November 5, 2013

Cheverny has conducted a number of strategic advisories over the past year (many in technology, media and telecoms) related to the future role of non-core divisions in a client’s portfolio of businesses. In these instances we often discover that the existing analytical framework around a division is coloured by both history and psychology.

Some of the psychological factors we have discerned (and worked to disentangle) at the nexus of strategy and investment/divestment decisions include:

History Defining Ownership Rather “Best Owner” Analysis
A division may be comforting historic presence in a portfolio yet history should not be the starting point for an analysis of its value. We would submit that this should begin with the question “is this company the best owner of this asset?”. If another owner can extract more value from the asset then it is a legitimate question if it should not be sold. This analysis can also helps fill out a list of potential buyers. If a division operates in a field where a disruptive business model may be emerging then a different question should be asked: is it worth investing in new ways of doing business, even if it imperils the status quo.

Capital & Resource Allocations Based On Last Year’s Budgets
In many instances a division’s capital allocation and share of corporate resources is intrinsically linked to last year’s budget rather than to a realistic assessment as to whether, for example, this capital could be better used elsewhere.

Changing Markets And Capital Structures
Sometimes a change in a market – perhaps one that requires more equity on the balance sheet – can generate a requirement to sell a division. This has to be weighed against the dilutive effects of raising more equity.

Are There Any Confirmation Biases Present When A Non-Core Division Is Analaysed?
In some circumstances certain managers will develop a thesis about a business unit and seek out confirmatory information, even to the point of tuning out information that challenges their thesis.

The Fallacy Of Losses
Historic losses are just that: history (and therefore nothing can be done about them). There is nothing that can be done about them. They do not constitute part of an investment/divestment decision, except insofar as they may be predictive of future losses. At times, losses and/or temporary setbacks create a sense among managers that there is ground to be recaptured, and that this in turn requires the company to materially enhance its commitment to the division. This can be compared to the “one more push” school of trench warfare in the Great War.

These, and other biases can be surfaced and understood in the context of a through-going analysis that looks at the competitive positioning of a division, relative value in the market, M&A benchmarks and capital structure analyses. Cheverny has assisted many companies in this regard, and often does so under a framework combing monthly retainers with a defined timeline and reasonable success fees in the event that a divestment strategy is implemented. This ensures alignment of interest and timely analysis, whether or not the decision is made to invest or divest.