Friday, 2 June 2017

Corporate Portfolio Strategy. Constructing a portfolio of businesses.

Each firm should manage its portfolio of businesses by determining whether it is the best owner of each business in the portfolio.
  • That is, whether it can create the most value from each business it owns.
  • If so, then the firm should keep the business.
  • If not, the firm should divest the business for a value that exceeds its value to the firm.
It should use the same basic philosophy when considering adding businesses to the portfolio.

Firms that can add the most value to a business usually have one of five advantages:

  1. unique links with other businesses within the firm,
  2. distinctive skills, 
  3. better governance,
  4. better insight and foresight, and 
  5. an influence on critical stakeholders.

The firm that can offer one or more of these advantages can change over time as the firm, business, or economy changes.

  • At the beginning of a business, for example, the founders are the best managers, but this will usually change.
  • The needs of the business change as it expands and needs additional capital, a wider variety of management skills, and more connections to other businesses such as buyers and suppliers.
  • A typical path of a business begins with the founders and end in a conglomerate corporation.

When constructing a portfolio of businesses, the firm should take five steps:

  1. assess the gap between a firm's current value and its as-is-value,
  2. identify internal opportunities to improve operations,
  3. determine if some businesses in the firm should be divested,
  4. identify potential acquisitions or the initiatives to create new growth, and 
  5. assess if the company's value can increase from changes in capital structure.

Diversification considerations are not part of the list.

  • The purported benefits of diversification are illusive, while the costs are real.
  • For instance, diversification can hurt the value of the firm it it lowers the ability of the managers to focus on how to create value for each of the various businesses.

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