Managing a Business/Management answers needed
Could you please help me with the answers of following questions
1. Discuss the terms ‘Ownership’ and ‘Management’ with reference to Public Enterprises.
2. What is Social Audit? Explain the need for Social Audit in the present context.
3. “There are some important features of the State Level Public Enterprises (SLPEs) in the country with a little or no difference between one state and the other.” Critically comment on the statement with special reference to coverage and features of SLPEs.
4. Define a Project. Explain the characteristics and stages of a project. Illustrate your answer with the help of a hypothetical example.
5. How can Restructuring and Commercialization render Public Enterprises more attractive to potential investors? Explain giving relevant examples.
6. Write short notes on the following.
a) Public Accounts Committee (PAC)
b) Turnaround Strategies
c) Management Buy Out.
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5] How can Restructuring and Commercialization render Public Enterprises more attractive to potential investors? Explain giving relevant examples.
There are several restructuring methods: doing an outright sell-off, doing an equity carve-out, spinning off a unit to existing shareholders or issuing tracking stock. Each has advantages and disadvantages for companies and investors. All of these deals are quite complex.
A sell-off, also known as a divestiture, is the outright sale of a company subsidiary. Normally, sell-offs are done because the subsidiary doesn't fit into the parent company's core strategy. The market may be undervaluing the combined businesses due to a lack of synergy between the parent and subsidiary. As a result, management and the board decide that the subsidiary is better off under different ownership.
Besides getting rid of an unwanted subsidiary, sell-offs also raise cash, which can be used to pay off debt. In the late 1980s and early 1990s, corporate raiders would use debt to finance acquisitions. Then, after making a purchase they would sell-off its subsidiaries to raise cash to service the debt. The raiders' method certainly makes sense if the sum of the parts is greater than the whole. When it isn't, deals are unsuccessful.
More and more companies are using equity carve-outs to boost shareholder value. A parent firm makes a subsidiary public through an initial public offering (IPO) of shares, amounting to a partial sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the newly traded subsidiary.
A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is growing faster and carrying higher valuations than other businesses owned by the parent. A carve-out generates cash because shares in the subsidiary are sold to the public, but the issue also unlocks the value of the subsidiary unit and enhances the parent's shareholder value.
The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains some control. In these cases, some portion of the parent firm's board of directors may be shared. Since the parent has a controlling stake, meaning both firms have common shareholders, the connection between the two will likely be strong.
That said, sometimes companies carve-out a subsidiary not because it's doing well, but because it is a burden. Such an intention won't lead to a successful result, especially if a carved-out subsidiary is too loaded with debt, or had trouble even when it was a part of the parent and is lacking an established track record for growing revenues and profits.
Carve-outs can also create unexpected friction between the parent and subsidiary. Problems can arise as managers of the carved-out company must be accountable to their public shareholders as well as the owners of the parent company. This can create divided loyalties.
A spinoff occurs when a subsidiary becomes an independent entity. The parent firm distributes shares of the subsidiary to its shareholders through a stock dividend. Since this transaction is a dividend distribution, no cash is generated. Thus, spinoffs are unlikely to be used when a firm needs to finance growth or deals. Like the carve-out, the subsidiary becomes a separate legal entity with a distinct management and board.
Like carve-outs, spinoffs are usually about separating a healthy operation. In most cases, spinoffs unlock hidden shareholder value. For the parent company, it sharpens management focus. For the spinoff company, management doesn't have to compete for the parent's attention and capital. Once they are set free, managers can explore new opportunities.
Investors, however, should beware of throw-away subsidiaries the parent created to separate legal liability or to off-load debt. Once spinoff shares are issued to parent company shareholders, some shareholders may be tempted to quickly dump these shares on the market, depressing the share valuation.
A tracking stock is a special type of stock issued by a publicly held company to track the value of one segment of that company. The stock allows the different segments of the company to be valued differently by investors. Let's say a slow-growth company trading at a low price-earnings ratio (P/E ratio) happens to have a fast growing business unit. The company might issue a tracking stock so the market can value the new business separately from the old one and at a significantly higher P/E rating. Why would a firm issue a tracking stock rather than spinning-off or carving-out its fast growth business for shareholders? The company retains control over the subsidiary; the two businesses can continue to enjoy synergies and share marketing, administrative support functions, a headquarters and so on. Finally, and most importantly, if the tracking stock climbs in value, the parent company can use the tracking stock it owns to make acquisitions.
Still, shareholders need to remember that tracking stocks are class B , meaning they don't grant shareholders the same voting rights as those of the main stock. Each share of tracking stock may have only a half or a quarter of a vote. In rare cases, holders of tracking stock have no vote at all.
Reasons for privatization/commercialization
The desire to involve the private sector in the management and provision of public enterprise/
infrastructure /and services is prompted by the recognition that government regulations and
processes are not always conducive to efficient operations of commerce al activities and by
recognition of the private sector's relative strength in this field. Also, in recognizing that
investment sources outside government must be tapped in the provision of such enterprise infrastructure
and services involvement of the private sector provides the opportunity to share risks and, in
times of rapidly changing economic environment to respond quickly to market/demands and
The principal strengths of the private sector
A] A much stronger management capability due to its ability to recruit and compensate qualified managers and technicians;
b)Relative freedom to operate outside of political and bureaucratic constraints (e.g.
in procurement and the working of overtime);
c] Better company specific labour management;
d)Potentially greater experience in developing facilities and providing services attuned to the competitive world of global trade; and
e)Access to non-traditional resources for investment in the infrastructure to serve trade which some individual governments may lack.
These attributes of the private sector enable it to respond rapidly to market changes through speedy decision making and investment.
Government policy to promote private sector involvement may, therefore, include the following long-term aims which can be achieved through partnership:
A]Improve efficiency and productivity of operations
One of the foremost if not the primary reason for involving the private sector in the
operation and management of public enterprise is to increase efficiency. It is generally considered that a
profit oriented investor operating in a competitive environment will strive to minimise costs and
improve services. These are necessary measures if the operator is to retain and expand the
clientele whilst earning a satisfactory return on investment. With this in mind some governments
have turned to the private sector to exploit the functioning of this market discipline in their public enterprise.
The Government's objective is not to achieve profits for the private investor per se.
Rather the goal is to improve efficiency and thereby reap the benefits of lower cost and improved
enterprises. Enhanced performance also makes a nation more attractive for new investors that will be major consumers of transport 'services, for example,
foreign and domestic industrialists.
b)Reduce the financial and administrative burden on the public sector
Public management of an enterprise on a day-to-day basis generates a
considerable demand on governmental resources in terms of time and personnel for what is
largely a commercial enterprise. Whilst this resource demand falls most heavily on directly
concerned ministries and agencies it can be shown that it frequently spills over to those peripherally involved (e.g., Treasury) organization and even to the Cabinet itself.
In the process of re-engineering the functions they undertake some governments have adopted
Privatization [commercialization ] at least in part, for the public sector. Whilst professionals in government will continue to be required to manage the residual responsibilities that the government chooses to
retain, they will only be a fraction of those that were on the public roster when it played the combined
roles of owner, manager, operator and regulator. The argument can be made in many countries,
however, that there need not be an overall diminution of employment in the sector as increased
efficiencies and enhanced performance can lead to greater competitiveness resulting
in growing throughput and resultant demand for staff.
Transferring activities to the private sector puts them into the business realm where only those
positions which are required to undertake the successful and profitable commercial mission
of the public enterprise, are retained. Thus, not only will there be a substantial reduction in governmental personnel focused on the public enterprise, but also a reduction in the total number of managers and labour involved per fixed amount of traffic handled.
c)Generate maximum revenue and reduce investment
A valid reason for the commercialization of public enterprise can be to generate increased revenue for
The government. This can be achieved through improvements in efficiency and reductions in costs
which can be translated into profit sharing possibilities. Importantly, government can also reduce its risk in terms of revenue expectation by divorcing lease payments from the amount of throughput;
however, this would be at the cost of forgoing increased income from expanded
business levels. If this is the principal objective it is important that it be acknowledged as its successful
attainment will be determined by the approach adopted.
A number of governments, have adopted privatization in part as a tool of broader social policies aimed at redistributing wealth or moving marginal communities
closer to the middle of the economic mainstream. The aims of such policies cannot be faulted,
but where they are to be applied they should be clearly enunciated.
Privatization decisions based on social objectives will have direct implications as to the
implementation approach ultimately adopted. As with all privatization objectives, 'such an
approach should be devised not only with the social target in mind but should ensure that the preferred
role of the port is also achieved.
e) Promote private sector involvement in the economy
Some economies have been primarily driven for several decades by governmental
spending. The Government's role has been pervasive resulting in a large bureaucracy. Even industrial
activities, transport, distribution and retailing have-been carried out, at least in part, bypublic
sector enterprises, which has directly inhibited private sector investment and large segments
of the private sector may have atrophied.
To redress this situation, one motive announced by some governments for privatization is
to increase opportunities for private investors, either directly or through share purchases. The
intent is to create enhanced entrepreneurial activity with anticipated multiplier effects throughout the
1]Attract new or additional business and trade
On some occasions private project sponsors are solicited who are already involved in trade
or transport services . The rationale is that if a port user such as a
shipping line which controls a significant amount of cargo becomes an investor, it can be expected
that much of the investor's traffic, which may be discretionary in its routing, will be funnelled
through the port.
If this motivation applies to a particular privatization programme, care should be taken
in the formulation of any pre-qualification of bidders and in actual contract negotiation. For example,
some shipping lines have a separate stevedoring or terminal management subsidiaries so
that arrangements with the port operating group will not necessarily ensure capture of the
parent company's business. Obviously, actual investment by the group is more likely to generate a
focus on a particular port than will a simple management contract.
Within any approach to involving the private sector in the financing and operation of
ports and related activities, an additional important element is the sharing of risk. Clearly it is
important to define the objectives of the programme of commercialization/privatization as it will
serve as a measure of risk. While this is dealt with in a later section related to the protection of
the investor/operator, it can be an important reason for governments to consider involving the
private sector as a means of reducing exposure to economic, technological and management risk.
The consequential objectives arising out of these long-term policy aims may include a number of the following:
A]Promoting private sector involvement in the development of port infrastructure or provision of services;
the need for government investments in the sector;
c) Upgrading the professional skills of port managers, staff and workers;
d) Creating competitiveness in the provision of port services and operations;
surplus workers and restrictive labour practices;
f)Spreading the ownership (affirmative action); and
Attracting foreign investment and importing foreign expertise.
g) At the operational level, the policy aims may be translated into the following operational
objectives which will require the formulation of a comprehensive development strategy:
Establishing quantifiable operational targets (e.g. what level of efficiency and
productivity of the enterprise may reasonably be expected to achieve);
the throughput capacities of the various elements of the enterprise;
b]Identifying the facilities or services in which private sector participation is desirable or should be promoted;
c]Assessing the true operating costs of the port to provide a basis for the "privatization" exercise;
d]Identifying alternative funding sources, including whether foreign investment is
necessary or desirable and the means through which such investment could be attracted.
the areas where new technologies might be introduced; and
a strategy for rationalizing labour structure and practices.
It is important that there be a clear internal (and preferably external) understanding as to
what specifically the government intends to accomplish via its commercialization and
privatization programmes. The conclusions reached in the above considerations, when coupled
with the factors addressed in the following section, provide the essential framework for devising
the most effective project-specific approach to commercialization or private sector participation.
By comparison with the complex framework within which government operates, the
private sector functions within a commercial environment which is relatively straightforward and
easily defined. This in itself is one of the strengths' of the private sector and given adequate
freedom to operate, allows the private sector to focus its resources on specific criteria of success.
Among the primary private sector objectives of joining public-private sector partnerships and
which may be harnessed in achieving broader goals are:
An overriding aim of the private sector is to make an appropriate return on its investment.
It is this consideration which is the driving force in a competitive environment, and which
encourages attainment of the highest levels of efficiency. An objective of the private sector
involving itself in infrastructure development is, therefore,.to identify opportunities where its
skills and resources can best be employed to maximize returns within an environment of
manageable risk. Government actions to control tariffs or cap profits, therefore, will have a
direct impact on the primary objective of the private sector and may make projects unattractive
unless well defined.
b)Spreading investment risk
Major companies and organizations in the private sector that have built special
capabilities and skills in a particular area are sometimes exposed to investment risk either within
the sector or the country in which they operate. In addition, through their successful operation
in other areas they may have built large capital reserves which they would wish to employ
effectively. These are strong reasons for the private sector to seek to diversify their investments
while at the same time focussing on areas where they have proven competence and competitive
advantage. Governments may be able to exploit this objective of the private sector by providing
suitable investment opportunities.
marketing positioning and creating a vertically integrated operation
The private sector relies heavily on its reputation for successful implementation of
projects. While some projects may be less profitable, they can provide an essential introduction
to follow-up or downstream activities. Examples include proving their capability of working in
third countries or exploring opportunities to broaden investment through the development of
infrastructure related to their main area of business, such as provision of office accommodation
which may be integrated with mass transit rail systems. This approach is closely related to
creating a vertically integrated operation in an effort to spread risk and provide an integrated
service to customers. Examples exist in the shipping sector where shipping lines have
established cargo management units specifically with a view to taking over key ports, inland
clearance depots and transport operations. Appropriate packaging of projects, which may provide
opportunities to combine public service facilities with more commercial activities, can assist
governments in attracting investors to projects which would be only marginal if marketed in
Application of proven management skills and technology
D]In general the private sector has established a reputation for stronger management due to
its ability to recruit and adequately compensate qualified managers and technicians. In addition;
through its operation in various parts of the world, the private sector has invested heavily in
building experience in developing and applying technology, operating facilities and providing
services attuned to the competitive world of global trade. This expertise is seen as a marketable
commodity which the private sector would like to see applied in other locations and industries.
Governments may be able to attract market leaders to invest in high technology activities.
6] Write short notes on the following.
A] Public Accounts Committee (PAC)
What is PAC?
• The Committee on Public Accounts is constituted by Parliament each year for examination of accounts showing the appropriation of sums granted by Parliament for expenditure of Government of India, the annual Finance Accounts of Government of India, and such other Accounts laid before Parliament as the Committee may deem fit such as accounts of autonomous and semi-autonomous bodies (except those of Public Undertakings and Government Companies which come under the purview of the Committee on Public Undertakings).
• With the coming into force of the Constitution of India on 26th January, 1950, the Committee became a Parliamentary Committee under the control of Speaker.
• The Chairman is appointed by the Speaker from amongst its members of Lok Sabha.
• The Speaker, for the first time, appointed a member of the Opposition as the Chairman of the Committee for 1967-68. This practice has been continued since then.
• A Minister is not eligible to be elected as a member of the Committee. If a member after his election to the Committee is appointed a Minister, he ceases to be a member of the Committee from the date of such appointment.
The Public Accounts Committee consists of fifteen members elected by Lok Sabha every year from amongst its members according to the principle of proportional representation by means of single transferable vote. Seven members of Rajya Sabha elected by that House in like manner are associated with the Committee. This system of election ensures that each Party/Group is represented on the Committee in proportion to its respective strength in the two Houses.
Process of Election
In April each year a motion is moved in Lok Sabha by the Minister of Parliamentary Affairs or Chairman of the Committee, if in office, calling upon members of the House to elect from amongst themselves 15 members to the Public Accounts Committee. After the motion is adopted, a programme, fixing the dates for filing the nominations/withdrawal of candidatures and the election, if necessary, is notified in Lok Sabha Bulletin Part-II. On receipt of nominations, a list of persons who have filed nomination papers is put up on the Notice Boards. In case the number of members nominated is equal to the number of members to be elected, then, after expiry of time for withdrawal of candidatures, the members nominated are declared elected and the result published in Bulletin Part-II. If the number of members nominated after withdrawals is more than number of members to be elected, election is held on the stipulated date and result of election published in Bulletin Part-II.
Association of Members of Rajya Sabha
Another motion is moved in Lok Sabha recommending to Rajya Sabha to nominate seven members of that House for being associated with the Committee. After adoption, the motion is transmitted to Rajya Sabha through a Message. Rajya Sabha holds election of members to the Committee and the names of members elected are communicated to Lok Sabha.
Appointment of Chairman
The Chairman of the Committee is appointed by the Speaker from amongst the members of Lok Sabha elected to the Committee.
As a convention, starting from the Public Accounts Committee of 1967-68, a member of the Committee belonging to the main opposition party/group in the House is appointed as the Chairman of the Committee.
Minister not to be Member of Committee
A Minister is not eligible to be elected as a member of the Committee and if a member, after his election to the Committee, is appointed as a Minister, he ceases to be a member of the Committee from the date of such appointment.
Term of Office
The term of office of members of the Committee does not exceed one year at a time.
Association of Members with Government Committees
A member, on his election to the Committee, has to communicate to the office of the Committee, the particulars regarding the various Committees appointed by Government with which he is associated, for being placed before the Speaker. Where the Speaker considers it inappropriate that a member should continue to serve on the Government Committee, the member is required to resign membership of the Committee constituted by Government. Where the Speaker permits a member to continue to hold membership of Government Committee, he may require that the report of the Government Committee shall be placed before the Committee on Public Accounts for such comments as the latter Committee may deem fit to make, before it is presented to Government. Whenever the Chairman or any member of the Committee on Public Accounts is invited to accept membership of any Committee constituted by Government, the matter is likewise to be placed before the Speaker before the appointment is accepted.
Functions of the Committee
The Public Accounts Committee examines the accounts showing the appropriation of the sums granted by Parliament to meet the expenditure of the Government of India, the Annual Finance Accounts of the Government of India and such other accounts laid before the House as the Committee may think fit. Apart from the Reports of the Comptroller and Auditor General of India on Appropriation Accounts of the Union Government, the Committee also examines the various Audit Reports of the Comptroller and Auditor General on revenue receipts, expenditure by various Ministries/ Departments of Government and accounts of autonomous bodies. The Committee, however, does not examine the accounts relating to such public undertakings as are allotted to the Committee on Public Undertakings.
While scrutinising the Appropriation Accounts of the Government of India and the Reports of the Comptroller and Auditor General thereon, it is the duty of the Committee to satisfy itself—
— that the money shown in the accounts as having been disbursed were legally available for and applicable to the service or purpose to which they have been applied or charged;
— that the expenditure conforms to the authority which governs it; and
— that every re-appropriation has been made in accordance with the provisions made in this behalf under rules framed by competent authority.
An important function of the Committee is to ascertain that money granted by Parliament has been spent by Government “within the scope of the demand”. The functions of the Committee extend “beyond the formality of expenditure to its wisdom, faithfulness and economy”. The Committee thus examines cases involving losses, nugatory expenditure and financial irregularities.
While scrutinising the Reports of Comptroller and Auditor General on Revenue Receipts, the Committee examines various aspects of Government’s tax administration. The Committee, thus, examine cases involving under-assessments, tax-evasion, non-levy of duties, mis-classifications etc., identifies loopholes in the taxation laws and procedures and make recommendations in order to check leakage of revenue.
Regularisation of Excess Expenditure
If any money has been spent on any service during the financial year in excess of the amount granted by the House for the purpose, the Committee examines the same with reference to the facts of each case, the circumstances leading to such an excess and make such recommendations as it may deem fit. Such excesses are thereafter required to be brought up before the House by Government for regularisation in the manner envisaged in article 115 of the Constitution. In order to facilitate speedy regularisation of such expenditure by Parliament, the Committee presents a consolidated report relating to all Ministries/ Departments expeditiously.
Selection of Subject for Examination
As the work of the Committee is normally confined to the various matters referred to in the Audit Reports, and Appropriation Accounts, its work normally starts after the Reports of the Comptroller and Auditor General on the accounts of the Government are laid on the Table of the House. As soon as the Committee for a year is constituted, it selects paragraphs from the reports of the Comptroller and Auditor General that were presented after the last selection of subjects by the Committee for in-depth examination during its term of office.
Assistance by Comptroller and Auditor General
The Committee is assisted by the Comptroller and Auditor General in the examination of Accounts and Audit Reports.
Constitution of Working Groups/Sub-Committees
A number of Working Groups/Sub-Committees are constituted by the Chairman from amongst the members of the Committee to facilitate the examination of the subjects selected by the Committee and for considering procedural matters. A Sub-Committee is also constituted for scrutiny of action taken by Government on the recommendations contained in the previous reports of the Committee.
Calling for Information from Government
The Committee calls for, in the first instance, background note and advance information from the Ministries/Departments concerned in regard to subjects selected by it for examination.
The Committee undertakes on the spot study tours/visits of various Departments/Establishments connected with the subjects taken up for examination and hold discussions with the representatives of the concerned official/non-official organisations located at the place of visit. Each study tour is undertaken with the specific approval of the Speaker.
Evidence of Officials
The Committee later takes oral evidence of the representatives of the Ministries/Departments concerned with the subjects under examination.
Ministers not called before Committee
A Minister is not called before the Committee either to give evidence or for consultation in connection with the examination of Accounts by the Committee. The Chairman of the Committee may, however, when considered necessary but after its deliberations are concluded, have an informal talk with the Minister concerned to apprise him of (a) any matters of policy laid down by the Ministry with which the Committee does not fully agree; and (b) any matters of secret and confidential nature which the Committee would not like to bring on record in its report.
Report and Minutes
The conclusions of the Committee on a subject are contained in its Report, which, after its adoption by the Committee, is presented by the Chairman to the Lok Sabha. Minutes of the sittings of the Committee form Part II of the Report. A copy of the Report is also laid on the Table of Rajya Sabha. The Reports of the Committee are adopted by consensus among members. Accordingly, there is no system of appending minute of dissent to the Report.
Action Taken on Reports
After presentation to the Lok Sabha, copies of the Report are forwarded to the Ministry or Department concerned which is required to take action on the recommendations and observations contained in the Report and furnish action taken replies thereon within six months from the presentation of the Report.
Action taken notes received from the Ministries/ Departments are examined by the Action Taken Sub¬Committee/Committee and Action Taken Reports of the Committee are presented to the House. A copy of the Report is also laid on the Table of Rajya Sabha.
Statements of action taken on Action Taken Reports
Replies received from Government in respect of recommendations contained in the Action Taken Reports after approval by the Chairman are also laid on the Table of Lok Sabha/Rajya Sabha in the form of Statements.
[The constitution and working of the Public Accounts Committee is governed by Rules 253 to 286 and 308 to 309 of the Rules of Procedure and Conduct of Business in Lok Sabha and Directions 48 to 73, 96A, 97, 97A, 99 and 100 of the Directions by the Speaker, Lok Sabha.]
d) Turnaround Strategies
Turnaround strategy objectives
The overall goal of turnaround strategy is to return an underperforming or distressed company to normal in terms of acceptable levels of profitability, solvency, liquidity and cash flow.
Turnaround strategy is described in terms of how the turnaround strategy components of managing, stabilising, funding and fixing an underperforming or distressed company are applied over the natural stages of a turnaround.
To achieve its objectives, turnaround strategy must reverse causes of distress, resolve the financial crisis, achieve a rapid improvement in financial performance, regain stakeholder support, and overcome internal constraints and unfavourable industry characteristics.
Turnaround strategy as turnaround stages and turnaround strategy components
Turnaround strategy components
The components of turnaround strategy are:
• Managing the turnaround in terms of turnaround leadership, stakeholder management, and turnaround project management.
• Stabilising the distressed company by ensuring the short-term future of the business through cash management, demonstrating control, re-introducing predictability and ensuring legal and fiduciary compliance.
• Funding and recapitalising the distressed business.
• Fixing the distressed company in strategic, organisational and operational terms.
Turnaround stages comprise of the following:
• Recognising the need for a turnaround.
• Turnaround situation assessment.
• Emergency management
• Turnaround plan refinement
• Turnaround restructuring
• Turnaround recovery
Turnaround strategy phasing
CRS Turnaround's turnaround management philosophy revolves around short-term survivability (getting the business "out of the hole") while endeavouring not to compromise longer-term turnaround viability (how to "climb the mountain") thereafter.
In doing so, we find answers to the following questions:
• How did it fall into the hole? (causes of distress).
• How deep is the hole? (severity of the financial crisis, and number and nature of internal and external constraints faced).
• How will it get out of the hole? (short-term turnaround strategy).
• What does it mean to be out of the hole? (short-term financial turnaround objectives and stakeholder support).
• How will it climb the mountain? (longer-term turnaround strategy inclusive of asset reduction and strategic repositioning).
• How high is the mountain? (vision).
View the turnaround phasing diagram.
Turnaround strategies often fail since they focus on achieving a longer-term vision without getting out of the hole in the first place – thereby dying in the process.
Turnaround strategies also often fail because they focus on getting out of hole without a strategy for sustainable recovery. Such turnarounds which focuses on short-time survivability or a financial turnaround alone tend to be short-lived.
To get out of the hole successfully, certain longer-term sacrifices often need to be made if the financial crisis is severe.
Seamlessly dovetailing the actions of getting out of the hole, and climbing the mountain, requires careful stakeholder management.
Generic turnaround strategies
The financial objectives of a turnaround is to achieve improved cash flow, profitability, solvency and financial returns.
The generic operational turnaround strategies associated with the value chain are:
Operational turnaround strategy
• Revenue enhancement.
• Cutback action, which has two dimensions - cost reduction and asset reduction.
View the generic turnaround strategies diagram.
An operational turnaround strategy may be, and usually is underpinned by a further set of generic organisational and strategic turnaround strategies:
Financial turnaround strategy
This turnaround strategy refers to financial restructuring with a view to strengthening the balance sheet and/or provide funding.
Reorganisation turnaround strategy
Operational turnaround implies changes to the value chain, which in turn requires changes in the organisational structure of the underperforming or distressed business. Reorganisation may also entail changes to the leadership team.
Strategic repositioning turnaround strategy
Improving effectiveness and efficiency may not be enough. Often the turnaround is also based on chances the business domain and value proposition of the business.
These turnaround strategies are normally employed in combination rather than individually, as illustrated in the diagram on the left
Operational turnaround strategy
The business case for different turnaround strategy-structure-value chain combinations dictates the degrees of freedom open to the turnaround practitioner.
The Hofer model for selecting turnaround strategy model reproduced below indicates which operational turnaround strategies to employ with reference to how far the turnaround situation is from breakeven.
View the diagram explaining the Hofer operational turnaround strategy model.
What is the ROI for each turnaround strategy or combination of strategies? Can the turnaround strategy be funded given the degree of financial distress the business finds itself in? How much time is stakeholders willing to give before wanting to see tangible results? What are the risks?
If the distressed company is operating in any of corridors A, B or C it needs a turnaround strategy to reach corridor D where returns at least equal the opportunity cost of capital.
This could be achieved through cost reduction.
However, if the distressed company is operating in corridors A or B, it needs revenue enhancing strategies in addition to cost reduction.
This means beefing up its demand generation capability (segment, target, position, sell, after-sales service) and its demand fulfillment capability (inbound logistics, operations, outbound logistics, general service delivery capability).
CRS Turnaround has had considerable successes in the past where turnaround strategies were based on improved sales and marketing in addition to a mere cost reduction focus.
Finally, if the distressed company is operating in corridor A, it needs asset reduction strategies in addition to revenue enhancing and cost reduction strategies.
Revenue enhancement as a turnaround strategy
Revenue enhancement focusses on increasing sales through improvement of systems, processes and technology in the primary value chain activities:
• Customer management processes such as sales and marketing, and after-sales service to increase turnover through more effective sales force performance, new products, improved functionality and range of products, new markets, better promotion, etc.
• Operations management processes - inbound logistics, operations, outbound logistics - to increase performance on quality and lead time, thereby raising customer satisfaction through increased service delivery capability.
• Innovation processes - Research and Development to increase the ability to offer the market new products.
The lead time for revenue enhancement is normally longer than that of cost reduction.
If the business is in a financial crisis and revenue enhancement cannot be funded, revenue enhancement often follows after cost reduction and/or asset reduction initiatives have generated cash.
Increasing sales are required if the distressed company operate below breakeven.
Revenue enhancement takes longer to have effect than cost reduction though.
Cost reduction as a turnaround strategy:
Cost reduction is the turnaround strategy having the fastest impact on the bottom line.
Overhead and direct costs in the primary value chain and support functions are normally reduced to a level that can be borne by the level of sales that will remain after cost cutting.
Overhead cost reduction takes place in chunks. Removing more and more chunks eventually means that some business units or product lines cannot be supported anymore, and the sales associated with those fall away too.
Cost reduction often involves retrenchment of employees, especially in turnaround situations where salaries and wages represent a large portion of the cost structure.
We don't believe in cutting costs to the bone - thereby inhibiting the organisation's ability to create, fulfil and administer demand.
Asset reduction as a turnaround strategy
Working capital reduction is common to any turnaround.
However, if the distressed company is too far below breakeven, working capital reduction, revenue enhancement and cost reduction strategies alone will not suffice.
In this situation, the turnaround strategy is normally to shrink the business into profitability.
In such cases, cutback action takes the form of shrinking into profitability by means of portfolio disinvestment.
This involves closure or sale of business units, divisions, operations and assets, and outsourcing of value chain activities in order to focus on the remaining profitable or potentially profitable business units or sections of the value chain.
Such downscoping represents a kind of strategic repositioning by itself.
As with cost reduction , closure and outsourcing of business units involves retrenchment of employees.
Portfolio disinvestment through selling off assets is often used as mechanism to raise cash for the turnaround.
For more information on revenue enhancement and cutback action, see operations consulting.
Reorganisation as a turnaround strategy:
In our experience, reorganisation always forms part of turnaround management.
Reorganisation deals with all the people issues in the business. It entails restructuring, restaffing, reskilling and turnaround leadership revitalisation to yield improved leadership, management, organisational structure, organisational alignment and culture.
Reorganisation is invariably required to ensure success of the other turnaround strategies viz. strategic repositioning, revenue enhancement, cost reduction or asset reduction.
Depending on the turnaround situation, reorganisation can be limited to leadership alignment, and better management systems for planning and control of the company.
Often, however, the extent of reorganisation required goes as far as changes in top management and in the organisational structure.
For more information on reorganisation, see organisational consulting.
Strategic repositioning as a turnaround strategy:
Strategic repositioning holds the most potential but is the most neglected turnaround strategy according to academic research.
When properly employed, strategic repositioning yields the most spectacular and sustainable turnaround results.
Strategic repositioning changes the mission and customer value proposition of the distressed company by changing what products are offered to what markets and in which fashion.
In doing so it changes the revenue - cost - asset structure of the business, yielding improved profitability and return on capital employed. It may do so by either growing, shrinking or refocusing the business.
For the single business unit business, strategic repositioning entails a compete rethink of why it is in business and how it is to achieve a sustainable competitive advantage.
For the multi-business unit or multi-product line situation, strategic repositioning may additionally entail portfolio disinvestment, as in asset reduction, to focus on the core business.
Conversely, it may entail growing the portfolio to enhance sales and profitability. Growth, however, normally requires investment inter alia in new technology and people, and switching costs exist. If the business is in severe distress, lack of turnaround funding often prohibits this line of action.
Strategic repositioning is therefore in practice more often employed after cost reduction has been successful, if at all.
For more information on strategic repositioning, see strategy consulting
The impact of stakeholder support on turnaround strategy
Stakeholders are seldom interested in a turnaround plan that may look good on paper, but which won't show results in the foreseeable future.
Stakeholders often require short-term results first before finally approving a longer-term plan.
In turnaround management it is therefore imperative to resolve the financial crisis, and rapidly show an impact on cash flow and the bottom line to prove survivability.
Selection of turnaround strategies therefore has to heed turnaround phasing requirements, typically:
• Stabilise the business, and execute first-stage restructuring such as reorganisation, cost reduction and working capital reduction using short-term or internally generated finance.
• Having gained the support and confidence of stakeholders, embark on the major restructuring programme involving revenue enhancement and strategic repositioning using finance of a longer-term nature.
e) Management Buy Out.
'Management Buy out '
An instance whereby the managers and/or executives of a firm purchase a controlling interest in the company from existing majority shareholders. In most management buyouts the management group is required to borrower large sums of capital in order to afford to payout existing shareholders, which as a result, leads to the firm holding a greater amount of debt on its balance sheet.
In the majority of management buy out cases, management will buy out all the outstanding shareholders and take the company private, under the belief that the management group has the expertise to lead the business successfully if it controls ownership. Quite often, management will team up with one or more private equity firms to buyout the business due to the buyout experience required to facilitate such a transaction.
A management buy-out (MBO) is an acquisition in which the acquiring group is led by the company's own management and executives.
The key difference between an MBO and a regular acquisition (takeover) is that the company is bought by its own management rather than by another company or by a group of outside investors.
Managers are rarely wealthy enough to buy the company on their own and additional funds may have to be raised, usually under the form of debt financing. MBOs therefore often take the form of a leveraged buy-out (LBO), where a large part of the purchase price is debt financed and the remaining equity is privately held by a small group of investors.
The MBO may also be financed by private equity investors who receive shares in the new company in return for their money.
What do managers and shareholders gain from agreeing to an MBO? A public company that is acquired by its management is taken private. Obvious gains from going private are the savings from reduced registration and listing costs, less stringent regulatory and disclosure requirements, and the elimination of shareholder servicing costs. These savings can be significant for smaller groups. A second benefit is the reduction in the management-shareholder agency costs. If managers own the company then this increases their incentives to work harder and to make decisions that are in the long term interest of the firm. Finally, the substantial amount of debt often loaded upon the firm as a result of a MBO forces managers to make the firm leaner and more efficient.
One important consideration regarding MBOs is that managers usually have more information about a company than outside shareholders. This could lead to a conflict of interests where managers try to buy the company when they have inside information that indicates that the future of the company is better than previously expected. In other words, managers may try to buy the company on the cheap when it is undervalued. Outside shareholders know, however, that managers have an informational advantage and therefore demand a higher price in order to sell their ownership. Managers may therefore have to share some of the gains from the MBO with outside shareholders.
Menzies Hotel was bought in 2011 by its management after the parent company, Piccadilly Hotels, went into administration. The sale resulted in a financial restructuring of Menzies Hotels, in agreement with its lender (Lloyds Banking Group), under a new company called Cordial Hotels. The company is now majority-owned by the management team.
The management of a company will not usually have the money available to buy the company outright themselves. They would first seek to borrow from a bank, provided the bank was willing to accept the risk. Management buyouts are frequently seen as too risky for a bank to finance the purchase through a loan. Management teams are typically asked to invest an amount of capital that is significant to them personally, depending on the funding source/banks determination of the personal wealth of the management team. The bank then loans the company the remaining portion of the amount paid to the owner. Companies that proactively shop aggressive funding sources should qualify for total debt financing of at least four times (4X) cash flow.
Private equity financing
If a bank is unwilling to lend, the management will commonly look to private equity investors to fund the majority of buyout. A high proportion of management buyouts are financed in this way. The private equity investors will invest money in return for a proportion of the shares in the company, though they may also grant a loan to the management. The exact financial structuring will depend on the backer's desire to balance the risk with its return, with debt being less risky but less profitable than capital investment.
Although the management may not have resources to buy the company, private equity houses will require that the managers each make as large an investment as they can afford in order to ensure that the management are locked in by an overwhelming vested interest in the success of the company. It is common for the management to re-mortgage their houses in order to acquire a small percentage of the company.
Private equity backers are likely to have somewhat different goals to the management. They generally aim to maximise their return and make an exit after 3–5 years while minimising risk to themselves, whereas the management rarely look beyond their careers at the company and will take a long-term view.
While certain aims do coincide—in particular the primary aim of profitability—certain tensions can arise. The backers will invariably impose the same warranties on the management in relation to the company that the sellers will have refused to give the management. This "warranty gap" means that the management will bear all the risk of any defects in the company that affects its value.
As a condition of their investment, the backers will also impose numerous terms on the management concerning the way that the company is run. The purpose is to ensure that the management run the company in a way that will maximise the returns during the term of the backers' investment, whereas the management might have hoped to build the company for long-term gains. Though the two aims are not always incompatible, the management may feel restricted.
The European buyout market was worth €43.9bn in 2008, a 60% fall on the €108.2bn of deals in 2007. The last time the buyout market was at this level was in 2001 when it reached just €34bn.
In certain circumstances, it may be possible for the management and the original owner of the company to agree a deal whereby the seller finances the buyout. The price paid at the time of sale will be nominal, with the real price being paid over the following years out of the profits of the company. The timescale for the payment is typically 3–7 years.
This represents a disadvantage for the selling party, which must wait to receive its money after it has lost control of the company. It is also dependent on the returned profits being increased significantly following the acquisition, in order for the deal to represent a gain to the seller in comparison to the situation pre-sale. This will usually only happen in very particular circumstances.
The vendor may nevertheless agree to vendor financing for tax reasons, as the consideration will be classified as capital gain rather than as income. It may also receive some other benefit such as a higher overall purchase price than would be obtained by a normal purchase.
The advantage for the management is that they do not need to become involved with private equity or a bank and will be left in control of the company once the consideration has been paid.