Tuesday, January 20, 2009
Analogy #233: Ownership Vs. Control
In the recent financial meltdown, people from all sectors of society have seen the value their investments wiped out. Some was due to poor investment decisions by the investment companies. Some was due to being victims of Ponzi scemes from people like Bernie Madoff.
These losses point out the difference between ownership and control. The investors owned their money. The investment houses, however, controlled the money. When the owners tried to pull their money back out of the investments, they found that the money no longer existed. The ones who controlled the investments had either stolen it or lost it through bad financial decisions.
The owners of the money lost much of their wealth. The controllers of the money ended up making really good salaries/bonuses.
So where is the real power—in ownership or control?
Many of the discussions in a strategic planning process seem to center around ownership:
1) What position do we own?
2) What should we own in our portfolio?
3) What core competencies, skill sets, intellectual property, etc., do we need to acquire (for ownership)?
4) What should we no longer own?
5) How can we get the things we own to run more efficiently?
The underlying assumption is that the better the mix of the things one owns, the better the overall strategy. However, as we saw in the story, sometimes a better measure of success is what we CONTROL, rather than what we own.
Just as ownership of financial investments in the story did not guarantee wealth, ownership of all your strategic assets may be a mistake. Being able to control the strategic environment should normally take a higher priority than ownership.
If you control the environment, you are better able to move in positive harmony with the environment as it shifts over time. This is because you can control both where you go and where the environment goes.
By contrast, ownership in an investment tends to lock you into more of a static position. Some flexibility is lost. As the environment shifts, that investment can go out of favor. It’s hard to get out of an investment that is out of favor. Just ask the owners of newspapers how easy it is to sell out of these poor investments. Nobody wants to take them off their hands.
The principle here is that strategic discussions should spend more time looking for ways to control one’s destiny, instead of how to own things.
Take a look at Nike. It doesn’t own any factories. It doesn’t own any major professional sports teams in the US. Instead, Nike has spent its time controlling the evolution of sports and the key influencers in the sports field. This has allowed Nike to continually move to wherever sports outfitting has gone and be a leader. It even helps determine the direction of the industry, due to its clout.
Why own factories when you can control them? Nike gets the products produced the way it wants (control) for probably less than if it owned the factories. Nike can sidestep some of the manufacturing ownership and labor controversies. If something goes wrong, Nike can shift to another factory (flexibility). If the product mix shifts, Nike can more easily shift away from manufacturers of the obsolete to manufacturers of the up-and-coming.
The negative factors associated with ownership include the following:
1) Less Flexibility
Once entangled with ownership of assets, it is harder to untangle one’s self when it is time to move onto the next big thing. If all of your assets are tied up obsolete technology, it is harder to free up capital to exploit new technology. In the current credit crunch, it is harder to find others to loan you the money to buy into ownership. That is why the automakers need a government bailout to move from gasoline to new technology engines.
2) More Bureaucracy
At some point, there tend to be diseconomies of scale in management when a company gets too large. Big conglomerates can choke on their internal bureaucracy. If the pieces are kept smaller and more independent, they can keep the entrepreneurial spirit alive in a lean and mean, efficient structure. Some has suggested that “too large” can occur as small as with 200 employees (depending, of course on a number of industry factors). At that point, some suggest that the company be broken up.
Also, an employee in a large impersonal conglomerate may not be as motivated as someone who has more of an ownership stake in a smaller entity. A loose gathering of owner-operators can be far more powerful than a mass of mere employees. This is one of the benefits of the franchising model.
3) Conflicts of Interest
As we talked about in detail in a previous blog, you may have fewer customers for a division if you own it. The idea is that many of our competitors do not want to do anything to put cash into our hands. The more pieces we outright own in the business ecosystem, the more pieces that our competition may boycott so as to avoid us. If we merely align with these pieces, rather than own them outright.
4) Less Efficient Use of Capital
If you want to get 100% ownership, you have to invest 100% of the capital. However, there are often ways to have the power and influence which come from 100% ownership by only putting up maybe 40% of the capital. You money can go a lot further if you are willing to settle for a controlling share rather than 100% ownership.
If you try to acquire something to get ownership, you typically have to pay a large acquisition premium over the current value to obtain the property. In essence, that high premium price means that you are handing over much of the future profit potential to the former owner which absorbing all the future risk on your own.
Contrast that with the idea of forming an alliance with the other company, where they may be so interested in the benefits of working together that they give you a discount. In addition, because they are still owners of their part, they are absorbing their part of the risk, not you.
5) Less Speed
Coffee manufacturers have often wanted to get their cold coffee beverages into the vending distribution system. They have found it much easier to form alliances with carbonated beverage manufacturers (who already have a vending distribution system in place) rather than take the time to build a 100% owned vending distribution network. By partnering with people who already have key pieces in place, one does not lose precious time trying to develop an expertise or ownership in this area.
6) Lose Benefit of Specialization
In alliances and outsourcing, one is putting together a group where everyone is an expert in their field. They specialize at excelling in their area and are not distracted by getting into areas outside their expertise. If you try to own 100% of everything, it is likely that all of your parts will not be the best in their field. Even if the piece you bought was an expert before you purchased them, the large corporate infrastructure and internal politics could weaken that expertise. You will have weak links in your system.
With all of these problems, why do people focus on getting ownership? The reason is because they are looking for the benefits of control. The more of an industry ecosystem you can control, the more of your destiny you can control. And that usually leads to greater profits.
So, rather than first looking to ownership as a means of getting control, use your strategic analysis to first look at other ways to more efficiently and effectively gain control. This could be strategic alliances, distribution agreements, licensing, outsourcing, franchising, minority ownership, or some other such arrangement. Try to structure them to get as much control (with as much flexibility and as little money) as possible. In the long run, this can create a far stronger strategy.
Strategic success is more dependent on control than ownership. Although ownership can be one means to gain control, there are often other alternatives which are a more effective and efficient way to gain that control. Make sure these other options are front and center in your strategic discussions and not an afterthought.
Yes, it’s true that these other forms of business structure bring their own sets of risks. Alliances can fail as often as acquisitions. But when a mess is made, it is often easier to undo the mess under these alternative structures. The point is not to automatically flock to one type of structure for every situation. When building the strategy look at them all (and don’t automatically assume that ownership is always to be preferred).