SME loan collateral and
unsecured individual lending.
In future, says Gleave, sources of capital
for businesses of all sizes will alter radically.
“It was a very long process to raise capital
in the past. There was a tendency just to
go and get a bank loan when you wanted to
fund growth. Now we’re gradually seeing
bonds and alternative sources of capital.”
24
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Mighty big
but not yet
multinational
8
9
by Professor Peter Nolan,
Judge Business School
Agricultural revolution
Tim Graham/Getty Images, Jon Arnold Images/Alamy
Fueled by soaring GDP, Chinese firms
are becoming more innovative and
competitive. Yet the country struggles
to create truly multinational giants
Peter Nolan’s latest book is
Crossroads: The End of Wild Capitalism
(Marshall Cavendish).
Agrarian economy
Proportion of GDP
accounted for by
agriculture, 2009
Source: CIA World Factbook
12
10
8
6
4
2
0
Germany
US
Japan
EU
Russia
Brazil
China
% of GDP
On the face of it, these are boom times
for Chinese businesses. Twenty-seven of
them are on the FT 500 list of the world’s
leading companies, their collective market
capitalization exceeded only by the US. In
high-income countries it is widely believed
that China used the global financial crisis
to embark on a worldwide buying spree.
Yet the facts do not bear that out.
Large companies from high-income
countries are deeply embedded in the
Chinese economy, but the reverse is not
true: China’s own large companies are
almost invisible in the West. Its total stock
of foreign direct investment is less than a
fifth that of the Netherlands, for instance.
There are notable exceptions, such as
Lenovo, the PC manufacturer, and Haier,
which is making inroads into the white
goods market in Europe and the US. Even
so, at a mere US$20bn (€13.9bn), China’s
foreign investments in high-income
countries are equivalent to that
of a single mid-ranking multinational.
In recent years, China’s giant stateowed banks have undertaken hugely
significant reforms, so that by 2009 the top
three banks in the world in terms of market
capitalization were Chinese – and China
has 10 banks in the FT 500. Despite this,
China’s banks were conspicuously absent
from the wave of mergers and acquisitions
during the global financial crisis.
And the few attempts by Chinese
companies to make a substantial
acquisition or large equity investment in
a high-income country – such as Sichuan
Tengzhong’s failed bid for GM’s Hummer
brand – have attracted intense media and
political scrutiny. This helps explain why
many large Chinese businesses are still
mostly targeting their domestic economy.
While China’s large companies are at
the early stages of becoming globally
competitive, there is a deep challenge
ahead to build global leaders. It is tempting
to think China has caught up with its
high-income overseas counterparts, but
it has some way to go.
Many smart venture capitalists with an eye on China are now
investing in potato – not computer – chips. As the country’s
consumer class becomes wealthier, there is a growing demand
for quality (often organic) produce at a higher price.
Agriculture is a marginal sector in many Western economies.
Not so in China, where it accounts for 10.6% of GDP, employs
around 300 million people and is now benefiting from serious
investment as officials, focused on food security, insist the country
must grow 95% of its grain demand. The growth prospects have
prompted Goldman Sachs to invest in breeding Chinese pigs, while
other banks are putting money into milk. Regulations on foreign
ownership of agricultural companies are tougher than many other
sectors, making direct entry for external competitors difficult.
Li Guoxiang, a researcher at the Chinese Academy of Social
Sciences, says investors should consider the whole market rather
than simply focus on particular niches. “The capital always chases
the profits,” he says, “and the collective market is quite lucrative,
with returns on investment approaching 60%.”
The central challenge for China’s government is to make its
farmers more productive. Many farms are too small for tractors, so
new laws are designed to encourage larger properties. If the 700
million rural Chinese earn and consume more (a typical farmer
spends just US$300 (€208) a year on discretionary purchases) the
economic and social gains for the country could be enormous.
10
To Russia with love
What will China invest in next? To find the
answer, you need only go to Kimkan, an
open-pit mine in Russia. This muddy square
mile is almost impossible to drive to, but
just under its surface lies enough iron ore
to build hundreds of millions of cars. That’s
why Chinese officials are poring over it –
and many other Russian sites like it.
China is Russia’s largest trading partner
and the two are heavily reliant on each
other. Kingsmill Bond, Chief Strategist at
Moscow investment bank Troika Dialog,
says: “Russia has resources that China
needs, while Russia needs capital and
China has excess savings.”
In 2009, China replaced the US as
the world’s largest consumer of energy.
Water, oil, gas, iron, coal, copper, bauxite
– if you’re selling, China’s buying. It has
pumped money into African oil, invested
US$25bn (€17.4bn) in Australia’s resources
industry in 2009 and Shanghai is becoming
a world leader in ocean engineering as it
seeks oil and gas fields.
At the same time, the government
is reshaping its domestic resources
landscape. In Shanxi, the mountainous coal
heartland, local government has begun an
enforced consolidation which could close
95% of mining companies while doubling
the region’s coal production capacity to
1.2bn tons a year by 2014.
China’s first truly global business
may be in mining or energy. Four of its
ten largest companies sell resources.
PetroChina, the biggest to date, plans to
invest US$60bn (€41.6bn) over the next
decade in overseas exploration. Don’t be
surprised if it hits the acquisition trail: it has
a war chest of US$20bn (€13.9bn).
25
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Agenda April/May 2011
The big issue by Antonia Ward
26
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A new
kind of
power
game
Jeremiahs predicting ‘peak oil’ may be
overreacting – but companies that fail to rethink
their energy strategy may struggle to compete
North American
natural gas
resources are
running low
Jerry McBride/Press Association
o
ffer the typical CFO a 48% return on investment,
and they would be intensely curious but deeply sceptical.
And yet research by the Carbon Trust, the British not-for-profit
organization that encourages businesses to improve their
environmental performance, shows that investment in energy
efficiency projects delivers an average internal rate of return of
48%. This is an astonishing figure given that most finance
directors, when quizzed, suggested that such projects would
deliver a return of around 20%.
If that weren’t enough to convince the average CFO,
operations director, facilities manager or head of logistics to
focus on their energy use, the short- to medium-term horizon is
clouded by unpredictable energy costs, the threat or promise of
new energy efficiency legislation and concerns over security of
supply. Some boardrooms are alert to the dangers. AT&T
appointed its first Director of Energy in 2009. Some companies
rank energy risk ahead of health and safety, credit and security.
Volatile energy prices are hardly new. As Michiel Soeting,
Global Chairman of KPMG’s Energy and Natural Resources
Group, says: “It is very tough to make predictions around energy
supplies. Even if you consider specific niches like oil, price
spikes from all the way above US$100 a barrel down to US$30
make it very tough to predict. There are all kinds of estimates
about the investment required to upgrade and expand the
world’s capacity, and these are always measured in trillions.” He
also points to new technologies such as natural gas produced
from shale (and the great economic success of the Barnett
Shale in Texas) which “throw away all economic and demandsupply models. New extraction techniques mean there are
tremendous resources of gas coming on stream in the US,
which have actually turned the whole gas market upside down.”
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Agenda April/May 2011
The big issue
The various contradictory theories about ‘peak oil’ – the
point at which the maximum rate of global petroleum extraction
is reached, after which production enters terminal decline –
epitomize the uncertainty any business must confront as it
seeks to firm up its energy strategy. Some dismiss ‘peak oil’ as
an alarmist fantasy. Optimistic proponents of the theory suggest
the global decline in production will begin after 2020 – by which
time large-scale investment in alternative sources will avert any
crisis – while pessimists confidently predict a chain reaction that
will trigger the collapse of the global industrial economy.
Dr Richard Ward, CEO of insurance market Lloyd’s, believes
that a particular combination of pressures (constraints on
‘easy-to-access’ oil, the environmental and political urgency of
reducing carbon dioxide emissions and a sharp rise in energy
demand from Asian economies) will herald “a period of deep
uncertainty in how we will source energy for power, heat and
mobility, and how much we will have to pay for it”.
Businesses might be forgiven for a little eye-rolling at the
news that the end of the world (as we know it) is nigh. Again.
The existing model of access to relatively cheap, combustible,
carbon-based energy sources has been rendered obsolete.
Companies that merely protect their traditional energy practices
will be more insecure and less competitive.
So what can businesses do? “It’s important to separate oil
from energy,” says Dr Gary Kendall, former Executive Director of
think tank SustainAbility, whose clients include Coca-Cola, Shell
and Ford. “There isn’t an energy crisis: there is a liquid fuels
crisis. We’ve got dozens of technologies to generate electricity
and many of them are plain, efficient and sustainable. They’re
not without problems – you can’t put up wind turbines just
anywhere, for example, and solar panels take energy to produce
and cover land that could be used for something else. But there
are genuine opportunities to make the production of electricity
zero-carbon and efficient and we’ve got unlimited sources:
sun, wind and the rotation of the earth. It’s expensive, but only
because fossil fuels are artificially cheap. Companies will have
to ask what premium they are prepared to pay to get long-term
certainty and avoid volatility in the energy markets.”
In an era when energy will cost more and be less reliable –
for countries and companies – Kendall and Soeting maintain that
“There isn’t an
energy crisis:
there is a
liquid fuels
crisis. We’ve
got dozens of
technologies
to generate
electricity“
How smart is your grid?
Smart grids
Electricity networks that can
intelligently integrate the actions
of all users – including generators,
consumers and those that do
both – could hold the key to a
secure, efficient energy future.
“When countries enhance
connectivity, they become
significantly more flexible in
their energy mix,” says Soeting.
Smart meters
Connecting smart meters in
businesses and households to
central monitoring systems will
help utilities swiftly detect and
adddress outages or overloads.
No surprise, then, that China’s
investment in smart grids could
be worth US$100bn (€69bn).
IBM plans to launch nine smart
grid projects across China and
expects to generate US$400m
(€277m) in revenue there.
Smart protocols
China is perfectly placed to
establish nationally unified
protocols and standards. In
the US, specifications may be
decided on a state-by-state or
even utility-by-utility basis. China
is not retrofitting its smart grid on
to a 100-year-old infrastructure.
Intelligent control over electrical
power grid functions will turn
the distribution network from
a one-way street (running from
power plants to businesses and
homes) into a multi-direction
power network.
Even oil-rich Russia has
been driven to develop
its own electric car
a more diverse energy mix is the most
pressing priority. “I’m optimistic about
an increase in the energy mix,” says
Soeting. “To meet demand, the mix will
change to include coal, gas and oil,
definitely, and wind and solar eventually.”
Portugal and Norway have, he says,
benefited from forward-thinking policies
to integrate renewables into their energy
mix. But China remains the world’s
largest investor in renewable energy
projects, having spent around US$120160bn (€83-111bn) between 2007 and
2010. A fifth of all electricity generated in
China’s northern region comes from wind,
on a par with Norway and Denmark. Solar
power in China’s rural areas is expected
to grow by 20-25% annually.
Even a country with the most diverse
energy mix must improve delivery, says
Soeting. “The issue is around how we
create an infrastructure to make energy
available. How do you transport gas
from one side of the world to another?
How can you develop grids in poorer
developing countries, because a quarter
of the world’s population has no access to
electricity? We’re seeing positive trends:
initiatives in Turkey and the Black Sea,
pipelines through the Baltic Sea across
Europe. There is plenty of gas in Russia
but you need to make sure there is a
pipeline and that it’s uninterrupted.”
The investment required is so colossal
that governments will be forced to solve
many energy issues. “It’s important
to have proper government policies to
enable access to resources, to drive
sustainable behavior among consumers, to
encourage long-term investment and
stimulate technical development: in 2008,
the Bush administration opened up around
two million acres of federal property in
Wyoming, Colorado and Utah, starting the
oil shale development in that region,” says
Soeting. “Similarly, it’s important to have
subsidies and government grants around
renewable energy.”
Exploiting existing energy
management products and services
could mean installing smart electricity
management systems, organizing
operations to maximize energy
productivity and upgrading buildings.
Making it easier to control energy
consumption could mean introducing
flexible de-rating of plants, interrupting
processes at times of peak energy
demand and changing shift patterns.
Cost can encourage the right behavior,
says Soeting. “Where a company wants to
reduce cost, it might say ‘Let’s change our
lighting to lamps that consume
80% less than normal lamps. Let’s rent
28
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Powering down
Central Asia 2008
A widespread shortage and severe
winter in Tajikistan froze reservoirs
and in Dushanbe, the capital, power
to residential areas and many
businesses was cut.
When energy becomes a national crisis
North America 2005The price of natural gas
in North America has
rocketed as demand
outstrips supply. The
US chemical industry’s
natural gas costs are
estimated to have
rocketed by US$10bn
(€6.9bn) over two years.
energy-efficient buildings so we pay less
to utilities.’ At KPMG, we have just moved
into a new office with smart lighting – it
makes us feel good and makes us money.”
Auditing energy use is a logical place
to start. Energy efficiency has to be
brought to the attention of senior
management through regular reporting,
with clear responsibilities and targets
assigned to each area.
The ramifications of reconsidering
energy use could call entire supply chain
models into question. Companies with
long, complicated supply chains need to
consider their suppliers’ or logistics
operators’ potential exposure to energy
prices and security as carefully as their
own. The trendy ‘just-in-time’ business
model means disruptions can quickly
escalate costs and damage reputations.
Diversifying the energy mix isn’t
just a national issue, but a corporate
necessity. Investing in back-up generation
or more permanent domestic generation
facilities, possibly using microrenewables, could mean businesses are
able to benefit financially while mitigating
risk. Renewable energy production
on-site, meanwhile, could attract
government incentives, and smart energy
management could help make the most
of the short-term operating reserve
South Africa 2008
Lights went out in 2008,
as daily power cuts caused
chaos. In Pretoria, enraged
commuters set fire to
trains after long delays.
Bloomberg/Getty Images
Argentina 2004
Half the electricity supply depends
on gas-powered plants and natural
gas supply fell behind demand as
the economy rebounded in 2004.
Tankers of fuel oil had to be
imported from Venezuela.
China 2004
China’s energy
supply could not meet
the demands of its
booming economy.
The government raised
electricity prices, set
air-conditioning limits
and shifted factory
production times.
Iraq 2003Electricity supplies have
waned since 2003. In 2010,
four hours of power a day in
temperatures exceeding 50°C
led to widespread protests.
Pakistan 2008-10
A surge in demand and failing
infrastructure led to power
shortages across the country.
Last year, the government
banned neon lights.
market by increasing generation when the grid requires it or
reducing use when demand is high.
Using automated distribution to respond to demand – and
developing technologies to manage it – has been spurred in
part by plug-in electric vehicles. “The transport sector is 95%
dependent on oil,” Kendall says, “so the movement of goods,
services and people is 95% dependent on a single fuel. And for
150 years, our economic development has been predicated on
the assumption that oil supplies grow to meet rising demand.
That assumption is going to be turned upside down.”
Soeting believes electric cars could revolutionize the energy
industry. “When more people start charging electric cars
overnight, all these cars connected to the grid can act like an
energy storage device for large power companies – they will
actually produce power very efficiently because they know they
can offload excess capacity during the night from all these
batteries. If these cars stay connected, they can even tap back
from these batteries into the grid.”
Because of our dependence on oil, ‘black gold’ has become
the foundation on which the infrastructure of entire nations is
built. Which means, some experts say, that the multi-trillion
dollar investment needed to create smarter, greener national
energy supplies can only be provided by national governments.
New York Mayor Michael Bloomberg disagrees. As a key
player in the C40 Cities climate leadership group, Bloomberg
encouraged the rollout of electric taxis in Hong Kong and insists:
“Countries talk; cities act”. And companies, he might have
added, need to innovate. But how many actually are?
Jeremy Leggett, a former oil industry consultant who now
runs energy provider Solar Century in the UK, has suggested
that “the biggest challenge we face on securing our energy
future is a failure of imagination.”
29
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Agenda April/May 2011
Left field by Paul Simpson
The peril
of Utopia
Whether you’re Trotsky or FoxMeyer, don’t be so transfixed by dreams that
you can’t make an about-turn when it could save your organization
30
The basics
of change
management
Change is a means
to an end – better
performance. So...
1 Create a vision
and case for change
2 Align top teams
around the strategy
and required
performance
3 Engage
stakeholders
4 Craft your
communications
strategies and plans
5 Develop talent
strategies
6 Focus on
organization design
and capability
development
7 Boost cultural
change
8 Create effective
performance
management
9 Assess results
10 Act accordingly
closure of three warehouses and
prompted workers to fear for their jobs)
never gelled. Hundreds of staff had to be
called in to rectify the problems. You might
wonder why FoxMeyer pressed on. The
enormous carrot for directors was that the
company anticipated saving around
US$40m (€27.7m) a year.
So as the company encountered a
problem, managers would ask: “Is it
a deal-breaker?” No single flaw was
deemed serious enough to break the deal
– and it never occurred to anyone that the
frequency with which the question was
asked should itself have triggered a
rethink. FoxMeyer ignored all warnings
partly because management didn’t have
the internal expertise to gauge why and
how badly things were going awry.
Leon Trotsky was
punished by Stalin
for his ideological
flexibility in
challenging times
Hulton Archive/Getty Images
I
n 1920, People’s Commissar Leon
Trotsky reached what was, for him,
a terrible conclusion: the Communist
utopia would have to be postponed. “The
Soviet Union was at the very edge of the
abyss,” he wrote. Foreign trade was down
99.9%, the grain harvest had shrunk by
37% and Russia was only producing 4.3%
of the steel it had been making before
November 1917.
Time, Trotsky concluded, for a tactical
retreat from Marxist-Leninist ideological
orthodoxy. He suggested the state should
tax peasants rather than take all their grain,
and allow small businesses to operate.
After the Kronstadt sailors – who had
sparked the Bolshevik revolution –
rebelled, Lenin reluctantly agreed.
The New Economic Policy (NEP) started
in 1921. Fellow revolutionary Victor
Serge noted: “Famine and speculation
diminished. Restaurants re-opened and
pastries that were actually edible were
a rouble apiece.” Trotsky’s U-turn put the
economy on a sound footing, but after
Lenin died in 1924, Stalin abolished the
NEP, exiled Trotksy (having him
assassinated in 1940) and reverted to
the top-down, state-driven economic
policy which, pursued for 70 years,
wrecked the regime.
The NEP proved that even hardened
revolutionaries, backed by a ruthless and
powerful state, can only change so much at
once. Many bosses still ignore this lesson
– with disastrous results. If managers at
FoxMeyer, the US drug distributor, had
been more flexible, the company might
still exist. Its demise is cited as one of the
great supply chain disasters. In truth, what
killed FoxMeyer was less about supply
chains and more about catastrophic
mismanagement of change.
Every company has to revamp its IT
system and shake up its distribution
operations once in a while. With a fatal
audacity, FoxMeyer’s managers tried to
do both at once. But the new enterprise
resource planning (ERP) system and
the software used to automate its
distribution centre (which led to the
So confident were executives that they
began bidding for contracts with prices
based on expected cost reductions that
never materialized. Before long, FoxMeyer
was losing millions. In 1995, sales had
topped US$5.1bn (€3.6bn). In August 1996,
the firm filed for bankruptcy protection and
was soon sold for just US$80m (€55m).
Successful change management
projects can transform a business’s
performance, giving it a significant, durable,
competitive advantage. Poorly managed
initiatives where results aren’t properly
monitored can destroy a company. Their
better judgement swayed by a utopian
vision of an automated, low-cost future,
FoxMeyer bosses – unlike Trotsky – never
considered the judicious tactical retreat
that could have saved the organization.
17
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Agenda April/May 2011
C.S.I. New York/AF archive/Alamy
AOB
Need to know...
Forensic
What is it?
‘Forensic’ means ‘suitable for use in
a court’ so to some, it is about investigating
misdemeanors – from breaking company
guidelines to negligence and fraud – which
could result in litigation. Yet Adam Bates,
Global Head of Forensic Accountancy
at KPMG, says: “Forensic is also about
helping companies prevent fraud, deal with
regulators and mitigate risk. Businesses
need clear policies and well-designed
controls if they are to reduce the risk of
a major reputational or financial disaster.”
What are the right policies?
“Companies need to ensure employees,
customers and suppliers know how
to behave,” says Bates. “This includes
policies on expenses, bribery and
inappropriate adjustments to accounting
records, as well as a culture that
encourages people to report concerns
outside the normal management
structure.” He advises making policies
as succinct as possible: “You don’t
need 500-page manuals.”
What should companies look for?
Patterns in the data. “As much data was
created in the world in 2010 as had been
created in the years leading up to 2010,”
says Bates. “That’s a lot of data, but it does
give you more scope to spot transactions
that don’t fit.” If a third party supplier is
usually paid in a New York account and
mysteriously asks for payment in a tax
haven, that should raise the alarm. On
expenses, Bates suggests, claims should
be regularly investigated at random – that
way, a certain percentage of abuse will
be detected, which may also deter others.
And, Bates says, risks aren’t always internal
or even local: “Some companies who
thought their policies were tough have
been caught out in fast-growing economies
where policies were being ignored”.
When should management seek advice?
Dealing with expenses abuses is often
best handled internally, unless suspicion
falls on the very top of the organization. If
companies suspect they are the victim of
a more complex fraud, especially one with
an international dimension, they should
seek external aid. In such situations,
refusing to call in the experts is, Bates
says, “like having a problem with your
eyesight and buying your spectacles from
the grocery store, not the opticians.” Major
forensic investigations require a massive
team to hit the ground running quickly.
Internal audit/security departments,
squeezed by the financial crisis, just
don’t have the resources to cope.
Do recessions stimulate fraud?
The cliché suggests they do, but Bates is
not convinced. In his view, it’s more that
with revenues falling and businesses in
urgent need of cash, existing frauds are
more likely to be exposed. The headline
figures may suggest fraud is booming but
there is a time lag (sometimes of years)
between fraud being committed and
registering on a company’s radar.
Does technology make it any harder?
No. Bates says: “It just makes it different.
Some of our investigations don’t feature
a single scrap of paper.” He looks forward
to 2020, by which time every transaction
will leave an electronic footprint. The key,
he says, is how companies manage this
information: “You don’t want to be rich in
data and poor in insight.”
If there’s one question to ask, it is…
“What would do the most damage to our
business?” Bates adds: “Companies need
to map the risks and analyze the way these
risks are being mitigated, to understand
how exposed they are in each case.”
Contact us
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Agenda or request
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publication, please
email us at:
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governance, please
visit the Agenda
website at kpmg.
com/agendaonline
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1
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