UK: CORE CONCERNS AT GKN.

UK: CORE CONCERNS AT GKN. - The reshaping of 'Britain's biggest engineering group' has produced a very strange creature.

by Geoffrey Foster.
Last Updated: 31 Aug 2010

The reshaping of 'Britain's biggest engineering group' has produced a very strange creature.

No one talks much about Pareto these days. Poor old Vilfredo has passed from the scene. Perhaps it is because his 80:20 Principle (if it really was his) has been invoked so often that were it to be applied just once more - to the product range or to the client list or the assets - there might be no business left at all. Nevertheless his ghost appears constantly. It is largely under his influence that companies all over the land are being 'focused' as though they were so many microscopes. Keen eyes are everywhere peering through lenses. Sharp instruments are carving away at unhealthy growths and mistaken acquisitions that have adhered over the years, and paring each specimen back to its ever-profitable 'core'.

Yet sometimes it is not clear which is the cancer and which the core. Bumps that were previously dismissed as superficial can suddenly become recognised as vital to the functioning of the whole. At other times, particularly after a run of disappointing results, whole organs that have long been proclaimed as core businesses are pronounced unnecessary, and surgically removed. Again this cannot happen too often or there will be nothing left. Separating the core from the non-core is an essential task of business development, and one that calls for sound judgment, plus considerable breadth of vision.

Few managements have exercised judgment in this matter with more care and deliberation than GKN's. And few have cut away greater quantities of extraneous matter. But, then, not many have been at it for so long. The process was already under way when GKN was knocked sideways by the early '80s recession, and by the time the storm had passed 'Britain's biggest engineering group' was a whole lot smaller than it used to be. That recession effectively cut the UK workforce by half. At the end of it, steel fasteners (ie nuts, bolts and screws) had gone, along with hardware distribution, and the company had all but severed links with construction - in 'normal' times another big consumer of steel.

Steel itself has taken longer to get rid of - GKN still wants a buyer for its 39% of UES, United Engineering Steels of Rotherham. But the group has shuffled off its interests in welding equipment and injection moulding, and is practically out of engine parts. Ironically, the above might just conceivably have been a core activity today, had the 1983 bid to acquire the motor components group, Associated Engineering, not been thwarted by the Monopolies Commission. After all, manufacture of automotive components has been GKN's biggest business for a very long time. Without AE, management judged that the group's engine parts operations were too small to compete on an international scale. So it got out instead.

That suggests one qualification for a core business. In spite of all the trimming around the edges, changes in the composition of GKN have not been as radical as might appear at first sight. What has changed dramatically, as chairman Sir David Lees points out, is the geographical balance of the group's operations, with the decline in the relative importance of the home market. 'At the beginning of the 1980s,' notes Lees, 'two-thirds of the group was in the UK and one-third was overseas: today those round numbers are almost exactlreversed.' Indeed, in the calendar year 1992, almost exactly two-thirds of the sales of GKN subsidiaries were generated abroad, and almost exactly two-thirds of their assets were located outside the UK. Lees has a reputation for being meticulous.

It is a long while since the geographical shift became visible, but only quite recently has top management been heard expounding on the subject of core. At the beginning of the 1980s, when the group was already moving away from its historical dependence upon steel - and upon steel products of a rather basic order - Sir Trevor Holdsworth, Lees's predecessor as chairman, announced that the policy would henceforth be 'to concentrate upon the manufacture of technologically-oriented pro-ducts of high added value ... (and) to direct our thrust to world rather than national markets'.

At the same time, Holdsworth promised 'to increase substantially the group's involvement in the services sector, both in wholesale and industrial distribution and in a variety of problem-solving services to industry'. During the 1980s, of course, services were widely regarded as the salvation of the British economy. GKN was in the van here: its interests in the services sector were already well established at the opening of that eventful decade.

Distribution operations had not entirely come to an end with nuts and bolts, nor with steel stockholding, and they were soon expanding again as the group set about buying motor parts distributors from the late '70s onwards. Prominent among the 'problem-solving services' was equipment hire: of steel scaffolding which was hired out to construction companies, and of wooden pallets, hired to industry in general - and food manufacturers in particular. The Chep pallet pool had been set up in the UK back in the mid-1970s as a joint venture with the Australian company Brambles. In 1980 the same two partners ventured jointly into waste disposal (another 'problem-solving service') by acquiring one of Britain's biggest operators in this field, which they renamed Cleanaway.

During the mid-1980s, briefly, GKN sprouted a third leg. In those days managers used to spend a lot of time explaining that the group was now nicely balanced. The first leg, motor components, consisted of most of the technologically-oriented, high added-value, manufacturing businesses (plus quite a few that were not). Services made up the second. The third was defence, an offshoot of the automotive sector. This, too, had its origins in the 1970s, when GKN began building armoured vehicles as a speculative venture, partly with the aim of utilising spare capacity. The original Saxon troop carrier, assembled out of standard parts obtained from anywhere in the industry, was joined in the early '80s by a much more sophisticated tracked vehicle, developed with government money. This was the Warrior, which performed creditably in the Gulf War.

Although defence was much the weakest leg, there was no secret about the group's intention of developing this third limb. GKN meant to be a leading UK producer of weaponry. But then came 'Options for Change', bringing a cutback in the number of Warriors on order for the British Army. GKN had by this time acquired its minority holding in Westland Group, the Yeovil helicopter builder. Yet it was obviously no longer sensible to harbour ambitions about becoming a major defence contractor, and the third leg was quietly allowed to atrophy. The fighting vehicles business reverted to its accustomed place in GKN's scale of things: just another member of one of the automotive sub-groups, lining up alongside manufacturers of less complete (andcertainly more mundane) products such as axles, wheels, body panels and tractor cabs.

When Lees and his team came to consider what constituted GKN's core, there were few obvious candidates among these. It is true that one or two of the operations have an international dimension: there are axle companies in England and Italy, for example, and wheels are produced in England, Denmark and (by an associate) in India. But in neither of these cases, nor in sundry others, could the group point to a deep and lasting penetration of world markets or to any really sophisticated proprietary technology. To neither product category, therefore, could it look for the longer term growth and stability that would justify heavy and sustained investment. In other words, neither could be counted as core.

The one outstanding exception in the automotive sphere was the manufacture of constant velocity joints. GKN has gone unchallenged as the world's leading producer of CV joints since landing Birfield all the way back in the 1960s. Along with much else, the acquisition brought Hardy Spicer, a Birmingham manufacturer of driveshafts and the supplier of CV joints for Alec Issigonis's innovatory front-wheel drive Mini. Also through Birfield, GKN secured a sizeable minority stake in a German company called Uni-Cardan. When front-wheel drive cars first appeared in Germany it was Uni-Cardan which provided the vital transmission links.

GKN's interest in the German producer grew by stages, to just under 100% today. Meanwhile, as the world's car makers progressively adopted front-wheel drive as standard (or, in some cases, opted for independent rear suspension which also needs CV joints and driveshafts to transmit power to the wheels - or launched four-wheel drive models which require twice as many), the group climbed in alongside. In Continental Europe it bought, through Uni-Cardan, controlling stakes in existing transmissions manufacturers. In the US, a latecomer to front-wheel drive, it opened two factories on greenfield sites in the early '80s, and is currently building a third. In the former Third World, during the past decade, it has taken minority stakes in local producers as far afield as China and Brazil (hoping to convert these to a majority later on), and provided the necessary technology.

These days the group supplies some 30% of the total world demand for CV joints and driveshafts - twice as much as the next most important producer, NTN of Japan. Outside Japan its main competitors are the car makers themselves, some of which manufacture a lot of their own joints although GKN also sells to most of them. Yet this picture has not changed much over the past decade or so. By the early '80s CVJs were GKN's biggest business by far - also the most profitable - and the group already bestrode the market like a colossus. The difference was that in those days there was more to look forward to, both from recovery of the car market - once the recession ended - and from a continuing trend towards front-wheel drive (and towards four-wheel drive). Not only is car production forecast to grow at an exceedingly modest rate during the rest of the '90s, but the vast majority of new cars are now fitted with CVJs - 98% in Western Europe, according to GKN, and over 90% worldwide.

Nevertheless, management has lost none of its fondness for CVJ manufacture, which is the essence of GKN's core. 'We're lucky to have the driveline business,' remarks Sir David Lees. 'It's a fine business and one that's growing.' Even an annual 2% - the projected increase in car production next year and after - would mean a useful addition to an activity that currently generates revenues of around £700 million. In the short term Hardy Spicer can expect to grow rather faster than that, as it strives to keep pace with the build up of Japanese motor companies in the UK. But behind Lees's optimism is the expectation (or hope?) that, over the years, more car makers will see the wisdom of focusing on their own core operations, and buy in a higher proportion of their CVJ requirements from the specialists - ie from GKN.

To encourage that conclusion was the aim of the latest reorganisation a couple of years ago, which brought all the driveline businesses in Europe and America together under one managing director. This is Trevor Bonner, the head office accountant who was seconded to Uni-Cardan and chaired the German company when it came to GKN's rescue in the troubled early '80s. Bonner has since been leading a drive on quality and costs in order to improve competitiveness. (The success of these efforts are sharply reflected in the group results for 1992, incidentally, which show pre-tax profits 34% up at £127 million while turnover rose only 4% to £2.5 billion.) Meanwhile, R and D has been redirected too. Group technology centres in Britain, Germany and the US now focus almost entirely on developments in driveline systems.

Defending GKN's existing position in CVJs and related areas promises to be expensive enough. Making further inroads will be even more costly. 'It's going to require a lot of investment,' accepts Lees. The group's other main core activity is not exactly a cheap night out either. On the contrary, despite being fundamentally low-tech, a pallet pool has a formidable thirst for funds. Merely to offer a service calls for a lot of up-front expenditure. When Chep was launched in the UK, the partners equipped eight depots and took on 100 employees, without, at that time, having any customers. Once properly established, the operation should be highly profitable (which is why it is core, of course), but growing is always slightly painful. 'The requirement for investment expands with the business,' Lees points out.

He should know. From the UK, Chep expanded into Western Europe, creating national pools in almost every territory, beginning with Benelux. Today there are 26 million Chep pallets circulating within Europe - or stacked high in depots - which would certainly present an obstacle to any newcomer who might think of entering the fray. Towards the close of 1990 the partners went feet first into the US, where they have already built up a network of 130 depots, with a pool of two million pallets. This attempt to take America by storm is costing them $70 million a year. (By way of comparison, GKN is spending $50 million to lift its US production of CVJs by 60%.).So far the omens are good. Marcus Beresford, the recently arrived managing director of industrial services, confirms that Chep USA 'should break-even around the end of the year', and move into profits in 1994.

The US is at least a homogeneous market. Nearer home, Beresford is wrestling with the threats and opportunities offered by the theoretical single market in Europe. (If cross-border movements on pallet were to increase significantly, but remain uncontrolled, it seems that all the pallets would end up in Britain or Germany: the Netherlands would not have any.). But Beresford has matters of a more general kind to ponder too, like the future of the UK waste management company, and the plight of scaffolding hire, and prospects in the automotive after-market as the US comes out of recession.

Automotive parts distribution has been one of GKN's more spectacular non-success stories. Of the parts distributors that were acquired with such hopes - and at such cost - a dozen years ago, only the US operations (admittedly the biggest) remain on the books. The British and French ventures were divested. 'There was a step change in distribution,' comments Lees wryly. 'It was a step too far.' Waste management however is a tale of a different kind.

Cleanaway has had its problems too, notably with a large and recaltricant incineration plant on Merseyside, but these are now said to be solved. Lees considers waste management 'a rattling good business'. Turning over around £100 million, Cleanaway is bigger than Chep UK and, according to Beresford, 'absolutely at the top end of performance businesses'. (A performance business, in GKN parlance, is one that is not core, not strategic. It is consequently - and curiously - expected to show a more rapid recovery of invested capital in order to justify its existence.). One of Beresford's present tasks is to come up with proposals for developing Cleanaway, possibly to the extent that it qualifies as core. This could mean taking it international, although bringing British waste disposal methods to many other West Europeans, say, might smack of coal dust to Newcastle.

If Cleanaway were to be elevated to the status of core, it could give rise to several intriguing possibilities. First, Britain's best known engineering enterprise might count two service organisations among its core businesses, and just one manufacturing sub-group. Second, both the service sector cores would be joint ventures with an overseas partner. Chep UK is 70% owned by GKN, but the Continental and US pallet pools are evenly shared with Brambles. Cleanaway is also a 50:50 split. GKN has enjoyed cordial relations with Brambles for 20 years, Beresford points out. No doubt. But the history of joint ventures suggests that, ultimately, the interests of the venturers tend to drift apart. And is it possible that a major UK industrial company should have two businesses which it acknowledges to be core, yet which it does not fully control and whose figures it does not consolidate?

Looking back, GKN's attempts to break with its iron-bound past have been punctuated with false starts. (It may have been saved from others by the MMC's rejection of its bid for AE, and by the Government White Paper which forestalled further investment in defence.). There have been major consolations, like the progress in palletisation, which have irrevocably altered the shape of the group. Yet it is a strange beast that has resulted. GKN is no ordinary conglomerate. But with one large, prominent, highly-skilled and narrowly-focused engineering business towering above the rest, and joined to an assortment of totally unrelated, low-tech, service operations, what is it? It is hardly a camel - more like a giraffe.

It is unavoidable that the creature should have shrunk compared to what it was. In real terms, last year's turnover reached barely halfway up the 1970s peak. Like other once great British companies, GKN has had to adjust to a changed world. More worrying is its relative lack of mobility. The record profits of 1989 were also, in real terms, well short of the figure of 10 years before, and they were almost wholly provided by businesses that were showing signs of maturity at the earlier date.

Maybe GKN does not need any more variety. Lees believes that its spread is 'arguably too wide' even now.He favours 'pushing out at the edges of what we already do'. In that case, it will be necessary to push out with enough force to offset the constrictions of the marketplace. Management is surprisingly relaxed about the prospect of low market growth in the core driveline business, which is the repository of most of the group's special skills. Allied to drivetrain are two technologically strong small businesses, one making viscous couplings (giving a driver much improved control on treacherous surfaces), the other producing materials for catalytic converters, both of which promise to grow considerably faster than CVJs. It could be important that they do. For a component supplier these days, even for a powerful multinational component supplier, as Bonner admits, 'It's difficult to drive down costs sufficiently to meet pressures on margins'. And it is not going to get any easier.

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