Agenda Magazine Issue 7

8/6/2019 Agenda Magazine Issue 7

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Issue 7 / April/May 2011

nsights into growth, performance and governance

Agenda

India hasshowed theworld how

to managean economyInfrastructure king GM Raoon why the West getsgovernance wrong

p8 M&A p17 Growth p26 PowerMaking dealsthat delivervalue, notheadlines

Are youselecting thewrong kindof CEOs?

Why its timeto rethinkyour energysupply

Understandingthe worldsfirst economicsuperpower

p22China

2011 KPMG International Cooperative (KPMG International). KPMG International provides no client services and is a Swiss entity with which the independent member rms of the KPMG network are a


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Alan BuckleGlobal Head of Advisory, KPMG

Business is complex. Our goalis to help you cut through that.

By cutting through complexity, we believe

we can help you preserve and create value

for your investors in the long run.

What do we mean by this? We certainly

dont mean simplifying things. Robust

businesses have a clear, coherent strategy.

But that strategy must be validated by

your experience of the real world. That experience can take

many forms: sales data, market analysis or gut instinct. But

especially in times of uncertainty, even good companies can

make piecemeal changes and lose sight of the big picture.

The CEO or CFO of a global company headquartered in

North America or Europe may be less optimistic than theircounterpart with a head ofce in Delhi or Shanghai. If you can

see past the famous twin impostors triumph and disaster

and keep the bigger picture in mind, you will be better placed

to take advantage of the upswing.

The most startling global economic shift is the growth of China

and India an issue explored in detail in this edition of Agenda.

China is already the worlds second-largest economy. In the

next year, it will again become the worlds largest manufacturer

a position it last held in 1830. So to refer to China and India asemerging markets is nonsensical. They have emerged. We

are too quick, today, to hail every trend as revolutionary, but this

magnitude of change is experienced once in a lifetime. Our aim

in this issue is to help you understand the implications for

your business today and in the future.

Alan BuckleGlobal Head of Advisory, KPMG



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The end of CSR?Shared value, not charity, is the new fashion and that starts with a US$300 home for the poor

What does G-20 membership meanto India? A seat at the high table and apulpit from which to lecture those whohave long lectured India. While it hasno illusions about its influence, a stellareconomic performance in the pastdecade has given India confidence toplough its own furrow and introducea development angle to G-20 debate.

India would like the G-20 to be adeliberative body that sets directionsand incubates ideas, not a hard decision-making group backed by financialsanctions. So India opposes quantitativetargets such as the proposed 4% ceilingon current account surpluses and deficits.The country runs a current account deficitof 3.5-4%, and regards the notion thata 4% deficit is alarming enough to bepenalized as simply ridiculous. Indeed,it believes the deficit helps ameliorateglobal imbalances, enabling it to absorbthe global flood of dollars that has sodiscomfited other emerging markets.

Unlike Brazil and some Asiancountries, India does not see itself facingcurrency wars or destabilizing dollarinflows. Far from imposing capitalcontrols on inflows (as Brazil, SouthKorea and others have done), India hasrelaxed its capital controls on foreigninvestment in bonds.

After India became independent in1947, its inward-looking socialist policiesmade it a chronic underachiever. Buttoday the country is accepted as aserious policy guru, averaging 9%GDP growth between 2005 and 2008.At the G-20 in Seoul, Prime MinisterManmohan Singh brought developmentto the fore, saying surplus-rich countries,notably China, should invest in buildinginfrastructure, not just at home but in theThird World. This, he said, would ensurea better use of surpluses than endlesslyincreasing foreign exchange reserves.Whether or not such constructiveinitiatives will fly remains to be seen.

Swaminathan S. Anklesaria Aiyar isa research fellow at the Cato InstitutesCenter for Global Liberty and Prosperity.

Sending staff to help in homelessshelters. Ploughing profits intothe rainforest. The list of corporatesocial responsibility (CSR)

initiatives is inventive. But many companiesare belatedly deciding that being nice forthe sake of it has its limits.

University of Michigan Professor AneelKarnani has sounded the death knell forCSR, declaring: The idea that companieshave a responsibility to act in the publicinterest and will profit from doing so isfundamentally flawed.

The new buzz is around creating shared

value (CSV) the idea that embeddingcommercial capabilities in emergingeconomies lifts communities out of povertyand creates new markets.

Vijay Govindarajan, Professor ofInternational Business at Tuck School ofBusiness, says a US$300 (207) households the key to CSV. He wants to turnslums into liveable residential areas withcheap, mass-produced homes. Aside fromtransforming run-down areas, this couldcreate a new market, rather like theultra-cheap, compact Tata Nano car.Its a challenge for commerce, saysGovindarajan. The worlds poor representthe fastest-growing customer segment.

CSV is already paying off. HindustanUnilevers Project Shakti, a direct-to-homedistribution system, run by 45,000entrepreneurs in Indian villages, accountsfor 5% of the companys revenues inIndia. Mexican food giant Grupo Bimbohas helped thousands of shops train staffand upgrade facilities and benefitsfrom their expertise. In Japan, Hitachiis to invest around US$11bn(7.6bn) in social innovation inthe next three years.

At last, some goodnews for embattled

French president

Nicolas Sarkozy.

Everything can

look like a failure in

the middle, says

Harvard Business

Schools Rosabeth

Moss Kanter. Her

theory is that

change can often

feel wretched when

youre halfway

through, where new

projects can stall

and workers flag.

Everyone loves

inspiring beginnings

and endings, says

Kanter. But the

middles need hard

work. So if an idea

still inspires you

like Sarkozys

much-maligned

change program

stick with it.

LeadingEdge

NEWRULES

No.1 Kanter's Law

G-20: why its Indiasturn to lectureits global rivals

Opening gambitWe are what we repeatedlydo. Excellence, therefore,is not an act but a habit.Aristotle

by SwaminathanS. Anklesaria Aiyar

Will a flat-packhouse help beatpoverty andboost profits?



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Agenda April/May 2011

Ones to watch

Whais ontheir

to dolist?These five leaders work invery different sectors andparts of the globe but theyall face career-definingchallenges in 2011

With assets of over US$7bn (4.9bn),Alliant is the sixth-largest credit unionin the US. The not-for-profit financialgroup has weathered the global

recession, but CFO Mona Leung isconvinced cutting-edge analytics canensure it stays better informed in future.

The story so far Credit unions essentiallymember-owned banks offering credit andbanking facilities at reasonable rates areused by 43% of Americans. Their profilesoared during the financial crisis, as theirlosses were often proportionally lowerthan their Wall Street rivals, thanks to theirsmaller size and lower reliance on riskyloans. During 2008, lending by credit unionsrose 7% as banks cut back. In 2010, Alliantsmembership rose to 255,000, assets were

up 8% to nearly US$7.6bn (5.3bn) and netincome soared 93% to US$50.9m (35.3m).

Whatsnext? Leung, who came to Alliantafter working her way up at the likes ofPepsiCo and Sears, believes analytics arentjust for corporate giants. She is upgradingAlliants ERM system, incorporating toolsthat will help it rapidly model risk scenariosusing real-time information. The aim, shesays, is to serve members better, keepabreast of vital indicators of credit problemsand model extreme-worst-case scenarios.We dont just ask: Are we going to be in arecession?, says Leung. We ask: What ifwere in recession for five or ten years?She adds: You can have the right tools andthe right talent, but if the culture isnt ready,none of it will matter. Alliant has revampedits website and says 70% of transactionsnow occur over the internet.Shellsucceed if Software integrationis seamless and embraced by staff.Consumers stick with credit unions asbanks recapitalize. Leungs scenarios serveAlliant in a crisis and her focus on efficiencycushions the group against uncertainty.

Gee-Sung Choi secured top spot in theglobal TV market and helped Samsungbecome No.2 in cellphones. This SouthKorean titan is now the worlds largesttechnology firm by sales. Choi plansa huge investment in R&D and greentechnology to change the companysimage and bring in new business.

The story so far One of the runners on the

Olympic torch relay through New York in2004, Chois 30-year career at Samsung hasbeen a professional marathon. AppointedCEO in 2009 as a new generation ofmanagers took charge, Choi admits thathistorically Samsung succeeded by doingthings better and faster: annual revenuesquadrupled to US$116bn (80.4bn) in theten years to 2009. He sees the speed oftechnology as an opportunity and a threat.

Whatsnext?In 2010, Samsung investedUS$23bn (16bn) to increase capacity inits chip, display and phone units. Greentechnology is one R&D focus: Samsunghas a solar-powered smartphone and wantsto make domestic solar cells. The global listof top companies is being replaced byApple, Google and Facebook. Our job is toprepare Samsung for the next generation,so it can keep evolving into a greatcompany, he says. Expect services of thekind that make iTunes so successful.

Hell succeed if Samsung focuses oninnovation, not imitation, and cracks thesmartphone market. Its tablet device,Galaxy Tab, finds a profitable niche.

MonaLeung45, CFO, Alliant Credit Union (Chicago)

Gee-SungChoi59, Vice Chairman and CEO, Samsung

t



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He has lectured in economics, spentten years at the OECD and has been

advising Greek governments andministers since 1998, so GiorgosPapaconstantinou is well-placed to takeon one of the biggest challenges facedby any finance minister in the world.

Thestorysofar When Greeces budgetcrisis triggered a loss of faith in its sovereigndebt in spring 2010, Papaconstantinounegotiated a lifesaving US$146bn (101bn)bailout with the IMF, European Central Bankand EC. Although he had spent much ofhis adult life outside Greece, he sensedthe national mood, accepting an immediatewage cut. The debt-to-GDP ratio reached

142.5% in 2010 and Greece has effectivelybeen locked out of long-term debt marketssince the crisis began.

Whatsnext? Papaconstantinou expectsthe governments program of fiscalconsolidation, structural reforms andprivatization to boost investor confidenceand lead to a return to long-term debtmarkets by 2012. Austerity measures including landmark reforms to public sectorpay and pensions, and VAT hikes were theEUs deepest in 2010. But Papaconstantinouis also targeting tax revenues andmanagement practices in public institutions:he estimates that 1.2m businesses areunaudited and 1.3m Greeks are in arrears.

HellsucceedifHis measuresconsolidate public finances and stimulateinvestment. European leaders are able torestore wider confidence in the Eurozone.

Breaking the Boeing-Airbus duopolythat dominates commercial aircraft isa daunting task that has defeated many but if Chinese aerospace manufacturerComacs planned launch of a flagshipjetliner in 2016 takes off, the rewardswould be enormous.

Thestorysofar In 1997, Boeing acquiredUS rival McDonnell Douglas, which rana fledgling production line in Shanghai,spelling the end for the Chinese airlineindustry. Comac, founded in 2008, is avaliant attempt at resurrection. One-thirdstate-owned, it agreed to a US$7.5bn(5.2bn) facility in 2010 with ChinaConstruction Bank for its C919 aircraft,linchpin of its expansion plans, targetingthe Boeing 737 and Airbus A320. Zhangheads the State Commission of Science,Technology and Industry for NationalDefense, and is deputy chief of Chinasmanned space programme.

Whats next? Putting Chinese astronautson the moon could prove easier thanmeeting a test-flight target of 2014.Progress has been uneven, but Comac isnow taking orders from Chinas big threeairlines. Zhangs target is to produce 150C919s a year for 12 years, meeting30%-40% of domestic demand in its classand winning 10% of the global market.

Hell succeed if Comac minimizescosts without compromising safety andsustainability. The state forgoes returnson development capital and offersincentives for foreign countries to buy itsairliners. Zhangs other roles dont distracthim from running Comac.

Brazils part-state-owned energymultinational smashed records in 2010

with a US$70bn (48.5bn) IPO doublethe next-largest float of the past 20years. With Petrobrass value matchingQatars annual GDP, investors expect thescholarly Jos Sergio Gabrielli to rampup growth as Petrobras aims to be theworlds largest oil producer by 2015.

The story so far Brazil used to rely onrenewables, with 80% of domestic energycoming from hydroelectricity. That allchanged in 2007, with a string of offshoreoil finds by Petrobras that should makeBrazil a net exporter of oil in 2011 and aglobal top-ten producer soon after. Profits

in 2009 of US$28.9bn (20bn) were strongin a troubled climate. Gabrielli, a professorof macroeconomics before he became thecompanys finance director in 2003 (andCEO in 2005), is admired for his even-handed stewardship and financial smarts,but must deliver strong results.

Whats next? Critics say Petrobras spendstoo much time on political investmentsand should focus on profiting from itsoffshore finds. That illustrates Gabriellisdilemma: the government is a minorityshareholder with majority voting rights andhe cant determine the price he sells oilat domestically. Still, Petrobras reckons itsLibra and Tupi fields may hold 15bn barrelsof crude, which could be a game-changer.It already has 11.2bn barrels in reserve.A planned US$224bn (155bn) investmentbefore 2015 could double output.

Hell succeed ifThe oil market staysbuoyant (Petrobras anticipates the averageprice will be above US$80 a barrel over fiveyears). The government allows Petrobras toexpand globally and invest in growth. TheLibra and Tupi fields meet expectations.

Jos SergioGabrielli61, CEO, Petrobras

ZhangQingwei49, Chairman of Comac

GiorgosPapaconstantinou49, Finance Minister of Greece

The global list of top companies is being replaced byApple, Google and Facebook. Our job is to preparefor the next generation so we can keep evolving



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Best practice by Paul Simpson


M&A:How tocreate value,

nEvenothoughteighthout ofeten aacquisditionslfaiil, mnany ermssstilllook to them for growth. Here are eight steps to getting it right

Patrick Bateman, the anti-hero ofAmerican Psycho, Bret Easton

Elliss cult novel, works inmergers and acquisitions onWall Street or, as he jokinglycalls them, murders and

executions. The gag is far from accidental.Ever since a group of wealthy Americanentrepreneurs, including oil magnate JohnD. Rockefeller, went on the acquisition trailin the late 19th century earning collectiveinfamy as the robber barons the mediaand public perception has been that theM&A business is driven by greed, self-aggrandizement and chicanery.

CEOs havent always helped theircause. For every Rupert Murdoch and BillGates, whose acquisitions seem drivenby strategic vision, there are many otherbosses such as the late tycoon RobertMaxwell who seem to live for the dealor use takeovers in a smoke-and-mirrorsshow designed to mask their businesssunderlying underperformance.

Economic historians talk of vewaves of acquisitions, starting with dealsbetween monopolies in the 1980s andending with the equity-driven deals of the2000s that were fueled by globalization,deregulation and booming stock markets.

But two themes recur throughout: thevarying attitude of governments (which

have been supportive or hostile and almostevery nuance in between) and a concernabout whether these deals deliver value.

The last stock market bubble killed orstalled many deals. For Laurence Capron,The Paul Desmarais Chaired Professorof Partnership and Active Ownership atINSEAD Business School, that is no badthing: This is the perfect opportunity forcompanies to rethink their M&A strategyand the process they have been using tobuy companies. M&A deals in past decadeshave, on average, destroyed value for the

acquirers shareholders. Now is a goodtime to step back to better understand

the market for corporate control.John Kelly, Head of Transaction Services

at KPMG in the UK, echoes Caprons callfor boards to take a reality check: In 2006and early 2007, with cheap money andmarkets encouraging management to beaggressive, acquisitive companies weregiven the benet of the doubt evenwhen they didnt deserve it. Nobodywas pointing out that, in many cases,the emperor had no clothes on. Thereis another way as these eight stepsto rethinking deal-making demonstrate.

However intensive the planning,innovative the nancing orwatertight the contract, peopleare the key to extracting value


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PictorialPress/Alamy


John D. Rockefeller wasfted and hated for hisdeal-making acumen.Todays acquirers treadmore carefully

1Dont start with the dealWith every acquisition in the balance untilits completed, the temptation is not torisk wasting resources by deferring anystudy of how you will extract value froma deal until the last minute. Yet mostmanagers, analyzing their purchases inKPMGs 2010 M&A study, wished theydstarted their integration planning sooner.

If the bidder doesnt understand whatand where value can be obtained, how canthey be sure they are not paying over theodds? And how can they decide how bestto unlock the value they acquire?

This planning process goes far beyondcrunching data. The bidder needs tounderstand the mechanics of howsynergies can be obtained, what culturalchallenges they face and how compatibletheir IT and reporting systems are.

KPMG research suggests that acquirershave a 100-day honeymoon period to takehold of a business and start deliveringbenets. Unless they can make the hardchanges necessary in that period, they willlose value. The sooner they start planningintegration, the easier it will be to focuson the initiatives that help extract value,mitigate risk and maintain momentum.

2 Define your strategyWhy are you trying to buy? CiscoSystems, which has bought 145companies since 1993, divides itspotential acquisitions into threecategories: those that expand the market,take it into new markets or accelerate themarket. For every company it buys, it hasresearched 100 and entered into seriousconversation with ten.

Yet even Ciscos M&A specialists sayacquisitions are as much art as science.And sometimes, Kelly suggests, a dealmakes sense even if the rationale soundsunspectacular. United Biscuits, he pointsout, beat Golden Wonder to acquireJacobs Biscuits from Danone in 2004.Within two years, Golden Wonder was inreceivership and United had bought twoof its rivals core brands. (The GoldenWonder brand is now owned by NorthernIrish group Tayto.) The differencebetween a number two and a distantthree is a big deal, says Kelly.Sometimes, the simplest rationale this purchase protects our positionin the market is the best.


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Deal-makers: RupertMurdoch (left) and BillGates used acquisitionto fuel strategic growth,in marked contrast toRobert Maxwell (below)

Find out the secrets behind RupertMurdoch, the worlds top deal-maker:www.kpmg.com/agendaonline


EverettCollection/RexFeatures,MikeGoldwater,

Celebrity/Alamy,EdKashi/GettyImages

Ofce of Alliance Management to identify

alliances, but the US pharmaceuticalgiant will buy when necessary (half thecompanies it acquires have been partners),paying US$2.3bn (1.6bn) for ICOS in2004 to commercialize Cialis, a drug thecompanies developed in a joint venture.

6The hard truths about soft issuesWith 45% of Fortune 500 CFOs blamingpost-M&A failure on unexpected peopleproblems, Kelly says acquirers cannotafford to concentrate primarily on thehard mechanics of extracting value.However intensive the planning, howeverinnovative the nancing, and howeverwatertight the contract, people are thekey to extracting value and these softerissues cannot be left to chance.

The three soft issues on whichmany deals founder are: selecting themanagement team; cultural differencesbetween buyer and target company; andcommunication. Management shouldnt,Kelly warns, dene communication purelyin terms of PR and investor relations: Poorcommunication to employees is likely tohave a more detrimental effect than toshareholders, suppliers or customers.

7One size does not fit all

Some deals go wrong at the start, othersin the middle but many go awry after thepaperwork is signed. Im always surprisedat the lack of sophistication in post-M&Aintegration. Very few executives havea good model in mind, says Capron.

One question too few boards thinkthrough is the degree of autonomy anacquisition is allowed. There is no simple,right answer. You have to ask what makessense for the specic deal, says Capron.If youre acquiring an entrepreneurialrm, you need the entrepreneurs toremain committed if you are to delivervalue. And yet to avoid replication of effort,and internal inconsistency, you need tohave some degree of centralization.

KPMG research suggests that, while itmight be useful to replace managers whenbuying a bolt-on business, successfulacquirers retain key leaders at companiesbeing fully integrated. This approach helpedJohnson & Johnson commercialize suchvaluable products as Tylenol.

One overlooked aspect of successfulintegration is divestment. As Capron pointsout: Acquirers must be disciplined aboutselling resources they dont need, lest they

become overloaded with excess baggage.

General Electric divests as often as itpurchases, after reconguring its targets.

8 Balance risk and rewardIn the acquisition business, activity is toooften confused with achievement. Caproncautions: Keep in mind that overrelianceon acquisition adds to your overall risk.You can always grow your businessthrough acquisition. But that growth candestroy value, rather than enhance it.

It sounds obvious but, as Kelly says,many companies have ignored this simpletruth. In the heyday of M&A, while thechampagne glasses clinked, you wouldoften see an ashen-faced gure in thecorner the operations director, whosejob it was to make it work.

And yet, Kelly says, acquisitions willstill attract many. If youre a Europeanconglomerate, in a mature market, andyoure projecting forward three to veyears, youre probably realistically lookingat single-digit growth in a hard, maturemarket. That isnt going to excite investors.If you plan early, pay the right price, anddeliver the cost and revenue synergies, youcan deliver value for shareholders.


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Keys to success by Robert Jeffery

My father toldme not to enterthe family

bGM Rauo, founsder ofiAsnian infreastructsure titsan GMR, gambledan assured career in gold trading to go it alone. Now, he tellsAgenda, the West should heed the lessons of Indias success



in pure ambush marketing 9% a year. The government has pledgedterms, GMR has India sewn up. Taxi to spend US$1 trillion (690bn) betweenalong the runway at Delhi International 2012 and 2017 to bring it up to scratch, butAirport and the rst thing you see is central bank governor Duvvuri Subbaraothe infrastructure giants assertive royal says India needs a quantum step inblue logo, emblazoned on the steps that investment to reach the next level oftake you from your plane. As you whizz growth. GMR, as the largest player inthrough immigration, GMR pops up again, the market, has been the driving forcewishing you a pleasant stay. The highway behind airports, roads and other urbanto Delhis city center is one long stream infrastructure projects across the nation.of cranes and diggers. Grandhi Mallikarjuna (or GM) Rao,

This, says the cab driver, gesturing, the groups founder and chairman, isit seems, towards everything around us understandably hungry for more. Theat once, is GMR. government needs a strategy on this very

Many of the companys rivals would be quickly, he says. Whats been done socontent to keep a low prole, reasoning far is very minimal. If you look at otherthat if they do their job well, the public countries, they built infrastructure beforeneednt be aware of their existence. But they developed the economy, but wein a country where things dont always have done it the other way round. Thecome together, GMR is justiably proud government understands the scale of theof the efciency it has built into an airport problem, but in many cases the long-termthat houses the worlds fth-largest funds arent available right now.passenger terminal. That is unlikely to assuage Jeff Immelt,

Indias infrastructure has simply failed General Electric CEO, who recentlyto keep up with an economy growing by rebuked Indian authorities and investors,


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P o r t r a i t s : A t u l L o k e


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Keys to success

US$m

1bn

800

600

400

200

0

telling them: Theres billions of dollarsneeded on infrastructure spending and its

not happening you guys arent keepingyour side of the bargain. Foreigncompanies, he said, werent given a fairshot at larger projects.

In the companys bunker-likeboardroom within the Delhi airportcomplex, Rao predictably disagrees.He has worked with foreign partners onmany projects, he says. But in a countrylike India, you need local companies tolead projects because they understandthe landscape.

Few have as much local knowledgeas GMR. With 2,000 employees and

a 2009/10 pre-tax prot of US$42.4m(29.4m) on revenues of US$1bn(693m), the privately owned, Bangalore-headquartered company derives around40% of its income from airports, but isalso involved in roads, energy (includingpower plants and renewables projectsacross the developing world) and property.

Raos route to prosperity (he is saidto be Indias 14th-richest man) has beenfar from linear. The son of a gold traderfrom Rajam, a remote town in thesouth-eastern state of Andhra Pradesh,he failed his high school examinationsbefore eventually returning to academia,

gaining an engineering degree. As therst engineer in my family, my fatherurged me not to enter the family businessand I started my career with the StatePublic Works Department, he recalls. Therole didnt excite him and after his fathersdeath he took up trading again beforestarting a series of businesses 28 in20 years ranging from brewing to sugarrening. In 1994, he bought a stake in thefailing regional Vysya Bank which he latersold to ING, the rst foreign acquisition ofan Indian nancial institution.

By 2003, GMR had a growingreputation in highway construction,power plants and agri-business. But it st illcame as something of a shock when Raopersuaded Andhra Pradeshs governmentto award him the contract to build andrun Hyderabad International Airport.Everything was new to us, he says.We set out to learn everything we couldabout airports. We spoke to the bestconsultants and experts worldwide.I travelled the world, looking at thebest airports. GMR also hired keyemployees from airport operators in theUK, US and Singapore to head divisions.

From Rajam

to riches1950 Born inRajam, AndhraPradesh, son ofa gold trader1974 Graduateswith engineeringdegree fromAndhra University1978 FoundsGMR, a group thatstarts nearly 30businesses, fromsugar refining topower and roads1994 Buys stake

in Vysya Bank,which he latersells to ING2003 Wins contractfor GMR to buildHyderabad Airport2007 NamedEntrepreneur ofthe Year by theEconomic Times2009 Reports linkGMR (which ownsIPL cricket teamthe Delhi Devils)with a takeover ofLiverpool Football

Club. Rao says thedeal was never onthe cards

2010

2009

2008

2007

2006


Six years later, the Airport Council International ratedHyderabad the fth-best airport in the world. By then GMR

was busy revamping Delhi International Airport on a US$3bn(2.1bn), 30-year contract. It was already a working airport,so we had to minimize disruption. It was six times biggerthan Hyderabad Airport. It was like running a marathon thenperforming heart surgery at the end.

Terminal 3, the agship international terminal, was completedin just 37 months, with a peak workforce of 30,000. Raocompares it proudly with Heathrows troubled Terminal 5,which took 60 months and handles 25% fewer passengers.

A hands-on manager, Rao was onsite the day 3,000dummy passengers stress-tested the terminal before its grandopening. Such attention to detail he remembers meeting ourphotographer years previously, and even recalls the location sounds stereotypical for an Indian business leader, but not

everything about the 60-year-old is so predictable.Take his attitude to divestment, something some Indianbusinesses struggle with. When Delhi Airport was completed,GMR quit agri-business to focus solely on infrastructure. Agri-business was dear to me because it changed the village I camefrom. I went back and saw what it did. But you cant formattachments. It is painful, but necessary, says Rao.

Humble beginningsGMRs corporate values are unorthodox. Humility (dened asintellectual modesty and a dislike of false pride) ranksabove teamwork or entrepreneurship. Rao is puzzled whenI mention this. It isnt, I suggest, a value most Western businesseswould give such prominence. But if you lose humility, he says,when success comes along it will breed arrogance.

GMR stays grounded by spending 3-5% of prots on CSR.But while he admires the philanthropy of Bill Gates and WarrenBuffett, many of Raos management inuences are morefocused on the bottom line. He was impressed by The Scienceof Success, by the ultra-libertarian Tea Party funder CharlesKoch. When he read Jim Collins How The Mighty Fallwhich details lessons from failing enterprises he gave hismanagement team three days to immerse themselves in itbefore sharing their insights.

Understanding where things go wrong, he says, was anobsession that began at Vysya Bank, where many customerswere defaulting on loans and needed strategic analysis andadvice. Today, all GMRs senior leaders critically evaluate theirbusiness every six months. If you dont do that, people willjust tell you yes, its all ne, dont worry, he says.

As a self-professed baby of liberalization, Rao is among thevanguard of Indian entrepreneurs seeking closer relationshipswith the West and watching with interest as the countryseconomy gradually opens to outside investment. As he putsit, echoing the famous phrase by JFK: Before liberalization,a Western businessman would come and ask What can I dofor India?. Today, they ask What can India do for me?

Adrian Mowat, J.P.Morgans chief emerging markets strategist,believes the Indian economy could grow faster than Chinas,if it focuses on investment-led growth. India, says Rao, hasmoved beyond IT capabilities, mentioning leaders in banking andmanufacturing to prove his point. But people still dont recognizethe quality of Indian leadership. He names Tata and Reliance

Source: Annual report 2009-10

GMR Group netrevenue by year


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Industries as Indian companies makingmajor acquisitions abroad.

India isnt about being cheap, saysRao. Two hundred of the Fortune 500are in India today, and theyre not just herefor back ofce functions. They have R&Dcentres and knowledge centres.

The global recession, says Rao, didntaffect us We acquired a stake in [US-based power generation company]InterGen during the crisis and were ableto raise US$1bn (690m) easily. We raisedUS$3bn (2.1bn) from local banks to buildDelhi Airport. The Indian banking system isrobust and we have strong regulation.

The Indian economy is based arounddomestic savings, so it didnt have a greatdeal of exposure outside the country.

India was one of very few countries that showed how tomanage its economy. One of the main reasons for that is our

savings culture, and the way domestic consumption has keptpace with growth.

Rao points to Indias demographic dividend. By 2020, thecountrys average age will be 29, which gives it a signicant edgenancially and as an exporter of intellectual capital, over othereconomies that have ageing populations. Many analysts believethese demographics make India a better long-term prospect forinvestment than China but Rao downplays talk of any rivalrybetween Asias emerging economic superpowers.

Were not in competition. Most of our power equipmentcomes from China. If China develops technology, we will buy it.It is low-cost and we can leverage it to help us compete globally.The development of China is actually helping India to compete.

GMR is unlikely to compete in China, but Rao sees organic

growth in developing economies as the central plank of the 2020strategy he is developing to prepare for his own retirement at 70.GMRs 2010 sale of its InterGen stake to Chinas Huaneng Groupts this vision. The group has won airport business in Turkey andthe Maldives, and owns a major energy provider in Singapore.

The next big thingGMR is likely to bid for a second airport in Mumbai, which theIndian government has indicated will be among the last to beprivatized in the current wave, but sees growth in providingservices to airport owners in India and abroad. Rao is an eloquentadvocate of the aerotropolis model of basing new business andsocial developments around airport development, which is whyGMR often buys and develops land adjacent to its projects.

GMRs next moves will form part of Raos meticulous

succession planning. The companies he saw oundering whenhe was at Vysya Bank were often torn apart by family rivalries.More than 70% of Indian businesses are family-owned, hepoints out, and their evolution into international institutions willbe crucial to the countrys development. He brought in a familysuccession expert in 2007 to draw up a Family Business Board,backed by a code of conduct and a deadlock trustee who willrule on any disagreements once responsibility for GMRsdivisions is shared between his two sons and son-in-law.

A family works with passion, he says. Family membersare more focused on value because they cant just walk awayfrom the business. But the risk is how that affects governance,and how you approach conict resolution. If you can aligngovernance across all family members, it can bring great value.

Rao and GMR are leaving nothing to chance. Family membersaside, all senior executives are assigned short-term and long-term successors, while key positions have emergency reddot succession plans for unforeseen crises. That might soundinexible but it is symptomatic of Raos safety-rst approach.Risk, not opportunity, is the rst thing he considers in anacquisition, he says. Erring on the side of caution, he likes topoint out, has not been detrimental to the Indian economy.

India needs leaders like Rao, who pursue progress whilekeeping an eye on risk. But can the countrys cautious growthdo enough, fast enough, to heal Indias social divisions?

Heading away from the airport, we pass a business collegewith motivational aphorisms on its walls. One reads: Keep goodcompany. It is a lesson Rao, and India, are putting into action.

After two decades of debate, India hasgiven clearance for a second airport inMumbai. GMR is likely to bid for it.

Divestmentis painful butnecessary.You cant formattachments

For GM Rao,

succession

planning is

never left

to chance

Shutterstock


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1616

Vestas


Acumen by Robert Jeffery


Vestas in China: thegovernment has investedtwice as much in windgeneration as the US

Wisdomof the EastVestas lessons for

success in China1Relationships

matterTrust from

officials safeguards

investment

2 Quality sells Low

cost doesnt always

succeed in a rapidly

shifting market

3 Economies of scale

Multinationals

bigger solutions give

them an edge

4 Embrace change

Reacting fast to new

developments is key

Chinese takeawayA Danish wind turbine giant proves you dont have to

enter a joint venture to run a flourishing business in China

H

ohhot in Inner Mongolia is only 250 miles from Beijing, butseems like another world. Travel writer Paul Theroux calledHohhot population 2.5 million a garrison plunked down

in the Mongolian prairie. One resource the city can rely on is thewind whipping in from the Gobi desert. For Danish firm Vestas,the worlds largest wind turbine maker, it is an ideal home fora new Chinese factory which, with its 600 staff, is tangibleevidence of Chinas deepening commitment to sustainability.

We believed in China and renewable energy from an earlystage, says Jens Tommerup, President of Vestas China. That faithis paying off in 2010, the government installed an estimated18GW of wind energy generation capacity, double the US figure,part of a US$47bn (32.6bn) stimulus for green energy initiatives.

In an era when every CEO needs a China strategy, Vestassexperiences are pertinent. It derives 8% of its US$9.1bn (6.3bn)revenue from China, having installed its first turbine there in 1986.We built up a customer base and local understanding before wewent into production in 2006, says Tommerup. Weve builtrelationships with local authorities and the government.

Those relationships helped Vestas gain a foothold withoutjoint ventures. In October 2010, GE, Vestass biggest global rival,formed a partnership with Harbin Power. In contrast, Hohhot isVestass fifth Chinese factory and more than 90% of the parts inits tailor-made V60-850kW model are sourced locally.

Tommerup, 54, has worked in China for 14 years, learning thevalue of diplomacy and reliability. He says 120 staff focus on thequality of Vestass local supply chain, although there are still areaswe cant outsource we are committed to delivering productsof Vestass worldwide quality. He is reasonably pleased with theChinese graduates skilled technically, but if you measure themon innovation and creative thinking, there is still some way to go.

Its a hint at the challenges foreignfirms face in a huge, growing yet complexdomestic market. Spending on greenenergy is soaring, yet Bloombergestimates that multinationals only had14% of the Chinese market in 2009.Globally, Vestas may eventually facetough competition from Chinese rivals,but the domestic market continues togrow at unprecedented rates and the

company won 18 deals in China in 2010.Vestass early insistence on a localized

supply chain prefigured a 1990sgovernment directive that 70% ofwind turbine components be sourceddomestically. Experts say this policyhelped Chinese companies undercutmultinationals. Tommerup is moreupbeat: China is one of the largestmarkets for renewables, so we willdevelop things here that will becomeimportant to the global organization.There are over 100 players in the turbinemarket in China and the governmenthas to create a sustainable industry.It must make some tough decisions,but I see progress.

Because everyone in China hasseen the impact of pollution and that isrecognized in government, Tommerupis confident of growth.

Other multinationals, tempted bya quick profit in a vast market, shouldremember the exchange betweenPresident Nixon and Zhou Enlai, Chinasfirst premier, in 1972. Nixon asked Zhouto assess the French Revolutions impact.Zhou replied: It is too soon to tell.


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Learning curve by Paul Simpson


17

Back to thedrawing board

Companies focused on innovation and growth need visionary leaders.Could a designer, R&D guru or engineer be best for the top job?

Anyone looking over the shoulderof Mark Parker during a meetingmay be in for a shock. The CEO

of sportswear giant Nike is a relentlessdoodler, but his scribblings are far frommeaningless spirals: the 54-year-oldsketches training shoes, his first and mostabiding business passion, and his drawings

are often the prototypes for new ranges.As a teenager, Parker modified hissneakers so he could run faster. Today, hehas an entire company shifting into a highergear: Q3 FY2010 results showed a 9.9%leap in global revenues. Parker has madeChina Nikes second-largest market andreorganized the business so were notsome big, fat, dumb company.

The clich says that creatives lack theruthlessness required for the boardroomand find it hard to focus on the figures.When a business is driven by innovation,however, a more relevant question mightbe: What does a number-cruncher know

about R&D? Parker says: Designers areby nature more connected. They dig deeperin terms of insights, and they turn thoseinsights into innovations.

As companies position themselves forgrowth, some are turning to leaders withsofter skills. A stint as a designer orengineer may one day be more importantfor aspiring CEOs than an MBA or a spellin the finance department.

In 2009, Honda Motors reacted tosuggestions that it had lost the spiritof adventure that had characterized itstrailblazing days in the 1990s by appointingTakanobu Ito, the 55-year-old head of R&D(who had designed the chassis for thecompanys iconic NSX sports car) as CEO.

The move surprised many, but maybeit shouldnt have. Itos predecessor, TakeoFukui, had started in engineering. Ito hadjoined the company in 1978, held senioroperational posts and spent almosttwo years as Chief Operating Officer ofautomobile operations. His involvement inthe NSX suggested that the company wasserious about regaining its maverick streak.As if to underline the point, Ito started tellingthe media about the three joys of creating,

buying and selling and famously rode anew monocycle for the TV cameras. RexTillerson, who become CEO of Exxon Mobilin 2006, joined the company in 1975 as anengineer and never worked a day in finance.

Boards usually play it safe when pickinga new CEO. Studies consistently show thataround 20-25% of leaders in the US and UK

were formerly CFOs. Heads of marketingand operations are only slightly less likelyto make it to the top job.

It is clear, however, that boardsincreasingly expect potential CEOs tohave worked in different disciplines. In

2000, one quarter of the CEOs of thetop 500 companies on the Standard

& Poors (S&P) index had risen through asingle department. By 2005, that had fallento 9%. That trend has accelerated since.

In 2009, 21% of S&P 500 CEOs hadan engineering degree. One explanationis that, as one study of 150 high-techcompanies discovered, most were founded

by engineer-entrepreneurs such as BillGates (Microsoft), Steve Jobs (Apple) andLarry Page (Google).

There may be some aspects ofan engineers training that may makethem better-suited to the top job. JamesHeskett, a Professor at Harvard BusinessSchool, identified the core skills required ofa potential CEO of an organization as largeas General Electric: They include stamina,the ability to listen, learn and teach, avision of the future and the ability toinspire confidence. Jack Welch, arguablythe most admired American CEO of thelast 30 years, started at General Electricas a junior engineer. At 32, he was theyoungest manager in the companyshistory to run his own department.

Business schools are encouraging futureleaders to embrace diverse disciplines.Cambridges Judge Business School isrunning a Philosophy in Business electivewhere Kierkegaard rubs shoulders withKeynes. A head for figures and a stomachfor tough calls will always be pre-requisitesfor CEO success. But the ability to thinkcreatively neednt be restricted to thedesign studio any more.AF

P/GettyImages

Designer chic:Mark Parker stillcomes up withfresh ideas



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21


The great debate by Robert Jeffery

18

687bc

Capital: a love story

c.9000bc

Cattle classDomestication of livestock and cultivation of crops(particularly grain) means surpluses of both

which lead to them being used as currency.

The bottom lineWriting is inventedin Mesapotamia,motivated by theneed to keep recordsof accounts. Thecuneiform script, onclay tablets, is usedby merchants to track

goods nascent IOUs.

Cash economyThe first rudimentarycoins, made of leather,appear in Lydia, AsiaMinor, according tohistorian Herodotus.Roughly 50 years later,the Lydians invent thefirst true coins, made

of electrum.

400-600ad

Dark timesAfter Rome falls, the Dark Ages wreck Europesfinance system. Banks disappear for six centuries.

Britain doesnt use coins for nearly 200 years.

c.3100bc

The panel1 Jitendra SharmaKPMGs Global RiskManagement Leader and

a Partner in the US rm2 Adam GilbertHead of RegulatoryPolicy in J.P.MorgansCorporate RiskManagement group

3 Steven KaplanProfessor ofEntrepreneurshipat University ofChicago BoothSchool of Business

Has capital

changedfNew

oglob

ral r

egu

elation

vs wi

ell hit b

rank

?s hard, and private equity

coffers are low. Where can large businesses turn for liquidity?

You could argue that bigcompanies have neverhad it so good. The media mayseem full of bad news, butequities markets have bounceback far faster than other parts

of the economy, US multinationals aresitting on a cash mountain worth US$2trillion (1.4 trillion) and prot margins inmany parts of the world are healthier thanever, with net earnings for the worlds 25largest companies up 63% in 2010.

Yet when they have spent their heftyreserves, multinationals may facea more credit-constrained future. Theimplementation of Basel III rules from 2012will compel banks to keep bigger reserves,

d

of capital, impacting their protability andreturn on equity. Research company Preqinsays private equity fundraising was at itslowest level for six years in 2010. Andwhile large companies may be ourishing,their suppliers and customers complainabout recalcitrant lenders electronics giantSiemens has even applied for a bankinglicence so it can lend to customers in thegreen energy sector.

Global net nancial wealth is predictedto fall 36% by 2024, with a drop in savingfurther lessening cash available to banks.

Access to capital may soon look verydifferent. Are multinationals prepared forthis? Agendatook three views from themarket: Jitendra Sharma, KPMGs Global



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2219

Risk Management Leader; Adam Gilbert,Head of Regulatory Policy in J.P.MorgansCorporate Risk Management Group;and Steven Kaplan, Professor ofEntrepreneurship at University of ChicagoBooth School of Business.

Global M&A will top $3 trillion (2.2trillion) this year, up more than 25%,according to Thomson Reuters

Chequeing inBanks in Persia whicharise from temples first issue letters ofcredit, or Sakks, in 410AD. As the Mongolempire grows, underleaders such as KublaiKhan, these letters

evolve into cheques.

1200s 1634-1637

Flower powerPrices for Dutch tulips skyrocket as buyers pileinto them. A wild futures market arises and they

are a valuable currency until the bubble bursts.

London callingIn under two weeks,1.2 million is raisedfrom private fundsto start the Bank ofEngland. The firstcentral bank wasfounded in Sweden in1668 and managed by

the parliament.

1946

Going privateTwo academics found ARDC, the first privateequity firm. Its initial investment is a US$2m loan

to DEC, a forerunner of Compaq.

Would it be fair to say multinationalshave had too much easy access to

capital for their own good in the past?SharmaTheres no doubt there has beentoo much credit. Excess liquidity in globalcapital markets reduced the cost ofborrowing. But I dont think multinationalshaving access to relatively cheap fundingwas a major contributory factor to therecession. There were many factors, buton the corporate front, excess liquidity ledto highly leveraged M&A and that marketcame to a standstill in the summer of 2008.KaplanThe untold story is thatmultinationals, particularly non-nancials,have been spectacularly successful lately.They have US$2 trillion (1.4 trillion) ofcash on their balance sheets whichmeans they have come out of the worstdownturn since the Great Depression inmarvellous shape. Its part of the reasonthat stock markets have recovered sostrongly, and that things arent worse allround for everybody. Businesses havebeen prudent. They have cut quickly forthe downturn and they are coming outof it healthily. Thats very different tosomething like the downturn of the late1980s/early 1990s, when multinationalscame off very badly.

Why do multinationals have so muchcash, and how long do you expectthem to hold on to it?KaplanThree things are happening. One,which affects US multinationals, is the taxdisadvantage of bringing cash back to theUS. The second is that companies mayhave been more successful than theyanticipated. They have really tightened up

and got more efcient. Thirdly, there is asense in which multinationals baseline is alittle higher than normal, for precautionaryreasons. When we went into the crisis,they wanted to reduce their bank debt andmake sure they had a reasonable amountof cash. Now theyre waiting to seewhether theres a recovery, and theyrekeeping the cash there until they do.Gilbert Theres a bit of a chicken and eggthing going on here. The economy wontget going until companies start investingin things and generating householdincome, but they wont do that until theystart seeing income from households. Itshard to see what will break that. Werein an exceptionally low interest rateenvironment and companies would ratherhave cash than invest in new equipment.Sharma Keeping cash isnt a newdevelopment cash reserves atmultinationals have been steadily increasingas they have found ways to reduce costsand increase prots by nding newmarkets. Twenty years ago, they wereconverting assets to cash because theywere looking to emerging markets forexpansion. Right now, theres a lot of

uncertainty about what part of the cyclewere in. Companies are very cautiousabout what sort of multiples they are willingto pay. And countries like China are trying toincrease domestic consumption, albeit withprotectionist undertones.

What effect will Basel III have on banksand, by extension, large businesses?

Gilbert Basel III is an appropriate move. Itwill increase risk weights in certainactivities and will increase the calibrationof capital thats required even if banks justwant to stand still. It strikes at the heart ofbank activity, which is capital liquidity. Bankscan respond in a few different ways. Theycan front it up and lower their return onequity, they can change product offeringsto clients to become more capital-neutralor they can pass costs along. Youd expecta net increase in cost to banks of any givenasset, but its not clear to what extent.

Sharma Banks will have to tighten theirbelts and be a lot more efcient. They willneed to be more disciplined about whothey do business with and how theymaximize returns on capital. It wont affectthe Procter & Gambles of this world, butmid-market companies rely much more onthe sort of capital that banks provide.Kaplan Any time you increase capitalrequirements, you make capital moreexpensive and see less of it. Banks willhave less to lend. How big will the effectbe? Im not sure it will be that large. Largecorporates operate in capital markets, andthey have plenty available.Th

eTulipFollybyJeanLeonGerome/WaltersArtMuseum&

TheLegionsofAttilaDescendingfromHeavenbyMauriceBerty/ArchivesCharmet/TheBridgemanArtLibrary

1694



20/32

1971

20


The great debate

Capital concernCentral bankers inBasel agree on minimalcapital requirementsfor banks, put into lawby G-10 states in 1992.(Basel II would lay outregulatory practice.Basel III, addressing

liquidity, is on its way.)

Prime cuts

Banks overly exposedto high-risk mortgagesin the US are undonewhen property slumps.The shock sends banksinto a global freefall,leading to a three-yearfinancial crisis and

massive bailouts.

1997

Rock star finds spare ch-ch-changeDavid Bowie securitizes revenues from his backcatalogue, raising US$55m and showing the

versatility of the asset-backed securities market.

1988 2007

Another dollar...The US governmentannounces that thedollar can no longerbe converted intogold, bringing an endto the Bretton Woodssystem of currencybeing backed by

physical assets.

TheArtArchive,Alamy,Bloomberg,RexFeatures,Co

rbis,GettyImages,Shutterstock

CapitalgamesUnusual approachesto raising funds

Best BuyThe US retail giantlaunched its ownventure capital armin 2008, focusingon disruptiveopportunities.Investments includeelectric motorcyclemanufacturerBrammo and Zeo,which marketssleep aids.

FedExToday, the logistics

giant has annualprots of US$2bn(1.4bn). But in1973, founder FredSmith feared hecouldnt pay staff.Flying to Las Vegas,he won US$27,000(18,700) on theblackjack tables, andwired his winningsback to HQ.

Fest FilmsThe movie companyfunded its StarvingArtistsby ensuring

that the name ofevery investor,however small,appeared on screen.

IKEAIngvar Kampradstarted resellingmatches he boughtin bulk to hisschoolmates. Whenhe passed his highschool exams, hisfather gave hima lump sum as areward which heused to start IKEA.

TheBodyShopWhen Anita Roddicksought money toexpand her beautyproducts chain in1976, she sold 22%to the boyfriend of afriend for US$6,200(4,300). He held onto his shares untilthe business wassold to LOral in2006, netting himUS$227m (157m).

Regulationmay make

banks skittishabout lendingand openthe door toinnovation butthe barriersto entry arequite high


Private equity took a major hit duringthe recession. Will it ever recover?Kaplan Reports of private equitys demisewere premature. Two years ago, a reportclaimed that a large fraction of private-equityfunded companies would default. But thatassumed the deals were imprudent, whichthey werent. Debt structures in the recentboom were more conservative than in the1980s, one reason why a large number of

defaults have not materialized. Private equitywill be smaller than 2007, but it isnt goingaway. BlackRock has raised a US$15bn(10.4bn) fund thats not the US$21bn+(14.5bn+) it was several years ago, butit shows the interest is still there.

Sharma Private equity often comes inwhen companies are restructuring, andthat is driven more by the business cycle.PE rms might be taking a look at theirown funding as a result of the crisis, andits not yet clear how that will shake out.Gilbert Private equity has always beenimportant, and it always will be.

Is Siemens move into providingcapital for customers a positivedevelopment, and will other largecompanies follow suit?Sharma It could work, depending on yourstrategy. Theres a fundamental businesslogic to it for many companies. Banks haveretreated from certain sectors that might becentral to your business model, so it makessense to fund them directly, although theywould need to be prepared to deal with theinfrastructure, governance and compliancecosts of getting into that space.

Kaplan Chinese companies alreadyprovide very attractive nance to theircustomers. But on the ip side, thishas been tried before in the late 1990s,particularly among telecoms companies,and it ended up causing a lot of trouble.

GilbertTheres a pretty strong strain againstmixing banking and commerce. Regulationmay make a lot of people, including banks,skittish about the lending environment. And

if banks are eschewing activity because itisnt economic for them any more, that mayopen the door to innovation. But thebarriers for companies entering markets likethis are quite high, and they need to beprepared for the scrutiny that comes with it.

What would your priorities be if youwere a CFO, and how optimistic wouldyou be about the future of capital?Gilbert Id be broadly optimistic aboutaccess to capital. The question is: at whatprice? I have great faith in the ability ofnancial markets to come up with newvehicles, and it may be that CFOs lookincreasingly to non-bank providers.KaplanThe bank markets will get better,so I would be optimistic. Debt markets andhigh yield markets are holding up. Obviously,the wild card right now is the Middle East.Sharma In many ways, for credit-worthymultinationals, 2010 was a great year, withplenty of access to low-cost funding. Yes,there are problems, and there may bebigger worries on the horizon such as issueswith the Eurozone and sovereign risk. In themedium term, I would be examining myfunding mix quite carefully.


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21


Competitive edge by Robert Jeffery

Maverick, prophet, geniusIsao Nakauchi was all these. A king

of cost containment and lean supply chains, this retailtycoon foresaw Japans lost decade

I

n a life full of hyperbolic anecdotes, Isao Nakauchis favoritestory dates from his time as a teenage infantryman in World

War II. Cut adrift from his platoon in the Philippine jungle, hewas surviving on insects and leather peeled from his boots whena shell landed next to him. Luckily for me, the American shellswere manufactured in a slipshod way, like American autos, anddid not explode, he said.

Once Japans most successful and outspoken entrepreneur,Nakauchi, the Osaka-born son of a pharmacist, held no grudgeagainst the US. Aside from Mao Zedong (to whom he oftenlikened himself), America provided much of his inspiration. TheJames Cagney movie Angels with Dirty Faces(1938) introducedhim, he said, to the concept of department stores. Then,at a 1960s retail conference, he heard JFK talk about howsupermarkets were extending prosperity and was inspired toexpand his Daiei empire.

Daiei pioneered mass retailing in Japan, taking the UShypermarket model and allying it to a super-lean supply chain andaggressive promotion. But, by the time he died in 2005, Nakauchihad been forced to sell most of his assets. His rise and fall isa reminder that the availability of credit in a growing economydoesnt necessarily mean its business models are sustainable.

In 1957, when Nakauchi opened his first store in Osaka, Japanwas enjoying unprecedented growth. He began confrontingentrenched supply chains. When he sold beef at 39 yen for 100grams, he received death threats. When he couldnt find cheapsuits, he imported them from North Korea. Rivals accused him ofirresponsible price cutting, but he saw himself as an agent of theconsumer, empowered by Peter Druckers belief that demand,not cost of production, should set pricing policy.

Nakauchi instinctively understood thatcost containment drove sales growth.He made customer service training aconsistent priority, but he focused onspending in minute detail. When herealized customers were sampling Daieisconfectionery before buying it by weight,he pre-packaged it. This could have

backfired, but Nakauchi portrayed it asa revolution in customer convenience.Within six months, Daieis sales

exceeded a million yen per day. By 1994,the company was Japans most profitableretailer with more than 400 stores.Drucker, with whom Nakauchi wrotethe 1995 book Drucker and Nakauchi OnAsia, said Daieis creation of a moderndistribution system was part of thegreatest social achievement in any countryof the last 40 years and revolutionizedJapanese retail.

But Nakauchis authoritarian style (heeven wrote a musical about his business

acumen) deterred scrutiny and maskedthe fact that his retail miracle was builton cheap credit. Daiei reinvested profits ina terrifyingly diverse array of businesses,from language schools to the Daiei Hawksbaseball team, who played in a newUS$1bn (693m) stadium. These ventureswere seldom as profitable as the corestores, and when Japanese banks startedreining in risky loans, Daiei unravelled.

With a debt-to-equity ratio of 9:1, but96,000 employees, the group was too bigto fail. The assets were bought cheaply byinvestors before the state-run IndustrialRevitalization Corporation took over thestore business.

Nakauchi saw the end coming, was oneof the first business leaders to understandthe importance of the knowledge economyand predicted Japans Lost Decade ofnegative growth: If we are to learn, weneed to make the transition from studyingthe outcome of innovation to waysto produce it. And a true innovator hecertainly was: his super-lean supply chainprefigured Toyotas just-in-time method,a cost-saver adopted by car makers theworld over (and especially in Detroit).

Thatll be the Daiei:the famous retailer isone of Japans largestsupermarket chains

American idols: JFKand Jimmy Cagneyinspired Nakauchi

StuartIsett/Polaris/Eyevine,AFP/GettyImages



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22


Ten issues

22

What youdont knowabout...

CAlmosthevery miajnor comepany seses thee worlds sbecondulargestseconiomny as keey to prsotablsegrowth. But being in China is no longer enough. These ten factors could help you stand out


1Return to an old world orderChina is not a new global economicsuperpower. By 2030, if it does becomethe worlds largest economy, this will bea return to business as usual. If you takethe long view, Chinas pre-eminence notthe Wests is the historic norm.

As William Kirby, Professor of Chinastudies at Harvard University, has pointedout: China was the worlds largesteconomy in 1800. Its empire was thestrongest, richest and perhaps bestgoverned on earth. The wealthiest menon the planet were Chinese.

But the industrial revolution andmisrule (especially in Mao Zedongs25-year reign) rebalanced the globaleconomy. Although some analysts havepredicted Chinas renaissance for almost100 years, only in the past 40 have suchforecasts been taken seriously.

Now, Kirby says, the West hasfinally realized that a place that valuesentrepreneurship, education, engineering,internationalization and a governmentstrong enough (sometimes too strong) to

get things done can be a powerful partnerand a formidable competitor.

After rebalancing the global economyin its favor, China now needs to rethinkits own: its GDP may be growing by 9%a year but, with the IMF predicting globaleconomic growth of only 4.4% in 2011,how long can it maintain that pace?

Some estimates suggest a 10% declinein export growth could cut GDP growth bytwo percentage points. The governmentsbid to reduce reliance on exports bystimulating the consumer economy haspushed inflation to nearly 5%. A perilousproperty bubble has developed. As SimonGleave, Partner, KPMG in China, putsit: Large GDP growth tends to hide amultitude of problems. But the state islearning to handle them.

Chinas renewed confidence is reflectedin a campaign to bolster its soft power bypromoting Confucius. The 250 institutesdevoted to the philosopher across theglobe are a powerful reminder of Chinasearly days as a global superpower.

The new Confucius(551BC- 479BC) cultis a symbol of Chinasreturn to the top


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2

APIC/GettyImages,ChinaFotoPress,RainerDittrich/G

ettyImages

Heavy investment is

making China a worldleader in solar energy

The Ivy League of the EastIf the 21st-century global economy istruly to become a knowledge-basedone, countries would do well to investin learning. And China is doing just that on a scale that budget-conscious rivalgovernments must envy.

Peking University, the most highlyregarded academic establishment inChina, is ranked only 37th on the list of theworlds best universities. But ProfessorRichard Levin, president of Yale University,says: In 25 years only a generationstime Chinas universities could rival theIvy League.

In October 2009, nine universitiesformed the C9 League, the countrys IvyLeague-in-waiting. Some particularlyPeking and Tsinghua are renownedalready. Others have noted specialisms:Harbin Institute of Technology is linked tothe space program, while Shanghais JiaoTong has a strong engineering reputation.

By tripling the percentage of GDP spenton higher education to 1.5%, China has

quintupled its university student populationsince 1997. In 2007, 5.5 million Chinesewere studying at universities and colleges.There have been problems, though:student-to-teacher ratios have soaredand the quality of education has in somelocations been questioned.

Levin says that building a world-classuniversity isnt easy It took centuriesfor Harvard and Yale to achieve parity withOxford and Cambridge but insists thatChina has the will and resources to makethis ambitious agenda feasible.

The biggest challenge may be

modernizing teaching itself. In 2001, PekingUniversity started a pilot program thatoffered a select group of students a liberalarts environment. The goal, Levin says, wasto encourage students to be more thanrecipients of information andto learn to think for themselves. But suchdevelopments will take time. Changingpedagogy is much more difficult thanchanging curriculum, Levin says.

3Made (surprisingly well) in ChinaWould you be prepared to pay 50% less for a smartphone that is80% as good? Its the sort of proposition that could provide Chinawith an enduring competitive edge in the next decade.

The Made in China label used to suggest low cost butreasonable quality. However, a series of product recalls (well-publicized by the Western media) has tarnished Chinas reputation.Since then, the government and business leaders have beendetermined to close the quality gap, imposing stiffer regulation,improving storage and shipping and trying to emulate the sortof best practice found in Japan. With Chinas middle class set totreble in size over the next decade, there is a compelling domesticincentive for companies to compete on quality.

Azim Premji, who runs Indias IT giant Wipro, says: Dontunderestimate China. It has done some incredible work in electriccars, is very innovative in fundamental R&D for solar energy and isdeveloping automobiles, software and renewable energy as part ofa national program.

But thats only part of the story. During 2010, KPMGs GlobalBusiness Outlook Survey estimates, China surpassed India asthe favored outsourcing destination for the Asia-Pacific region.In 2009, the Chinese government identified 17 policies that wouldstimulate outsourcing and, by 2010, the industry was worthUS$10bn (6.9bn). Many of the 3,000 outsourcing companies arecash-rich and the ministry of trade and commerce is encouragingthem to make the right mergers and acquisitions abroad.

4The Tencent solutionPony Ma Huateng is not thestereotypical Chinese business leader.But then his business, Tencent, is far fromrun-of-the-mill. While it has not yet movedout of the domestic market, it is thethird-largest internet company in the worldby market capitalization. And despitehaving a charismatic founder, itsmanagement team is genuinely democraticand can say no to the chief executive.

Tencent proves that Chinese businessescan compete on more than just cost,as well as how different the domesticcustomer experience can be from that in

the typical Western business model.The story began when Shenzhen

software engineer Ma (above) built aninstant messaging system called QQ. Itquickly became Chinas most popularreal-time web communication service andat the end of 2010 was the worlds largestonline community, with more than 630million active users.

But Ma also did something Facebookand Twitter have so far only dreamt of he monetized social media usage. Tencentexpanded into mobile apps, gaming, datingand most recently e-commerce. Ma styleshimself as chief product experienceofficer and has brought in managers fromexternal companies to stop him and otherfounders dominating decision-making.

The result is a virtual goldmine.Tencents margins are estimated at around70%, and it announced first-half profits for2010 of more than US$500m (347m).

QQ arose at a time when manyinternet companies tried to slap Westernbusiness models on the China market andfailed, says Jack Ma, founder of Chinesee-commerce giant Alibaba. Rivals may beplaying catch-up for years to come.


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Ten issues

5Entrepreneurial spiritAnalysis of Chinas economic rise is oftenskewed by talk of just a few big brands suchas Tsingtao beer or NCPC pharmaceuticals.But China is the worlds largest andfastest-growing source of start-ups.

Running a private business was illegalin China until the late 1970s when DengXiaoping liberalized the economy, assuringthe population in the 1990s that to get richis glorious.

There are now more than 10 millionsmall and medium enterprises in China,accounting for 60% of the economy, 80%of jobs and, the Ministry of Science and

Technology estimates, 65% of high-techpatents filed since 1990.Small businesses have often clustered

together to reduce start-up costs, ease thefinancing burden and attract customers.The far eastern town of Zhili focuses ontextiles, for example, while nearby Huzhouis famed for bamboo products.

Such a model worked better when laborwas cheap and plentiful, but the one-childpolicy has brought wage inflation asbusinesses compete for a shrinking laborpool, driving up costs.

Small businesses can also beextraordinarily sensitive to exchange-rate

fluctuations. A 5-10% appreciation in theyuan would wipe out the cost advantageof many small exporting companies, onereason the state has done what it can tostave off such a rise. Less contentiously,officials are trying to encourage banks tolend more to small businesses.


6The logistics challengeOnline retailers are being drawn to Chinasincreasingly wealthy 420 million internetusers. Although credit card penetration inChina is low, it is expected to double by2013 and there are third-party paymentsystems available. The problem for onlinepioneers, however, is moving goods aroundsuch a vast landmass.

Logistics accounts for 18% of Chinas

GDP US$920bn (640bn) in 2009 twice the rate of most developedcountries. KPMGs China Logistics Reportpoints to inefficiencies in connectionsbetween transportation, storage andstock control functions. The countrysunderdeveloped infrastructure produces

transportation bottlenecks and there aretough regulatory constraints and localbarriers to entry.

For many companies, it is prohibitivelyexpensive to reach consumers outside themore developed eastern seaboard cities.

Things are looking up, though. The civilaviation sector has grown on average by17.5% per year over the past decade andthere are plans to build 97 new airports by2020. The government is also forecast tospend US$93bn (64bn) on rail links across15 cities over the next decade.

State-owned businesses still dominate,but private competition in the logistics

sector is growing fiercer as regulators allowforeign players to enter. FedEx has bought adomestic delivery business for US$400m(277m) and UPS has applied to operate.The pair are chasing a market of up to fivemillion packages a day and the chance toseriously stimulate the economy.

Second-tier banks knowthey have to be innovativeand aggressive to build

their market share

Many Chinesesupply chainsremain outdated

7Reforming rural banksModernizing Chinas rural banks has beengood news for the countrys SMEs. A lackof land ownership and tangible assetsmeant that many found it a challenge toextract funding from large, city-basedcommercial banks. But now rural bankshave been consolidated into newer, moreflexible institutions, fewer SMEs will haveto pay the high rates that undergroundbanks or trust companies demand.

China is trying to spread financialservices into areas where its been lacking,says Simon Gleave, Partner, KPMG in China.

The regulator is concerned about themarket share of the biggest banks. Second-tier banks are being encouraged to step up,along with co-operatives and village andtown banks (VTBs). To grow market share,these types of institutions know they haveto be quite aggressive and innovative.

The inevitable concern is how manyfacilities may become non-performing loans especially those handed out over the pastthree years atop a wave of optimism. Theoutlook for defaults will depend on GDPgrowth, fiscal revenues and property prices.

A lack of risk management experience inChina opens up opportunities for foreigninstitutions. By 2009, the China BankingRegulatory Commission had identifiedmore than 1,000 sites for new rural financeinstitutions, and some foreign banks have

already taken advantage of relaxed marketentry requirements. HSBC now has eightrural banks with 13 outlets, offering greaterflexibility on SME loan collateral andunsecured individual lending.

In future, says Gleave, sources of capitalfor businesses of all sizes will alter radically.It was a very long process to raise capitalin the past. There was a tendency just togo and get a bank loan when you wanted tofund growth. Now were gradually seeingbonds and alternative sources of capital.


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%ofGDP

0

Source: CIA World Factbook

12

USJapan

Germany

Brazil

RussiaE

U

China

10

8

6

4

2


Agrarian economyProportion of GDPaccounted for byagriculture, 2009

8

TimGraham/GettyImages,JonArnoldImages/Alam

y

Mighty bigbut not yetmultinationalby Professor Peter Nolan,Judge Business School

Fueled by soaring GDP, Chinese firms

are becoming more innovative andcompetitive. Yet the country strugglesto create truly multinational giants

On the face of it, these are boom timesfor Chinese businesses. Twenty-seven ofthem are on the FT 500 list of the worldsleading companies, their collective marketcapitalization exceeded only by the US. Inhigh-income countries it is widely believedthat China used the global financial crisisto embark on a worldwide buying spree.Yet the facts do not bear that out.

Large companies from high-income

countries are deeply embedded in theChinese economy, but the reverse is nottrue: Chinas own large companies arealmost invisible in the West. Its total stockof foreign direct investment is less than afifth that of the Netherlands, for instance.

There are notable exceptions, such asLenovo, the PC manufacturer, and Haier,which is making inroads into the whitegoods market in Europe and the US. Evenso, at a mere US$20bn (13.9bn), Chinasforeign investments in high-incomecountries are equivalent to thatof a single mid-ranking multinational.

In recent years, Chinas giant state-

owed banks have undertaken hugelysignificant reforms, so that by 2009 the topthree banks in the world in terms of marketcapitalization were Chinese and Chinahas 10 banks in the FT 500. Despite this,Chinas banks were conspicuously absentfrom the wave of mergers and acquisitionsduring the global financial crisis.

And the few attempts by Chinesecompanies to make a substantialacquisition or large equity investment ina high-income country such as SichuanTengzhongs failed bid for GMs Hummerbrand have attracted intense media andpolitical scrutiny. This helps explain whymany large Chinese businesses are stillmostly targeting their domestic economy.

While Chinas large companies are atthe early stages of becoming globallycompetitive, there is a deep challengeahead to build global leaders. It is temptingto think China has caught up with itshigh-income overseas counterparts, butit has some way to go.

Peter Nolans latest book isCrossroads: The End of Wild Capitalism(Marshall Cavendish).

9Agricultural revolutionMany smart venture capitalists with an eye on China are nowinvesting in potato not computer chips. As the countrysconsumer class becomes wealthier, there is a growing demandfor quality (often organic) produce at a higher price.

Agriculture is a marginal sector in many Western economies.Not so in China, where it accounts for 10.6% of GDP, employsaround 300 million people and is now benefiting from seriousinvestment as officials, focused on food security, insist the countrymust grow 95% of its grain demand. The growth prospects haveprompted Goldman Sachs to invest in breeding Chinese pigs, whileother banks are putting money into milk. Regulations on foreignownership of agricultural companies are tougher than many othersectors, making direct entry for external competitors difficult.

Li Guoxiang, a researcher at the Chinese Academy of Social

Sciences, says investors should consider the whole market ratherthan simply focus on particular niches. The capital always chasesthe profits, he says, and the collective market is quite lucrative,with returns on investment approaching 60%.

The central challenge for Chinas government is to make itsfarmers more productive. Many farms are too small for tractors, sonew laws are designed to encourage larger properties. If the 700million rural Chinese earn and consume more (a typical farmerspends just US$300 (208) a year on discretionary purchases) theeconomic and social gains for the country could be enormous.

10To Russia with loveWhat will China invest in next? To find theanswer, you need only go to Kimkan, anopen-pit mine in Russia. This muddy squaremile is almost impossible to drive to, butjust under its surface lies enough iron oreto build hundreds of millions of cars. Thatswhy Chinese officials are poring over it and many other Russian sites like it.

China is Russias largest trading partnerand the two are heavily reliant on eachother. Kingsmill Bond, Chief Strategist atMoscow investment bank Troika Dialog,says: Russia has resources that Chinaneeds, while Russia needs capital andChina has excess savings.

In 2009, China replaced the US asthe worlds largest consumer of energy.Water, oil, gas, iron, coal, copper, bauxite if youre selling, Chinas buying. It haspumped money into African oil, investedUS$25bn (17.4bn) in Australias resourcesindustry in 2009 and Shanghai is becominga world leader in ocean engineering as itseeks oil and gas fields.

At the same time, the governmentis reshaping its domestic resourceslandscape. In Shanxi, the mountainous coal

heartland, local government has begun anenforced consolidation which could close95% of mining companies while doublingthe regions coal production capacity to1.2bn tons a year by 2014.

Chinas first truly global businessmay be in mining or energy. Four of itsten largest companies sell resources.PetroChina, the biggest to date, plans toinvest US$60bn (41.6bn) over the nextdecade in overseas exploration. Dont besurprised if it hits the acquisition trail: it hasa war chest of US$20bn (13.9bn).


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The big issue by Antonia Ward



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A newkind ofpowergameJeremiahs predicting peak oil may beoverreacting but companies that fail to rethinktheir energy strategy may struggle to compete

ffer the typical CFO a 48% return on investment,and they would be intensely curious but deeply sceptical.And yet research by the Carbon Trust, the British not-for-prot

organization that encourages businesses to improve theirenvironmental performance, shows that investment in energyefciency projects delivers an average internal rate of return of48%. This is an astonishing gure given that most nancedirectors, when quizzed, suggested that such projects woulddeliver a return of around 20%.

If that werent enough to convince the average CFO,operations director, facilities manager or head of logistics tofocus on their energy use, the short- to medium-term horizon isclouded by unpredictable energy costs, the threat or promise ofnew energy efciency legislation and concerns over security ofsupply. Some boardrooms are alert to the dangers. AT&Tappointed its rst Director of Energy in 2009. Some companiesrank energy risk ahead of health and safety, credit and security.

Volatile energy prices are hardly new. As Michiel Soeting,Global Chairman of KPMGs Energy and Natural ResourcesGroup, says: It is very tough to make predictions around energysupplies. Even if you consider specic niches like oil, pricespikes from all the way above US$100 a barrel down to US$30make it very tough to predict. There are all kinds of estimatesabout the investment required to upgrade and expand theworlds capacity, and these are always measured in trillions. Healso points to new technologies such as natural gas producedfrom shale (and the great economic success of the BarnettShale in Texas) which throw away all economic and demand-supply models. New extraction techniques mean there aretremendous resources of gas coming on stream in the US,which have actually turned the whole gas market upside down.

o

JerryMcBride/PressAssociation

North Americannatural gasresources arerunning low


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The big issue


The various contradictory theories about peak oil thepoint at which the maximum rate of global petroleum extractionis reached, after which production enters terminal decline epitomize the uncertainty any business must confront as itseeks to rm up its energy strategy. Some dismiss peak oil asan alarmist fantasy. Optimistic proponents of the theory suggestthe global decline in production will begin after 2020 by which

time large-scale investment in alternative sources will avert anycrisis while pessimists condently predict a chain reaction thatwill trigger the collapse of the global industrial economy.

Dr Ric

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Agenda Magazine Issue 7