“In corporate finance, you are taught that a company doesn’t need to diversify because shareholders can always diversify. That’s true, but it also implies that if companies that aren’t diversified have core products that fail, the company fails too.”
A story in The Financial Times talks about a press release from Continental Auto Group—a German parts supplier to the automotive manufacturing sector. They announced a significant amount of employment cuts due to the shift toward electric and mobility in the automotive sector. At the same time, The Wall Street Journalreports that Cadillac, owned by General Motors, is preparing a big shift towards electric cars and is about to launch an all-electric SUV. They are requiring their dealerships to make upgrades to handle the sales and servicing of electric vehicles. Some dealerships don’t think the upgrades will generate the return on investment they want—and those dealerships are allowing Cadillac to buy them out.
This is not unexpected. It’s not that GM or Continental are doing anything wrong. When your strategy changes, your current shareholders and stakeholders are going to change too. The people who want to invest in you and associate with you will change. Some people may be the most climate-aware individuals, but they just don’t think Cadillac is the brand that’s going to make the electric transition, and they would rather open another dealership with a different maker.
Many years ago, I did a lot of investor relations strategies. There was one instance when a major resources company brought us in just after the investor relations team had done a series of interviews with the investment community. In the interviews, they asked one question: Are you going to be pleased with our decision to diversify? The investment community said no—they would sell their shares if the company diversified. There were two camps at the company. One believed they were in trouble if the shareholders left. The other camp believed that because a lot of companies diversify, theirs could do it too. But no one could make an argument or explain the logic of what is going to happen to them if they shifted.
Here’s the logic: In corporate finance, you are taught that a company doesn’t need to diversify because shareholders can always diversify. That’s true, but it also implies that if companies that aren’t diversified have core products that fail, the company fails too. It also implies that capitalism has efficient processes to save capital and redeploy it to another company or another investment, but the company will fail. But what if you don’t want your company to fail?
In our presentation, we told them that some of their shareholders would flee because they no longer want to associate with the company. Those investors have a portfolio of assets, and they buy shares to balance their portfolio to get a certain risk and reward profile. When a company diversifies, your impact on their investment profile changes. Of course, they’re going to sell you, but then someone else is going to want your equity to balance out their portfolio—and that’s not a bad thing. If your strategy is sound, you’re creating economic value and you’re managing risk, someone will want your shares. You have to find those people and educate them about the changes you’re making so that other institutional shareholders who want to own a diversified conglomerate will buy into your shares.
A version inspired by that study is coming to our Advanced Knowledge Management System—also called SLIDES—so you can see the thought process we used to help a company make that kind of transition. Every major company in the world is going to be thinking about this. As your strategy changes, how do you convince your board and management that an uproar from investors and stakeholders is expected? And how do you prepare to bring in new stakeholders to take their place?
You can see this in our Corporate Strategy and Transformation study where a company called Empire International is changing its business model. It’s moving away from servicing and for-profit activities to becoming a servicing engineering construction arm of Empire Energy. All the shareholders and stakeholders that bought into Empire Energy on the basis that one day they’d go private and have profits to bolster them are not going to be pleased. That’s a realignment of shareholders and stakeholders. If you want to see how to do that, that study is available to FIRMSconsulting Insiders.
This is an excerpt from Monday Morning 8 a.m. newsletter, issue #9.
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