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Secrets behind an 'everlasting company' - Views on News from Equitymaster
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  • Jul 1, 2013

    Secrets behind an 'everlasting company'

    We recently came across an article by a gentleman, Charles O' Reilly who is the Professor of Management at Stanford Business School. The article explored the reasons why some companies have done well consistently over a long period of time and seem to be everlasting. We thought it would be good to go through the reasons as they are hugely relevant for investors. Though the article illustrated examples of international companies, we believe that the reasons are also relevant for Indian companies / Indian subsidiaries of foreign companies, which have withstood the test of time.

    O'Reilly highlights the secrets for a company's long term success by using the examples of companies such as Toyota and Nokia. It would interest you to know that Toyota, a leading manufacturer of automobiles, started out as an automatic loom manufacturer. Nokia, a reputed name for mobile phones, began operations in 1865 as a paper mill. So what are the reasons that made these companies last as long as they did? To explain, O'Reilly discusses two important concepts - 'organisational ambidexterity' and 'overarching vision'.

    Organisational ambidexterity

    O' Reilly describes this condition as a company's ability to continue to exploit current opportunities while at the same time exploring new ones. He critiques Harvard Professor, Clayton Christensen's idea that a company cannot continue on its traditional path while embarking on innovation at the same time. He supports his theory by giving the example of Wal-Mart. According to him, Wal-Mart has been successful in rolling out its Express stores, the smaller versions of its supercentres, because Wal-Mart's senior managers got a chance to leverage on their existing capabilities in purchasing, logistics, real estate and information technology.

    Overarching vision

    O'Reilly believes that organisational ambidexterity by itself is not enough to ensure an organisation's survival. They need to have an 'overarching vision', i.e. a necessary clarity as to why different businesses within the same organisation are important. Otherwise, there would be a clash between the objectives of different departments.

    He gives the example of Ciba Vision, a maker of contact lenses, which started to innovate on 'extended-wear contact lenses' while it was in the business of traditional contact lenses. The Company created separate marketing, research and development and finance groups for the innovative project. At the same time, the person in charge of the new business initiative was an old hand, well-versed with the Company's traditional business. Further, Ciba Vision revamped the Company's incentive systems to reward managers for the performance of the entity as a whole. The results were very impressive. In the first ten years, post the launch of this initiative, the Company's annual revenues grew from US$300 m to more than US$ 1 bn.

    The most interesting thing that O'Reilly writes about is on large companies. He refutes the claim that large companies cannot afford to innovate while continuing with their existing line(s) of business. Rather, he believes that large companies can afford to experiment more given their size and profitability. So, even if some of their innovations/ventures turn out to be bad, there is a relatively less chance of the company being wiped out compared to a small counterpart. Though innovation is something we do agree with, as a major growth driver, we firmly believe that simply burning cash in unprofitable ventures is not something that any company should encourage.

    To conclude

    We agree with O'Reilly's observations that innovation and continuance of existing business can co-exist with each other. And this is an important ingredient for the long term success of a business. There are quite a few examples of companies in the Indian context, who have used this recipe to attain success.

    For example, Hindustan Unilever (HUL) has started with their policy of coming up with new product offerings or re-launching of old products in new formats. The Company has been launching 70-80 innovations annually since 2009-10, more than it did between 2000 and 2009. During 2011, HUL re-launched more than 50% of its product basket and launched 40 innovations in skin-care alone in 2010-11, paving its entry into new segments such as premium skin-lightening, hand and body lotion, male grooming and anti-ageing. All these products were launched under existing skin care brands - Lakme, Ponds, Fair & Lovely, Vaseline and Dove. The Company has also extended its renowned brands to emerging categories. For example, Hamam has been extended to hand wash, Rin to fabric whitening and Rexona to deodorants.

    ITC too has focused on diversification since the late 90's. It has spread its wings into different sectors including FMCG, Hotels, Paper, Clothing, etc. quite successfully.

    Tata Motors has evolved itself gradually from being an exclusive commercial vehicles manufacturer to a manufacturer of cars through organic and inorganic routes.

    From an investor's perspective, we like companies, which utilises its free cash flow rather than taking recourse to debt in order to innovate organically/inorganically. But, we firmly believe that this must be done without losing focus on the company's bottom-line. Concentrating just on revenue growth without focusing on the bottom-line and 'Return on Capital Employed' can give a short term boost; however, it will fail to create long term wealth for shareholders.

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