12/12/2012 - 07:53

Following the leader can end in failure

12/12/2012 - 07:53


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The herd mentality means we could be seeing more ‘all-business’ conglomerates.

ODD ONE OUT: BHP Billiton is one example of a successful ‘all-business’ model, but it is the exception rather than the rule. Photo: BHP Billiton

The herd mentality means we could be seeing more ‘all-business’ conglomerates.

IT’S human nature to copy what other people do; that’s why people often repeat the mistakes of their parents, why companies have a habit of mimicking what their rivals do, and why it’s so easy to predict failure long before it happens.

Unpopular as it has been to forecast the eventual collapse of the ‘all-resources’ business model being created by the merger of two commodities giants, Glencore and Xstrata, it is interesting to see that the first part of that prediction is coming true - copycat behaviour.

On several occasions over the past year I have written about the lack of logic in marrying a mining business with an agricultural commodities business, which is pretty much what ‘GlenStrata’ will be once the deal is complete.

The primary reason for saying the merger will not work is the obvious clash of culture inside the new structure. Not only do copper and wheat have nothing in common, the business of digging minerals out of the ground has little to do with high-speed commodity trading from the safety of a desk somewhere in Switzerland.

But, at the same time warning bells were ringing about the lack of logic in creating GlenStrata, it was just as easy to see that other company managers would mimic what an industry leader is doing and attempt to build their own allresources company.

Right on cue, enter the big US-based copper miner Freeport McMoRan, which last week said it was adding an oil and gas division to its minerals operations via the $20 billion acquisition of two petroleum companies which, in time, will represent about a quarter of the business when measured in terms of profit share.

Investors with long memories hated the Freeport announcement, knocking more than 10 per cent off the company’s share price because there is a reasonable chance that the deal will be value destructive; just as previous attempts to merge mining and oil companies were in the 1980s.

Believers in the theory of a conglomerate, which has multiple divisions in totally diverse areas of business, say that failure is not always the outcome if there is a strong head office that allocates capital, and which demands discipline of its independent operating arms.

Examples cited of the ‘all-busi-ness’ model succeeding include BHP Billiton with its oil and minerals operations, GE with its jet engine and banking units, and Wesfarmers with its retail and coal mining operations.

Unfortunately, successful conglomerates are the exception, not the rule. And while they often get mentioned, another aspect of human nature ensures that the unsuccessful attempts to create a conglomerate are not mentioned; that trait is called ‘forgetting failure’.

Two deals, GlenStrata and now Freeport, does not represent a trend, but it’s a fair bet that senior management in all major mining companies is busy analysing what’s being created and wondering whether adding an oil and gas operation could be a way to grow in the future, especially if commodity prices remain flat.

Rio Tinto, for example, must be looking at its mix of mining assets and wondering where it can achieve growth while also cutting back on excess exposure to a single commodity - iron ore. Chief executive Tom Albanese has ruled out oil, but chief executives come and go and a new boss will want to deliver growth in whatever form possible.

The same pressure to perform is being felt across the mining industry, where profit growth until now has been easy to achieve thanks to rising commodity prices.

Future profit growth will be much harder, and while it is tempting to suggest that investors sell mining companies that opt for the all-resources model, or which suddenly bolt-on an oil-and-gas division, that is not a recommendation you’re likely to hear.

The problem for investment advisers is that most are too young to remember past all-resources failures, and it’s easier to drift along with a trend than argue against it.

That is what’s happening with the creation of GlenStrata and the oil acquisitions of Freeport; and it is why other mining companies will mimic their merger moves, setting the scene for a stiff dose of shareholder value destruction.

Time’s up, Tesco

MERGING incompatible business units is one of the classic business mistakes that is constantly repeated, as if on an endless playback loop. But it’s not the only classic mistake, as a big food retailer has just discovered.

Tesco, one of Britain’s top companies, is on the verge of pulling out of the US, leaving behind $1.5 billion in losses after it failed to convince American shoppers to embrace its Fresh & Easy chain of supermarkets.

The first mistake made by Tesco was not offering the things Americans expect in a food shop, such as a bakery and fresh coffee.

By the time it added those features and made other changes to look more like its rivals, the damage had been done.

The second mistake was failing to understand the challenge of moving from a relatively small market into a bigger market; and while the British food sector is not small, it is a minnow compared with the vast and diverse US market.

Many Australian companies have made the same mistake when they have attempted to crack the US market, and many WA companies have failed when moving into the eastern states - and will continue to do so.

Open ocean

AT risk of stirring a hornet’s nest, it was interesting to follow the recent voyage of the Ob River, a liquefied natural gas carrier, as it traversed the North West Passage through Arctic ice with a load of Norwegian LNG for Japan.

There were two messages in the trip.

The first of these was that gas from Norway and Russia has found a quicker and cheaper route into Australian LNG producers’ ‘backyard’.

The second message is that the changing global climate, which is said to be the cause of reduced levels of Arctic ice, is not viewed in some parts of the world as the disaster it is portrayed in other parts.

“A lie gets halfway around the world before the truth has a chance to get its pants on.”

Winston Churchill


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