News

April 2016

RE-INVENTING THE COMPANY (OR PERHAPS NOT)

Several weeks ago I read an editorial in “The Economist” (24th October 2015 for those who wish to read more) entitled “Re-inventing the Company”. Not surprisingly the editorial was about the impact of Uber on the London taxi business – and many other markets as well, including Australia. Uber has become the flagship of a new type of company structure known as a “disrupter” and is certainly the best understood of the disrupters because the taxi business is relatively easy to understand. The focus of the editorial was on the fact that when you transact business with a disrupter you are generally also dealing with the owner instead of anonymous shareholders of multinational corporations (MNCs), many of whom are fund managers emotionally and physically disconnected from day-to-day interaction with customers. “The Economist” concluded that disrupters could transform the way companies work.

My only point of disagreement with The Economist editorial was that disrupters have been around for some time, but have been operating silently because, unlike taxis, they are generally hidden from the view of the general public. When I was growing up in a Victorian country town in the 1950s we had the choice of two local bakeries to buy our bread and this was largely the same throughout the state and probably Australia. The MNCs (three in number as I recall) then moved into the market and, before we knew it, all small bakeries in the state had closed and we were forced to buy our bread from the local supermarket. The small bakeries were legislated out of business, but disrupters
soon emerged and under pain of heavy fines and even custodial sentences, fought back to change the laws to the point where the small bakers today again control the market. Why do they control the market? There are several reasons, but two of the most important are:

o The customer is dealing with the owner who cares about the customer – not an anonymous investment fund whose only interest is increasing profits.

o Value for money, that is, not necessarily a lower price, but a better quality at a fair price.

Did the bakers simply return to their previous business model? No, they examined new business models and developed different ownership structures, such as franchises, and expanded their product ranges so they could meet the needs of culturally-diverse market.

The new disrupters are developing new business models to change the traditional way a particular business operates and Uber is a classic example of this practice. Disruption will often require laws to be changed or even the introduction of new laws. For example, the Turnbull government recently decided to accept the Harper report on Competition Policy which will result is significant deregulation as well as toughening laws (for example, ACCC) to ensure fair competition such as removal of the agency system in our own market. If you believe that deregulation has only a small part to play in the process think back to deregulation of civil aviation in Australia in 1988 and the death of the so-called “Two Airline Policy”. One of those “two” airlines has since departed the scene and two new airlines (Jetstar and Virgin Australia) dominate the market today because of their low fares which reflect their new business models.

Most disrupters benefit from revolutionary, low-cost IT and, indeed, it could be argued that the IT purveyors were amongst the earliest disruptors creating a platform for others to revolutionise business. Uber would not exist if it was not for the iPhone and think of what iPhone did to Kodak and the global music recording business. Think of what email has done to post offices globally, not just in Australia.

Disruption has been present in our own industry since the formation of AIRR which strengthened another group of disrupters, the privately-owned rural store which was competing against the establishment stores of Landmark and Elders. AIRR, of course, commenced operations with a new business model that prioritised efficiency and customer service, something not witnessed before in our industry. We have seen the impact of AIRR as a disrupter through Elders’ financial struggles over the past decade and, to prove my case, Landmark failing to meet the financial objectives of the Wall Street investment funds which control Agrium, the owner of Landmark. APPARENT is also a disruptor as are many of the small companies which sell generic crop protection and animal health products to the Australian market, thanks largely to enlightened legislation which decided that the principle objective of national regulator, APVMA should be to deliver low-cost, high-quality generic crop protection and animal health products to Australian farmers. I was working with a crop protection MNC when APVMA was established and I can assure you that they fought tooth and nail to remove these concessions prior to passage of the legislation through parliament, but in the end were unsuccessful. Of course the foresight of the MNCs was correct based on their now rapidly diminishing share of the Australian market and the fact that they are now merging to maintain the profit levels that their shareholders demand.

When one combines the three disrupters (AIRR, APPARENT and privately-held rural stores) the outcome is potentially even more beneficial for the customer and more devastating for competitors adhering to a traditional business regime. However, the immediate response of competitors to date has been “more of the same” rather than “how can we change the way we operate to compete?”

My attention was then drawn to another article, this time published by Credit Suisse (July 2015, if you wish to read more), “The Family Business Model”. This was the second such
study conducted by Credit Suisse. The first study, published in 2007, found that family-owned and managed businesses compared with public companies with anonymous shareholders was a superior form of structure because of:

o Long-term commitment of owners
o Visible and identifiable ownership, in contrast to ownership by numerous insti-tutional investors
o Track record of standing by their companies during hard times
o Trademark names that continue to open doors in the business community
o Consistency in decision-making and business practice, thereby lowering the business risks for external providers of capital
o Better alignment of owner and management interests

The more recent study confirmed all of the above, but found that family companies generally now earn a higher return on equity (ROE) than their public competitors and attribute this surprising development to:

o Desire to maintain control leads to more cautious and more efficient manage-ment and strategies
o Focus on value-added products and brand development
o Focus on core activities means they are less acquisitive and growth is organic
o Investment intensity (R&D or capital expenditure) is lower, but more efficient.
o Value creation through superior cash flow and asset growth

These studies were conducted on the performance of large, publicly-listed companies and a family company was defined as a company where the founding family maintained a controlling shareholding (even if listed on a stock exchange) and continued to manage the corporation (for example, Walmart, Mars, BMW, Google, L’Oreal). However, these principles apply equally to a family-owned rural store, AIRR and APPARENT as they do Ikea or Samsung.

When business began several hundred years ago, by dint of limited transport and communication facilities, virtually every business was a “family business” and, if not, was probably a partnership of two or more families. Thus, based on the Credit Suisse report, there are many advantages in returning to the family model, but if that family model is also a disrupter (think Google or Facebook) then the benefits – as measured by ROE – will be magnified many times over. But then think of the benefits if inter-dependent groups of family-controlled, disruptor businesses combine and act with a single purpose – to deliver the highest quality crop protection and animal health products to Australian farmers at a fair the lowest price.

However, I would like to end this article with a cautionary story. My first job in the commercial sector was with IBM (probably the earliest disruptor) and while the company did not invent the computer, it placed a computer in 70% of all businesses globally and developed the PC which is now found in virtually every home and school room. IBM was highly successful at everything it did, but developed a corporate arrogance that was pervasive. IBM had seven competitors and even developed a colloquial name for itself - “Snow White and the Seven Dwarfs”. Then one day a young entrepreneur visited and asked IBM to develop a software package for his fledgling company. IBM was so unimpressed with the entrepreneur that they supplied him with a software package off- the-shelf known as QDOS (Quick & Dirty Operating System), ignored contractual niceties, charged him US$100,000 and saw him on his way. The young entrepreneur was Bill Gates who founded Microsoft, QDOS became “Windows” and the rest is history. Microsoft grew to become the pre-eminent global IT company and IBM - which at the time was the world’s largest company by market capitalisation - commenced its decline. The cautionary story should have ended here, but it did not because yet another disrupter, Apple entered the market and subsequently took over Microsoft’s mantle. The moral of the story is that disrupters cannot afford to rest on their laurels because there may be another disrupter around the corner who has a better idea on how to run your business.