After more than two decades of studying strategic models in the industrial world, I would identify three primary categories. Readers can determine whether they apply to other sectors, as I believe they might.
The first category is the ‘pure play’ model. Often lauded by investors for its simplicity, this model revolves around a narrowly defined product (or service) portfolio. Reporting tends to follow a regional split. This model often achieves a valuation premium through (i) execution excellence supported by undiluted strategic and operational focus, (ii) an inherently defensive positioning since investors can effortlessly project themselves in the future, and (iii) an M&A consolidator or ‘compounder’ status.
The pure-play model reaches its limits when growth stalls, whether organically or inorganically, exposing the company to economic cycles, which leads to potential mispricing and vulnerability to takeovers.
The second category is the ‘diversified play’ model. Here a company consists of multiple ‘pure-play’ divisions, each operating autonomously through a decentralized organization. It might have started as a pure-play company looking to push its limits by investing in faster-growing adjacencies – a difficult yet noble objective. Reporting tends to rely on a product (or service) approach. To succeed, three main conditions must be met: (i) a reliance on a cohesive set of core competencies (unlike industrial conglomerates from the 70s), (ii) a winning business (operating) system leverageable across divisions, and (iii) an active, disciplined portfolio management strategy. Indeed, this model demands rigorous capital allocation skills to beat those of asset managers who would otherwise prefer pure-plays. Since diversified plays are complex, investors tend to (overly) focus on the financial bottom line. Success is measured by the market premium or discount to the sum of the company’s parts.
The limit of the diversified model is reached when the company underperforms (growth, return on capital, value-destructive M&A) and investors question the group’s cohesiveness. A breakup into pure plays becomes a plausible scenario, possibly enforced by activist shareholders.
Lastly, there is the ‘integrated play.’ In this case, a company operating a diversified model actively fosters collaboration amongst its divisions. The objective is to provide integrated solutions to customers across selected end markets and build a competitive advantage on that basis. Reporting can follow an end-market segmentation. The risk lies in overestimating the internal sources of synergies, a far too common pitfall discussed in ’The Connectivity Myth’ (2019.) This occurs when organizations are obsessed with portraying their organization as ‘ONE’ and look to connect everything with anything in search of elusive synergies without appreciating the costs of doing so (infrastructure, distraction, lack of clear accountability, internal politics.)
The main limit of the integrated model is its complexity. Any underperformance may be difficult to diagnose, thereby raising questions about the Company’s overall strategy and very raison d’être. Unlike diversified plays, there is no natural unwinding process, and thus no quick solution.
The viability of each of the three strategic models – pure-play, diversified, or integrated – hinges on the alignment of several dimensions: management strengths, strategic vision, organizational structure, reporting, and financial performance. Expect investors to be unforgiving.
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