Restructuring cure two-dimensional<\/p>\n
By Inghie Kwik<\/p>\n
JAKARTA (JP): Bernd Waltermann, president of PT Boston
\nConsulting Group wrote an article titled Corporate restructuring
\ntoward growth: 'C' curve, which was published on Jan. 6.<\/p>\n
Next to the article, Waltermann produced a graph showing the
\ntrajectory of 58 U.S. companies that underwent restructuring
\nefforts in the 1990s. The trajectory was plotted along two
\nvariables, with profitability on the vertical axis and investment
\non the horizontal axis.<\/p>\n
Successful restructuring efforts were shown to move left
\n(reduced investment), up (increased profitability) then right
\n(increased investment).<\/p>\n
Unsuccessful companies, starting from the same point, were
\nshown to increase investment with little improvement in
\nprofitability. The total graph depicted the letter \"C\", hence the
\ntitle of the article.<\/p>\n
On the basis of this graph, Waltermann suggested that
\nIndonesian companies follow the C curve in order to emerge from
\nthe crisis with higher profitability and better capital
\nallocation.<\/p>\n
The title and the graph of the article were attractive,
\nespecially since the article was authored by a senior member of a
\nwell-known firm. After careful reading, however, it was clear
\nthat the article was statistically misleading, and that the
\nadvice provided by Waltermann could be wrong for Indonesian
\ncompanies to follow.<\/p>\n
First of all, for Waltermann to make a general conclusion on a
\nsample of 58 U.S. companies is simply appalling. Take the
\npopulation of companies undergoing restructuring in the U.S. in
\nthe 1990s, and it is reasonably certain that each draw of 58
\nrandom samples would provide a different trajectory -- possibly
\neven representing different letters in the alphabet. With several
\nmillion firms operating in the U.S., how can Waltermann provide
\nany advice merely based on the performance of 58 companies?<\/p>\n
From his profession, Waltermann should know that the nature of
\na company in distress is simply too complex to be depicted along
\ntwo axes. Restructuring alternatives could not be force-fitted
\nalong a two dimensional curve. For distressed companies in
\nIndonesia, if there were any common underlining symptoms, they
\nwould be excessive debt to equity ratios and dismal productivity
\nlevels, when compared to international standards.<\/p>\n
These are not problems that can be solved by simply \"doing the
\nC-curve\". In fact, in many current cases of distressed Indonesian
\nfirms, management does not even have the leverage to think along
\ninvestment versus profit trade-offs. Their problems are often far
\nmore severe than suboptimal portfolio\/resource allocation.<\/p>\n
Another flaw in Waltermann's article is the underlying
\nassertion that for companies under distress, profitability and
\ninvestment are mutually exclusive choices.<\/p>\n
To provide a simple example, suppose that a widget company is
\nundergoing financial distress because its manual labor simply no
\nlonger produces products that are cost\/quality competitive with
\nits automated competitors.<\/p>\n
The company produces only one variety of widgets, and its
\nmarket share is rapidly being eroded by its better competitors.
\nSuppose that the only way for this company to maintain its share
\n(and profit) would be to get a bank loan to purchase automated
\nwidget machines and replace its manual labor.<\/p>\n
Waltermann's article suggested that such a widget company
\nshould not increase its capital base (e.g. don't get the loan)
\nbut instead find a way to become more profitable before further
\ninvestment. Yet in this case, profitability and survivability of
\nthe company depends on further investment.<\/p>\n
This may be a simple example, but if Waltermann has been in
\nIndonesia long enough, he should know that many companies here
\nface similar conditions as this example shows.<\/p>\n
Waltermann's article seems to assume that most companies have
\nportfolios of businesses that could be easily purged by
\nmanagement. This is certainly not the case in Indonesia and it is
\ndoubtful that this would be the case in the U.S.<\/p>\n
There are many companies that produce single products through
\nsingle business units. These companies do not have the freedom to
\n\"clean-up\" their portfolios as suggested. Even with companies
\nthat do have portfolios, \"cleaning-up\" by selling assets in
\nIndonesia today is probably one of the worse things to do given
\nthe depressed asset values and an illiquid market for assets. Of
\ncourse, some companies may be forced to do so in order to pay
\nback debt, but this is an entirely different issue.<\/p>\n
Finally, the nature of company distress should never be
\ngeneralized. Of course, as a rule of thumb, the pursuit of
\nprofitability before additional investment is always a good
\nthing.<\/p>\n
Nevertheless, most restructuring cases are far too complex to
\nfollow simple profit\/investment trade-off. Problems within
\ndistressed companies could stem from a multitude of internal and
\nexternal factors.<\/p>\n
Internally, they could stem from weaknesses in human
\nresources, organization, product development, strategy and
\nmarketing. Externally, they could be caused by changing
\ntechnology, changing demand patterns and macroeconomic shocks.<\/p>\n
Suppose a company has an excellent product, but is dying
\nbecause it simply has no money for a major advertising campaign
\nduring a down cycle in the market. Should such a company refuse
\nto increase its capital base and opt for profitability. How?<\/p>\n
For most unsuccessful turnarounds, corporate distress follows
\na spectrum of symptoms that ends with financial disaster. The
\nbeginning of distress is normally characterized by a
\ndeterioration in product, customer and\/or distribution channel
\nprofitability.<\/p>\n
The next level of distress is a deterioration in productivity
\nmarked by increases in labor\/material unit cost, increases in
\nsales\/marketing expenses and\/or increases in
\nfinance\/administration expenses.<\/p>\n
As the company moves closer to financial disaster, its revenue
\ngenerating capabilities would deteriorate as characterized by
\nfalling unit sales by customer, product line or distribution
\nchannel. This normally leads to decreasing capacity utilization.<\/p>\n
Deterioration in balance sheet structure normally follows.
\nDebt\/equity ratios balloon and current ratios collapse. Without a
\nturnaround at this level, a firm would eventually face the
\ninability to pay secondary cash flow commitments such as purchase
\ncommitments and fringe benefits.<\/p>\n
Finally, the death blow would arrive when the firm was no
\nlonger able to pay primary contractual cash flow commitments such
\nas interest payments, taxes, accounts payable and salaries.<\/p>\n
Each of the aforementioned symptoms need different solutions
\nand require careful balancing of complex decisions along many
\nimportant variables. At times, it may even become necessary to
\nincrease the capital base (e.g. get a new loan) simply to
\ncontinue the payroll, especially when the cost of liquidation
\nwould be higher than the cost of a going concern, even with
\nadditional investment.<\/p>\n
Granted, there are times when companies could face a C-curve
\ndecision, but this is only one among a myriad of decisions that a
\ndistressed company faces. Doing the C curve is certainly not the
\nkind of panacea that Waltermann was trying to portray.<\/p>\n
The writer is a businessman with previous experience in
\nconsulting and corporate restructuring.<\/p>",
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