The Upside of Turbulence

Many people have contributed to our understanding of agility, but few have contributed more than John Boyd. My last post described how U.S. fighter pilots dominated their adversaries during the Korean War despite inferior planes, fewer of them, and less secure bases. The secret of their success remained poorly understood until US Air Force Colonel John Boyd studied the Sabres several years later, while developing a next generation fighter plane.  Boyd, it turns out, was ideal for the job.  By the end he not only cracked the mystery of the Sabres’ success and designed the new plane, but also re-conceptualized combat in a way that highlighted how agility can trump superior resources or position.

John Boyd, then a Lieutenant, landed in Suwon South Korea in March 1953 hoping he would not arrive late for his second war. Nine years earlier, Boyd–then a high school senior–had enlisted in the U.S. Army Air Forces (the precursor to the Air Force), hoping to serve as a pilot in the Second World War. Upon completing high school, Boyd enlisted for active duty in April 1945, and was still in training when the war ended. Boyd served out the remainder of his military obligation as a swimming instructor.

This Friday, the London Business School Private Equity and Venture Capital Club hosts its annual Private Equity Conference. I will moderate the closing panel discussion called “Value Creation: Overtaking Leverage?” that will explore how buyout firms can create value not by piling on debt, but by improving the operating performance of their portfolio companies. This is a particularly topical issue right now, as debt has become more expensive, financing terms more onerous, and market conditions more challenging for portfolio firms.

In preparation for the panel, I have reviewed recent research–largely by financial economists–on private equity, operational improvement, and value creation. Recent papers provide some very helpful, and in some cases surprising, insights into how late-stage private equity firms add value. Below is a selective review of papers that bear on a set of questions related to how leveraged buyout firms create economic value through operational improvements. (For comprehensive reviews of private equity trends, see papers by Cumming et al. and Kaplan and Stromberg).

  1. Do leveraged buyout firms create economic value? Excluding fees, leveraged buyout firms

In turbulent markets, firms need portfolio agility–the ability to quickly and effectively remove resources from businesses that have stagnated or no longer fit a company’s strategy and reallocate them to promising opportunities. Before shifting resources among them, executives often  categorize units within a portfolio using frameworks such as the growth share matrix. Despite its widespread use, this framework gives a static snapshot of a portfolio at a point in time and overemphasizes the benefits of scale.

An alternative approach to mapping a portfolio begins by dis-aggregating an organization into components that correspond to opportunities, recognizing that these units vary by life-cycle stage-i.e., start-up, scaling the business, maturity, and decline. Opportunities begin 

My last post discussed Warfighting, the US Marine Corp manual that characterizes combat as disorderly, uncertain, fluid and plagued by friction that makes “the simple difficult and the difficult seemingly impossible.” This post focuses on resource allocation in turbulence, specifically how an officer with limited troops, ammunition, and attention can commit the resources under his control to achieve the greatest impact.

Allocating scarce resources entails difficult trade-offs even in stable circumstances. But Marines face the added complications of a situation in flux, acute time pressure, incomplete and often conflicting data, an enemy attempting to anticipate and thwart their plans, all with life and death at stake. Warfighting outlines principles that help Marine officers allocate resources in real time, without resorting to the fiction that they can predict how battle will unfold.  Below is my synthesis of the Marine Corps’s principles as they relate to resource allocation in turbulence:

Plunge in without overplanning. Officers can plot strategy in the map room, but battles are won or lost in the field. Marine Corps officers plan, of course, but they also recognize the limitations of their plans. Not even the best informed or most experienced officer, can foresee how an engagement will unfold. Rather than spend endless hours honing the perfect plan, Marines develop a good enough plan. Many follow the 70 percent solution— if they have 70 percent of the information, do 70 percent of the analysis, and feel 70 percent

Leaders recognize the value of agility in turbulent markets, but are often less clear on how they can enhance their own organization’s ability to identify and seize opportunities more effectively than rivals.  Over the past decade, I have analyzed more and less successful firms in some of the world’s most turbulent markets, including China, Brazil, European fast fashion, and financial services. My research revealed three distinct forms of agility-operational, portfolio, and strategic agility.

Operational agility is a company’s capacity, within a focused business model, to consistently identify and exploit opportunities more quickly than rivals. Toyota, Soutwest, and Zara exemplify this form of agility at the corporate level. In diversified groups, operational agility occurs (or doesn’t) within discrete business units. Opportunities create economic value either by raising a customer’s willingness to pay (which translates into higher price or volume) or by reducing costs. The best firms exploit both types of opportunity with equal fervor. Toyota, for example, has consistently anticipated consumers’ shifting preferences-for quality, fuel-efficiency, and environmental impact-and introduced vehicles to meet emerging needs. At the same time, Toyota’s production system weeds out activities that do not add value for customers.

Toyota illustrates another aspect of operational agility. Firm’s should exploit revenue and cost opportunities

In October 31, 1989 Mitsubishi Estate bought a controlling stake in the Rockefeller Group, owner of iconic buildings including Rockefeller Center and Radio Center Music Hall. The acquisition, for many, underscored the inevitable rise of Japan Inc. In the preceding decade, best-selling books like Clyde Prestowitz’ Trading Places: How we are Giving Our Future to Japan and How to Reclaim It and Ezra Vogel’s Japan as Number One confidently predicted that Japan Inc. would dominate wide swaths of the global economy by the 1990s.   Instead, Japan lost a decade, and Japan Inc lost its luster.

In the past few years, firms from emerging markets have acquired high-profile firms. Mittal Steel bought Arcelor, while the Brazilian-Belgian brewer InBev acquired Anheuser Busch. Many North American and European managers reassure themselves that the rise of emerging market firms will repeat the Japan Inc story–initial success, followed by massive hype that ends in a fizzle. The analogy to Japan Inc is reassuring, but deeply flawed.  This comparison ignores the underlying sources of advantage enjoyed by the best emerging

Turbulent markets create opportunities in three distinct ways: Churning markets introduce new resources into the economy, enable innovative combinations of existing resources, and stimulate novel consumer demands. New opportunities resemble the creation of a new dish in cooking, which arises from a new ingredient, a new recipe for combining familiar ingredients, or a shift in tastes.

Opportunities from new ingredients. In the sixteenth century, European explorers discovered unimagined ingredients in the New World, including the tomato. Italians initially thought tomatoes poisonous, and limited their use to decorative plants. Neapolitan chefs experimented with the new fruit, which thereafter became a staple of Italian cuisine. This new resource enabled previously inconceivable sauces, including Puttanesca, Bolognese, and Marinara.

The business analogue occurs when new resources enter the market. Resources include both hard assets (oil reserves or real estate, for example) and intangible assets

Turbulence produces threats and opportunities. Readers will nod their head in agreement with this statement in principle. Yet when thrust into a volatile situation, most people most of the time will fixate on risks and walk right past opportunities strewn along their path.

My last post described how students analyzing the steel industry in 1999 fixated on the risks of expanding into emerging markets and overlooked the opportunities. Most steel executives during the 1990s looked at the industry with the same risk-tinted glasses, viewing every change as a threat–globalization meant low-price imports while technological innovation would disrupt their established processes. A 2002 report by the consulting firm BCG concluded that “capitalism alone cannot solve [the] problem” of chronic losses in the steel industry. The report did not once mention Lakshmi Mittal, who had created a multi-billion Euro steel empire by exploiting opportunities in the world’s most volatile markets.

A focus on the downside of turbulence extends well beyond steel. In 2009, the World

It was a cool autumn evening in 1999, and Lakshmi Mittal listened as a team of MBA students painted a grim picture of the turbulence roiling the steel industry. Mittal had agreed to judge a case competition at the London Business School, where teams of finalists vied to analyze the success of his steel empire (including the private firm LNM and a public corporation Ispat International), and make recommendations to the firm’s founder and CEO.

Mittal’s success was undeniable. Since starting with a single steel mill in Indonesia in 1976, Mittal had built

2007 was a tough year for America’s microbrewers, firms such as Boston Beer Company, that brew speciality beers. The price of malting barley, used to color and sweeten beer,  nearly doubled after barley farmers in the U.S. planted more fields with corn to take advantage of government subsidies for corn-based ethanol.  The government introduced the subsidies to decrease American reliance on Middle Eastern oil, at a time when crude prices were rising and geopolitical forces threatened to disrupt supplies. That same year, poor weather in Europe severely limited yields of hops, which provide beer with a bitter tang, driving up the prices. Hops prices jumped just as the euro strengthened against the dollar, further jacking up the prices paid by brewers. That same year, SAB Miller and Molson Coors Brewing, the second and third largest brewers in the U.S., merged, creating a behemoth to further pressure profits of small brewers.

Microbrewing might seem like the kind of business that could escape market turbulence–the production technology hasn’t changed in centuries, demand is local, and the business is simple.  Yet even in this

Leading in turbulent times

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Don Sull is professor of management practice in strategic and international management, and faculty director of executive education at London Business School. This blog is dedicated to helping entrepreneurs, managers, and outside directors to lead more effectively in a turbulent world.

Over the past decade, Prof Sull has studied volatile industries including telecommunications, airlines, fast fashion, and information technology, as well as turbulent countries including Brazil and China, and found specific behaviours that consistently differentiate more, and less, successful firms. His conclusion is that actions, not an individual’s traits, increase the odds of success in turbulent markets, and these actions can be learned.