Financial or strategic controls?

EuropennMmgment

Pergamon 0263-2373(93)EOO13-I

~oumulVol. 12, No. 1, pp. 102-113, 1994

Elsevier Science Ltd Printed in Great Britain 02632373/94 $6.00+0.00

Financialor Strategic Controls? An Anglo-GermanCase Study CARR, Senior Fellow in Strategic Management, University of Manchester Business School; CYRIL TOMKINS, Professor of Accounting and Finance, Bath University; BRIAN BAYLISS, Professor of Business Economics, Bath University. CHRISTOPHER

This article examines a successful Anglo-German joint venture in order to compare approaches in the two countries when faced with the same strategic investment decision. The case uniquely illustrates some of the key contrasts found in a more extensive study of strategic investment decisions involving 24 British and 25 German vehicle component companies. This has been financed by the Institute of Chartered Accountants in England and Wales, to whom a report is now being submitted.

acquisition and market entry enables us to explore in particular depth some of the sharp contrasts we have observed in a more extensive study comparing 49 British and German companies, all in the vehicle components industry.’ We begin by comparing approaches to the investment decision itself, before looking at the detailed control approaches. Finally we will discuss implications for managers in the light of wider literature. The case has been read and approved by the Chief Executives of both companies.

The contrast was pronounced. The German company’s approach was primarily driven by strategic considerations both in respect to its investment decisions and subsequent control processes, and financial targets were explicitly played down; whereas the British company’s approach was primarily driven by financial considerations on both counts. The German company has performed more successfully and its distinctive approach proved decisive in ensuring the success of this major investment. British companies may need to adopt a more strategic emphasis in the face of international competition.

The UK Company’s Investment Approach The British company, let us call it Multifin Plc, is a diversified group of companies. The automotive part of the group predominates, and includes various loosely connected product areas as a result of opportunistic acquisitions, a number of which have been through backward integration. The group is quite young and was conceived as a conglomerate from the outset. In recent years the number of businesses in Multifin’s portfolio has expanded by a factor of six, and its turnover by 700%, though earnings per share have subsequently plunged, creating serious financial difficulties.

Introduction The question has long been controversial. Do strong financial controls undermine the longer term strategic approach needed to win out in international competition (Hayes and Abernathy, 1980; Abernathy et al., 1981; Hayes and Garvin, 1982). Some blame financial institutions for short-termism (Jacobs, 1991), but Marsh (1990) places any responsibility more squarely on corporate policies. Nowhere is this problem more acute than when dealing with strategic investment decisions. In this article, we compare the approaches of British and German companies (reputed as being longer term in their thinking), when faced with exactly the same strategic investment decision. This case study of a successful Anglo-German joint venture involving 12

The board of directors constituting the management team have predominantly finance and accounting backgrounds. Mr Peters, the managing director responsible for the Sharecom joint venture, which is the subject of this case study, is a chartered accountant by training. Following appointments in an engineering firm, first as finance controller and subsequently as finance director, he moved into general management. He has now been in general management for over 20 years mainly in engineering environments, and is currently one of Multifin’s three automotive sector chief executives.

As a diversified public company, Multifin is especially subject to pressures from its shareholders and the financial community to maintain EPS growth and to improve financial results. The company expects a return

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on investment (on business assets) of between 20% (absolute minimum based on assumed borrowing at 16% plus 4% safety margin) and 30% (‘if you get up to 30% your competitors start coming in with lower prices’). ‘Business assets’ are defined as plant and equipment, stock and debtors less trade creditors. Factories are normally rented and therefore not included as assets.

basic rule for pricing an acquisition is a price/earnings multiple of five, applied to current earnings. Earnings in the first year following an acquisition frequently remain low, but they expect to be able to achieve a payback by the end of the third year. A negotiating session on price follows: then a legal and accountant’s investigation before the deal is completed.

Multifin controls its businesses on a yearly budgeting cycle. Budgets and capital expenditure proposals are prepared and evaluated on an individual business basis, the companies themselves are not viewed as a composite whole. Financial reviews centre on last year’s performance against budget; whether next year’s budget proposal is acceptable; and if not, what loss making activities can be cut out:

In general Multifin’s primary orientation towards financial issues has precluded more detailed consideration of strategic issues, particularly as compared with their German joint venture partner Eincore:

‘With our British way of things we tend to look at each year as a year and this comes back to [the] short term. ’ Performances of individual business units are analysed in detail, monitoring figures for: sales, sales growth, trading profits, profit growth, growth in assets, return on net business assets, trading profit/sales, and net business assets to sales. Companies, or particular product lines of companies, that do not meet the high financial targets required are always under threat. Two years is the normal allowance in which to attain the required ROI targets before Multifin will take action. ? don’t think we are a hire and fire company, we tend to live with people longer than that, but at the end of that second year, . . . what 1 am really saying is that we as a public company are operating with shareholders to satisfy’. External financial pressure also largely dictated Multifin’s acquisition-oriented growth strategy. Mr Peters felt that such pressures had led to them seeking acquisitions at a faster rate than was ideal from a business viewpoint - in his view, a major factor contributing to the company’s more recent financial difficulties. Organic growth takes too long. ‘I mean, if you start from a greenfield site and design your own, it takes much longer’. ‘In other words you don‘t start with widgets, you start with the overall financial performance’. An acquisition target often results from suggestions and conversations with contacts within the City’s financial institutions: ‘A friend of mine rung up, . . . to say this company is available. It’s usually when a deal is put to you, you know an acquisition is available and we say, shall we or shan’t we?’ Acquisition negotiations go through several stages starting with the initial contact, then visiting the company followed by analysis of accounts and other financial data if Multifin like the company. The data is analysed in detail and a market price worked out. The EUR( )PBAN MANAGEMENT

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‘Whereas the Germans they say . . . zueare into widgets, and we stay in widgets and we won’t diversify out of widgets, we tend to be all over the shop. But we say widgets are interesting but now let’s have sprockets and let’s have this and let’s have that . . . ’

Eincore AG Eincore AG is a public company completely owned by the original founding family. The management team consists of a chairman (from the owning family) and two chief executives. The chairman (Kurt Schultz, 48 years old) has an engineering degree and an MBA from a prestigious business school. The chief executive involved in the Sharecom Ltd joint venture (46 years old) is also an engineer, with a US masters degree in industrial engineering combined with business administration. Mr Schultz has run the company for 20 years and has always provided a strong influence on strategic direction, while at the same time emphasising decentralised accountability and staff development. The chief executive responsible for the joint venture has run the product division for 12 years. The market potential for widgets arose in the late 1960s when Eincore developed and patented a revolutionary new widget design. In the twenty years since then Eincore have followed a consistent and highly successful strategy, based on joint venture agreements, to make them the market leader in the widget original equipment market (OEM) supplying major car companies. They have stuck to their core business and widgets constitute a high percentage of turnover. Since the first joint venture in the early/mid 1970s Eincore’s market share in widgets has risen from 15 per cent to a figure of 60 to 80 per cent, overtaking its major US rival. Over 20 years, employment has risen steadily; profit levels have been high and have also grown steadily. In the last eight years (to 1989) an average compound sales growth rate of 14.5 per cent has been achieved. Over the longer term, Eincore has proved far more successful than Multifin, both in terms of its performance in the marketplace and (perhaps more surprisingly) in terms of its financial performance as measured, for example, by earnings per share growth or return on capital employed. By contrast with Multifin, Eincore’s strategy is highly

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focused. Eincore see their strategic direction as ‘systems supplier’ to the automotive industry, always staying close to their core business. Engineering (including both design and development) accounts for 12 to 15 per cent of Eincore employees in the widgets division (worldwide). They concentrate on engineering excellence as a way of combating cost competition from smaller component suppliers. ‘We always said if we just make a piece to drawing we will always have very tough competition . . . so we said we have to move up market and we have to really do a lot in engineering. We have increased our engineering department every year substantially. ’ As a system supplier they control the component suppliers rather than compete with them. Over the last five years bought in component value has increased from 50 per cent of sales value (not costs) to 55 per cent. They strongly resist any attempt at diversification: ‘We had many opportunities where customers said well, you are doing widgets for us why don’t you do window regulators or brake cables or what have you . . . We have always felt that we want to do whatever we know best’.

The JV partner, Eincore, favoured their strategy over financial results. Backward integration is also avoided because this would tie them into particular component technologies and constrain engineering solutions. Such diversification dilutes expertise: ‘Our strategy was never diversification oriented . . . We don’t want to have thousands of presses standing around somewhere ana’ we have to tell our engineers please keep designing widgets in metal because otherwise our presses will be idle . . . Our strategy is not to be making backward integrations we want to make forward integrations. ’ They have an equally single minded approach to growth, namely to focus on engineering excellence in key product areas and develop the global market for those products in a systematic way. Their most important target is gaining market share by being present in every country with an automotive manufacturing base, a process of ‘forward integration in the direction of the market’. ‘We feel we have to be wherever there is a substantial developed car industy, because if we are not there the chances are that somebody else will be there.’

Since the early 1970s this strategy has resulted in twelve joint ventures with local companies in different geographical sectors of the global automotive market. Often Eincore will ask local manufacturers to recommend a JV partner. In the early days most of the joint ventures started small with low capital input (one sales engineer and two or three design engineers located in a corner of the partners’ premises). 104

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‘We went very consciously with JV partners because the company and the [owning] family did not have the management resources nor the financial resources to sustain that growth worldwide . . . within a decade. ’ The risk of failure was reduced knowledge of the market:

by having a good

How much effort would you put into understanding business position before a deal was agreed?‘

the

‘Since we are specialising, we know the market vey well. We know the competitors, we know the market sizes . . . it‘s not like saying what is the market for [say] door hinges, let’s get some facts together. We know that linformationl in widgets and we update it. ’ Eincore are confident that their strategy has paid off. Having exploited their initial lead in product technology to emerge as dominant market leaders ahead of US and Japanese rivals, their position is now further strengthened by the trend towards closer customer-supplier relationships. Domestically based competitors have left it too late to form the long term customer links necessary in the global marketplace, and their window of opportunity is closing. Eincore’s management philosophy is encapsulated in an 18 page document, and the ‘Eincore values’ are shown in Exhibit 1. The philosophy sets out Eincore’s position on its people, communications, technical knowledge, innovation, market, and results. The goal of the Eincore values is ‘to harmonise the interests of the company with the interests of the people in the company’. Results are, by design, the last of the values. ‘It is not by accident that lfinanciall results are last in our basic values because we say we want to do all these points people, communication, technical knowhow, innovation, market - we want to do all that correctly, and if we do that correctly we will be profitable. ’ Correspondingly, financial control systems at Eincore were considerably less sophisticated than at Multifin. Financial results mattered but, in any conflict of considerations, financial issues took second place to the need to maintain the essential integrity of what was felt to be a highly successful strategy. As will be illustrated in the case of this joint venture, their controls centred more on timely interventions to ensure such integrity was maintained.

The Sharecom Deal In the late 1970s Multifin lost one of its major profitable lines. The business went from f6M down to half a million inside 18 months. With cash coming out of the business they looked for re-investment in a product line linked to the previous area. Multifin bought an aftermarket (AM) company, selling widgets to accessory shops, fitters and garages, but decided it was ‘not very satisfactory’ on its own. They then looked for a second

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People The people in our concern are our most important capital. So management directs its attention mainly to the people. (Motto: There are no bad employees, only bad management of people). Communications and Information Informal, mutual communication is the raw material for good teamwork. The doing-level is part of the decision making process making it possible to overcome hierarchy problems. Technical Knowledge A high level of specialised competence in our field of endeavour as well as a continuing learning process take care of credibility with our partners. lnnovatlon We need innovative employees in all departments. Innovative projects have as a rule a higher risk of failure, innovative failures therefore are justified and shall be carried together. Market Scene Our quality, our partner-like conduct in relation to our customers and suppliers, and our service must be first class. We want ‘partner closeness’. Market Position Our goal is to be an international leader in selective areas of activity and we are determined to stay there by continually struggling for excellence. Results Profits and build-up of working capital are necessary for survival, but are simply the result of consistently following the previous points. Employees take a share of the capital and profits. It is the primary duty of the company’s management to take care that our basic values remain the guidelines of corporate identity.

Exhlblt 1: The Eincore Values

company to add to the first and found Sharecom Ltd, which also operated in the widget aftermarket. Its assessment was based on a financial appraisal, rather than any thorough review of its strategic or competitive position. Mr Peters responded to the question, ‘Were you going for a specific aftermarket opportunity?‘: ‘No. [Our current product line was going down] and it occurred to us that widgets were the next thing . . . Much the biggest market was the aftermarket, in Britain that is. In Germany it was different, but in Britain the widget OEM unzs very tiny so it was natural fir us to head for the aftermarket. ’ Detailed financial data were produced based on forecasts of expected AM profit flows. These indicated a market EUROPEAN

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value for Sharecom of somewhat below f0.5M formed the basis of the offer price.

and

At the time of the negotiations Sharecom had an AM distributorship for Eincore widgets. In mid-negotiation, Multifin approached Eincore with a view to continuing the distributor arrangement. The answer was unexpected - ‘no way’! This refusal was followed by a counter proposal from Eincore. ‘We want you to be our partner not our distributor. . . . We can’t possibly run a business in Britain satisfactorily, we need partners to do it. We will supply the technology, but you manage it, and what we want to do is get into the OEM’. For Multifin, going for the widget OEM as opposed to the AM represented a major shift in direction. From Eincore’s perspective, however, this initial approach by Multifin was ‘a lucky coincidence’. Eincore were not actively looking for a UK partner at the time and they knew the UK widget market would take some time to develop; but Multifin’s involvement with Sharecom presented a joint venture opportunity that was too good to miss, in that it fitted their previously successful joint venture formula: ‘We always ty to find a local partner who is active in the automotive supply industry . . . he should ideally already supply components lin a similar area] so that he has the contacts with the people - with the decision makers . . . We bring the product, the engineering knowhow, the patents, the support, and we expect from the local partner in essence, management and customer connections in the local culture. ‘ Some years earlier, they had thoroughly considered Sharecom as a joint venture partner, but had rejected the idea because Sharecom lacked relationships with OEM customers in the UK: the OEM, rather than the AM, being the primary target of their interest. Whilst Multifin had no experience of the widget original equipment market, it nevertheless enjoyed close relationships with UK car companies as a result of other automotive activities within the group. Thus when approached about the dealership, Eincore responded with the proposition that they would supply the engineering expertise if, in return, Multifin would supply local management expertise together with the links to the local automotive manufacturers necessary to exploit the local OEM potential. Like many other of Eincore’s joint venture decisions, this decision was not subjected to any formal financial appraisal. Often JVs start from a zero capital base, and decisions about equipment or fixed assets purchase are taken informally, on an incremental basis: this preserves flexibility and reduces risk. In this case, the 5050 equity arrangement implied a substantial investment, but one comparable with other JVs undertaken in the past, and Eincore took little interest in the financial aspects of the Sharecom deal. Both the Chairman and the Chief Executive involved

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were aware of financial appraisal techniques but did not apply them. They were happy to let Multifin deal with the financial side of the Sharecom deal. ‘This is partly Herr Schultz’s style and maybe mine. We are both engineers, we did a joint venture when we felt we had a chance and only in recent years when these companies got very big [did] we get into these things like how to evaluate and what are the future prospects and so on.’ ‘1 have to admit that . . . before we signed the deal with Multifin Z don’t think we ever talked to our Ifinancial] controller. ’ In broad terms, Eincore told Multifin that they expected that it would take Sharecom about three or four years to break into profit in the OEM; Multifin’s detailed financial analysis, on the other hand, was based on a more ambitious two year target. They had listened to Eincore’s views, but trusted to their own past experiences of being able to achieve fast financial results. Multifin’s financial analysis was not based on any knowledge of the widget market, not even knowing who the main competitors were. They, nevertheless, almost immediately decided to go ahead on the proposed 50:50 joint venture deal. The financial negotiations with Sharecom went ahead using the original aftermarket financial breakdown. The two AM companies were merged with a combined turnover of f800,000 to form the new Sharecom Ltd. Multifin then began putting together a management team and monitoring the investment via their normal financial control system. At the time the implications of building up an OEM business rather than controlling an AM business were scarcely taken into account. ‘It just happened to arise, I mean looking back it was luck. When they put the proposition to us - 1 think at that time we realised that the potential, arm in arm with the Germans, was going to be far greater than for us alone. ’ The speed with which negotiations were conducted contributed to some lack of thoroughness, as is apt to happen with acquisitions (Jemison and Sitkin, 1986); but, surprisingly, even their financial analysis was not adjusted to take into account additional overhead costs, likely to be borne as the result of any attempt to enter the original equipment market. By the end of the second year these were already proving to be substantial.

The Sharecom Joint Venture Eincore maintained their policy of not becoming involved in detailed local management policies; though they recognised that on various crucial points they would need to get across their strategy and values to the Sharecom team. They believe that if you get the strategy right and the philosophy understood, the rest will happen automatically. ‘The only way, is to motivate the people who are the opinion leaders in the company who spread the message to have the 106

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same strategy. You cannot have a control instrument [that does this for youI. ’ ‘If you would ask the managers at Sharecom, they would have a fairly clear picture what our common target is, they may use different words and so forth but 1 think we have a common understanding on the targets, it is not formalised.’ Eincore were thus content for Multifin to exercise most day-to-day control over Sharecom, but exerted their influence to sustain their own basic strategy and values whenever this was necessary. Early on, for example, Eincore refused to allow compromise over matters of quality. In fact, had UK management enjoyed a worse rapport, or proven less flexible, the clash of views might well have soured the relationship. One new UK designed part was already being sold; but Eincore had its own design teams rework the design to improve surface finish, and demanded a change. To UK executives, this was ‘crazy’. They pointed out that not one customer had rejected the product, and any surface blemish was scarcely visible. Eincore was adamant. Multifin asked: ‘Would [Eincore] really then be prepared to contribute half of the f25,OOO tooling costs’? Eincore’s executives ‘didn’t blink an eye‘ and agreed on the spot, leaving Mr Peters feeling ‘hoisted with his own petard’. He confirmed, though, that throughout the joint venture, there had been a great deal of positive cooperation on quality matters: ‘Did you get any help in solving these quality problems from your German partner?’ ‘Yes, in terms of technical help and, by the way, if you design a component like that we believe you are going to get into problems, because we got into problems 10 years ago . . . that sort of advice was invaluable. ’

Vertical Integration The companies have never reached agreement on the issue of vertical integration. Although Sharecom, a first tier supplier to the automotive industry, is located close to its customers, its own suppliers are often remote. Many of their components have to be bought in from Germany, because high tooling costs make this more economical: 'Ifyou are up against one of those components where they have got a giant press . . . you could spend half a million pounds on the tooling and then there is no investment case for duplicating that investment. ‘

With 75 to 80 per cent of widget cost being bought-in component costs, Sharecom generally prefer, however, to source from within the UK whenever possible to avoid logistics and exchange rate problems. The downside of UK supply is delivery reliability and quality. Sharecom’s solution has been to buy into the com-

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ponent manufacturers’ business and create the required quality supplier. In Eincore’s view this is wrong and they should use German suppliers; ‘We &zve pruved to Sharecom that they could buy their sprocket from a German supplier cheaper fhan Willis but they prefer to buy from Willis. Sometimes our friends are very British and sometimes they pay for it. ’ Willis was bought by Sharecom as a turnaround prospect. With Mul~n management installed, Willis is now a Ford QlOl rated company with a goal of Ql rating in the future. Willis’s profitability has been successfully turned around and is now very good. The next step say Multifin is to diversify into other areas of sprocket supply in the automotive industry. Eincore are still unimpressed. They argue that neither they nor Multifin have expertise in sprockets and Multifin should consider a specialist partner if they are really serious. Eincore argued: ‘We turned it down and we didn’t even look at the profits. want to turn Willis into a comp~itive ~te~~se on the European scale it rakes a lot of money and it’s not w&h it. ‘

Ifyoureally

Market Strategy In general, Eincore have discouraged marketing policies, not in line with their up-market image. They resisted Sharecom’s perceived tendency to buy into businesses at low prices, which they felt was damaging to overall long term profitability: ‘Thq were more plume and sales ousted and they had a very hard fime to go and lose a possible contract because fhe price was not good. ’ At the outset, Sharecom inherited from Eincore a small amount of OEM business with the Rover group. Engineers were hired for OEM design work and to back up the OEM sales effort but beyond that, for nearly five years, the company was predominantly an aftermarket supplier. E&ore’s market strategy covered both AM and OEM. The original equipment market was very different to the aftermarket due to the long lead times involved. In a new market it can take up to two and a half years to get the first orders and a further 18 months to tool up ready for the production runs. Also Eincore’s global strategy relied on restricting each partner into a separate bounded geographic market place. They needed to convince Multifin to stay in line with this strategy. ‘We had quite extensive discussions with Mulfijin and Sharecorn about the strategy in the aftermarket business because obviously we had already an established organisation throughout Europe and the world. The key focus fir Herr ~hultz and myself with Shrew was to dwelt OEM business rmdget fhem in line with our a~~~ phi~hy. We had a hard time convincing Mr Peters that the future of Sharecom was in the OEM not in the aftermarket. ’

Global strategy was the cause of a serious dispute between the partners when Eincore made a deal with a US company giving that company exclusive rights in the US market. Such territorial arrangements were essential to Eincore’s global strategy, but cut off what was then a major potential source of Sharecom’s business, the US aftermarket. Eincore was as usual adamant, though its argument to Multifin was again based on the long term attractiveness of the OEM as opposed to the aftermarket: ‘Get into fhe OEM business as you’re doing and believe me when you get into the OEM business you will make money as ifthere were no tomorrow; so in all this argument about the aftermarket, you‘re talking minor petty cash figures. ’ The US dispute was resolved because of the good rapport, and because the UK management team was ultimately flexible enough to waive contract provisions even at the financial cost of US aftermarket business; but in the UK a more serious disagreement gradually built up with respect to OEM versus AM priorities a dispute which vividly hig~~ted the two companies’ contracting priorities, between financial versus strategic controls.

I

The German partner’s priority on

strate~ prevailed in the AngloGerman IV.

Multifin controlled the Sharecom venture via frequent, detailed financial reviews. Additionally over the first two years of the venture they completely replaced the Sharecom management team. The first year results were disappointing: ‘we lost money’. For the next four years the company ‘hardly made any money at all’ as profits from the aftermarket business were re-absorbed by OEM overheads. Additionally, a further f0.4M was invested in plant and equipment. The Sharecom management became known as ‘the jam tomorrow’ boys. ‘My board colleagues said, ‘Mr Peters, the minimum is 20% return and we are now looking at minus 4.83%“. 1 was under pressurefrom my colleagues to say hold on, what’s going on?’ As a wholly owned subsidiary the financial argument would normally have won out, but the influence of their partner ultimately prevailed. In response to the question, ‘Did you manage Sharecom differently because of Eincore’s influence?‘, h4r Peters replied: ‘Yes, our British attitude might have been at thaf point fo say, let’s analyse where our pm@ come from, our profits come from the aftermarket. The original equipment market is an absolute loss, we have hardly goFot any contracts. At that point you would say forget the OEM, your success is in the aftergrit. The Germans said, a~lute abash, we have an objective, agreed back at the start. Your AM business is merely fhere fo support overheads while you get into the original equipment market. ’

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Eincore exerts its influence over these and other strategic issues by means of regular (yearly) strategy meetings which it carries out with all its joint venture management teams; but they displayed little interest in highly, detailed and much more frequent financial control reports, copies of which were sent to them by Multifin. These strategic reviews plot out broad objectives for the future from which more detailed objectives are set in consultation with the management teams. Sharecom management say that this type of review is far more useful than the financial based reviews run by Multifin, Few decisions were reached as a result of Multifin’s financial meetings and they were considered more of a witch hunt; in contrast the Eincore strategy meetings were helpful and informative, and resulted in real decisions. Eincore expressed this difference in approach: We ure really always more conceded about where we stand with the customers, where are the projects, and whether the basic price is righf forkful projecfs rather than fhe currenf results. ’ The decisive breakthrough for Sharecom came four years into the joint venture, when one OEM customer decided to change suppliers in mid-production run. Usually, car companies wait for their next major model change before introducing new components, but in this case they decided to make an exception. The customer’s original volume projections were not large, some 300 widgets a week. However, once rival car companies began to fit widgets as standard equipment they were forced to follow suit, dramatically stepping up their demand for widgets. The increase from 300 to over loo0 widgets per week initially caused numerous quality related problems. However, partly due to Eincore’s influence, the approach to quality matters had already changed. Not only were quality problems overcome, but Sharecom is now a Ford Ql rated company and has thus achieved an important quality objective. Sharecom’s spectacular success in the UK marketplace continued with sales almost doubling every year over the next few years, with a maintained profit margin to around 8 per cent of sales. They are a prime supplier to the Rover group and supply certain Ford and Vauxhall models, with Honda coming through in a year or two. ‘We missed out on Nissan . . . in Japan “‘a competitor” has close links with Nissan . . . Tmpfa? - we are still busy ~ghfing fhaf one. ’ From being a ‘bit-player’ they have moved into the market leader position and intend to stay there.

The Working Relationship In making joint ventures work, Eincore emphasise the importance of short decision making processes. For this reason they usually work with partners where the chairman is also the owner of the company. They avoid working with large international corporations, less able 108

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to reach quifk decisions, and describe their ideal joint venture partner as ‘about the same size [as us], and not linked to a big conglomerate’. ‘We tend to have a somewhat easier time if we know who is really shaping the philosophy of that partner’. Multifin are a conglomerate, but totally agree with the need for short decision making processes. They now have other joint venture partners and not all of the relationships are running smoothly. They agree on the need to have the directors, the decision makers, involved in the venture, that way if there is any squabble you can ring up your opposite number and get a decision above the ‘politics’ level. Once the problem is enmeshed in company politics the relationship is dead. Top level intervention successfully resolved three key conflicts already discussed: the question of paying for a complete new set of tooling to resolve the quality problem, the US aftermarket conflict of interests, and finally the whole question of the OEM versus AM strategy. Eincore say, having chosen your partner, the key factor in making a joint venture work well is building good relationships with the people involved. If they are not motivated to make the thing happen it will not happen. With overseas partners, for example, they take pains to avoid any stereotyped appearance of German superiority: ‘We ty not to give the feeling to our partners that we are frying to d~i~fe them. The real arf is to g~erafe the~~~ing thaf they [the partnersl are helped. If they don’t get something out of the relationship they will not understand why they have it. ’ Multifin agree about the importance of people relationships. Mr Peters sees Eincore as an extremely good partner. The right relationships proved vital in making this joint venture work, by maintaining a sense of positive cooperation which saw both sides through some highly contentious issues.

Discussion and Conclusions This joint venture was ultimately highly successful,

and justified the German company’s insistence that strategically the OEM was where future profits lay. Nevertheless, the venture took five years to break into profit. This was three years longer than the UK partner expected and one year longer than the German partner expected. Thus Multifin’s detailed and, seemingly, sophisticated financial figures were based on wildly inaccurate assumptions, in turn based on u~e~tic~y high targets representing little more than wishful thinking. During the early years, however, Sharecorn’s AM profits were useful in helping to fund the longer term OEM entry strategy. what happens when their chosen market matures remains to be seen, but at present Eincore are far more successful than their JV partner Multifin. Despite a

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successful performance by their Sharecom joint venture, and a continuing emphasis on close financial controls applied across their portfolio of companies, Multifin’s profits have plunged and the company now faces serious financial difficulties; Eincore has grown into a highly profitable organisation with market dominance in their chosen specialty area, and its success continues unabated. Given the opportunistic nature of this particular acquisition decision, the speed with which it was negotiated, and the impingement of complex strategic considerations, neither of the partners considered employing sophisticated, or even fomlised capital budgeting techniques (such as discounted cash flow methods) in the original investment decision. This is often the case with acquisition decisions (Stuart Jones, 1982; Simmonds, 1988; Kitching, 1967), though as Jemison and Sitkin (1986) point out, any lack of thoroughness at this stage frequently leads to acute problems later. Joint venture investment decisions also commonly have to be taken on more strategic grounds (Lyons, 1991). Although surveys of capital budgeting practice in Britain and the USA have indicated the increasing dominance of more sophisticated discounted cash flow methods (Pike, 1983; Klammer and Walker, 1984), this Anglo-German case tends to confirm that companies are less inclined to use such methods for such strategic investment decisions. A more surprising point of commonality is that neither company made use of any formalised techniques of strategic analysis, such as strategic portfolio techniques, Porter’s (1980, 1985) methods, or even strengths, weakness, opportunities and threats (SWOT) analysis. Haspeslaugh’s (1982) survey research suggested as many as three quarters of the US Fortune 500 companies were utilising strategic portfolio techniques; but perhaps such formal techniques are having less impact in Europe. Goold and Campbell’s (1987a) research on UK diversified companies found a number pursuing Financial Control styles, explicitly playing down strategic planning. Eincore, on the other hand is clearly strategically driven, so it is interesting that even these large German companies still appear to be characterised by essentially informal processes of strategy formulation. A final point of commonality between these two British and German companies is the emphasis of both Chief Executives on establishing a relationship of rapport and trust from the outset, and on maintaining this in the face of potentially very serious conflicts, which resulted from their otherwise quite contrasting approaches. That this proved so critical to success is confirmation of the point, so frequently stressed in relation to joint ventures (Ohmae, 1989; Lewis, 1990; Ghoshal, 1989; Lyons, 1991); the danger of being exploited, noted by Hamel et al. (1989), on the other hand, was less evident in this particular case, and more positive attitudes based on a very high degree of mutual trust appear here to have served both partners well. EUROPEAN

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From here on, however, any such commonalities in the approaches of these two British and German companies quickly ends. On closer inspection, Multifin’s acquisition strategy was clearly driven by financial objectives; its selection criteria were dominated in turn by the financial review; and its valuation methods establishing the bid price provided the same function as the payback method approach. Multifin engaged in virtually no strategic analysis and its knowledge of the business situation was extremely superficial. Short term financial gain and earnings per share growth predominated their analysis of the Sharecom deal and, in practice, precluded any long term strategic aim on the part of Multifin. Had Multifin pursued its usual approach without the benefit of a partner such as Eincore, it would probably have run into trouble. Mr Peters acknowledged that, given their somewhat opportunistic approach, they might easily have selected one of a number of UK AM widget companies who by now have been forced out of the market. In the event, the initially profitable aftermarket has subsequently declined in contrast to the original equipment market, taking out several AM participants. Even the UK AM leader is in deep financial trouble having failed to generate links into the major original equipment market. Multifin’s approach thus entailed considerable risk. Lacking sufficient knowledge of the aftermarket, the essence of their approach was to seize opportunities, but then to get out fast if the right financial returns failed to material& fairly quickly. Such opportunism in this case fortunately led to the partnership with Eincore, who were able to contribute resources, skills and better strategic thinking. This took Sharecom from being a bit-player in the AM and the OEM to being a dominant force in both - a remarkable and commercially successful achievement; but had Eincore not happened to turn up, the outcome would have been very different. Multifin’s other portfolio activities have subsequently run into financial problems, raising questions as to the adequacy of its approach. It is known that diversified conglomerates, particularly in Britain, face real tensions in attempting to integrate strategic and financial approaches (Goold and Campbell, 1987a). Thus senior executives at a ‘Financial Control’ style company, such as Hanson, eschew any involvement in strategic planning and rely almost exclusively on extremely tight financial controls, operated over short term horizons so that particular managers realIy are held accountable for the immediate financial consequences of their actions. Such an approach need not always preclude good longer term strategic thinking at lower levels of the organisation, since managers need to produce good results year after year; though financial constraints and the lack of any clear expectation to consider strategy can sometimes result in superficial strategic thinking even at lower levels (Carr et al., 1991). The acquisition situation is, however, an interesting special investment case in such conglomerates. Unlike many other types of investments, this acquisition was

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handled by the corporate centre, which therefore had to bear full responsibility for any weaknesses in strategic analysis. Our case evidences the extent of the risk Multifin was running in adopting such an opportunistic corporate strategy. Multifin’s strategic analysis was so superficial as to undermine the credibility of the detailed and seemingly sophisticated financial analysis, carried out at the time of the original investment decision. Financial projections appeared designed to demonstrate untenably short payback periods, rather than any reflection of reality. It is particularly surprising that the financial analysis was not even revised when, in midnegotiations, Multifin accepted a totally new deal offered by Eincore, based on entering the OEM as opposed to the aftermarket on which the financial analysis had been based; the financial characteristics operating in the two markets are quite different and, even in the short term, cash flows were bound to be seriously altered by the overhead ~plications of attempting to enter the OEM. The case thus powerfully reindorses warnings from Marsh et al. (1988) and Barwise et al. (1990) that, in strategic investment decisions, financial and strategic considerations are unlikely to be reconcilable unless financial calculations are based on a sufficiently thorough understanding of markets and competition. Financial Control style companies, such as Multifin, may be particularly vulnerable in this respect.

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cuntrol style conglomerates face potential long-term risks. Financial

Previous research by Goold and Campbell (1987b) suggested that UK ‘Financial Control’ style companies had outperformed ‘Strategic Planning’ style companies over some five years, in terms of profit ratios and growth measures. Their sample of three star performing financial control style companies, Hanson, BTR and Tarmac may not be typical and their research has not been extended to Continental Europe. Multifin’s performance, which was also extremely good over a similar period, has subsequently declined steeply. On the other hand, German companies such as Eincore, pursuing ‘Strategic Planning’ approaches, appear to be sustaining even better performances both financially and in competitive terms. Our findings, thus, highlight the longer term risks potentially associated with financial control style conglomerates. Multifin’s experience suggests that Financial Control style companies may be unduly relying on increased hurdle rates as a way of handling problems of risk and under-performance. Eincore’s relative success, perhaps, suggests more satisfactory alternatives. By contrast with Multifin, Eincore has consistently pursued a focused, long term and highly international strategy, based on combining their expertise with their partners’ local knowledge. They consistently turned

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down oppo~nities for diversification and backward integration, to maintain their market focus and to avoid diluting their area of expertise. Eincore correspondingly adopted a very different approach to the original investment decision. Their primary concerns focused instead on those key strategic issues which, though not quantifiable, were perceived as determining whether or not such a breakthrough would actually occur. The deal they proposed was also opportunistic: there being little time for extensive or formalised reviews. Yet, given such constraints, their strategic approach was far from superficial. Given their focused strategy and their regular strategic reviews, characteristic of the ‘Strategic Planning’ style, they already had a detailed understanding of the market and competition, They had long since identified the UK market opportunity. Well-tried criteria for evaluating joint venture partners were in place, and they were in a position to respond quickly to any opportunities arising. Sharecom had distributed their widgets to the UK aftermarket for many years and was therefore well known to them. Some years earlier, Sharecom had been thoroughly considered as a potential JV partner, and had been turned down mainly because it lacked UK OEM customer contacts which were felt to be necessary. Multifin’s OEM relationships resulting from its other activities, however, made up this deficiency and provided the local managerial support. Eincore was aware that both Multifin and its acquisition target Sharecom were weak on technological and manufac~ring skills, but they were confident that this was a deficiency that they could make up. Their main concern, from this point, was whether they would be able to establish a good rapport with top level UK management. Such a judgement on critical success factors, based on their own successful JV experiences, is again consistent with the literature on joint ventures and was borne out by subsequent events. Once the working relationship was deemed satisfactory, they might justifiably have been fairly confident of the success which ultimately followed. Such a difference in approach was even more marked in the case of Multifin’s subsequent decision to acquire the supplier company, Willis; Eincore were not prepared to countenance a decision based on what they regarded as poor strategic thinking, regardless of financial prospects which Multifin judged excellent. On this investment, somewhat to its surprise, M~t~in had to proceed independently. Even more recently, Eincore have again refused to be involved even though financial results for Willis have been turned around and now look attractive. The contrast in the two companies’ subsequent control methods reflected such differences in approach. Multifin closely monitored, and at top level fiercely debated, regular financial reports which Eincore’s management regarded as unnecessarily detailed and scarcely glanced at. Eincore, on the other hand, determinedly maintained control over just a few key strategic issues: quality, no~ithstan~g the cost; market discipline; and no

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dilution of their strategic focus in the original equipment market. Mostly Multifin was happy to defer to Eincore’s greater understanding when broad strategic choices arose; but clashes inevitably arose when Eincore’s determination to control strategic matters conflicted with Multifin’s financial policies. In the crucial clash of views over whether profits were ultimately really going to be found in the OEM or the AM, Eincore did not dispute Multifin’s damning financial reports; but they were adamantly determined that strategic objectives should prevail. Clearly, Eincore would have also had in mind their whole worldwide OEM strategy, but even taking a narrower financial view their judgement has been fully vindicated. Multifin’s emphasis on centralised financial control in this case proved counter-productive. Had Multifin followed its own financial guidelines, the OEM side of the business would have been closed down. The company might have made enough to justify the purchase of Sharecom, but would have lost out on the real profit earner which subsequently proved to be in the OEM. Lost profit opportunities are nowhere flagged up in such financial information systems, since profits earned by rivals are not monitored. Since breaking into profit the investment has returned in excess of 1000 per cent through OEM growth. Such contrasting approaches in Britain and Germany would appear to support suspicions, publicly expressed by customers such as Ford and General Motors who operate in both countries (House of Commons, Trade and Industry, 1987). They argued that German suppliers’ relative competitiveness reflected their managerial approach, particularly in attitudes to strategic and financial matters - a matter going beyond more obvious differences in the financial markets of the two countries. Multifin% Chief Executive concurred with this view and so did one of their major customers. Working with Eincore made Multifin think about their own overall management approach. Eincore’s success over so many years was perceived not merely as a reflection of the advantages of operating within the context of German capital markets, but as a ‘chicken and egg’ situation in which a coherent long-term strategy and good financial performance went hand-in-hand. Mr Peters was particularly impressed by Eincore’s management thoroughness; their insistence on getting technological and operational matters absolutely right; and especially by their consistency in pursuing long term objectives, even in the face of substantial short term problems and distractions: back twenty years there is nothing special about Eincore but they decided they were going to specialise in widgets. It was 2 or 3 years before they got going, but they were prepared to soldier on and get to the profitable phase. 1 think a British company probably would have changed ifs objectives. ’ ‘Ifyou go

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For its part, Eincore had substantial reservations about Multifin’s use of financial systems. Enhanced sophistication of formal information systems did not necessariiy result, they felt, in better decision making. Multifin’s problem, as they saw it, was not merely that staff lacked any more all-round knowledge relating to critical business issues; staff appeared to be engaged in endless rounds of meetings, discussing analyses of data, without actually taking strategic or indeed other decisions, affecting the real side of their business. Eincore’s staff had fewer meetings, but these were perceived to result in important decisions; being clear and agreed, these decisions resulted in changes which were implemented. To compromise the financial control style at all would be to expose top management to all the tensions identified in Goold and Campbell (1987a). Management accounting systems are themselves a reflection, not only of those City pressures which have themselves empowered the finance function, but also of complex organisational issues that have grown up partly as a result (Ezzamel et al., 19%; Ton&ins, 1991). Financial incentives, promotion systems, as well as penalties for under-performance, have long since forged a power system and a culture, striving for relatively short term ‘bottom line’ performance. ‘Strategic paradigms’ are not lightly to be changed (Johnson, 1987). To embark lightly on radical changes in approach would therefore be naive and, undoubtedly, some differences will remain, reflecting the different business context in the UK. Nevertheless, in the face of international competition from strategically driven companies such as Eincore, financial control style companies must either lose out or adapt. Ways must be found to improve the quality of strategic thinking underlying decisions. To date relatively few British companies have placed much emphasis on strategic controls of the type pursued by Eincore (Gould and Quinn, 1990). However, for decisions taken on more strategic grounds, it would seem to be equally important to take more seriously the matter of strategic controls.

Acknowledgement Full acknowledgement and thanks is given to the Institute of Chartered Accountants in England and Wales which is funding the project referred to in this paper. The authors also gratefully acknowledge the assistance of their case writer Christine Biscomb, a doctoral student at Manchester Business School.

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A comprehensive report entitled ‘Strategic Investment Decisions: A Comparison of UK and West German Practices in the Motor Components Industry’, by C. Carr, C. Ton&ins and 8. Bayliss, is now being compiled and submitted to the Institute of Chartered Accountants of England and Wales.

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1References Abernathy, W.J., Clark, K.B. and Kantrow, R.S. (1981) The New Industrial Competition, Harvard Business Review, 59, 5, pp. 68-82. Barwise, P., Marsh, P.R. and Wensley, R. (1990) Must Finance and Strategy Clash?, Harvard Business Review, Sept-Ott, pp. 85-90. Carr, C.H. (1990) Britain’s Competitiveness: The Management of the Vehicle Components Industry, London: Routledge. Carr, C.H. and Ton&ins, C. (1991) Strategic Controllership a Case Study Approach, hlam~ementAccounting Research, 2, pp. 89-io7.- Ezzamel, M., Hoskin, K. and Macve, R. (1990) Managing it all bv Numbers: a Review of Iohnson & KaoIan’s ‘ReleGance Lost’, Accounting and Business Research, Vol. 20, No. 78, pp. 153-163. Ghoshal, S. (1989) The Dunlop-Pirelli Union, INSEADCEDEP Case Study 389-021-lN, Fontainebleau, France, available from Case Clearing House of Great Britain and Ireland, Cranfield Institute of Technology, Cranfield, Bedford MK3 OAL. Goold, M. and Campbell, A. (1987a) Strategies and Styles: the Role of the Centre in Managing Diversified Companies, Oxford: Basil Blackwell. Goold, M. and Campbell, A. (1987b) Many Best Ways to Make Strategy, tiarvard Business Review, Nov-Dee, pp. 70-76. Goold, M. and Quinn, J. (1990) Strategic Controls: Milestones for Long-Term Performance, The Economist Books, Hutchinson. Hamel, G., Doz, Y. and Prahalad, C. (1989) Collaborate with your Competitors and Win, Harvard Business Review, (JanlFeb), pp. 133-139. Haspeslaugh, P. (1982) Portfolio Planning: Uses and Limits, Harvard Business Review, 60, 3, pp. 70-80. Hayes, R.H. and Abernathy, W.J. Managing Our Way to Economic Decline, Harvard Business Rmiew, July, 1980. Hayes, R.H. and Garvin, D.A. (1982) Managing as if Tomorrow Mattered, Harvard Business Review, 60, 3, pp. 70-80. House of Commons, Trade and Industry Committee (1987) UK Components Industry: Third Report from the Trade and Industry Committee Session 1986/87, London: HMSO. Jacobs, M.T. (1991) Short-Term America: The Causes and Cures of Our Business Myopia, Cambridge, USA: Harvard Business School Press. Jemison, D.B. and Sitkin, S.S. (1986) Acquisitions: the Process can be a Problem, Harvard Business Review, (March/ April), pp. 107-116. Johnson, H.T. and Kaplan, R.S. (1987) Relevance Lost: The Rise and Fall ofManagement Accounting, Boston, Massachusetts:

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Harvard Business School Press. Johnson, J. (1987) Strategic Change and the Management Process, Blackwell: Oxford. Kaplan, R.S. (1983) Measuring Manufacturing Performance: a New Challenge for Managerial Accounting Research, The Accounting Review, LVlll, No. 4, (Oct.), pp. 686-705. Kitching, J. (1%7) Why do Mergers Miscarry?, Harvard Business Review, Vol. 45, (Nov./Dee.), pp. 84-101. KIammer, T.P. and Walker, A.C., (1984) The Continuing Increase in the Use of Capital Budgeting Techniques, Journal of Business, 45, 3, pp, 387-397. Lewis, J.D., (1990) Making Strategic Alliances Work, Research Technology Management, Vol 33, No 6 (Nov-Dec., pp. 12-15. Lyons, M.P., (1991) Joint Ventures as Strategic Choice - a Literature Review, Long Range Planning, Vol. 24, No. 4, pp. 130-144. Marsh, P., Barwise, P., Thomas, K. and Wensley, R. (1988) Strategic Investment Decisions in Larger Diversification Companies, Centre for Business Strategy Report Series, London Business School, London. Marsh, P. (1990) Short-Termism on Trial, International Fund Managers Association, London. Mintzberg, H., (1987) Crafting Strategy, Harvard Business Review. National Economic Development Council, (1989) Recreating an Internationally Successful Engineering Industry, Memorandum by J. Jordan, Chairman of the NEDC Engineering Sector Group, 18 October, London: NEDC. Ohmae, K., (1989) The Global Logic of Strategic Alliances, Harvard Business Review March-April, pp. 143-154. Pike, R.H., (1983) A Review of Recent Trends in Formal Capital Budgeting Processes, Accounting and Business Research, Summer, pp. 201-208. Porter, M.E., (1985) Competitive Advantage Creating and Sustaining Superior Performance, New York: Free Press. Porter, M.E. (1980) Competitive Strategy: Techniques for Analysing Industries and Competitors, New York: Free Press. Roberts, J. (1990) Strategy and Accounting in a UK Conglomerate, Accounting Organisations and Society, Vol. 15, No. l/2, pp. 107-126. Simmons, M. (1988) SuccessfulMergers - Planning, Strategy and Execution, London: Waterlow. Stuart Jones, C. (1982) The SuccessfulMunagementof Acquisitions, Derek Beattie. Ton&ins, C.R. (1991) Corporate Resource Allocation: Tying to Integrate Financial, Strategic and Behavioral Perspectives, Oxford: Basil Blackwell.

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CYRIL TOMKINS, University of Bath, Claverton Down, Bath BA2 7AY

CHRISTOPHER CARR, University of Manchester Business School, Booth Street West, Manchester MZ5 6PB. Dr Christopher Carr is Senior Fellow in Strategic Management at the Manchester Business School. A Chartered Engineer and a Chartered Management Accountant, he worked for several years in the vehicle components industry, before carrying out a 13 year study of worldwide competition. His recent research also focuses particularly on interface issues between strategy and finance. Previous lectureships include Warwick Business School, where he obtained his doctorate, Buckingham University and Bath University. He is author of Britain’s Competitiveness: The Management of the Vehicle Components Industry, (Routledge, London) and of several articles in leading academic journals.

Cyril Tomkins is Professor of Business Finance and also Pro Vice Chancellor at Bath University. He is author of over 80 academic journal articles and research reports, and seven books, the most recent being Corporate Resource Integrate Financial Strategic and Behavioural Perspectives (Basil Blackwell, Oxford). His research focuses on financial management and control issues in large organisations, in Britain and overseas. His work also extends to the public sector and, with colleagues, he is currently working on a book on the management of change in central government. Other research interests include transfer pricing issues, and also perceptions of risk in investment houses.

BRIAN BAYLISS, University of Bath, Claverton Down, Bath, BA2 7AY. Brian Bayliss is Professor of Business Economics at Bath University, having formerly held Chairs at the Universities of Munster in Germany and AixMarseille 11 in France. His early experience was gained in the Government Statistical Service. More currently, he holds non-executive positions and is also Chairman of the EEC Committee of Enquiry on Physical Distribution by Road. He is author of many articles in leading academic journals, his most recent book being Transport Policy and Planning (World Bank, Washington DC).

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