Corporate restructuring toward growth: 'C' curve

Corporate restructuring toward growth: 'C' curve

By Bernd Waltermann

JAKARTA (JP): During this period of reshaping Indonesia's
companies and its economy, many executives look for lessons from
international experience on corporate restructuring to guide
their own management agenda.

One set of useful lessons on corporate restructuring comes
from the United States and is illustrated in what The Boston
Consulting Group (BCG) calls the "C" curve.

The first lesson is that to create value in a turnaround, most
businesses must first cut the capital employed in the business
and aggressively improve profitability -- before growing.

The second lesson is that successful restructuring for value
takes time, not one year but several years -- even in countries
with healthy capital markets.

The "C" curve illustrates these lessons through a sample of 58
U.S. companies that tried to restructure their businesses during
the 1990s.

Before beginning their turnaround programs, these companies
had profits in the lowest 25 percent of all companies as measured
by after-tax return on average capital employed (ROACE). The top
curve, the "C" curve, is the path followed by companies making
successful turnarounds. The bottom curve is the path traced by
companies that started from the same position but were much less
successful.

The chart's horizontal axis shows the capital employed in the
business versus the time from when restructuring started -- 1991.

So a company moving to the left of "1" is shrinking the
capital employed in the business. The vertical axis shows
profitability as measured by ROACE. Moving up on the chart means
getting more profitable.

Successful turnarounds are defined by companies that increased
their historical below-market shareholder returns to above the
market average. Unsuccessful turnarounds are defined by companies
that continued to deliver shareholder returns below the market
average even after years of attempted restructuring.

What happened in this sample of companies?

According to BCG, "C" curve companies aggressively cut capital
employed, create profitability and then capture new growth to
create value and compete. These successful turnarounds pursued a
very clear program to "clean up" their portfolios, reducing
investment in low-return businesses and improving the
profitability of their companies to acceptable levels before
growing.

These companies created superior value for shareholders by
restructuring the portfolio to deliver profitability, initially
shrinking their capital base typically by 20 percent to 30
percent and, at the same time, more than doubling profitability
(ROACE).

In contrast, companies that failed in their restructuring made
only marginal progress in improving profitability and did not
undertake restructuring actions that meaningfully reduced the
capital base.

In fact, the unsuccessful companies actually grew their low-
return portfolios, destroying shareholder value. The message is
clear in a turnaround as suggested by BCG: Seek profitability
before growth even when it means a significant reduction in
capital employed. Follow the "C" curve to create profitability
and shareholder value.

For the restructuring winners, three-quarters of the reduction
in capital employed came from the actual selling of assets, not
simple write-offs or accounting magic. These management teams
made hard choices about what businesses stayed in the portfolio
and what was divested. They made continual progress on driving
profit improvement. They set a clear priority on improving
profitability before pursuing growth.

The other message is that restructuring takes time. It cannot
be dictated or quickly achieved -- even in strong markets. For
the successful turnarounds, the heavy restructuring period (when
profitability was improving as the asset base shrank) typically
lasted two years to three years. It is important to set realistic
expectations, as management teams and as policymakers.

Management teams should take a hard look at the capital
employed in businesses. They should understand what they need to
do to get competitive levels of profitability and an asset base
that creates economic value in the business. They are required to
set aggressive but realistic targets to guide your restructuring.

The teams can expect to shrink in order to grow with
profitability, expect to make portfolio choices across businesses
and within each business based on value management disciplines,
expect a marathon, not a sprint, and follow the "C" curve to
recovery.

The goal of Indonesia's restructuring should be for Indonesian
companies to emerge from the crisis with higher profitability,
better capital allocation and capital efficiency and a value
management approach to balancing profitability and growth for the
future.

Hopefully many Indonesian companies will follow the "C" curve
in their own way to create value and competitiveness for
Indonesia's future.

The writer is president director of PT Boston Consulting
Indonesia based in Jakarta.