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12234_The a-Z of Management Concepts and Models

12234_The a-Z of Management Concepts and Models

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The most usual meaning of the term portfolio in a business context is the

collection of securities that we own. By extension, the term has also come

to mean a group of business units under one roof. It derives from the term

share portfolio, which refers to a stock market investment comprizing

shares of a number of different companies (spread investment).

By analogy, the term portfolio as used in business has come to mean a

more or less variegated group of business units or firms under the same

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ownership, together constituting what in legal parlance is called a group

of companies. Other common terms are corporation, concern or

conglomerate.

Portfolio structures can also be found outside the commercial sector. The

local authority for instance, constitutes what could be called a diversified

portfolio. It comprises a range of organizations unrelated to each other, such

as care for the elderly, schools, an engineering department, and so on. The

same thing applies to county councils and a host of other government agen-

cies, as well as to non-profit organizations. Again, trade union organizations

often operate publishing businesses and training programmes.

A portfolio can come into being in many ways. Sometimes a new corpo-

rate mission arises out of an auxiliary function. Other business portfolios

are the offspring of a customer-supplier relationship; this is also called verti-

cal integration. A shipyard may buy a steelworks to make its structural

steel (backward integration), or it may buy a banana plantation or a coal

company to secure cargoes for its ships (forward integration).

A car manufacturer may buy a chain of dealerships or the factory that

makes its back axles. An airline may buy into the travel agency business,

maintain its own engines and operate hotels.

Yet another way in which portfolios can arise is through development of

related business to satisfy customers’ needs better. In the data consultancy

business, groups of business units have developed in symbiosis, each satis-

fying one kind of need and thus finding more ways to reach customers.

One example is e-learning.

A portfolio may thus be either diversified or synergistic. Intermediate forms

also exist, of course. In good times there is a tendency to overrate syner-

gies and cite them as a motive for acquisitions, even though the true motives

may be quite different.

Portfolios often become diversified because synergies, with time grow,

diffuse and eventually, meaningless. This means that a change in owner-

ship may have to be considered. A common pattern is that a portfolio which

has grown up on a basis of synergies in production gradually loses its syner-

gistic connections. Market relations are evolving into an entirely different

business situation. An example of this is the publishing industry, which

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originally included ownership of presses, binding departments, typeset-

ting, etc. Commercial connections in business have gradually become

blurred to the extent that a daily newspaper, for instance, may only be one

of the owners of its printing press.

Managing and developing a portfolio is a matter of working with busi-

ness structures rather than business strategies. The chief executive of a

company or corporation that contains a large number of diverse business

units is in fact in the business unit industry. Since a company almost always

contains more than one business unit, its management must be able to:

•buy into new industries.

•strengthen business units, for example by acquisition

•withdraw from unwanted industries

•sell business units that can be better managed by others

•allocate resources in the form of capital and costs

•ensure that individual business units are strategically managed

•take advantage of synergies in the form of greater business

strength or more efficientoperative management of business units.

When a company consists of several units with little or no synergy, discus-

sions of corporate mission are apt to be long and complicated.

Some thinkers have dubbed an intermediate form ’business areas’ by which

they mean synergistic portfolios where market synergies or similarities

of customers’ needs make it possible to find some sort of common trade

logic.

If we are managing a portfolio that consists of a number of business units

with different corporate missions, one of our main problems will be that

of dismantling structures that do not fit. Entrepreneurial managers will

disinvest without a qualm, but power-oriented managers seem to balk at

selling business units.

There are of course logical and justifiable reasons for the existence of port-

folios of disparate business units. These reasons include:

1. The dynamics of the business have generated organic growth,

as in the case of the Volvo Bus Corporation in the Volvo Group.

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2. Technological skills have lead to the development of business areas

related to the original one only by technology.

3. The main business area has been highly profitable but offered

no opportunities for new investment.

4. It is desirable to spread business risks.

5. Strong links exist between business units in terms of customer

needs or technology.

6. Costs or capital structures can be shared.

Mixtures of legal structure (companies or units with the same owner) and

business structure often occur. It is important, therefore, to recognize the

difference between legal and business structures.

A company’s portfolio strategy usually depends on cyclical conditions in

the market. In bad times companies want to reduce investment, whether

in products or staff, which generally means that the value of its business

units goes down. This might apply to both operating companies and admin-

istrating companies such as property companies or investment companies.

It is unfortunate for the many portfolios which develop quickly during the

good times that market prices fall when the economic situation worsens.

People involved in fast-growing portfolios may feel that it is unfair to

suddenly see the market value of their group reduced to perhaps a tenth

of what it was just a short time ago, when it was racing away from projected

performance.

At one moment everyone wants to buy and nothing is for sale; almost at

the very next, everything is for sale and nobody wants to buy. Many players

accustomed to moving in the fast lane are suddenly taken by surprise when

markets collapse.

Seen over longer periods, it is possible to say that intensive accumulation

of capital during periods of healthy profits creates pressure on manage-

ment to invest in good business opportunities: management preferences

tend towards breadth and depth in business.

Thus the value of business units, in the same way as with real and move-

able estate, tends to fluctuate wildly from the development curve,

depending on the need to satisfy demand or the pressure to supply. Some

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spectacular examples of market price shift were offered by the 2002 change

in the economic climate.

Portfolio strategy

Two lines of thought are especially worthy of attention in respect of

portfolios:

1. All business is legitimate (except when it is strictly illegal, as in

the case of drug dealing), whether it is manufacturing, the

production of services, or trade.

2. The dangers inherent in moving from businesslike reasoning to

speculation are not generally noticed.

The first statement can seem trivial. Yet it is interesting because at certain

times it has been much easier to make money through speculation – in

fact, trading – than through the hard work of producing goods or serv-

ices. It has not been the thing for economists and engineers to go into

industrial production, as it has been so much easier to be successful in

company trading, property, shares or options. A phrase like ’fast buck’

has led to the debasement of the transaction economy, at the same time

as it has represented the height of fashion for many years: an expecta-

tion that prices would rise or fall has been a basis for trading since time

immemorial. Still, it is a good idea to distinguish this from distribution,

a term that indicates a knowledge of suppliers and customers, of utiliz-

ing economies of scale and capital rationalization by optimizing batch sizes

from supplier to consumer.

A typology for business activity is given below (see also Business model).

Extraction
and
cultivation

Production
of goods
and services

Distribution Speculation
(Trade)

Production
of services

Knowledge

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All business is legitimate (except in such a strictly illegal activity as drug-

dealing) but the importance of different kinds of business activity may vary

from one time to another. The production and extraction of natural

resources have obviously had their golden age; trade and speculation

reached their latest peak in the 1990s, and ’knowledge business’ is now

gaining ground.

Many business leaders do not realize it when they abandon business logic

for speculative thinking. This lack of insight means that they are unpre-

pared for the risk factors involved with speculation where the object in

question is concerned, whether it is shares, property or whatever.

Although mistakes may lead to financial difficulties or bankruptcy, it is not

necessarily speculative thinking that is at fault but rather the lack of insight

into the different conditions and underlying risks that are inherent in such

thinking.

Business units in a portfolio are run according to two ways of thinking,

exactly as the shares in a share portfolio:

1. Industrial logic in terms of net worth and profits, as represented

by fundamentalists.

2. Speculative logic based on assessments of future prices, such as

ticks (price movements).

Let us point out two problems that are very likely to lead to financial risks

which players may not be aware of:

1. Diversification generally occurs in times of prosperity.

2. There is usually a transition from business logic to the logic of

speculation.

Diversification seems to be a knee-jerk move in good times. The bound-

ary between diversification and synergic acquisition is the same one that

separates what on the one hand does not give customers added value and

what on the other, does. The mood of business leaders at the peaks and

troughs of long periods of prosperity or recession tends to produce a

certain kind of behaviour that intensifies the amplitudes of trends.

When we speak of synergy we usually mean the benefit of shared costs

or greater value for customers. Synergy is actually a special case of other

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concepts that we can group under the umbrella term ’complementariness’,

i.e. the extent to which different business units complement one another.

See also Synergy.

In upturn periods we tend to exaggerate our company’s capital many times

over, a psychological frame of mind that impels us to speculate. Business

leaders who in one industry turn into success stories overnight often find

it difficult to assess the risks when investing speculatively in other indus-

tries. Such people may be consummate managers within a certain

business framework but often find themselves ill equipped to make the

decisions called for in a portfolio comprising units from different indus-

tries. The jump from being a unit manager to managing a portfolio is much

greater than they might have imagined. This can be reduced to the simple

question: what differentiates a company manager from the manager of

a portfolio?

RECOMMENDED READING

1.Michael S Allan, Business Portfolio Management: Valuation, Risk

Assessment, and EVA Strategies.

2.Robert D Buzzell and Bradley T Gale, The PIMS Principles: Linking

Strategy To Performance.

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