Wednesday, June 30, 2010

How Entrepreneurial Winners place their Bets

It is never easy to know where to put serious money into growth. Biofuels or Shale? Russia or Iraq? Coal or Nuclear? Who would be a CEO?

When I was in Retail trying to work out which central and east European countries to invest in when, I think I learned an important lesson. We kept trying to do financial based analysis - DCF models of numbers of stations, projected volumes, costs, margins etc. I remember the prevailing margins in Poland at the time were tiny, and we couldn't really make a good financial case, so we fudged it for a year or two and built resources and land a bit more slowly than, say, Bulgaria, where the margins were much higher.

Wrong! It was sort of obvious that the margin assumption in particular was like a roulette game. It was driven by very short term political factors which could and did change - monthly, yearly, when there were elections etc. We would have been much better off keeping our assessment at a higher level. What were Porter's five forces saying to us? What major trends were coming over the hill? How confident were we of building strong relative capabilities? Most important (and I used this one) - would I let my closest friend be a retail manager in this place (in other words could you work within business principles and a realistic chance of coming out literally alive).

When these fundamentals were positive, only then should we have looked at prevailing economics, and more as a tactical factor. How long were we ready to operate at a loss? What leverage could we exercise on the government and other price setters? Would building sites increase or decrease that leverage? Could we hedge the short-term risk with smart prioritisation, eg major land banking?

While indeed the Shell approval forms at the time did have the strategy stuff in them, the bottom line was the money, and the money was a random guess. By hook or by crook, we got most decisions right, but I believe the dominant logic in the finance arm of the company didn't help.

Which brings me to how entrepreneurs work. One belief I have is that they place massive emphasis on trends and forces.

Some examples.

The main driver behind Tesco's big win in the 80's and 90's in the UK was the Maggie Thatcher planning regulation change in favour of out of town shopping. They spotted that, piled in, won big. OK, their operation was brilliant too, but most important for them (and followers) was the trend.

We all think Welch and GE was about six sigma and up-or-out and other stuff we read in books. But his little secret was GE capital, running on the trend the financial deregulation and technology gave big opportunities to the finance sector (and most banks were asleep). Furthermore there was a trend of shareholder value in managing quarterly earnings targets, and a finance arm makes that easy. The finance arm is a double edged weapon - it is like betting the company on a red roulette number, look at ABB under Barnevik - but the trends made it a great bet.

One of the guys from Dragons den talks about how we works behind government policy shifts and demographic stuff. Look at care homes, IT in health, managing public/private partnerships. It has been possible to fail in all these areas, but the sectors overall have usually done well, and a smart entrepreneur only needs a winning sector and strong management capabilities and he/she is up up and away. This is essentially the Branson formula as well.

The best business model I ever saw was in care homes for the mentally and physically handicapped, executed by my wife's sister in Northern Ireland. She had the right nursing experience and contacts from her regular employment, her husband had money and skills to invest in land and building. And they had the trends of more handicapped people living longer, and government wishing to privatise where possible. Bingo. They have made many millions very quickly (sorry darling, Shell career doesn't allow you to keep up with your sister!), with almost zero risk, and earned them too. Smart. By the way, this story utilises another old business truth - where there is muck there is brass. You'll never find too many people investing in the fairly unappealing game of caring for handicapped folk.

What all the above business plans will have had in common is an acceptance of risk in financial projections through their early stages. Who knew for sure what the subsidy structure for North West trains was going to be when Branson put in his bid? Or what would happen to land prices in the Thatcher planning revolution? Major risks, but smart risks.

OK, so this is decent theory and I have a case study from 15 years ago, so what?

I'm just wondering if parts of Shell still have the same problem. I'm looking specifically at Downstream in Asia. Perhaps that is unfair. We jumped into Nanhai. We signed an exciting deal this week with Qatar and CNPC. We did (finally) put some retail assets into India - only of course to be making a loss on every litre for the time being. (And easy for me to say that making losses on every litre is not a problem - it is not my money or my GPA). But is that enough, fast enough?

Start from the three hard truths. More demand, especially in the East. Tougher access to supply, especially of easy oil. And growing constraints from environmental pressures. That is the Shell or oil industry of the major trends. How would a smart entrepreneur react to that? Where would Branson or the Dragon's Den put their money? I'm not convinced that it would be fully aligned with Shell's current choices - putting it mildly.

I suppose I'm really calling for Strategy to stand up and be counted. In the absence of brave strategy - that is stuff driven by trends and forces and fundamentals and competitive capabilities, not boring (but essential) things like portfolio management and planning. In the absence of strong strategy, finance always wins. And finance doesn't like risk or uncertainty. Entrepreneurs love those things.

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