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Vaporized: FP&A’s Role in Sizing the Downsized Company

  • By Bryan Lapidus, FP&A
  • Published: 3/7/2018

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Here’s a thought for FP&A professionals: Does your company matter? Has its reason for existence disappeared? If it vaporized would anybody care?

These morbid thoughts came to mind after I attended AFP 2017 in October. That’s when speaker Robert Tercek talked about industries and companies being “vaporized,” or reconfigured by digital transformation. The sudden demise of General Electric makes Tercek’s talk all too relevant.

In generations past, conglomerates were admired for the way their way of capturing efficiencies in management talent, back-office processing, expensive assets and lower costs of capital, while offering diversification of internal capital allocation. These attributes of success seem out of step with today’s markets, and FP&A should take a critical look at them when considering investments, M&A, and growth options. For example, GE will sell off industrial units until they are down to three core businesses. Fellow conglomerates Honeywell, United Technologies, and Tyco are in various stages of downsizing, too.

The main question for FP&A is whether the perceived benefits of the conglomerate can be achieved in other ways without giving up strategic benefits. Let’s review the list:

  • Cost of capital: Large companies with physical assets often had the best access to capital. However, we have had a decade of low interest rates around the globe giving companies access to cheap debt. Rich stock valuations mean that companies can issue shares for spending capital. Furthermore, the explosion of private equity has meant that companies do not need to raise capital in public markets; PE has $1 trillion waiting to be deployed. What is the best way to access capital now? It will be interesting to watch what happens as global rates rise, with the US Federal Reserve planning three rate increases in 2018.
  • Internal capital allocation: The idea behind this is closely aligned with cost of capital and management efficiencies—who should an investor trust to invest excess capital? Sometimes, cross-subsidization works well, as when a cash cow product or service funds growth in a different area, usually related to core strategy and capabilities or as external research and development. Conglomerates tend not to have a core strength, so this amounts to investing money outside of business lines for bolt-on acquisitions. Business theory would say that companies should return that capital to investors so they can invest it per their own portfolio goals.
  • Back office scale. Is there efficiency to be gained? Operations have become more automated and less people intensive. There are centers of excellence that are geographically distributed to low cost areas, or third-party contractors that are tightly integrated into your work stream so that it is hard to distinguish employees from contractors.
  • Returns on physical assets. The purchasing of physical assets is being replaced by the on-demand rental of assets as needed, fed by cloud computing and algorithms that match buyers and sellers. The growth of service and digital sectors does not require the same investment in physical, depreciating assets. Is there a strategic benefit to owning the physical assets, or can you buy them on demand? How will your balance sheet and financial ratios change if you become an “asset-lite” company?
  • Diversification: Is this really good for companies? Diversification can dampen volatility by providing access to different geographical or customer markets; however, if you are in a high growth business, will your investors be better served by mixing in slow growth business? Would you want to invest earnings from a high beta, high growth company (say Netflix) into a low beta, low growth company (say a regulated utility)?  

FP&A has a responsibility to place capital according to its best return for the company. Many of the assumptions about the benefits of company size and scale have been vaporized due to market conditions, digitization, and the need to be nimble. FP&A professionals should take note, and adjust to the new reality.

Bryan Lapidus, FP&A, is a contributing consultant and author to the Association for Financial Professionals. Reach him

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