The Winning Edge Compiled By: Chhaya Sehgal

Strategic Cost Benefit Analysis of different

Business Restructuring Propositions

Six classic case studies

1. Diageo in high spirits

The background

Diageo was formed in 1997 through the merger of Guinness and Grand Metropolitan. Both
companies were themselves products of earlier mergers - Guinness had famously acquired
Distillers in 1986, while Grand Metropolitan had diversified from its origins as a hotel chain into
spirits (IDV), food (Pillsbury), restaurants (Burger King), and pubs.

As with most mergers, the initial changes were relatively superficial. Executives argued for
the synergies between the various businesses, but the only real integration occurred between the
spirits businesses of the two companies. Fairly quickly, however, a more focused strategy
emerged. When Seagram’s announced the sale of its spirits and wine business, Diageo quickly
moved in to pick up as many brands as it could (competition rules prevented a complete
acquisition). Pillsbury and Burger King were sold off, and the Guinness business was integrated
into the global spirits organization.

The premium drinks strategy

The purpose of all these changes was to make Diageo the world's leading premium drink
company. During the post-merger Integration, CEO john McGrath and his executive team had
homed in on their real strength: the ability to build a premium consumer brand, and leverage it
on a global basis. They built a sophisticated methodology - the “Diageo Way of Brand Building” -
based around insights into their consumers' need states. They identified a set of global priority
brands (e.g. Smirnoff, Baileys) for managing on a worldwide basis. And they developed a unique
organization structure in which country operations were organized not by geographical region
but according to their expertise and potential. There were four "lead" markets (UK, US, Ireland,
Spain) that were expected to take leadership roles in developing new brands, 14 "key" markets
where Diageo already had a strong position, and then a larger group of "venture" markets, in
which there was a "tight focus on fewer brands, using a more flexible model." The theory was
that brands would be developed in the lead markets and then rolled out quickly on a global basis
through the key and venture markets.

The enormous success of Smirnoff Ice has validated the Diageo model. Under new CEO Paul
Walsh, Diageo has invested heavily in "ready to drink" (RTD) brands including Smirnoff Ice. These
were initially aimed at the female pubgoer who did not like beer but increasingly targeted toward
male drinkers. Smirnoff Ice was launched in 1998 in the UK, and once it was proven there it was

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rolled out over the next two years to a further 15 countries, with total sales so far in excess of 1.5
billion bottles. And not only is Smirnoff Ice a big seller in its own right, it also has two very
attractive side-benefits: it helps to invigorate the core Smirnoff brand, and it takes market share
away from beer. For the global beer companies like Heineken and Interbrew, Diageo is suddenly a
serious threat.

The lesson

Diageo provides a clear example of a company that understands and leverages its core
competence. Rather than pursue multiple strategic thrusts back at the time of the merger, the
company put its faith in its ability to build global drinks brands, and it created an organization
that allowed it to extract value from that ability. In a difficult market, Diageo still managed 9
percent organic growth over the last 12 months, and it looks well set for further growth as it
launches new RTD products such as J&B Twist.

2. Ford’s Venture into Consumer Services

The background

Jac Nasser became CEO of Ford Motor Company in 1998, with a reputation as a problem
solver, cost cutter, and agent of change. One of his key initiatives was to enter the world of
automotive consumer services, which covers such things as car financing, insurance,
maintenance, repair, parts, and recycling. These ser- vices were estimated to account for 60
percent of the total value of the automobile industry, and most of it was far higher margin
business than Ford's core business. Nasser wanted Ford to become a major player in this
downstream part of the business system.

Building an auto services group

Nasser hired Michael D. Jordan to create Ford's "Automotive Consumer Services Group."
Their first significant move in 1999 was to buy Kwik-Fit, the UK-based exhaust repair company
owned by Sir Tom Farmer, for £1 billion. A number of smaller acquisitions followed, in the areas
of car servicing, collision, and recycling. The strategy was to buy operations across this
fragmented sector and to create the first consolidated automotive services group. Nasser and
Jordan saw enormous opportunities for gaining synergies between the various parts by cross-
selling services, transferring best practices, and building a complete set of consumer-oriented
services.

Emerging problems

But while the strategy looked good on paper, it proved difficult to implement. Apart from Kwik-
Fit, which had a well-known brand and operations in five countries, there were very few
companies of significant size worth buying, so it took a long time to make progress. And from the

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perspective of Ford as a whole, with 2001 sales of $131 billion, even Kwik-Fit was a relatively
small acquisition.

But the real issue ended up being problems elsewhere. Ford reported weak results in 1999
and 2000, thanks to a declining performance across the whole industry as well as problems of its
own in Europe. Buying Volvo and Range Rover used up much of the company's cash reserves.
Then, in 2000, the Firestone tire problem hit, and Ford was thrust into a public relations
nightmare, leading to extensive product recalls and large write-offs. In early 2002, Chairman Bill
Ford, the great-grandson of the founder, had had enough. He ousted Nasser and took the job of
chief executive himself. With the company now in a very weak financial position, and with its
reputation tarnished, Bill Ford announced a back-to-basics strategy -35,000 jobs were cut, along
with five factories and four product lines, and the automotive consumer services group, which
was a non-core activity as well as being clearly associated with departed CEO Jac Nasser, was
quickly axed. In 2002, Kwik-Fit was sold to UK private equity group CVC for £330 million.

The lesson

Ford fell into the classic value trap in building new businesses. It saw a logical extension of its
business by building on its existing consumer base, and finding new services that those
consumers could buy. But by moving down this route, Ford found itself in unfamiliar territory -a
fragmented, service-intensive, local industry rather than the globally consolidated, capital-
intensive world of car engineering and manufacturing. It was by no means impossible for Ford to
traverse this gap, but it needed to develop a new set of capabilities, and overcome the inertial
resistance to the new strategy. And ultimately, Bill Ford never completely bought into the idea.

He was a "car guy," and for him (and his family) this meant designing, building, and selling cars,
The jump into automotive services was a big one, and Nasser did not have either the time or the
good fortune to pull it off.

3. Fitting it together with Lego

The background

Founded in 1932 by a Danish entrepreneur, Ole Kirk Kristiansen, Lego became an

international success story in the post-war years. Its famous plastic bricks were first sold in
Denmark in 1947 and then quickly rolled out across Europe and North America. Gradually the
basic bricks gave way to more complex model sets, then a range of related products including
Duplo, Lego Technics, and Lego figures for girls. By the late 1980s, Lego was one of the biggest
toy brands in the world,

Lego remained family-owned and was built around four core values: creativity, play,
learning, and development. The word Lego was formed from the Danish words leg gout (play
well).

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The threat

In the early 1990s the toy market changed dramatically with the introduction of Nintendo's
N64/Game Boy and Sony's Play station. Children were no longer content' with self-guided play.
They quickly embraced the interactive offerings from the electronics industry. And rather than
playing for the sake of playing, they began playing for the sake of winning. Traditional toys were
still selling but the growth was in the electronics segment,

Lego's response

Lego's initial reaction to the threat of electronic toys was to do nothing, Game con- soles
were anathema to the values of the company -they were not creative and they did not help the
child develop. Lego had also experimented with combining bricks with electronics (Lego Dacta) in
the 1980s without much success.

But faced with the continuing growth of electronic toys, in 1996 Kjeld Kristiansen, CEO and
grandson of the founder, created a new division, Lego Media, to develop software, music, and
videos. Three interactive software products were developed on CD-ROM: Lego Creator, Lego
Chess, and Lego Loco. A new programmable "Intelligent brick" product called Mindstorms was
launched at the top end of the market. And Lego developed its online offerings with a range of
games, kids' clubs, and merchandising opportunities.

But despite (or because of) all this, Lego found itself in difficulties. It posted its first-ever loss
in 1998. The following year was profitable, largely because of its enormously successful Star Wars
product range. In 2000 there was a deeper loss.

The lesson

Why the bad results? Lego suffered all the classic problems companies face when entering
new markets. Nintendo and Sony were established competitors and were not prepared to give
up ground to Lego without a fight. The multimedia industry was immature and all players,
including Lego, struggled to make money out of it. In addition, Lego moved beyond its proven
areas of capability. As Paul Plougman, executive vice president, said in 2000: "We lost focus. We
will now refocus on our core business, which is materials for open-ended play for children."
Lego has now scaled back many of its multimedia operations and is focusing on those that fit with
its core values and capabilities, including a themed product line called Bionicle. With cost-cutting
measures in place, 2001 was once again profitable.

The underlying lesson is important -it is not enough just to follow your customers into new
product areas, you also need the capabilities to deliver on their new demands. Lego could not
hope to compete head on with Sony and Nintendo. Instead it had to rethink its product range to
combine its core values and skills with what today's children are looking for.

4. Mike Harris and the creation of Egg

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The background

In 1995 Peter Davis became CEO of Prudential Insurance, which at the time was seen as a
rather slow-moving and old-fashioned company in an industry undergoing rapid change.

Davis made a number of acquisitions to take the company into new areas of insurance and
investment, but his central thrust was what became Egg -a business designed to offer banking,
mortgages, and other financial services via the telephone and cut out expensive branch networks
and commission-hungry independent financial advisers.

The creation of Egg

To lead the Prudential's foray into telephone banking, Davis approached Mike Harris, who
had made his name in UK business circles by leading the creation of First Direct bank when he
was at Midland (now HSBC). Davis knew Harris quite well, and quickly convinced him to take the
job. And Harris, like Davis, felt that the time was ripe for a new class of customer-focused
intermediaries to compete with the lumbering, vertically integrated incumbents in banking,
cards, and insurance.

During 1997 the business plan for Egg took shape. It would be established as a completely
separate company, financed and owned by Prudential but with its own buildings, its own culture,
and its own brand! Consumer research had established that while people liked the concept, they
could not square it with the Prudential's traditional image. So Harris and his team chose Egg,
which evoked many of the values they were looking for. The name "proved to be a very hard sell
to the board," but with Davis's backing it was accepted.

Harris and his team invested heavily in customer research to try to understand how people
really wanted to interact with their bank. His team followed 1,000 people for a year, and Harris
personally took part in customer feedback sessions on a weekly basis. The original concept was
for a telephone-only bank, but as the potential of the Internet became apparent, they developed
an online offering as well. Their timing was fortuitous: UK Internet usage boomed during 1998,
largely thanks to the launch of free ISPs like Freeserve, so Egg became de facto the first Internet
bank in the country.

The result

Egg was a spectacular success. Within days of launching the business, Egg had to more than
double the size of its call center operation to cope with customer demand. Thanks to its separate
business model, it managed to get the new capacity up and running within four days. In contrast,
Davis observed, "the Prudential would not have found the forms in four days."

Launched in 1998 after a spend of £80 million, Egg reached its initial five-year target of
500,000 customers and £5 billion deposits in six months. It then developed its product line to
become a financial services supermarket, offering loans, insurance, mortgages, credit cards, and

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The Winning Edge Compiled By: Chhaya Sehgal
funds as well as banking. After an IPO in 2000 - to "institutionalize its independence," according
to Harris -Egg broke into profit in the fourth quarter of 2001 and reported pre-tax profits of £9.4
million on revenues of £79.6 million in the third quarter of 2002. With 2.4 million customers,
Egg's market value at the end of 2002 was £1.1 billion, and it was set for expansion into France.

The lesson

While there were many contributors to Egg's success, two factors were key. First, the
complete separation bf Egg from the rest of Prudential gave Harris the freedom to move quickly
into a new area, unencumbered by tradition or bureaucracy. Second, Harris and his team were
obsessive about consumer research: they did not just repeat the First Direct model he launched
at Midland bank, they started with a clean sheet of paper to find out what consumers really
wanted.

5. The destruction of Marconi

The background

General Electric Company (GEC), the British company with no relation to America's GE, grew
rapidly in the 1960s under Arnold Weinstock's domineering but effective leadership. Like its US
counterpart, GEC became a conglomerate, with interests in such diverse businesses as white
goods, defense electronics, telecoms, and power systems. While there was no real logic
underlying this array of businesses, Weinstock held the company together through a combination
of his imposing personality and a strict system of financial controls. At its peak GEC had sales of £
11 billion and a cash pile of £2 billion.

Simpson's masterplan

Lord Weinstock retired in 1996 and was replaced by George Simpson, a former executive at
Rover. Over the course of the next five years, Simpson and his Finance Director, John Mayo,
masterminded a complete rethinking of GEC's corporate strategy. He decided to focus the
company on the fast-growing telecoms equipment industry. He bought two mid-sized US
competitors (Reltec for $2.1 billion and Fore for $4.5 billion) and invested in developing a range
of new products to compete with industry leaders Cisco and Nortel. To pay for this growth, most
other businesses, including defense electronics, white goods, and power systems, were, sold off.
To reflect this change of strategy, GEC was renamed Marconi.

The denouement

Marconi's share price peaked in August 2000 at £12. Then things started to go badly wrong.
The dot-com bubble burst, and demand for new telecom equipment dried up. Lucent, Cisco, and
Nortel all announced profit warnings. Marconi's share price dropped, even though it denied that
its sales had been hit. Then, when the profit warning finally came, angry investors dumped the
stock. The downturn was far more severe than anyone anticipated, and with large and mounting

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debts Marconi was facing bankruptcy, its shares worth less than 1 percent of their peak value.
George Simpson and John Mayo were forced out. A new executive team was brought in, but by
then £37 billion of market value had been destroyed in just a year and a half.

The lesson

Marconi's story is a classic tale of an over-ambitious growth strategy and subsequent

collapse, But the lesson to take away is that despite their ultimate failure, Simpson and Mayo
did some important things right.

First, they correctly reasoned that if Marconi was going to become a major player in
telecoms it would have to grow aggressively and it would need a strong US position. Hence its
acquisitions of Fore and Reltec. This approach worked for Cisco. Where Marconi went wrong was
that it paid cash, partly because it had plenty of it, and partly because it did not have a full listing
in the US (so its paper was not an attractive currency). So rule one -if you are going to overpay
for an acquisition, better to overpay with your own overpriced shares. The cash drain from
these acquisitions is what ultimately killed Marconi.

Second, Marconi's decision to major on one business, and sell the rest, is exactly what the
markets were asking for. Conglomerates were OK in the 1970s and 1980s, but the trend during
the 1990s was toward highly focused corporations. Indeed, Simpson was lauded for his courage
in breaking up and focusing the company he took over from Lord Weinstock,

But Marconi's failure underlines how risky this sort of refocusing can be. Simpson put all his
eggs in one basket, but it was a relatively untested and new basket at that. Such dramatic
changes in corporate strategy can work. For example, Spirent made a successful transition from
industrial conglomerate to fast-growing telecoms company during the late 1990s. But more often
than not major changes in strategy take the company into new areas that it does not really
understand, and the results end up being disastrous -as the shareholders of Vivendi and Enron
will confirm,

6. Volkswagen strikes back

The background

Volkswagen began importing the Beetle in the early 1950s. The Big Three (GM, Ford,
Chrysler) did not take it seriously. One executive called it "a personal insult." It was noisy,
cramped, air-cooled, and it had its engine "where the trunk was meant to be." But it was
enormously successful, with sales growing to a peak of 570,000 in 1970. This was partly due to
the Beetle's unique positioning as a small, affordable car (“Ugly is only skin deep" stated one
famous ad). But more importantly it achieved cult status among the hippies and beatniks of the
1960s anti-establishment movement.

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Success continued into the 1970s, The Beetle was replaced with the Rabbit (Golf in Europe),
but it never reached the same level of popularity. Quality problems started to appear. New
competitors, particularly Honda and Toyota, arrived in the US for the first time. And the decision
in 1978 to start manufacturing in the US proved to be a fateful one for Volkswagen, because the
cars lost their distinctive European styling and handling.

Close to exit

Through the 1980s, Volkswagen's US market share declined. The brand's unique positioning
disappeared, and the product quality was not up to the standard of Japanese competitors. The
manufacturing plant was closed in 1987. By 1993 Volkswagen was selling only 49,000 in the US,
and thought to be losing significant amounts of money. Industry observers were predicting that
the company would soon follow the lead of Peugeot, Fiat, and Rover, and exit the US market.

But Volkswagen's new CEO Ferdinand Piech refused to give up on the world's largest and
most competitive car market. And he oversaw a remarkable turnaround, from a low of 49,000
units in 1993 to the most recent figures of 356,000 in 2001.

Secrets of a turnaround

How did Volkswagen do it? There were four key elements to the turnaround. First, it sorted
out manufacturing quality. The turning point came in 1992 when Bill Young, President of the US
operation, refused to accept any of the new Golfs and Jettas from the Mexican plant because of
quality problems. This was a gutsy decision because it meant the dealers had no cars to sell for six
months, but it proved he was serious. The Mexican plant got its act together, and quality
standards improved markedly.

Second, the brand image was revived. Volkswagen had become famous for it’s off- beat
advertising, but it lost its direction during the 1980s. In 1992 the US company replaced its long-
standing agency DDB Needham with a small Boston agency called Arnold, which managed to
recapture the values and spirit of the earlier campaigns. Its tagline: On the road of life there are
passengers and there are drivers... Drivers Wanted.

Third, a new management team was put in place, led by Clive Warrilow, formerly head of
Volkswagen Canada. He faced a disillusioned workforce and angry dealers, but through a strong
focus on empowerment, trust-building, and partnership he was able to win them around.

Fourth, and by no means least, was the New Beetle, a product that was conceived,
designed, and built in North America. If anything symbolized the return to glory of Volkswagen in
the US, this was it -a throwback to the company's heyday in the 1960s, but at the same time a
thoroughly modern product built on the same plat- form as the Golf. The turnaround was already
in place before the New Beetle was launched, but this proved to the sceptical US public that
Volkswagen was truly back.