Organizational Capital: Business Model Innovation

One of the reasons we believe that traditional fundamental metrics will hardly apply today is due to the fact that the world economy has been transitioning from the industrial age to the information age-where Alvin Toffler calls this the Third Wave.

This means that the current underlying trend which deepens the integration of global markets (globalization), intensifies comparative advantages and the international division of labor plus competition driven technology innovations has been paving way for a reconfiguration of global economic structures.

This also means that capital in a traditional sense has also been evolving to incorporate organizational capital-or a procedure implemented by businesses to complete work (wikipedia.org).

The Boston Global Consulting Group presents a recent paper "Business Model Innovation" highlighting on these:

According to BCG, (bold highlight mine)

``This combination of product innovation and business model innovation (BMI) put Apple at the center of the market approximately 30 times larger than its original market. It also helped expand the company's share of the traditional computer market, as new customers become so attached to their iPods that they took another look at the Apple's computers.

``The greater frequency of disruption and dislocation in many industries is shortening business model lifecycles. New global competitors are emerging. Assets and activities are migrating to low cost countries. Systemic risk is growing as global business becomes increasingly interconnected. Social and ecological constraints on corporate action are emerging. All these factors require businesses to bolster and accelerate innovation. The discipline of BMI offers a fresh way to think about renewing competitive advantage and reigniting growth in this challenging environment.

``Business model innovation means more than a brilliant insight coming at the right place and the right time. To confer a reliable advantage, BMI must systematically cultivated, sufficiently supported, and explicitly managed.

Here is a diagram of the conventional model.

The BCG says that BMI is helpful during times of crisis or instability in the sense that

-it provides companies a way to break out of competition via process or product innovation.
-it help address disruptions or technological shifts-to cope with new business demands
-it addresses specific opportunities, by enabling companies to concentrate on either lower prices or reduce risks and cost of ownership for customers-usually by means of reengineering or reinventing themselves.
-companies often find it easier to gain consensus around the bold moves required to reconfigure an existing business

To add, BMI delivers superior and sustainable returns according to BCG, aside from offering "a premium over the average total shareholder return" on their industries or businesses See exhibit 2

And BMI can take several forms (see above).

Read the entire BCG paper here

And it is probably a reason why workers may have been more productive even during today's crisis. To quote Garrett Jones (Source Tyler Cowen: Marginal Revolution), ``Workers mostly build organizational capital, not final output. This explains high productivity per 'worker' during recessions."

A Tectonic Shift In The Global Banking Industry!

It is said that a picture is worth a thousand words.

Well below are some stirring graphs that highlights on the unexpected changes arising from the recent global financial crisis.

As the old saw goes, in every crisis there are opportunities. In the present case, we seem to witnessing an evolving transition to a new order in the global financial industry.

All graphs from Financial Times...

At the topmost window, the market cap of banks as % of the GDP of key developed nations depicts of a "leveling"-where the pecking order of market cap erosion have been heaviest in UK, followed by Europe, the US and Japan. This has led to nearly a congruous distribution of market cap as a ratio to GDP as the crisis evolved.

The next chart ("What difference a decade makes") is THE revelation: China has snatched the banking industry's leadership (lowest chart) from what used to be a stranglehold of the West (upper pane)!

And for a better visual, FT.com provides a great comparative breakdown of the top financial companies of the world in 1999 and in 2009...

The above had been the ranking of top global financial institutions based on market capitalization in 1999...

And the radical transformation seen in the present ranking.

As Peter Thal Larsen and Simon Briscoe wrote at the Financial Times, (bold highlight mine) ``New names have meanwhile arrived as if from nowhere. This is partly a reflection of shifting economic power: China’s three big banks dominate the rankings after joining the stock market in 2006 and 2007. Australian and Brazilian banks have also risen to prominence. But the shifting composition also offers evidence of how well different countries have managed their financial systems. Canada, for example, has been praised for its risk-averse approach to regulation. A decade ago, no Canadian bank made the list. Now there are five in the top 50."

So aside from China we have major commodity producers sharing the honors or a wider distribution of financial leadership.

But where will the next best growth area be?

Based on Boston Consulting Group's investment banking model, we will likely see a shift in the leveraged based business model to one of stabilizing profitability through a return to a simpler smaller model, smaller profit pools, greater client demand for simpler financial solutions and specialized capabilities of individual investment banks in an environment of increased regulatory and governmental influence.

And the region, as illustrated above, which has the least increase in government intervention could likely benefit most.

Combined with many other fundamental factors as high savings, growing middle class, demographic trends, urbanization and etc..., Asia looks likely a winner!

San Miguel’s Shifting Business Model: Risks and Opportunity Costs

``An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”-Benjamin Graham

We recently read with interest how San Miguel has been scaling down on its Beer business model and has been phasing into the energy sector gradually.

Note: Our comments here are not intended for any recommendation but serves as to analyze on the possible opportunity costs of the shifting corporate strategy of the second largest publicly listed company (technistock.net) of the Philippines.

Although we are not clear about the details of the proposed changes in the structure of ownership of San Miguel, Japan’s Kirin Holdings which has reportedly acquired a cumulative 19.7% stake in the company in 2001 and 2005, is reportedly in talks to acquire a majority share.

According to Finance Asia, ``Japan’s Kirin Holdings and San Miguel Corporation yesterday announced that they have signed a memorandum of understanding which includes an exclusivity clause for Kirin to acquire a further 43.25% stake in San Miguel Brewery. No financial details were disclosed, but based on San Miguel Brewery’s last traded share price, the stake is estimated to be valued upwards of $1.25 billion.”

Yet, recently San Miguel [SMC: SMCB] acquired the 27% stake of the Philippine Government Service Insurance System (GSIS) in Meralco (abs-cbnnews.com) and a 50.1% stake in Petron from a London-incorporated investment fund Ashmore Investment Management Ltd while dabbling on the idea to enter the telecoms industry with Qatar Telecom (gmanews.tv).

Thus, San Miguel’s business model is being overhauled over a very short period of time.

The Risk Variables

From our point of view, the shift in San Miguel’s corporate strategy comes with the following risk variables:

1. Competency risk. As the company veers away from its métier, it will incur a learning curve. While the company may “acquire” experience to reduce the costly interfacing of such learning curve, the drastic changes in the business path could entail some challenges in the operational, management and or corporate culture by way of frictions.

2. Country concentration risk. San Miguel which used to diversify its business internationally seems to be putting all of its eggs into one basket-banking on the Filipino consumers.

3. Restrained Profits. The consumer based energy industry is a heavily regulated industry with attendant regulatory profit caps. Meanwhile growth prospects are likely to follow the growth conditions of the local economy’s growth.

4. Political Risks. Extreme price changes in consumer energy could lead to highly volatile social mood swings. In times of political extremities, where governments can turn “outside-in”, the risk of nationalization could play a significant ‘sword of Damocles’ over the company’s new business model.

5. Late Mover Disadvantage. The telecom industry is a highly competitive capital intensive environment. Trying to gain market share from the existing players at time where the mobile user’s penetration level is at 60% seems quite challenging. It would be better for the company to acquire one of the existing players or adopt a ‘pail and shovel’ approach by introducing technology related which could cater to the industry.

The Opportunity Cost

San Miguel’s decisions will also mean lost opportunities. And this will include the loss of capitalizing on:

1. Asian consumption growth.

While today’s financial crisis is expected to hurt consumer spending everywhere, it is simply part of the business cycle which ultimately will segue into a recovery.

From our point of view, today’s crisis should be used as an opportunity to position for such cyclical transitions and eventually reap on the rewards of the prospective dynamism of the fast growing region.

According to the Economist in 2007, ``CHINA has the world's biggest thirst for beer, comfortably outstripping the country in second place, America. But the Chinese market is highly fragmented. Around half of all the suds sold in America is produced by Anheuser-Busch, brewer of Budweiser. Snow, China's most popular cold one, commands only around 5% of that country's market.”

Figure 4: Economist: Top TEN Beer Markets

In short, a fragmented market in a rapidly growing economy like China can translate to enormous potentials to secure added market share and expand profits.

2. Currency regional currency gains. Exposure overseas extrapolates to revenues in localized terms. With our expectations of Asian currencies to appreciate over a longer horizon, the potentials of such currencies gains could compliment profits will be missed.

3. Exploit Other Global Opportunities. San Miguel could have used the present opportunities to expand into consumer related industries parallel to their field.

The Boston Global Group in their 2008 New Global Challengers identifies the possible success dynamics for companies in Rapidly Developing Economies (RDE) over the coming years, see figure 5.

Figure 5: Boston Consulting Group: 2008 New Global Challegers

According to BCG, ``Our analysis of the 2008 BCG global challengers reveals globalization dynamics that are already affecting every market and industry, reshaping the world’s economic landscape.”

The BCG candidates for the world’s fastest growing companies come from mostly the BRIC (Brazil, India, Russia and China) zone. While our neighbors have some representative Indonesia (1), Malaysia (2) and Thailand (2), the Philippines have none.

The 6 BCG models quoted from Atlantic community

``1. Taking RDE Brands Global: Having established their brand identity in their home markets, companies attempt to take their brand global. Usually their expansionary growth is entirely organic, as witnessed at India’s Bajaj Auto or Brazil’s Nature cosmetics.

2. Turning RDE Engineering into Global Innovation: Low labor costs and strong R&D performances offer RDE companies global competitive advantages, as with Brazil’s Embraer, the world’s third biggest aviation company.

3. Assuming Global Category Leadership: Faith in their own product’s strength drives some of the challengers to an attempt to assume a leading role in their line of business. China’s battery producing BYD has successfully realized such a strategy.

4. Monetizing Natural Resources: Spurred by soaring commodity prices, the challengers can increasingly use mergers and acquisitions (M&A) to expand globally and to secure viable growth. An example would be India-based Hidalco’s recent purchase of Canada’s Novelis.

5. Rolling Out New Business Models to Multiple Markets Companies such as the Mexican mobile-network operator America Movil adapt their branding and marketing strategies to different regions, while retaining their basic business model. This has allowed them to expand their business into new markets while localizing operations in each.

6. Acquiring Natural Resources Assisted by their government, some challengers — especially Chinese ones — focus on securing their access to resources to ensure long term growth.”

Basically, San Miguel’s main opportunity cost is the cost of globalizing its business model.

There could be two possible angles from which we suspect could have shaped these strategy shifts:

One, the San Miguel management believes that recent globalization trends might be reversed over the long term and thus has positioned defensively by going domestic or

Second, the company’s chairman Eduardo Cojuangco Jr., who is founder of the National People’s Coalition and has ran against Fidel V Ramos for the 1992 presidency but lost, could possibly have politically associated strings to these acquisitions with the 2010 elections only a year away.