Strategic judgments about the business logic, added-value logic and capital-market logic are critical to making good portfolio decisions, notes McKinsey.

In an article containing excerpt from the new book: “Strategy for the Corporate Level: Where to Invest, What to Cut Back and How to Grow Organizations with Multiple Divisions” authored by Marcus Alexander, Andrew Campbell, Michael Goold, and Jo Whitehead, McKinsey’s Andrew Campbell points out how some companies have made tough decisions to make informed trade-offs among different reasons for buying or selling businesses.

Strategic Judgments Key To Corporate Portfolio Decisions
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Strategic judgments: Three logics for business decisions

The McKinsey article highlights that the choice to invest, cut back, buy, or exit is ideally guided by three logics viz.: business logic, added-value logic and capital-markets logic. The article elucidates these three logics through a few real-life examples of how corporates made their challenging portfolio decisions.

The article first highlights the scenario where the business is structurally less attractive but the management can add value. Here most management teams try to avoid business with low returns, weak positions, and limited growth prospects. However, if the management is good at adding value to these businesses, the article notes the default answer should be to focus on what the management is good at.

Narrating the experience of Grupo Bimbo S.A.B. de C.V. (BMV:BIMBOA) (OTCMKTS:GRBMF), a $14.1 billion Mexican baking giant, the world’s largest bread-manufacturing company, the article notes despite Grupo Bimbo’s products have notoriously low margins, its stock price has gone up 700% since 2000. The article highlights the company’s strength in adding a lot of value to the bakery businesses it owns is through strong focus on operations such as managing delivery routes for its trucks. By leveraging its strengths, the company grew organically through acquisitions of Weston Foods, sections of Hostess Brand’s bread business and most recently Canada Bread Company Ltd (TSE:CBY) (OTCMKTS:CBDLF). All these decisions made the company as one of the largest bakers in the world today.

The articles notes considering the risk of buying or holding structurally unattractive business, Grupo Bimbo must juggle all three logics.

Strategic judgments: Structurally attractive business

The article next focuses on the scenario where the decision makers can’t add value but the business is structurally attractive. The article notes even if the manager is not good at adding value to the business, it can quickly learn to add value. For instance, when Rolls-Royce Holding PLC (LON:RR) (OTCMKTS:RYCEY) acquired the marine business of Vickers in 1999, it also acquired Ulstein offshore business. Though Rolls-Royce could see that, from the perspective of business logic, this was a structurally attractive business, unfortunately it would be unlikely that Rolls-Royce would add much value to Ulstein in the short-term.

The article notes Rolls-Royce took care to build some new capabilities by hiring a new head for its marine business. The new team drew on lessons learned in civil aerospace and defense to offer long-term service support to ship operators, enabling Rolls-Royce’s marine business to grow from about £750 million in revenues in 2000 to more than £2.5 billion in 2010. However to reach the position of a leading competitor in the marine business, the company had to develop many of the ownership skills needed to turn the vision into a reality.

Turning attention to a situation where the decision maker can add value to a structurally attractive business, but it’s overpriced, the article notes one can structure a deal to reduce the risk through an ‘earn-out formula’. This formula would facilitate both buyer and seller to see the deal as attractive due to different assessments of its future prospects.

The article concludes that leaders can make wise choices only by using all three logics together. However, financial analysis can’t substitute for strategic judgments about the attractiveness of the business, the ability to add value, and the reasons for over or under valuations in the capital markets.