Non-core Operations, Part Of The Wider Vision Or Just A Distraction? Part 1 The Disposal Decision

Many groups will have some operations, or even whole subsidiaries, which might be regarded as 'non-core'. These will be ones which fall outside those areas in which the business's management believe it has a competitive advantage and which are central to the business's future plans. These two articles discuss why businesses may wish to dispose of non-core subsidiaries, and how best to go about it.

Disposal of an operation is not usually a manger's first choice but it is sometimes a necessary response to changes in markets and demand, and where these changes have resulted in a poor performing operation, then its divestment can leave the company in a much stronger position.

Why Do Businesses Have Non-core Operations?

Businesses find themselves with non-core operations for a number of reasons including:

• As a by-product of acquisition - in some cases a target business will have had subsidiary operations in areas which the acquirer had little or no experience, but which came as part of the package. In some cases the purchaser will have clearly had no interest in these in the first place, in which case they are obviously early candidates for disposal as part of the post acquisition integration process while the new owners seek to concentrate on those activities in which they have a competitive advantage. In others, acquirers sometimes decide to try to integrate these operations into their business on a longer term basis, with varying degrees of success. And of course, expansion and acquisition strategies will change over time, which leads on to...

• Historical legacy / market changes - as businesses develops, yesterday's core activity can easily becomes today's non-core relic. Does Nokia still make Gumboots, or IBM make mechanical adding machines?

But in some cases, non-core activities have arisen as a result of deliberate attempts at diversification or are the result of opportunistic exploitation of a niche. Development of a widening range of services can be an understandable approach by businesses as provision of a full range of services, the 'one stop shop' approach, can be seen as a way of binding customers in, squeezing out competitors and maximising the return from a customer relationship; each of which on the face of it sounds a sensible argument.

The problem with this is that you inevitably begin having to do things that are outside the business's core competencies which leads to the danger that:

• you risk ending up as being a jack of all trades, rather than an absolute master of your own specialism;

• poor performance in a non-core area can adversely (and sometimes disproportionately) effect the core relationship; and

• your distraction from your core business can give your competitors an advantage. This will be exacerbated if you have problems in the non-core areas as this tends to lead to a management focus paradox; you can't leave these businesses to less able management due to the risks involved, but do you really want to have your best management's time focused on your worst businesses? Wouldn't you rather have your best managers focussed on where they will do most good, which is presumably driving forwards your core businesses where you have most competitive advantage?

Finally, the old argument that becoming involved in a range of activities diversifies the business's risk is also less heard these days. It is generally accepted that investors can buy this diversification anyway in the market, much more efficiently and effectively, by acquiring a diversified portfolio, so why would they need you to do it within your business?

How Do You Make A Disposal Decision?

A disposal is often the final option considered in respect of an unrelated, unprofitable, or unmanageable operation. Even with operations like this, management may still attempt to turn the operation around, by for example increasing investment into it.

But businesses will have limited resources and will therefore seek to put these resources to work where they can generate the best return. So if they can switch their available capital away from areas where profits and prospects are low, to ones where they are high, then they will seek to do so and so a company may sell off a business unit in order to focus their resources on a market it judges to be more profitable, or promising. There are a number of well known tools and portfolio models that can therefore be used to identify potential disposal candidates, ranging from the Boston Consulting Group matrix, where 'dogs' will obviously fall into this category, to the GE approach characterised as a desire to exit any sector where GE is not number 1 or 2 in its chosen market.

Leaving aside those businesses which are disposed of because they are actually failing, or because of a clear lack of strategic fit, the range of specific drivers that can lead to a disposal can however include:

• Raising cash - in some cases by disposing of businesses which are doing well, for value, so as to generate cash to either reinvest in the rising stars, or to de-gear;

• Pressures on management time - as discussed above, when the core business requires focused management, non-core businesses can simply be too much of a distraction and represent a substantial opportunity cost in terms of skilled managers time;

• Reducing costs - managing a range of non-core subsidiaries can involve a high level of central overhead, (even dormant companies will have administrative holding costs and so arranging to deal with these can simplify corporate structures and save costs);

• Substantial break-up value - taking this to extremes, sometimes the value of the businesses individual assets is worth more than the firm as a whole and a partial (or even a full) disposal program is therefore a way of extracting value;

• Over capacity - in a market can lead to a decision to close operating units to reduce this problem;

• Regulatory risk- onerous levels of regulation or potential liabilities in an aspect of an operation may lead to a desire to exit on risk management grounds.

• Too small a market or market share - the business may decide the market, and its potential growth is too small for them to be competitive in, or bother with;

• Investment requirement - A substantial cash requirement to maintain or develop the business often leads to a decision point as the alternative to a business decline in the absence of investment may be to seek a disposal while the operation may still have a value;

• Stability - some areas of business may be particularly volatile or risky and so may unduly skew the business's results;

• Clarity - a disposal of non-core activities can be used to communicate strongly to the markets what the business believes is now core to its success; and finally,

• Competition requirements - can result in businesses being forced to make disposals, either after a deal, or as a condition of it going ahead.

In the next article we look at what your might want to achieve by way of a disposal and how this effects the way you may want to go about it, as well as the factors that can combine to block a divestment decision.

So does your strategic planning include a process that reviews your operations to identify core and non-core operations? If so, what is the reason for continuing with the non-core activities and how often is this reassessed? Are there dormant companies cluttering up the structure and taking time and cash to maintain? If so, can these be cleared out to save long term costs?

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