The Antifragile Strategy

Jan09

One of the business magazines that I subscribe to recently posted its top five list of the best business books of 2013.  One of the books was Antifragile by Nassim Nicholas Taleb, who is also the author of one of the most thought-provoking books of recent years, The Black Swan.

In the Black Swan, Taleb made a convincing case that “Black Swans” i.e., large, improbable and highly consequential events are both unpredictable and, in many walks of life, deterministic of key outcomes.  This was an unsettling notion for many CEOs (and some strategy practitioners), as it suggested that classical economic-driven planning efforts are at best misleading and, in some scenarios, are useless.

Antifragile is a logical follow-on to The Black Swan and suggests that we must learn how to be less vulnerable to randomness and volatility and become “antifragile,” that is, poised to take advantage of stress, errors and changes.  This is tricky to do, because if we do too much to eliminate volatility (such as take frequent steps to eliminate small forest fires), we can make things more fragile (in the forest fire example make the “black swan” large forest fire disastrous).

So, the key question is, how can a company develop a strategy that allows it to be antifragile?  We suggest several areas to focus on which include, but are not limited to:

  • Invest in process-based competencies that allow you to quickly and flexibly respond to changes in your core markets, and don’t be afraid to outsource activities that are truly noncore;
  • Establish the right filters to stay in front of competitor and customer data, and be prepared to act on the data; and,
  • Understand and scrutinize the data thoroughly.

This last point on data is a critical one, particularly in this age of “big data.” What may seem like an acceptable conclusion based on a first glance at data may, upon doing some deeper, second-order thinking, not be such a good idea.  Taleb gives a flippant, but interesting, example of this in Antifragile, in which he asks if you would be comfortable if I told you we were going to leave your Grandma in a room at an average temperature is 70 degrees for the next two hours while you go out.  Many folks would say “yes” to this, but if you dug deeper and learned that I would set the temperature in Grandma’s room at zero degrees for the first hour and 140 degrees for the second hour, you may think differently (and not have a Grandma when you get back).

None of these suggestions are easy to do, as they require folks to think differently and, perhaps, in opposition to a company’s well-established cultural norms.  A little bit (or a lot of) discomfort in the strategy development process that allows a company to be more antifragile, however, could pay great dividends down the road.

 

 

Getting Acquisitions Right – Beware of NOT Letting the Facts Get in the Way

Jul23

Well-known British author and intellectual Aldous Huxley once made an observation that we at Avalon have to sometimes (gently) remind our clients of in some form, namely:

“Facts do not cease to exist because they are ignored.”

Although we’re pretty confident that Huxley did not make this observation while ruminating on a CEO’s track record with acquisitions, we know from our collective, deep experience in the acquisition domain that he could have easily done so.  Acquiring a business can be a complex, messy endeavor that involves transfers of people, personalities, processes, technologies, customer relationships, know-how and more, and it rarely, if ever, goes exactly as expected.  A strong story line on the surface (e.g., “immediately accretive,” “strong market fit” etc.) can mask underlying issues that may have been identified and addressed prior to the acquisition.

At Avalon we have found that an up-front, objective assessment of key performance and synergy (e.g., “softer”) characteristics across potential acquisition targets can make a critical difference in maximizing success (For a more complete process description, follow this link http://www.avalonassociates.com/our-approach/acquisitions/).  One client of ours successfully employed this process to acquire a company that helped it meet its primary goal i.e., industry diversification to reduce the impact of cyclicality in its core industry.  What defined this particular acquisition’s success, however, were the added capabilities that our client gained from the acquired company that enabled it to expand its core industry product lines and gain market share when the inevitable down-cycle came.

Our client’s success was driven by their objective assessment of the softer characteristics of its ideal acquisition targets, particularly engineering depth, product development capabilities, and management style.  Specific, well-defined and measureable metrics were developed, rated and weighted for each of these characteristics along with the more traditional financial performance metrics.  This fact-base proved invaluable in finding the right acquisition target and, just as importantly, eliminated some targets that our client thought were the best fit but fell short in important areas once all the facts were considered.

Hockey, Antennas and Adhesives

Jun17

Given that our Boston-based partners at Avalon are avid sports fans, we are fortunate in that we are experiencing an unusually high level of professional sports success in our city right now, with a possible 8th championship in 12 years across four major sports within reach.  As I write this, the Boston Bruins Hockey Club is playing in the Stanley Cup finals for the second time in three seasons and is on a roll.

One of the interesting stories on the Bruins is that of 41-year old Jaromir Jagr.  Jagr won a Stanley Cup with the Pittsburgh Penguins twenty one years ago.  In a profession where the average career is about three years, this is remarkable.  Over this time frame, the National Hockey League (NHL) has evolved on many different dimensions, including:

  • Number of Competitors – In 1991-92 the NHL had just added their 22nd team, in contrast to the 30 teams in the league today;
  • Technology – New technologies, such as hockey sticks made from fiberglass, composites or titanium instead of wood, have been introduced into the game;
  • Rules and Regulations – Many rule changes have been introduced, such as two-line passes to create more breakaway opportunities, but none as impactful from a business standpoint as the introduction of a spending limit for teams in the form of a salary cap; and,
  • Key Activities – offenses and defenses have evolved over the last twenty years in the NHL, and players are generally faster, better conditioned and more highly skilled due to better youth systems and education in/application of best practices in nutrition, skills development and conditioning.

Jagr is still playing in part because he has evolved along with the changes in the market and, in particular, has embraced the Bruins’ defense-first style of play that has proven successful in the current NHL market environment.  Moreover, in an industry where egos run rampant, Jagr has accepted a pay package that is commensurate with his contributions and fits within the mandated salary cap structure; he has not let his Hall of Fame credentials and past glory days skew the reality of what type of player he now is.

In the more mundane, but no less exciting, industries that Avalon typically works in such as antennas, adhesives, and controls, an attention to the details of how your competition and markets are evolving is just as critical to success.  The best companies will regularly evaluate their surrounding environment, assess the implications of any changes, and be prepared to act appropriately and rationally ahead of their competition as needed.  Unlike the NHL, however, sometimes these environmental changes, such as the introduction of a disruptive technology, entirely change the game that you are playing.

Understanding and effectively applying the Art of Strategy can be the difference between enduring, successful growth and the negative consequences of showing up for the proverbial basketball game with a hockey stick.

Using Data Strategically – Or Why Harvard Always Bests MIT

May10

For many amongst us, the recent release of college admissions notifications can yield some unexpected data that require important follow up decisions and, perhaps, some rumination about what should have been done. One such data point produced much shock amongst the representatives of the Avalon team that matriculated at MIT, namely that MIT accepted over 40%….40%!… more applicants this past year than Harvard did.

Fortunately, we at Avalon are all highly trained professionals and know not to accept facts without validating the legitimacy of data, sources of data, and method of analysis. In this case, the source was reputable (i.e., actual admission rate data from MIT and Harvard), the data points were accurate but the measurement was done on a relative basis that made it easy to draw the wrong conclusion.

Turns out, Harvard let in 5.8% of its applicants this year and MIT let in 8.2%. If you take the 2.4% difference between these two admission rates and divide it by the Harvard acceptance rate of 5.8%, you get a 41% difference! Accurate, but once you understand this data and put it in the right context, you realize that both Harvard and MIT are extremely difficult schools to gain acceptance to and the data was presented in a way that made it sound like MIT was a safety school for those sharp Harvard applicants.

This example illustrates an important element of strategic analysis, namely that it is critical in conducting objective, rigorous analysis to validate data and understand exactly the context and assumptions behind the data. This is especially important in the middle market, where fewer companies are public and good data on markets, financials, and competitors can be hard to come by. The old cliché “trust but verify” is highly applicable here, and the better discipline you employ with understanding the data, the better foundation upon which you can develop your strategy.

The Art of Strategy in Practice: Emerson Electric

Apr04

I read a recent interview with David Farr, CEO of Emerson Electric with great interest.  Emerson is a Fortune 500 company that was founded in 1890 and has nearly 128,000 employees and $25 billion in revenue today.  Given this scale and heritage, it would not seem a likely candidate for any awards involving nimbleness and innovation. After reviewing this article you might think again, as Emerson has done an admirable job of adapting to its competitive environment, leveraging its competencies and continuing on its impressive growth trajectory; in short, effectively employing elements of the Art of Strategy.  Some examples:

  • Emerson closely monitors its competitive environment and understands when the playing field has evolved in such a waythat they should either double down or exit a business, even if it involves exiting their original business (i.e., electric motors), as David Farr did shortly after becoming CEO.
  • Emerson is attune to industry trends and understand the opportunities and challenges associated with such trends and adapts accordingly; one key trend impacting their U.S. operations is the high rate of innovation in manufacturing automation (which is partly a response to high quality competition from other countries and also the drop off in U.S. technical skills).
  • Identifying and attacking new market opportunities that leverage Emerson’s core strengths and take advantage of trends; new markets include cooling in data center operations and industrial scale garbage disposers to handle food waste.

Our highest growth middle market clients may not have the resources of an Emerson Electric, but they share an appreciation for the importance of thinking strategically about their business and effectively employing the tools of the Art of Strategy on a regular basis to ensure that they maintain their leadership position.

What is Your Business Worth?

Mar26

One of the principle, if not most critical, considerations that either a buyer or a seller of a business has is valuation.  There are a number of well-used tools and approaches to business valuation that are commonly grouped into one of three categories:

  • Cash Flow/Income-based Valuations: as a business is ultimately only as good as the cash flows that it generates, this approach involves estimating the cash flow generation potential of the business over time.  Net Present Value (NPV) is one of the most common approaches used here.
  • Market-based Valuations:  this approach involves evaluating comparable companies in the market, deriving benchmarks for how these companies are valued and then applying these benchmarks to your company.  The most common approach here is using a multiple of earnings, typically EBITDA (Earnings before Interest, Tax, Depreciation and Amortization).
  • Asset-based Valuation: this approach involves estimating the value of all of the assets in a company, both tangible and intangible, and using that to estimate value.  This is frequently used in instances where there are lots of intangible assets and/or limited current income in the business.

A less frequently used method for businesses (but one which is used for real estate) would be to estimate replacement costs i.e., how much would I need to invest to build a similar business and use that as a basis for value.

There is no one right way to value a business and, although valuation professionals do not like to hear this, there is a healthy balance of both “art” and “science” in deriving a fair valuation.  In fact perhaps the most reliable method that Avalon has found in valuing small/midsize privately held companies is to ask the owner what they think their business is worth and then divide that number by two!

If you are a small or midsize business and are considering selling your business, or are a buyer seeking acquisitions of this size company, a few tips on how to handle valuation considerations are:

  • Be aware of how the other party thinks about valuation, and also how your particular industry customarily looks at value.  Different industries use different valuation metrics, and also command much different valuations.
  • Size does matter;  companies that are $20 M in revenue and lower command much lower relative valuations than large companies in the same industry.
  • Be current in your knowledge; EBITDA multiples, for example, will change depending on overall market and economic conditions, and that 7x that you could have gotten 18 months ago might now be more like 5x.
  • Use multiple methods to estimate value.

Ultimately, the right valuation is what a buyer and seller can agree to, and keep in mind that there might be other options (e.g., earnouts, contingent payments) that can help bridge gaps.

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