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.