Issue 2, Dec 08 – Jan 09 Agenda Insights into growth, performance and governance Proudly found elsewhere The slogan that revolutionized Procter & Gamble Salvage business Eight secrets of truly effective turnarounds “Cash isn’t king, it’s God” Infosys CFO V. Balakrishnan on variable costs, ethics and egos George Soros believes the 21st century belongs to Asia. Is he right? © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. ‘‘ The rebalancing of the global economy is an opportunity, a threat and a risk. Publication name: Agenda: insights into growth, performance and governance Publication no HM 200 - 001 Publication date December 2008 Printed in the UK by MPG impressions. Environmental Management System ISO 14001 accredited and Forest Stewardship Council (FSC) chain of custody certified Printed on Think Bright, manufactured from 100% Elemental Chlorine Free (ECF) pulp, of which 50% is recycled post- consumer fibre and is sourced from well-managed forests independently certified according to the rules of the FSC. Confident that rebalancing is near the top of your agenda, we explore some of the most crucial aspects of this transformational economic change. At its most trivial, this process will see us become overly familiar with the ancient curse: “May you live in interesting times.” At its most profound, it could revolutionize the business models that have made the West so prosperous for most of the last 50 years ‘‘ The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.The views and opinions expressed herein are those of the authors and interviewees and do not necessarily represent the views and opinions of KPMG’s network of firms. © 2008 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the United Kingdom. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. If you take the long view, the last 250 years – when the West’s GDP per capita has far exceeded the East’s – are an historical oddity. This anomaly is now being corrected. China and India are re-emerging as economic superpowers. Although this global rebalancing started before the financial downturn, the volatile state of the economy and changes in the world’s political leadership means the process will affect business in unexpected and unpredictable ways. How will your business rise to the challenge? AlAn Buckle Global Head of Advisory 02 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. contents 04 Lessons in leadership 06 Keys to success 08 The great debate 12 Learning curve 16 Left ﬁeld 17 Best practice 18 Known unknowns 22 The big issue 26 Acumen 30 Any other business 31 Strategic intelligence Internal audit looks outward; Einstein’s genius; Asia’s take on the credit crunch Five new CEOs and CFOs relying on emerging economies Infosys CFO V. Balakrishnan’s insights into proﬁtable management Will George Soros’s ‘new paradigm’ change the way we do business? What an underrated explorer can tell us about China The fox, the hedgehog and the secrets of a well-balanced boardroom Rescuing a business is all about luck, focus and thinking the unthinkable Ten factors that could change business in the year ahead Why the real oil crisis isn’t about price, and what you can do to limit the damage P&G’s Jeff Weedman on how you can proﬁt by collaborating with competitors Quizzing HP Russia’s Arturo Cornejo; does Hollywood hate accountants? 18 22 08 26 Agenda: Insights into growth, performance and governance is published by Haymarket Network,Teddington Studios, Broom Road,Teddington, Middlesex, TW11 9BE, UK on behalf of KPMG International. Editor Paul Simpson Managing Editor Robert Jeffery Art Editor Jo Jennings Production Editor Vanessa Longworth Sub-editor Stephanie Jones Staff writers Laura Bridgestock, Sophie Jenkin Group Production Manager Jane Emmas Production Controller Hannah Pettifor Board Account Director Kate Law Senior Account Manager Caroline Watson Group Art Director MartinTullett Editorial Director Simon Kanter Managing Director, Haymarket Network Juliet Slot. Reproduction by Colour Systems, London, UK. Cover photography by Daniel Acker/Landov/PA Photos. No part of this publication may be copied or reproduced without the prior permission of KPMG International and the publisher. Every care has been taken in the preparation of this magazine but Haymarket Network cannot be held responsible for the accuracy of the information herein or any consequence arising from it. Views expressed by contributors may not reﬂect the views of Haymarket Network or KPMG International or KPMG member ﬁrms. 13 Agendamagazine 03 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. strategic intelligence Crunch time for internal audit Can smart investment help IA do more for less? providing integrated assurance across risk, control and compliance. He suggests that its remit, in an era where a myriad of new risks have emerged, could be extended further to such areas as data analytics, trend identiﬁcation, supply chain, strategic planning, corporate culture, 69 percent of businesses source some internal audit, up 19% since 2005* new business opportunities and tax strategy. But how do businesses fund IA’s broader role? Nolan says microtrend Frugal engineering In essence, frugal engineering is achieving more with less.The term was coined by Renault-Nissan CEO Carlos Ghosn who, on a visit to India, saw companies evolving a new low-cost business model to create products at a price that many local consumers could afford to pay (see Great Debate, p12). Indian business theorist C.K. Prahalad says this approach works better in start-ups that lack the “legacy mindsets and legacy costs” of established ﬁrms, and believes innovative ‘frugal’ companies have a global opportunity to grow. For example, Indian mobile phone giant Airtel is hugely proﬁtable – partly because it outsources many functions to Eriksson and IBM – yet has some of the cheapest call rates in the world. outsourcing or co-sourcing could meet business needs while keeping costs manageable: “Forward-looking companies are increasing their use of co-sourcing arrangements to plug skills gaps and raise quality. “Now is the time to beef up with more sophisticated IA capabilities, not strip it down. The need is for smarter investment, not less investment. Really good co-sourcing arrangements can help businesses pay less and get higher quality for the money.” The outlook for IA is changeable as risks multiply, costs are under pressure and strategic sourcing tempts many * Source: GAIN 2008 Annual Benchmarking Study by The Institute of Internal Auditors What would Albert do? Albert Einstein earned US$18m (€12.1m) in revenue from merchandising last year – not bad for someone who died in 1955. In tough times, surely a genius can teach business a thing or two. 1. Be ﬂexible He deﬁned insanity as: “Doing the same thing over and over and expecting different results.” 2. Never be satisﬁed As he said: “The important thing is not to stop questioning.” 3. Be a sustainable leader “Try not to be a person of success, but rather be a person of value.” Leadership built on values lasts longer. 4. Sharpen your focus Michael Augel, an IBM programmer, always wears blue suits at conferences because, he says: “Einstein had 10 sets of the same clothes in his closet. He didn’t want to waste time choosing what to wear.” 5. Stickability matters “It’s not that I’m so smart,” he said once, “I just stay with problems longer.” 6. Treasure your mavericks Like some internet visionaries, Einstein was seen as a maverick. The most inﬂuential scientist of the 20th century was never given a lecturer’s post or a doctorate. Popperfoto/Getty Images. H. Armstrong Roberts/Retro Files/Getty Images The Sarbanes-Oxley (SOX) fuelled boom for internal audit (IA) is over. In the long run, that could be good for business, if management makes the right calls. Sarbanes-Oxley was so big it warped the IA function by focusing it on one complex piece of regulation. With that task stabilized and the economy worsening, Mike Nolan, KPMG’s Global Head of Internal Audit, Risk and Compliance Services, says: “I fear many management teams may simply look to cut cost at a time when the function needs to be upskilled not downsized.” Nolan believes that IA should return to a broader role it enjoyed before SOX. It should play a key role in 04 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. Gulf in expectations A new currency could be born in 2010 Joseph Caley/Shutterstock Until now the most famous symbol of the Gulf’s booming economy has been Dubai’s Burj Al Arab hotel (below). But in 2010, six states – Saudi Arabia, Bahrain, Kuwait, UAE, Qatar and Oman – plan to adopt a single currency. The new currency would create an economic bloc owning 45% of OPEC’s oil reserves, with a GDP of US$815bn (€551bn). The Gulf launched its own common market in 2008 but interregional trade is still conducted in U.S. dollars. With inﬂation across the region hitting 11% in 2008, the global slowdown may help stabilize the economy. The as-yet-unnamed currency could replace the dollar as the reserve currency for Islamic and Arab banks. Financier George Soros is among those who believe the Gulf currencies would beneﬁt from being freed from the dollar, and expects them to use their cash reserves to invest in – and dominate – aluminium, energy and petrochemicals. Presidential tonic Oscar Schnell/Shutterstock Will Obama’s victory boost U.S. GDP? % GPD growth 20 Barack Obama’s victory marks the ninth time the White House has changed political party since 1932. Seven such shifts increased America’s GDP. But only Richard Nixon and Ronald Reagan actually boosted growth compared to the year before.The most inspiring presidential precedent is Franklin Delano Roosevelt. In 1932, the Democrat inherited an economy that shrank by 23.3% and, in 1933, managed to ensure it contracted by just 3.9%. If Obama delivered that kind of turnaround, he would be a shoo-in for 2012. Change in U.S. GDP performance the year after an election 19.4 10 2.2 0.1 3.3 0 -0.3 -0.4 -0.7 -2.7 -10 -20 1933 1953 lt er w ve e o os nh se Ro Ei 1961 K JF 1969 1977 1981 1993 2001 n er sh an on to rt ix a ag Bu in N C Cl Re John Warburton-Lee Photography/Alamy leading g edge How the U.S. crisis could change Asia Finance Asia’s North Asia editor, Dan Slater, says the downturn will lead Asian leaders to re-evaluate economic policies. The patterns of trade may shift These economies will switch from growing through exports to developed economies, to being used by developed economies for the same purpose. Commodity exporters such as Russia and Brazil, and manufacturing champions like China, have the cleanest balance sheets for decades and bulging foreign currency reserves, so they are well placed to reduce their trade surpluses as the U.S. and the EU turn to exports as a source of growth. In the short term, the effect is likely to be a much-needed rebalancing of the world economy. The U.S. ideal of an economy turbo-charged by the capital markets has lost some of its lustre Asian nations with high savings rates will grow on the back of savings channelled through their banking systems. U.S. innovation could slow as capital markets provide less ﬁnancing to tech start-ups. We could see a return to high-end manufacturing. Margins would shrink if trade wars ﬂared.The worst-case scenario is protectionism and global deﬂation. Fast growing economies will still peg currencies against the U.S. dollar The point of pegging to the dollar was to avoid inﬂation. Until the U.S.Treasury switches outright to printing money rather than issuing bonds, pegs will be maintained or adjusted to contain inﬂation. Huge dollar holdings by countries such as China and India make abrupt changes unlikely. The U.S. needs to reinvent its approach to corporate governance The idea that shareholder returns are supreme – with equity loaded up with 30 times leverage to increase shareholder returns – has been shown to be what the Japanese always thought it was: greedy and short-termist. Stakeholder capitalism will take on a new lease of life. It’s good news for consumers in China, India and the Middle East For the last 50 years, many emerging economies have relied on Western consumers to grow. Relying on their own may upset the U.S., making growth more self-sustaining in the cash-rich Middle East and Asian markets and obviating the need for them to ﬁnance the U.S. trade deﬁcit. But it would be good in the long run, especially if they open their markets to U.S. exports. This crisis could change the way the world views democracy The free market is theoretically tied to political freedom. But the U.S. political system has behaved erratically, showing a striking lack of leadership at times.The ﬁrst vote for the US$700bn (€550bn) ﬁnancial bailout failed, as many members of Congress pandered to constituents. Many countries may regard their authoritarian leaders with renewed respect. 07 Agendamagazine 04 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. What’s on their ‘to do’ list? 02 01 They’re new in their roles, reliant on emerging economies to grow in difficult times. What can you learn from the challenges facing these CFOs and CEOs? michAel mAngAn President of Black & Decker power tools OsmAn shAhenshAh Chief executive of oil company Afren West Africa is one of the largest untapped sources of oil and natural gas,but investors fret over instability.Afren is convinced its business model maximizes security and production and minimizes risk, by being positioned as an indigenous company in all areas and partnering with majors. The story so far Co-founder Osman Shahenshah oversawAfren’s rapid growth as CFO. Since becoming CEO in 2007, he has developed the business strategically and financially. With investment banking, oil and a stint at The World Bank on his CV, he has already initiated an April 2008 share issue that raised US$236m (€186m) What’s next? Afren relies on know-how, not wealth. Non-executive chairman Dr Rilwanu Lukman,once OPEC’s secretary general,advises the Nigerian government. By partnering with officials, developing proven reserves and investing in training and development, Afren aims to produce over 20,000 barrels a day in the region by the end of 2008. Operating in six countries, Afren has a portfolio of production, development and exploration assets. Funding is a key differentiator for small oil companies. Shahenshah struck a deal under which Japanese groupSojitzwillpumpUS$500m (€393m) into a joint venture. Oil prices and piracy off Nigeria remain concerns. He’ll succeed if… The Sojitz deal pays off, Nigeria asks smaller players to develop reserves, and Afren’s flagship Okoro Setu field meets expectations. The U.S.housing crash hit the construction industry – and Black & Decker – hard. With Michael Mangan at the helm, sales are growing in Asia and Latin America and shrinking in the U.S. and Europe. The story so far Black & Decker grew strongly in the early part of the decade. But with 60% of its income generated from the U.S., it has to diversify. Mangan served as CFO for eight years, improving cash flow, before becoming president in September 2008, when second-quarter earnings of US$96.7m (€71m) fell 18%. That beat expectations in a tough market and the group, with no serious debt maturing until 2011, is rich enough to fund the right acquisition or six. What’s next? Diversification is crucial. Investment in infrastructure in emerging economies is driving power-tool demand but competing with local suppliers that discount heavily is tough. Huge projects like the Beijing Olympics have driven up the year-on-year costs of steel – the company’s main raw material – and other components. With sales dipping 3.6% in the third quarter, Mangan must juggle the drive to grow in Asia, product launches and the need to cut costs. He has already overseen a 10% reduction in the global workforce. Efforts to make the group’s distribution network more productive are starting to pay off. He’ll succeed if… New products maintain market leadership, he acquires shrewdly, and more units become as diverse as Emhart Teknologies, which generates 60% of sales outside North America. 06 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. 04 03 sundAr rAmAn CEO of cricket’s Indian Premier League How do you build a sport from scratch? Sundar Raman, 36, is tackling this issue head-onashestrivestoturnthespectacular first season of India’s Twenty20 cricket competition into a viable, long-term concern as a global entity. The story so far IPL shook cricket to its core – the first game drew 12.5m viewers – by applying commercial lessons from U.S. sports and English soccer. IPL’s Twenty20 format is perfect for a timepoor age. Sony and WSG paid US$1bn (€777m) for a 10-year TV deal with IPL’s owners, the Board of Cricket Control in India (BCCI). Selling the eight franchises raised US$724m (€575m). What’s next? Raman will aim to maximize revenue from sponsorship, merchandizing and hospitality.A new Champions League Twenty20 competition involving South African and Australian teams is a step in the right direction. Global expansion could well test BCCI, not seen as a great administrator. But Raman, who has run media agency Mindshare in the region, is confident: “Cricket viewership is more than that of soccer, yet its sponsorship market is much smaller. Why? Because it hasn’t been exploited to its fullest.” He’ll succeed if… Cricket grows. India already attracts 80% of the sport’s global revenue so he can’t rely on a bigger slice of the same pie. Raman also needs to persuade sponsors to spend in a crunch. jing ulrich Chairman of China Equities, JP Morgan As managing director and chairman of JP Morgan’s Chinese equities business, Jing Ulrich is a respected media pundit,advises the world’s largest institutional investors and is one of Forbes’ 100 Most Powerful Women in the World. But the Chinese stock market – the world’s best performer in 2007 – has been one of the worst in 2008, so she has a tough job on her hands. The story so far A Harvard and Stanford graduate, Ulrich rose swiftly from Credit Lyonnais to Deutsche Bank before joining JP Morgan. Ulrich is now leading the expansion of the company’s China equities business. In the short term, the going has been tough but she remains confident. Ulrich was chosen as ‘Young Achiever of the Year’ in the Women of Influence Awards 2005-6, sponsored by the American Chamber of Commerce in Hong Kong. What’s next? Certain sectors – particularly banking and infrastructure – are still growing rapidly in China. But investors are nervous over slowing growth rates. JP Morgan’s relatively comfortable financial position insulates it from any immediate panic. She’ll succeed if… She keeps offering valued counsel to institutions investing in the world’s most dynamic emerging economy. The state’s US$585bn (€396bn) stimulus – which she describes as a “New Deal with Chinese characteristics” – can maintain sustainable growth. Tax breaks and looser credit could revive housing. Longer term performance of Chinese stocks will be driven, in part, by a revival of China’s domestic consumption. “Cricket viewership is more than that of soccer, yet its sponsorship market is much smaller.Why? Because it hasn’t been exploited to its fullest” lessons in leAdershiP 05 jonAs sAmuelson CFO of Electrolux Electrolux’s appliances were once a staple of every Western home, but the company faces fierce competition from price-conscious rivals and needs to evolve. New CFO Jonas Samuelson is confident it can flourish, persevering with the launch of its appliance brand in North America. The story so far Samuelson, 40, made his name at Saab and General Motors, as executive director of North American sales, returning home for a spell as CFO of the thriving Stockholm-based, airtreatment market leader Munters. What’s next? Electrolux made its fortune selling refrigerators in post-war Europe. By the 1990s, recession and competition forced a wave of plant closures. In 2004, president Hans Stråberg started to invest in Eastern Europe and close Western European and U.S. plants and in 2006, Electrolux was overtaken as world leader by Whirlpool, which bought Maytag. Innovations such as robotic vacuum cleaners grow the brand, but Samuelson must cut costs without big divestments (the outdoor division, including Flymo, was spun off to shareholders in 2006) while funding Stråberg’s plans to sell high-tech ovens in the U.S. He’ll succeed if… He can beat a projected 2008 income of US$550m (€405m) in 2009 and cut European costs while funding innovation and new products. In North America, Electrolux raised prices to boost revenue. Can it do the same in Europe? GO FURTHER Find more about these businesses at: www.afren.com; www.bdk.com; www.iplt20.com; www.jpmorgan.com; and www.electrolux.com Agendamagazine 07 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. 03 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. keys to success ‘‘ At Infosys, we say you can trust in God but you have to base your decisions on the data ‘‘ Infosys CFO V. Balakrishnan says his company owes its remarkable rise to budgets, simplicity and variable costs words by paul simpson photography by aashith shetty Y ou can tell a lot about a CFO’s state of mind by asking them to identify the biggest problem facing their business. Ask any CFO in the West that question at the moment and you’re likely to get a short, bleak and predictable answer. When I ask V. Balakrishnan, chief financial officer of technology giant Infosys, he says:“Talent. That’s the biggest challenge we face. Our total workforce is now 100,000, we have an attrition rate of about 13% and we’re hiring 25-30,000 people a year. We get 1.5 million applications for those jobs, so we can only take on 2% of those who apply. We are the employer of choice in India, but managing change on that scale is a challenge.” Balakrishnan – or Bala as he is invariably known – exudes the quiet kind of confidence you might expect from a man who once described Infosys as “God’s own company”.But then he does happen to be CFO of a business that started, with US$250 (€198) of capital, in 1981 and now has revenues of US$4.8bn (€3.8bn), half that amount in cash sitting in various bank accounts, and absolutely no debt.A company that sets out to delight customers, rather than merely satisfy them, and enchant employees. This sounds too good to be true in a Disneyfied kind of way, but Infosys’s revenue-per-client figures – which soared by 350% between 2003 and 2007 – suggest it might just be the case. Balakrishnan also, he believes, happens to be in the right place at the right time in our economic history. He is convinced that, as he puts it, “this century belongs to Asia” and that this continent is the global economy’s new centre of gravity. The issues that pepper our conversation reflect this conviction. Where his peers in the West might be speculating about credit, interest rates and recession, he is more preoccupied by retaining talent, the quality of India’s education system and whether his country is investing enough in infrastructure to grow by 7-8% a year.(His concern isn’t entirely altruistic: lack of investment means that Infosys invests around US$13,000, or €8,800, per employee in infrastructure every year.) But surely, I suggest, he must be a bit worried as he looks into the future. After all, 90% of the group’s revenue comes from Europe and North America.“Confidence is very low,” he admits,“and Agendamagazine 09 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. that presents challenges.There will be some impact on IT spending by large companies. At the same time, there are substantial cost savings associated with outsourcing – companies can convert their fixed costs to variable costs, become more competitive and reduce their time to market – and we know that companies will spend 30-40% less with us than with the IBMs of this world. “The global IT services spend is around US$800bn (€541bn). India’s share of that market is only 5%, so we are confident there are enough opportunities for us to grow.The challenges that we see are more to do with scaleability, attracting the right people and the quality of our leadership.” Budgets and egos Depending on which theory or guru you believe, success in business is down to thriving on chaos, seven effective habits or making the most of the right-side of your brain. Balakrishnan – who joined Infosys in 1991 from Amco – mentions none of these factors as he discusses the group’s rise, but starts with the mundane business of budgets. “At Infosys, people take the budget very seriously. If people want to spend beyond the budget, there is a very clear approval process. We then use various models to analyze the impact of the spend in the long term. And we collect a lot of data on the 10,000 projects we have. If you have a lot more data, the situation is a lot more transparent. That’s why 99% of our projects come in within budget and on time.” Data isn’t collected for the sake of it. Infosys reduces the risk of analysis paralysis by only tracking data that is useful in decision making. “At Infosys, we always say that you trust in God but you base your decisions on the data,” says Balakrishnan. “If you collect data on different aspects of a company, you get a clearer picture of the business and you’ll take more sensible decisions than if egos and emotions get involved. If you don’t have the data, you don’t know what’s happening.” This can make Infosys’ decision-making process sound as dry as the Atacama desert but the group has made some bold decisions,such as its US$753m (€508m) purchase of UK IT consultant Axon. Through experience, Infosys has rewritten some of its rules. After a traumatic break with General Electric in 1994, Balakrishnan says: “We decided no client should account for more than 10% of our revenue. We want to delight customers but we do not want a client to run our business.” 12 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. keys to success Paul Simpson is an editor at Haymarket Network. 5 Innovation. “Affordability is the biggest challenge for India,” Balakrishnan has said. So the launch of products likeTata’s Nano car is good news. 27.82% 27.79% 26.62% 6 Infrastructure. India has the cash – US$300bn (€202bn) in reserves – so all it has to do is improve execution and delivery. 41.38% Animated genius In the Indian business community, Balakrishnan is cherished for using comic Bollywood animations to spice up what might have been a rather arid financial presentation at one of the stylish AGMs Infosys throws in Bangalore. Shareholders are, of course, much more likely to savour that kind of inspiration if your revenue and your operating margin have both been growing by 30%, as Infosys’s were in 2008. Keeping it simple may not make headlines, but as put into practice by Infosys, it looks akin to genius. Not that Balakrishnan – or his colleagues – would be immodest enough to point this out. ● 4 Technology. Reduced telcommunication costs and other advance technologies mean “geography is history”, helping India compete. Infosys’s net margins Net profit as percentage of revenue, after exceptional items and excluding tax reversal 2006 2007 2008 in cash. We are not averse to debt. We would take on debt if we needed to, but we are in the technology business and technology is risky enough in itself. Why should we enhance those risks by taking on large debt?” Amassing debt unnecessarily or through wishful thinking about business conditions would contradict another of his guiding principles: “You run your company in good times as you would in bad times. Keep your organization lean and organize yourself so that your costs are as variable as possible.That way you will still profit in the good times and are better placed to survive the bad.” And here, once again, his conversation turns to divine beings.“I was in conversation with someone the other day and they said to me: ‘Cash is king’. I told them:‘No it’s not, cash is God.’ If you’re out of liquidity, you’re dead.” Even with all that cash in the bank, and the values of many companies falling, he says Infosys 3 Education. India has an English-speaking graduate pool of 2.5 million and more than 500,000 engineering graduates every year. But education must remain a priority for investment. 45.73% “We have about US$2bn in cash. We’re not averse to debt but technology is a risky business, so why add to that risk with debt?” 2 Demographics. Close to 67% of the population is under 30. 44.89% Cash, debt and risk A sense of trusteeship has informed Infosys’s fiscal policies, which are conservative to the point that some analysts have suggested the group is allergic to debt. Here, Balakrishnan is happy to set the record straight: “We have about US$2bn (€1.6bn) is unlikely to go on an acquisition spree. “We don’t have to acquire companies to grow. We only need to buy companies which are a good strategic fit for the business and are available at the right price.” Which, I suppose, brings us back to data again. Like most CFOs, Balakrishnan is too experienced to believe in any silver bullet for business success. If any author distilled Infosys’s story into a how to-succeed-in-management-without-trying terribly-hard bestseller, simplicity would have to be in there somewhere. Simplicity in the way budgets are set and adhered to and the way the company is run. Indeed, Balakrishnan makes the point that such simplicity should apply to the company’s mission statement:“Keep the business rules simple. If they get too complicated, it’s hard for everyone to understand them.” Such simplicity, in his view, must be reinforced by openness. Some companies routinely boast that they have an ‘open door’ policy when, in reality, the door is only open when the CEO is out the office. But perhaps because it was founded by seven colleagues rather than a lone father figure, Infosys has striven to create a culture where any member of staff really can approach any manager. But to make this work, he says: “You have to set the example at the very top. And that openness is one of our non-negotiable values.” Infosys’s return on capital Return on average capital employed 2006 2007 2008 Balakrishnan invokes God a lot. With some leaders, this might suggest arrogance, even a hint of divine certainty, but the Infosys CFO sounds humble whenever he mentions the supreme being, almost as if each allusion is a reminder that no executive, no matter how powerful, is above judgement. The same sense of humility prompts him to suggest that companies might be more successful if their leaders acted as if they were trustees of the business, not managers. “It’s important to have strong ethical values,” he says. “That makes the business more sustainable. We have turned away business rather than do something we knew was wrong.” INDIAN SUMMER Why Balakrishnan is optimistic for India 1 Red tape is being cut. In some sectors, like software, there is almost no government interference and work is underway to ease restrictions on foreign investment in others. 13 Agendamagazine 11 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. Hulton Archive/Getty Images. Yuri Kotchetkov/EPA/Corbis. Jemal Countess/Getty Images. Richard Lewis/AFP/Getty Images 12 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. GrEat DEbatE Is this what a new paradigm feels like? In his book, George Soros argues that Asia’s rise marks the birth of a new economic order.We asked three specialists to discuss his view By PAUL SIMPSON F or any CFO keen to explore the state we’re in – and what shocks may lie ahead – one slim volume is essential reading. George Soros’s The New Paradigm For Financial Markets: The Credit Crisis Of 2008 And What It Means does what the title suggests and more. The financier believes what we’re experiencing isn’t simply a credit crisis but a permanent shift in the global economy that will end the West’s economic pre-eminence and establish Asia as the centre of the world economy. So is he right? And what does this mean for business? To explore all these issues, Agenda talked to: Mark Dampier, head of research at London stockbrokers Hargreaves Lansdown; Ian Gomes, chairman of high growth markets at KPMG; and Herman Yu, CFO of Chinese media group Sina. To read his views in detail, see Soros’s book, The New Paradigm For Financial Markets: The Credit Crisis Of 2008 And What It Means (BBS Public Affairs) How should Western business react? Gomes There is an opportunity here. The West still has a lead in innovation and technology and companies, confident of their competitive edge, could invigorate their business by investing in POWER PLAYERS Clockwise from top left: Vladimir Putin, Deng Xiaoping, George Soros and India’s Manmohan Singh are central figures in the new paradigm “What we’re seeing now is the last industrial revolution, affecting 5bn people” Is Soros right in his central thesis: that economic power is transferring from West to East? Gomes There is a paradigm shift in the way capital is flowing from West to East. Companies have seen opportunities in less-developed Eastern economies and they have changed dramatically. Look at the accumulation of wealth in the Gulf, China and India. The Gulf and China have built sovereign wealth funds that invest in the West and other emerging countries. We are also seeing The Soros view more south-to-south investment flows. There’s a two-way flow we have never seen before. Yu The U.S. has a huge debt, a lot of it foreignfunded, so people were looking to diversify their risk even before the sub-prime collapse. That said, I believe the dollar will be a primary currency for international trading for a long time. In the long run, we may become less dependent on it, and move to a basket of currencies. That would be less risky. Dampier Western developed economies have huge deficits while many of the developing economies have huge surpluses. But you can’t write off the American economy. I’m sure people made similar predictions after Vietnam. And the Iraq war now is a huge drain on the U.S. But the internal dynamics of the U.S. economy make it resilient. It has a strong entrepreneurial culture and is one of the few Western economies that isn’t plagued by the kind of demographics that will increase healthcare and pension costs. I’m not denying there is a shift – what we are seeing now is the final stage of the industrial revolution, affecting five billion people, only what took 200 years in the West is being done in 20. 1 The free market doesn’t automatically achieve equilibrium. Without regulation, markets will lurch from boom to bust. 2 The sub-prime crisis is the completion of a process that has eroded America’s status as the sole economic and political superpower. 3 The U.S. dollar will lose its status as the global reserve currency. 4 The sub-prime collapse will accentuate a shift of economic power from the West to China, India and the Middle East which, though not immune to the effects of recession in North America and Europe, will in the long term perform better than the West’s economies. Agendamagazine 13 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. Gathering momentum the productivity of their staff and use as few people as possible. In China, where labour is much cheaper, companies prefer to employ as many people as they can because they believe it gives them a strategic advantage as they grow. Gomes These economies are developing innovative business models and ways of producing products of quality at the right price. The best thing the West can do is partner companies using these models and learn from them. Yu I would add a note of caution. Doing business in these economies isn’t always as straightforward asintheWest.Companiesshouldn’tunderestimate the time it takes to understand the complexity of the business environment, local regulation and dealing with governments. If you understand that, you can make a rapid return on your investment. Thought emerging economies weren’t expanding into the West? Think again… 322 The number of developed market companies acquired by Indian businesses in the past ﬁve years US$23bn (€18.3bn) Total value of acquisitions by emerging market businesses since 2003 US$330m (€263m) The amount paid by Chinese conglomerate Li & Fung for U.S. handbag retailer Van Zeeland, one of 25 acquisitions by Chinese companies in developed economies over the past ﬁve years 53% Rise in number of acquisitions in developed markets by Brazilian businesses, Q2 2006-Q1 2008, compared to previous two years Source: KPMG’s Emerging Markets International Acquisition Tracker report THE OLD REGIME Clockwise from top left: The traditional view of emerging economies was deﬁned by Chairman Mao, Mother Teresa and Vladimir Lenin. But, as Soros points out, that is changing Chairman Mao image by Andy Warhol; other images in this feature have been digitally manipulated to resemble Warhol originals China and India. At the same time, this shift could challenge the West’s traditional business model. Most people in China and India are still at the bottom of the pyramid and many businesses have to start with a price point, what people can afford to pay, and work backwards from there. In the West, we’ve usually done it the other way around: devised a product, figured out what it costs to make, added a margin and come up with a price. Yu What the West shouldn’t do is just apply its model to Asia. In China, we’ve seen many multi-nationals come in and fail, especially in the technology and internet sectors, because they haven’t adapted their product or business model. Instead, many Chinese companies have reinvented a Western model and succeeded. Dampier The big danger is arrogance. The lesson every Western business should take from this is that competition is fierce, it’s going to get fiercer, and they are kidding themselves if they believe being in a high-end market makes them immune. Yu To give you a small example of what I mean, many U.S. high-tech companies want to improve It is often suggested that China and India can only compete on cost, not quality, and are not as innovative as the West. Are these criticisms fair? Gomes The innovation gap isn’t as big as the West would like to believe. China isn’t all about copying, reverse engineering and manufacturing. Huawei, the telecoms company, spends US$1bn (€670m) on R&D which, given local labour costs, it says is equivalent to four times the same R&D spend in America. The success of Indian IT may originally have been down to cost but it has moved high up the quality curve. Also, Chinese and Indian components are widely used in Western manufactured goods. So it is unfair to suggest they only compete on cost, not quality. Dampier Developing economies start by copying best practice to bring it up to standard. Look at Japan. And the industrial revolution is happening very quickly in China and India. We tend to forget that. Yu I don’t think this is a cultural issue. A lot of this has to do with the size of the market and consumer spend. If you’re in a small market, you don’t need to innovate. As the economy grows – and consumers spend more – you will see more innovation. The internet sector has grown at about 50% a year in China and a lot of Chinese IT companies have floated on Nasdaq this year. The quality issue isn’t as simple as it’s portrayed in the Western media, when it covers a product recall by a Chinese supplier. Many multi- “China and India accounted for around 45% of the world’s growth last year” Mao (acrylic silkscreen print) © The Andy Warhol Foundation for the Visual Arts/ARS/DACS 2008/Bridgeman. Times Newspapers/Rex Features. Sipa Press/Rex Features. Joel Saget/AFP/Getty Images. GREAT DEBATE 14 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. nationals who make products in China focus only on cost. Companies that consider quality control too haven’t suffered as much. If we are seeing a paradigm shift, why haven’t these countries developed more global brands? Gomes It takes a lot of time, money and trouble to build a brand. It’s easier and cheaper to buy one than build one – as Lenovo did when it acquired IBM’s PC business – and I expect more Chinese and Indian companies to do that. But there have been some spectacular successes: look at Samsung in mobile phones and Embraer, the Brazilian airline manufacturer that has pretty much conquered the small-plane market. Yu The absence of global brands reflects the stage China’s economy is at. It’s been growing by 8-9% a year for 10 years. In some sectors, growth has been greater. I was talking to the boss of a toilet paper company, and their sales have been growing 40% a year. When domestic growth is that fast, it’s hard to think about expanding into foreign markets. But that day will come as Chinese companies gain scale and experience. Dampier If you think of the really famous brands, like Coca-Cola, they took ages to build. When I visited Russia, it struck me that the middle class was very keen on its own brands. It was just the upper class that was into foreign brands like Mercedes and Rolls-Royce. If you look at what happened in Japan, brands like Sony and Toyota took 20 years to emerge. In the next 20 years, I expect to see China, India and Russia all developing more global brands. Yu There will be speed bumps – China is not immune to the downturn – but the government is trying to incentivize consumer demand. The stimulus package does help exporters, but the long-term shift is still towards a more consumerdriven economy. The big worry is inequality, especially between rural and urban China. But the government has recognized this threat and is trying to spread the wealth more equally. Dampier That would be my worry in many of these economies. In Russia and the Gulf, for example, too much of the wealth is held by a few billionaires. It needs to trickle down. Gomes The West has a much better system of providing venture capital than China and India. There are some concerns over transparency and intellectual property, and the perception is that both governments have become a little less open to foreign investment. Look at the Indian retail industry. The Reliance group is expanding into that sector in a very big way, opening 1,000 stores a year and moving to capture the whole supply chain.Will that be fully opened to foreign investment? The jury is still out on that. Yu To me, China seems more open to foreign investment than two years ago. Banking, for example, was opened to foreign investors last year. Dampier Economies growing as fast as China’s and India’s will hit bottlenecks. But there are three other factors that need to be considered. In different nations, to different degrees, the green lobby could have an impact. The unfortunate truth is that these countries are also more likely to suffer natural disasters. In China, the demographics aren’t very good. India’s are superb – the average age there is 25. Young people are usually more mobile, more flexible, more willing to take risks. And the older the population, the greater the cost. Yu The Chinese government’s strict fiscal policies should limit damage. Even after the stimulus package, you still need a 20% deposit to buy a house, which is very conservative. If the U.S. had that kind of policy, the economy wouldn’t be suffering from the sub-prime collapse. As long as China and India support free trade, they present an opportunity for business to expand into countries with a rich resource – at a very cheap rate – which accounted for around 45% of the world’s growth last year. ● “China isn’t all reverse engineering. Huawei spends US$1bn on R&D” What could threaten these economies? Dampier Politicians. Look at Russia, although its disputes have often been misreported by Western media. Russia is desperate for foreign investment to develop its oil fields – where output is actually falling – but the perception is such that they’ll struggle to find partners.They’ll crack it eventually. Gomes For China and India, the big challenge is to bring millions out of poverty and into the consuming class. Investing in quality education and relevant skills is a very high priority if demographic advantages are not to become a liability. For India, insufficient investment in infrastructure is already adversely impacting growth. Haier points the way upwards One innovative, yet regimented manufacturer has proved that brands from emerging economies can become global players. Haier is now the world’s fourth-largest white goods maker, a remarkable reinvention inspired by charismatic CEO Zhang Ruimin. When he bought the ailing state-owned refrigerator business in the mid-1980s, Zhang made his standards dramatically clear. In one celebrated incident, he joined staff in smashing defective refrigerators with a sledgehammer. “If it can be done, he will make every employee a strategic business unit,” says Professor Marshall Meyer of Singapore Management University. “That’s the degree of accountability for results and mistakes he expects.” Such methods work. Haier now boasts global revenue of US$16.2bn (€12.5bn), is very profitable, operates in more than 100 countries and has almost 50% market share in some U.S. market segments. Haier’s aggressive product development – such as a climatecontrolled wine cellar and fridges for shared homes – reflects Zhang’s strategy for goods to be “Innovated in China” not just made there. © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. LEARNING CURVE Lessons from a eunuch What the story of China’s greatest explorer can tell us about this economic giant BY SHAUN CAMPBELL its massive manufacturing output, China is surprisingly weak in innovation. A full 57% of exports are from foreign-invested factories. . . China’s big, state-run R&D institutes are close to the cutting edge at the theoretical level, but have yet to yield many commercial breakthroughs.” Although the number of Chinese patents granted in Europe, the U.S. and Japan soared by 37% between 1995 and 2005, its overall share of patents is smaller than Sweden’s. No wonder premier Wen Jiabao plans to make “indigenous innovation” drive the economy by investing in science and technology. Global horizons The sheer size of Zheng’s fleets persuaded 30 states to pay homage to China, as this emerging superpower flexed its muscles. Now, China’s economic musclepower is changing the world: it was the second largest exporter in 2007 (behind Germany). Millions of entrepreneurs GO FURTHER Zheng He’s adventures are explored in When China Ruled the Seas by Louis Levathes (Oxford University Press). For more on China’s economic expansion, try Jagdish Sheth’s Chindia Rising: How China and India Will Beneﬁt Your Business (McGraw Hill), Pete Engardio’s Chindia: How China and India Are Revolutionizing Global Business (McGraw Hill) and Will Hutton’s The Writing On The Wall (Little, Brown). Zheng He upset Confucian mandarins by pioneering technology, exploring the world and opening new markets now look outward like Zheng. China has 35 companies in the 2008 Fortune 500. Groups such as Lenovo and Haier are world famous, but more Chinese businesses will acquire a global presence, especially in the booming internet sector. Confucian wisdom After Emperor Zhu Di’s death, China reverted to Confucianism. Change was stability y revered. Building a ship with feared, stabilit offence. The more than two sails was a capital offence.The between ween modernization and tension bet conservatism persists. Private firms thrive authorr Will Hutton says, “the state but, autho sector or is less productive than under sect Mao.” ao.” If China is to prosper, its M leaders aders need to balance change le nd stability more shrewdly than aand he mandarins who ignored tthe Zheng’s legacy and turned their backs on the world. ● Goh Chai Hin/AFP/Getty Images Western business leaders perplexed by their inability to ‘get’ China could do worse than consider the giant, long-haired eunuch who became the country’s greatest explorer. The fact that Zheng He (1371-1433) is hardly celebrated in his homeland offers clues to China’s relationship with the rest of the world, its struggle to innovate and its attitude to science and technology. Captured by a Ming army that invaded Yunnan when he was 11, Zheng was castrated and made a servant of the imperial court. After this inauspicious start, the 7ft (2.1m) eunuch became one of Emperor Zhu Di’s shrewdest advisors. As admiral, he explored most of southern Asia, Europe and Africa, reaching the Cape of Good Hope, within spitting distance of the Atlantic. After his death – he was tossed into the sea and not, as was usual for influential eunuchs, reunited with his testicles to enjoy the afterlife – conservative bureaucrats torched records of his heroic voyages. Scientific edge Zheng oversaw construction of 300 wooden ships, the largest of which was around 400ft (130m) long: Columbus’s largest, in comparison, was 85ft (25m) in length. Even today, we don’t know how frameworks made without iron supported the weight of Zheng’s ships. As a technological pioneer, Zheng harked back to Chinese inventors of old. But only now, 600 years later, are science and technology again a national priority. In 2006, China announced plans to make its students more scientifically literate than those in the West by 2020. Exceptional innovation Zheng thought big. His voyages were equivalent to seven and a half circumnavigations of the globe. He introduced an astonished Chinese public to the giraffe and launched Chinese goods, especially pottery and glassware, glassware, in new markets. Such remarkable innovation has, until recently, recently, been the exception – not the rule. Pete Engardio, editor of Chindia: How China and India Are Revolutionizing Global Business, says: “Considering 16 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. left field How to avoid a fine mess Ancient wisdom about woodland creatures, coupled with the character traits of two great comedians, could improve the way you manage and take decisions By paul simpson Everett collection/Rex Features A re you a hedgehog or a fox? It’s a simple question with no easy answer. In the seventh century BC, Archilochus, the Greek warriorpoet, wrote 10 words that still provoke debate about the nature of leadership: “The fox knows many things, the hedgehog one great thing.” In fable, the fox’s versatile intelligence is powerless when faced with the hedgehog’s singlemindedness, depth of knowledge and ability to turn itself into a prickly ball. Ergo, hedgehogs rule. Jim Collins, who analyzed the traits of outstanding companies in his book Good To Great, believes most top CEOs are hedgehog-ish in their clarity of purpose: “To a hedgehog, anything that does not somehow relate to the hedgehog idea holds no relevance.” Yet if you explore the philosophy behind the debate, the hedgehog’s superiority is less emphatic. Hedgehogs tend to believe, as the thinker Isaiah Berlin noted, that “every genuine question has one true answer”. Foxes instinctively feel that just because ideas clash, one idea isn’t necessarily true and the other false.Political and corporate dictators tend to be hedgehogs; William Shakespeare and Leonardo da Vinci were foxes. As a role model, the ultimate renaissance man seems vastly preferable to, say, Saddam Hussein. And business writer John Kay questions whether knowing one big thing is as useful as Archilochus suggests. As Kay notes, American psychologist Philip Tetlock tested 30,000 expert predictions about world events against 300 outcomes over 20 years. Tetlock found that the ‘experts’ were “scarcely better at predictions than chimps” and worse than if they had used simple forecasting rules based on extrapolation. Donald R. Keough, former president of CocaCola, would not be astonished by Tetlock’s research. He lists “put all your faith in experts” as one of the commandments for business failure. Keough speaks from bitter experience. Consultants and experts persuaded him in 1985 that launching ‘New Coke’ was a masterstroke. After 400,000 complaints, people filling up their pick-up trucks with old Coke and a class action law suit from a group calling itself ‘Old Cola Drinkers of America’, Keough was advised by experts to hold firm. Luckily, he ignored them, believing they had underestimated the brand’s emotional resonance with the public. If Keough had been more hedgehog-ish, Coke would have lost millions more. Summing up this sorry episode, he quoted James Thurber: “It is better to know some of the questions than all the answers.” The current economic turbulence suggests that all kinds of data – think sub-prime mortgages – that might seem irrelevant to a hedgehog can become very painfully, and expensively, relevant. It also suggests that knowing all the answers is impossible anyway. So should we all be foxes? As is so often the case, Laurel and Hardy can enlighten us. Oliver Hardy was a hedgehog who knew how to act funny as a polite southern gent who does the wrong thing for the right reasons. Stan Laurel orchestrated their comedy, had the flexibility to learn from – and not be crushed by – the genius of Charlie Chaplin, and the vision to realise that if the act didn’t adapt to talking pictures it would die. That balance, Kay suggests, defines “effective management teams, which is why the modern tendency to appoint hedgehogs and allow them to surround themselves with other hedgehogs is so dangerous.” At the next board meeting, categorize directors by their species. If you have the balance wrong, your board could be as useful as a comedy double act with two straight men. ● HEDGEHOGS AND FOXES MADE EASY Isaiah Berlin attributed different characteristics to foxes and hedgehogs Foxes • Are serial entrepreneurs • Are highly social • Constantly re-assess strategies based on latest information • May masquerade as hedgehogs – or turn into one • Can seem too flexible • May lack strategic clarity Hedgehogs • Work to ‘unwavering’ rules and keep a single focus throughout • Acquire great knowledge in one field • Make up their minds quickly and decisively • Don’t like giving up on ideas – good or bad • Can be too singleminded and define issues too narrowly Agendamagazine 17 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. 03 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. best prActice The subtle art of turning round your business in a storm Rescuing a troubled company means coming out of denial, finding cash – and thinking the unthinkable by RhymeR Rigby 1 What state are you in? “The first thing any CEO or CFO needs to do in a turnaround is to understand why they’re there,” says Philip Davidson, KPMG’s Head of Restructuring Advisory. “They need to take stock of their customers, suppliers and other stakeholders.Where do they stand vis-à-vis employees? What’s the market doing? Is the turnaround needed because the market’s contracting? They need to be crystal clear about the position they’re in.” Buyenlarge/Time Life Pictures/Getty Images A lbert Einstein famously noted that: “In the middle of every difficulty lies opportunity.” The good news is that if you turn your underperforming business around, in probably the most uncertain business environment for 70 years, your reputation will be made. American company doctor Greg Brenneman says: “If you have a chance of working for a healthy company and a sick company, choose the sick one. The sickest ones need the best doctors and it’s a lot easier to stand out in a company that needs help.” The bad news is that such transformations are a lot harder to effect than they were. Not as tough as devising the theory of relativity – but close enough. The turnaround industry has changed beyond recognition in the last 15 years. In the popular imagination, it’s still associated with charismatic, larger-than-life characters, such as former ICI chief Sir John Harvey-Jones, who would enter a business all guns blazing, troubleshoot here, slash and burn there to create a lean, mean organization. But the era when you could turn a business around by confiscating the checkbooks is over. A more considered, multi-pronged and collaborative approach is required. Just as Alcoholics Anonymous offers 12 steps to help drinkers come back from the brink, so corporate turnaround has a few guiding principles. Agendamagazine 19 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. best prActice A good example of the clarity and honesty required is Balfour Beatty chairman Steven Marshall’s pert assessment of the troubled Torex Retail, which he was asked to rescue in 2007: “It required extremely urgent change because, financially and reputationally, it was looking over the edge of a cliff.” This examination should tell you which areas are hemorrhaging money. When Brenneman saved Continental Airlines in 1994, he swiftly identified the 18% of its flights that were bleeding cash, cut them and stabilized the airline.Sometimes,savings can start with initiatives that sound mundane. In 2001, Cisco Systems cut admin costs by shrinking the number of key suppliers from 1,300 to 420 and earned volume discounts worth hundreds of millions. 2 Do you need your CEO? The shift in turnaround thinking is perhaps best illustrated by the role of the existing CEO, says Davidson. “When I started in turnarounds 20 years ago, it was almost inevitable the CEO would go and a company doctor would take control.” That person would be a situational expert and, in the still comparatively localized companies of yesteryear, that was often what was required. Now, those trying to turn around businesses may see existing managers as a pool of specialist knowledge worth keeping. Managers may have been part of the problem, but can be part of the solution, commanding staff loyalty – especially if the turnaround is largely due to externalities. A rescue may involve a chief restructuring officer working with managers. The trick, as Mark Hurd showed when he rescued NCR in 2003 by cutting jobs, costs and underperforming executives, is not to suffer fools gladly. 3 Hunt for buried treasure Examining a business’s balance sheet thoroughly can unearth undervalued assets. During the turnaround of drinks firm Robinsons, it was discovered that by drilling bore holes deeper, and bringing them within EU nitrate levels, their value multiplied 20-fold to US$34m (€27m). These hidden assets needn’t be as concrete as springs – CAD software supplier Autodesk revived its fortunes by focusing on an underperforming customer segment. This treasure-in-the attic approach should not be counted on: only a minority of failing businesses have significant assets that are undiscovered or unleveraged. 4 Sort out your priorities Once you understand your situation, you need to take control with a wellthought-through plan that makes it absolutely clear which parts of the “To proactively manage the crisis you must have a good fix on where you are and understand the risk factors that could affect you” business need direct attention and which don’t. Brenneman emphasizes the need to stick to a clear strategy. That sounds obvious, but in many underperforming firms, dispirited managers may lurch from one disaster to the next. Sometimes, it’s not all about cost: resuming profitable growth can be vital.After Michael Eisner had been ousted as Disney CEO in 2005, with shareholders in open revolt after a run of box-office failures, his replacement Bob Iger bought Pixar. The merger made Disney attractive to Hollywood creatives, made the studio’s model of developing animated films and TV series more collaborative and developed product to appeal to ‘tweens’ (10 14-year-olds) with synergistic successes like High School Musical. That focus can work in surprising ways. In 1987, with sales of electronic components and computer products flat, U.S. firm Arrow Electronics, second in the market, bought the third biggest supplier and became market leader, a position it still holds. Great turnarounds 1617 Gustavus Adolphus Turned a decaying Sweden into the third largest empire in Europe – and also created the world’s first central bank, to secure prosperity. 1969 2005 Rupert Murdoch Andrea Jung The Australian media baron turned ailing British tabloid The Sun into the UK’s best seller within a decade by embracing populism and changing senior management. With Avon struggling, Jung acted as if she’d been hired to turn it around. She cut staff, changed marketing plans and reversed some deals to cut the right costs and save her job. AKG Images. Sipa Press/Rex Features. Brad Barket/Getty Images } }} }} } Three leaders who made the transformation 20 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. 6 Take back control Many modern companies are fairly decentralized.This is great while times are good. But when the going gets tough, democracy and consensus can be ineffectual. Command and control may work better. In 1991, with Bang & Olufsen in deep trouble, new CEO Anders Knutsen did all the usual things: laid off staff,de-layered management and streamlined operations.But,through a strategic plan called Break Point 1993, he also dealt with many of the problems caused by an earlier decentralization, making the business more centralized and responsive to customer needs. The shift must be handled sensitively, with respect for people and their autonomy. It’s a short step from pragmatic centralization to meddling micromanagement. And you need people on side: if staff don’t believe in the turnaround, it won’t happen. 7 Understand your costs “It’s not enough just to cut costs across the board. A more sophisticated approach is needed,” says Davidson. Costs need to be analyzed so it is clear which relate directly to sales, and over what period of time they generate returns.Cost should be viewed as ongoing investment and,like any investment, challenged by reference to the business’s objectives. If the business’s mediumterm future is in jeopardy, costs that only benefit the longer term are an obvious cut. Likewise,“if you look at taking out cost and the effect on sales is neutral, then it goes. But if it is negative, you go to the next level of analysis.” You have to get the balance right. Survival depends on your stakeholders having belief in your future. Cutting costs that adversely affect the core of the business can have disastrous consequences. On the other hand, Davidson says, if survival is a matter of months, cutting a cost that relates to next year can make sense:“It’s all about allocating a scarce resource.”To be able to do this with confidence, it is vital to have accurate, up-to-date information. If, as one turnaround specialist noted of a stressed business, your accounts could have been written by a novelist, your task will be considerably harder. 8 Think the unthinkable “You need contingency plans,” says Davidson. “You have this great plan in place, but what if you lose a major customer or supplier? I met with a transport business recently. Great turnaround plan, really focused on liquidity. But I asked how many of their top 20 customers would have to fail to put the plan at risk and the answer was one. One question about contingencies got to the heart of what that company needed to do next. Most companies go bust because they run out of cash. If you’re not proactively managing your situation, you increase the risk that you will go bust.” The two places you don’t want to be as a manager, says Davidson, are hope and denial. Managers often believe they can trade their way out of difficulty, forgetting they traded into it in the first place. To find the cash you need to keep going, you need to abandon the Micawberish hope that something will turn up and face reality and come out of denial to confront the uncomfortable issues that threaten your business. As Davidson says: “You need a really good fix on where you are, where you need to get to over whatever period of time and understand all the risk factors that might affect their performance.” If you do all that – and enjoy a little luck – you’re most of the way there.● Warner Bros./Getty Images 5 Who needs to know? The flow of information to employees and other stakeholders is almost as important as the flow of cash. If people are in the dark, rumors will spread. Show employees you respect them enough to keep them informed and they’re much more likely to stand behind you. Even if all you have is bad news, it’s best coming from you and managed by you. What not to do when business turns infernal “If stupidity got us into this mess,” the humorist Will Rogers wanted to know, “why can’t it get us out of it?” Rogers’ point has been amply proved throughout corporate history. In 1957, with the Hollywood studio system fading, MGM bosses shut their animation operations, believing reissues would yield as much revenue as new projects. Ousted cartoonists formed HannaBarbera, who dominated the animation world. Cash looks even more alluring in a recession. And in 1973, with Elvis Presley and his maverick manager Colonel Tom Parker both strapped for money, Parker sold the rights to royalties on Elvis’s material for US$5.4m (€4.3m) to RCA. Artist and manager split the money 50/50. It seemed a strange deal then, but with Elvis’s record sales passing the billion mark in 2007, it looks like the biggest bargain since native Americans sold what we now call Manhattan to the Dutch in 1626 for a few trinkets. The best firms use a downturn as a reality check. But the same year as RCA bought out Elvis, dime-store chain W.T. Grant insisted on paying its quarterly dividend to shareholders, even borrowing to do so, though it was making losses. To stimulate sales, cashiers were ordered to offer credit cards to “anyone that breathed”. Staff who didn’t issue enough credit cards were humiliated – some had to push peanuts across the floor with their noses – and in 1976, the chain went bust, with US$800m (€509m) of bad debt. Sometimes, the errors are much more understandable. In the urge to fix problems, managers can forget their core business. In the 1990s, fastgrowing aerospace group Loral focused so much on its troubled Globalstar satellite investment, it didn’t notice its core business was losing market share. Loral ended the 1990s as a company in trouble. Agendamagazine 21 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. Known unKnowns Predicting is always difficult, especially where the future is concerned, but here are 10 trends that may shape your business 03 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. ON THE HORIZON 2 Plane truth Many boards have recently looked as alert to peril as the dinosaurs just before a meteor smashed into Mexico 65 million years ago. CFOs believe such crises prove that risk management should be a strategic partner in a business, but how do they convince managers? Programs to align risk controls to business needs – and software to aggregate, measure and assess risks – will help. But René Stulz, professor at Ohio State University in the U.S., says risk managers must change tack. He says firms misjudge known risks (by relying on past data or not sensing the correlation between different risks), don’t realize how fast risk can change, and don’t communicate risks properly to management. Stulz says “scenario analysis focusing on possible financial crises” modelled on economic analysis, not past crises, is essential in the finance sector. Creating a culture where risk is factored in, not by bureaucrats wielding fancy software but managers on the front line, won’t be easy or quick. But it’s better than the alternative. 10 5 Aviation industry net proﬁts Source: International Air Transport Association 0 -5 -10 Year -13 2000 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 3 Developing Bransons Where is the Brazilian Richard Branson? If developing economies are to create the next Virgins, they need the support networks that made Silicon Valley an engine of innovation. An American non-profit organization called Endeavor is trying to rectify that. CEO Linda Rottenberg believes the best way to fight poverty is to select and mentor entrepreneurs in developing nations. Since 1997, Endeavor has put 409 entrepreneurs in touch with CEOs, ministers and investors in their own markets and elsewhere. This is good news.A Fulton School of Engineering study found a 5% drop in new ventures equated to a 3% fall in GDP growth. Each Endeavor entrepreneur typically creates 118 jobs and their combined sales now stand at US$2.51bn (€1.93bn). Brazilian wind-turbine-blade maker Tecsis, mentored by Endeavor, has won a US$1bn (€670m) deal to supply GE. Only 44 Fortune 500 firms are based in developing economies. Some pro bono advice from business leaders may help improve that tally. Ritu Manoj Jethani/Shutterstock. James Leynse/Corbis. Risky Risky business Proﬁts (US$bn) 1 When Boeing’s Dreamliner 787 takes to the skies in 2010, it could do for airlines what Intel did for PCs. John Quelch, professor of business administration at Harvard Business School, says: “The ‘Dreamliner’ brand will be as prominent on fuselages as ‘Intel Inside’ on PCs.” He says Dreamliner may have a bigger influence on passengers’ choice of flight than the airline. Despite delays, Boeing has already sold 900 Dreamliners. Airlines have been tempted by low fuel consumption (20% less on long haul than 767s), higher cabin pressure (the journey should feel nicer) and gust suppression technology to reduce motion sickness. With Dreamliner, Boeing is pioneering a collaborative development process in which its partners share the risk, design burden and virtual development. If it works, this process could save Boeing money and time developing the heirs to Dreamliner and may give it an edge over Airbus. Agendamagazine 23 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. Shipping Inflation nearly hit 30% this year, but foreign direct investment in Vietnam will still soar by 37% to a record US$11bn (€7.4bn) in 2008. For companies with stickability and a longterm view, this could be the time to invest. Prices are relatively low and GDP growth – expected to reach 5% in 2009 – is still strong. Vietnam has stability, an increasingly well-educated workforce, labor costs about half those in China’s coastal industrial zone and booming agribusiness, gas, oil and tourism industries. Mobile phone use is set to double by 2010. As a nation, Vietnam has renewed entrepreneurial zeal, with private start-ups abounding The state, which controls 38% of GDP, plans to sell 1,500 more state enterprises by 2010. Bureaucracy, corruption, poor regulation, and a creaking infrastructure will deter some, but GE began making turbines here in the spring. The risks are large but so, GE believes, is the opportunity. Using shipping to ‘green’ your global distribution channels will be much harder than you might have assumed. If shipping were a country, it would be the sixth largest emitter of CO2 in the world. UN research says emissions from shipping are almost double that for aviation – three times higher than thought. Shipping emissions are expected to double by 2020. A ‘green gauge’ for ship designers, new targets for ship recycling and tighter rules for sulfur and nitrogenoxide emissions will hardly placate eco-warriors. Mandatory EU emissions standards caps, which are likely over the next few years, will be a more positive step. What can the industry do? New water resistance technology could cut fuel usage. Under California’s new rules, ships must use diesel – not highly polluting bunker fuel – to power auxiliary engines in port. The U.S. Navy is developing kite-powered cargo ships that could use 30% less fuel. If progress isn’t rapid, shipping miles could eventually become as controversial as air miles. Foreign direct investment in Vietnam (US$m) Source: Vietnam Ministry of Industry As the joke goes, Silicon Valley wasn’t founded on ICs (integrated circuits), but on ICs (Indians and Chinese) who started one fifth of America’s high-tech firms. U.S. IT is reeling from tough H1B visa quotas for highly skilled foreign workers, the credit crunch and fewer new arrivals from Asia. In 2003, 195,000 H1B visas were issued; 2008’s quota (65,000) was reached after a day. Bangalore’s ‘Silicon Ghat’ and Hetel, the boom city at the heart of China’s new Silicon Valley, look increasingly attractive to skilled workers. There are now 253 million Chinese online, compared to 190 million Americans. In 2007, American investors pumped US$616m (€416m) into Chinese IT start-ups, suggesting China could use U.S. finance to grow an Intel or Google. In contrast, Silicon Valley venture capitalist Sequoia recently held a summit to suggest U.S. start-ups cut costs. Wannabe IT tycoons were greeted with a tasteful slide of a gravestone bearing the words: “RIP good times”. Vietnam 11,000 Ovidiu Lordachi/Shutterstock. Corey Hendrickson/Getty Images. Hero Lang/AFP/Getty Images. Silicon Valley blues 7 2008 6,739 2007 2,360 2006 2005 2,021 2004 1,610 4 5 6 Head count What does your head office cost? A simple question, but in Maxxim Consulting’s 2008 survey of 20 large British firms, only four CEOs knew the running costs of – or the staff numbers at – their HQs. In good times, head offices grow organically. Typically, doubling a company’s size increases head office staff by 75%. Scrutinising head office costs could save money and improve morale but there are risks to be weighed. A 2004 study of 600 global corporations found no strong evidence that smaller HQs improved financial performance. If too many functions are dispersed, managers may miss a strategic opportunity. Savings may offset some risks associated with a loss of control. Just by deciding its HQ would only support core businesses, one multi-national cut head office costs by 50%. Having halved its head office staff since 2007, UK technology company Smiths Group now publishes its HQ costs. Such transparency may help morale. Financially trivial expenses can have a large symbolic value, and hiding them fuels suspicion. 24 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. on the horizon 8 Software is the new weapon of choice African agriculture Militaries will always use sophisticated machinery, but software is starting to take over. Even the traditional bigticket items — aircraft, ships and submarines — rely on software for their effectiveness. Take the Joint Strike Fighter, a multi-role stealth aircraft under development for U.S. and other forces, at a cost of US$300bn (€233bn). The aircraft looks impressive, but as the project matures, block upgrades to its software package will make its sensors and weapons much more effective. If the software doesn’t work as designed, billions of dollars worth of equipment might not do the basic job it was bought for. Australia’s Collins-class submarines couldn’t use their weapons properly for years after a series of software failures. Of course, that sort of problem can – and frequently does – afflict hardware development. But changing hardware is more costly and time-consuming than changing software, so the Joint Strike Fighter is likely to be the first of many similar developments Software is much more important because intelligence analysis is so fiendishly complex. Finding and tracking terrorist groups, drug cartels and peopletraffickers involves sifting through vast amounts of data – most of it innocuous and irrelevant. Only cleverly designed software (running on large, fast computers) can do the job. None of this comes cheap. Software bugs on your home PC are one thing. On a battlefield, where the outcome might be life or death, they are a different matter. The level of redundancy and reliability mandated for such systems ratchets up cost. And the military often wants it all and wants it now. The ‘spiral development’ model – in which supplier and customer consult to evaluate early results and identify trouble spots – has been accepted by the Pentagon, but is hardly universally understood. Economics dictate that software will eat into defence budgets once reserved for hardware. As U.S. defence expert Norman Augustine says: “Software is difficult to grasp, weighs nothing and obeys the second law of thermodynamics – it always increases.” Like Danish author Karen Blixen, Daewoo Logistics Corp now has a farm in Africa.The Korean conglomerate has long had a profitable commodities division which trades in crops like cereal and rice.Worried by volatile prices and security of supply, it aims to grow 5.5 million tonnes of corn on a million-acre plantation in Madagascar by 2023. Other companies and countries will follow suit. China, whose trade with Africa will reach US$100bn (€67.5bn) in 2008, is poised to invest, as are Kuwait and Saudi Arabia, both as short of arable land as South Korea. Some African leaders, frustrated by 20 years of slow manufacturing growth, now look to agriculture, seeking investment to improve infrastructure and supply chains.Angola offers farmland for development, while Ethiopia is open to foreign investors. African agriculture may not be an obvious priority, but Daewoo’s deal could be the catalyst for more foreign firms to work with the continent’s economies. Andrew Davies is director of the Operations and Capability program at the Australian Strategy Policy Institute 9 Structural defects Gridlocked roads cost the U.S. economy US$78bn (€61.3bn) a year in wasted fuel. India’s straining infrastructure, which hasn’t grown as fast as its economy, costs the nation at least 1.5% of GDP a year. These are just two examples of a global crisis. A report estimates that the world must spend US$40 trillion (€27 trillion) on infrastructure over the next 25 years if cities – now home to over half of humanity – are to maintain power, water and transport. Public investment is now being resumed as treasurers prime the economic pump. The row over who runs projects – state or business – is a false dichotomy.A more fruitful tack might be to analyze good private-public relationships.The state could lead more lightly and make better decisions, while companies should realize that current incentives can encourage cost overruns. Infrastructure can offer five-year returns of 8-13% if projects run well. If they don’t, gridlock could spread from roads to economies. Bettmann/Corbis. Dave Hamman/Gallo Images/Getty Images. 10 Agendamagazine 25 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. 03 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. the big issue the real oil crisis Volatile oil prices,environmental pressures and the credit crunch should act as a powerful wake-up call to rethink your company By Walter Hale aND HeNry HariNgtoN Toby Adamson/Getty Images. Shutterstock S ometimes, attention to detail pays off spectacularly. Last year, just by using routing software to eliminate left-hand turns from drivers’ schedules, delivery firm UPS saved three million gallons of fuel, cut 28.5m miles from its delivery routes and reduced CO2 emissions by 31,000 tons. As big a difference as that small, simple change made to UPS, CFOs will have to be far more creative to flourish in an era when the volatility of oil prices and pressure to be environmentally responsible will reach unprecedented levels. The era when CFOs could rely on cheap oil is long gone. Once so cheap that transport was a negligible consideration on cost sheets, oil spurred globalization, encouraging investment in low-cost factories abroad. Cheap oil laid the basis of the low inflation economy.Though estimates of when/if oil production peaks vary immensely,the International Energy Agency (IEA) predicts the world will struggle to produce enough to make up for steep declines in existing fields. By 2030, the world is expected to use 50% more oil than today. In less than seven years, the IEA says: “A supply-side crunch, involving an abrupt escalation in oil prices, cannot be ruled out”. One explanation for this is that the extraction and distribution of oil will be subject to a host of unpredictable actions and inactions that may constrict supply. Finding oil oozing out of the desert sands in a state ruled by a benign autocrat is a thing of the past.The areas where oil is found have become harsher, more remote, climatically challenging and subject to environmental scrutiny or the vagaries of corruption. And security of supply remains a worry. The paradox is that recent record oil prices have made large profits for international oil companies, some of whom have seemed reluctant or unable to invest.That could be the memory of a US$10 barrel of oil deterring investment or the prospect of a US$200 barrel making a delay worthwhile.Margins in the refinery industry are vapour thin, deterring investment in new capacity. Standard & Poor’s maintains that while the major international oil companies (IOCs) have considerable cash, there are fewer opportunities for investment because they lack access to large oil reserves. IOCs face tougher competition from state-owned national oil companies (NOCs) which now account for 72% of the market and spend a bigger percentage of their revenue on research than the oil majors. state security Such uncertainties are shaping government policy. Wayne Chodzicki, Global Oil and Gas Sector Lead for KPMG, says: “Countries like China, India and Korea are seeking joint ventures beyond their borders with both national and independent oil companies to secure future oil supplies.” Such eagerness is understandable. By 2030, the net oil cliMate busiNess Global warming is a high risk for three industries oil and gas Predicted falling demand after 2016 could see values of firms slip 5-15%. automotive Unpredictable new technologies which may be commercially viable by 2015, new competitive dynamics and new rules mean corporate value could rise or – if regulators get tough – fall by as much as 65%. aluminium Margins will become volatile if aluminium comes under EU emissions trading regulations, energy costs rise, and recycling increases. Source: McKinsey Agendamagazine 27 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. ThE bIg ISSUE imports of China and India will exceed today’s combined imports of the United States and Japan. The pressure to alleviate what Shell calls “supply/ demand climate stresses” – and stop Earth frying – will fall hardest on business. In the U.S. election campaign, for example, the closest either candidate came to a plan for energy security was the cry of “Drill baby drill,” at the Republican convention. Somepoliticianshavebeenlessevasive.California governor Arnold Schwarzenegger says America has allowed oil price to dictate energy policy:“We’re 96% dependent on oil for transportation fuel; just 8% of our national grid is powered by renewable sources. That’s shameful. To remain the world’s leading economic power, we must strive to be the leading energy power. Denmark gets nearly 20% of its power from wind.The Danes set a goal and stuck with it, even when it wasn’t popular and oil prices were low. The same is true of Germany, with solar energy.And Brazil, with ethanol.” Sweden aims to “break oil dependency” by 2020. Despite rising industrial output, the use of oil has already fallen from more than 70% of energy supply in 1970 to 30% today. The government commission plan targets a 25-40% cut in oil consumption by industry, achieved by greener cars, energy-efficient plants, use of IT alternatives to business travel and telecommuting. As an environmental trendsetter, Sweden’s thinking may set the regulatory context business operates in. The challenge for business With the IEA’s predicted oil price crunch only seven years away, Chodzicki says businesses should look at energy “in the whole portfolio of what they do”. The first step is to review your business’s exposure to changes in regulations, new technology and consumer behavior. Energetic world Saudi oil is in demand now, but bio-energy is becoming popular in Europe and Arnold Schwarzenegger isn’t the only American intrigued by the energy-saving potential of electric cars Freza/National Geographic Getty Images Sean Gallup/Getty Images Ric Francis/AP/PA Photos Controlling energy costs isn’t easy. Ideally, large companies would buy energy on long-term contracts, insulating their business against short-term price fluctuations. But the energy futures market can’t take the strain over the longer term, making hedging costly. Instead, businesses might have to invest – effectively bet on – energy-efficient technologies. Sugar giant Tate & Lyle has done just that, installing a biomass boiler to generate 70% of power for its London cane refinery and cut CO2 emissions by 70%. Packaging giant Tetra Pak has wagered on renewable energy. Though production will increase, it aims to cut CO2 emissions by 10% by 2010, using savings from such initiatives as ‘eco driving’ – teaching hauliers to conserve fuel – to fund a switch to ‘green’ electricity at its plants. The financial, political and market-driven case for using less oil will force CFOs to reconsider every aspect of their business. They could start with that most basic tool: the budget.Tim Lodge, director of investor relations at Tate & 97.8 60.0 80.0 Libya 101.5 Russia 115.0 Nigeria 136.3 United Arab Emirates 179.2 Kuwait 262.3 Iraq Iran Canada Saudi Arabia Source: Energy Information Administration Venezuela “Firms need to re-evaluate supply chains and factor in higher oil costs – or the need to use less of it” Proven oil reserves 2007 (billions of barrels) 41.5 36.2 28 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. The power Number politics you crunching can’t ignore World oil prices (US$ per barrel) 80 Source: Energy Information Administration 60 40 20 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1993 1994 1992 1991 1990 0 Lyle, says:“Energy is a major direct cost for us in manufacturing and transport, and also an indirect cost through fuel for farm machinery and fertilizer”. But in many companies, on a plant-by-plant basis, energy costs can seem small so local managers don’t worry about them. Investment in energy-saving is often seen as optional – behind glamorous spending on extra capacity in good times and being trimmed in bad times – and companies look for a payback in five years when 10 would better reflect the lower risk inherent in such projects. “CFOs need to re-evaluate every aspect of their supply chain, factoring higher oil cost – or the need to use less of it – into the price of their output,” says Chodzicki. “When extra transport costs are considered, CFOs may want to bring manufacturing closer to markets”. And reassess distribution networks too: direct-to-customer distribution might be greener and more efficient than sending goods to a distribution centre first. Sweatshops and supply chains The supply chain shouldn’t be re-evaluated purely on cost. Just as Western labour unions monitor working conditions in ‘sweatshops’ abroad, businesses will be accountable for their supply chain’s carbon footprint and may have to do a ‘carbon audit’ on businesses they outsource to.Wal-Mart has taken a step towards this by introducing a ‘packaging scorecard’ – to reduce packaging across its global supply chain by 5% by 2013 – which rates suppliers on, among other issues, their transport policy and renewable energy use. On top of that, Chodzicki says, they should not ignore the environmental aspect of oil security.There is talk of the U.S. restricting imports of oil that isn’t ‘green’, putting a question mark over oil derived from Canada’s oil sands. Importing refined products, environmentally preferable to transporting unrefined crude, could leave importers hostage to countries that refine. Even home-grown energy security – ethanol produced from corn – has proved controversial because of the environmental damage caused by its water use. Believing demand will be restrained by higher prices and environmental costs, Lodge is sanguine about supply bottlenecks. He says maintaining the economy will be a priority so farming and railways will be given preferential access to oil: rail is Tate & Lyle’s preferred mode of transport in the U.S. The credit crunch will not,as some have hoped, miraculously ease supply and demand. The shrinking economies are significantly more energy efficient than those whose growth will slow. In North America, a 1% rise in GDP raises industrial energy use by 0.3%; in China, a 1% rise boosts industrial energy use by 0.7%. Chodzicki warns, business can’t use the credit crunch as an excuse to delay acting on the environment. “The credit crunch has pushed the environment off front pages but it will resurface.The question then is: how much will extra taxes and other government involvement in environmental protection add to business’s energy bills?” ● If you want to know more about the energy industry, go to KPMG’s energy portal at kpmgglobalenergyinstitute.com Every CFO is primed for the question “How big’s your carbon footprint?” But as alternative energy becomes a marketable reality, just knowing how much your company contributes to climate change isn't enough. Understanding how you can use new forms of energy – and investment methods – to cut cost and meet regulations will be essential as the U.S. studies mandatory carbon reduction legislation and the EU aims for renewable energy to make up 20% of consumption by 2020. “Not knowing how your carbon footprint breaks down is risky,” says Richard Sharman, Head of KPMG’s Carbon Advisory Group. “In the past, CFOs haven’t had to understand the numbers associated with electricity or energy use. But these are crucial numbers. Governments will mandate that energy data sits in board reports, and executive committees will want to know about it.” Managing this challenge proactively means understanding the potential of alternative forms of energy, such as wind, solar and geo-thermal power. Auditing your energy use and buying renewable energy is a good start, says Sharman: “At the simplest level, CFOs need to understand the options, from building a wind turbine on the roof of a factory to looking at alternative energy as an investment opportunity.” “Businesses have a great opportunity to act now,” says Sharman. This might seem like an unnecessary distraction, as the credit crunch bites, but it's an issue CFOs can't afford to duck. New global investment in renewable energy (US$bn) 9.8 7.1 9.8 19 79.2 23.4 Asset financing US$79.2bn Public markets US$23.4bn Small projects US$19bn Corporate R&D US$9.8bn VC & PE US$9.8bn Government R&D US$7.1bn Source: New Energy Finance Source: Nasscom 100 21 Agendamagazine 29 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. c acumen Inventive innovation Finding it hard to sustain growth in tough times? Jeff Weedman of Procter & Gamble says smart businesses can work with rivals to ramp up product development By paul simpson Y ou can read books about the virtues of open innovation but for Jeff Weedman, Procter & Gamble’s plain-speaking vice president of external business development, it boils down to maths. “P&G employs some 9,000 researchers. That sounds like a lot of knowledge. But there are one and a half million scientists and researchers in our subject areas. What would you rather do – rely on the 9,000 or tap into the one and a half million?” This might sound easy, but Weedman says it’s a huge corporate journey. “It’s going from ‘Not Invented Here’ to ‘Proudly Found Elsewhere’,” he says. “You can’t do that without leadership from the top, a flexible approach to intellectual property (especially from your lawyers) and changing the corporate culture.” But, Weedman says, it’s definitely worth the effort. “It’s hard to create 4-6% organic growth, year in, year out using the we-invent-it-all model. But if you set a target, as our CEO A.G. Lafley did, to source half your innovation externally, you change the business model and you don’t face the problem of spending more and more on R&D with diminishing returns.” When Lafley announced that target in 2000, 10% of innovation was external. Weedman jokes that P&G’s Cincinnati head office was once so open-minded it was dubbed ‘the Kremlin’. But inspired by Lafley’s goal, that has changed. What started in 1996 as a small intellectual asset management group has morphed into a larger external business development strategy unit that has helped P&G double sales in the last decade and achieve a 15% margin in 2008. P&G defines success not by counting patents but by monitoring how many ideas reach the market. More than half its innovations are now ‘Proudly Found Elsewhere’. To open up P&G, rules had to be rewritten. All P&G patents can now be licensed out either five years after they are awarded or three years after they are first used in a P&G product. Money raised from licensing flows back to the units where the patent originated. Weedman says: “Getting people to do things they didn’t directly benefit from was tough.” And P&G will explore any kind of innovation: “It’s not just about technology. If someone has a new idea about reaching consumers, that’s innovation too.” R&D spend is still high – around US$2.2bn (€1.7bn) – but investment is more effective under a model P&G calls ‘connect and develop’. Weedman applies a few key criteria to each new deal: “Does it work? Is it robust? Is it proprietary? If I can figure out how to get around someone’s intellectual property then someone else probably will. Is it cost effective? Some cool technologies can’t be turned into something the customer will pay for. Is this a one-off? Or are there other ideas in the inventor’s pipeline?” On occasions,notably with homewares manufacturer Clorox, P&G has struck up a partnership with a company traditionally considered a rival. He warns CFOs not to get too excited about earning revenue from patents they don’t use (“If you don’t want them, the chances are no one else will”). But you may make money from a patent you have a limited use for. For example, P&G’s formula that helps the body more easily absorb calcium, developed for Sunny Delight, has been licensed to Tropicana. For Weedman, the beauty of this model is that such partnerships enhance both parties’ R&D. He also found that ‘connect and develop’ has an unexpected consequence: “Selling off old ideas forces everyone to develop new ideas faster.” ● “It’s hard to create 4-6% organic growth year in, year out using the weinvent-it-all model. Open innovation helps you avoid diminishing returns in R&D” Open sesame P&G has its own Connect and Develop website at www. pgconnectdevelop.com where you can register quickly and find out which needs are driving its development. 30 Agendamagazine © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. ANY OTHER BUSINESS From Moscow to Hollywood, insights into the global business agenda Q&A What do you like most in a CEO? Vision, someone who looks outward and isn’t always focused on one element – like the numbers – and who listens before making a decision. Arturo Cornejo, CFO of Hewlett-Packard Russia, on CEOs, surﬁng and the grandeur of nature And what do you like least in a CEO? Impulsive changes of direction, without consultation. It’s hard to reach your objectives if you know they could change in two weeks time. Tell us something nobody else at work knows about you I grew up in Lima, Peru, not far from the beach. What do other managers not understand about the ﬁnance function? Fortunately, my colleagues at Hewlett-Packard understand ﬁnance pretty well but in training we discovered that some managers struggled with the cost of capital concept – for example, the cost of giving customers extra time to pay their debts. What would you be if you weren’t a CFO? A professional surfer. 2008 I n s i g h t s i n t o p r o g r e s s i v e i n t e r n a t i o n a l m a r ke t s World Building Blocks Focus Infrastructure Hitting Headlines and Bottom lines Fighting Fraud and Corruption in High Grow th Markets Disengaging from Entrapment “Next Eleven” Series – Part 6: Korea What do you do to relax? Scuba diving, surﬁng, skiing. I don’t get to do them as often as I’d like but I ﬁnd the grandeur of nature helps to put things in perspective. What do you like most about your job? Having a visible sense of what’s going on in the company, the country, and worldwide, evaluating how this may impact our business and mitigating the risks. I also like the fact that as a CFO, the metrics of success are fairly clear. Real Progress Investments in Brazil The importance of preserving cash in a downturn Research into cash and working capital management C AS H M A N A G E M E NT The importance of preserving cash in a downturn Insights from 2008 research into cash and working capital management What do you listen to in the car? Classical music mostly, I like Latin music and progressive rock. My wife buys most of the CDs and I’ve been listening to Andrea Bocelli a lot. What has surprised you about Moscow? The number of Mercedes and Rolls-Royces I see. What advice would you give to someone at the start of their career? You’re going to spend most of your life working, so do what you want to do. Don’t worry too much about money at ﬁrst. If you enjoy what you do, work hard and are good at it, that will come later. To receive a copy of either of these publications, please send an email to [email protected] To ﬁnd out how KPMG ﬁrms can help your organisation, visit kpmg.com/succeeding And ﬁnally... The percentages What’s on European CFOs’ agendas for the next six months? CFO Europe Research Services’ report, The Strategic CFO, asked 117 of them: Source: The Strategic CFO report, by CFO Europe Research Services, part of CFO Publishing Corporation, in collaboration with KPMG in the UK Are likely to negotiate lower prices with suppliers High Growth Markets 02 73% 32% 41% See the Far East as the biggest regional threat Of those expecting to expand in emerging markets are more interested in gaining access to those markets than cheap labor Heroic ﬁgures Has Hollywood got it in for accountants? A study by two Ontario universities has found that 61% of on-screen accountants behave unethically, and most are just plain dull. The best the profession can hope for, according to the survey of more than 100 movies, is sweet-but-drab, like Renée Zellweger’s Dorothy in Jerry Maguire (above). Time for an all-action thriller starring Colin Farrell as a wise-cracking, take-no-prisoners number cruncher who faces down creditors and proves that his shifty sales director’s revenue forecasts are wildly optimistic? Frank Gaglione/Getty Images. Everett Collection/Rex Features. How long is a typical working week? Probably 55 hours, sometimes more. But I also regularly check emails on my mobile outside work. Aren’t likely to use bond issues to raise capital, with up to 85% likely to reject other creative techniques High Growth Markets magazine Insights into progressive international markets A DV I S O RY Which book has inﬂuenced you in your work? This is going to sound corny, but I have found The Hewlett-Packard Way, written by our founders Bill Hewlett and Dave Packard, inspiring. When they grew the company in the 1950s, management was still about automation and hierarchies and they pioneered the open-door style – there were no cubicles at Hewlett-Packard – and teamwork. 80% Find out more Agendamagazine 31 © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved. © 2008 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. All rights reserved.
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