UK: The incredible dinosaur - How BTR is re-inventing itself.

UK: The incredible dinosaur - How BTR is re-inventing itself. - BTR hopes to disprove the old adage that bigger is better. By halving its size, the manufacturing giant believes it can revive its flagging fortunes.

by Andrew Lorenz.
Last Updated: 31 Aug 2010

BTR hopes to disprove the old adage that bigger is better. By halving its size, the manufacturing giant believes it can revive its flagging fortunes.

Industrial conglomerates don't come much bigger than BTR. With sales last year of £9.5 billion and more than 1,000 business units worldwide, the company is Britain's largest manufacturer outside the pharmaceutical sector. Or rather, it was the largest. By the end of 1998, its chief executive Ian Strachan will have halved the size of the original BTR business in the most extensive refocusing drive ever implemented by a large UK group.

Few analysts dispute that reorganisation on this unprecedented scale is necessary. For five years, until Strachan took command in January 1996, BTR was sailing in the wrong direction. While the business environment changed fundamentally, BTR stuck determinedly to the tried-and-trusted formula that had brought it two decades of outstanding achievement under the formidable leadership of Sir Owen Green and his finance director, Norman Ireland. But for most of the 1990s, BTR's share price, the ultimate barometer of corporate success, went nowhere. It had underperformed in four of the previous six years when Strachan took command on 1 January 1996.

The previous May, when he arrived at BTR's dowdy head office, Silvertown House, off Vincent Square on the fringes of Victoria, Strachan broke the BTR executive mould. He was a graduate - mid-'60s in history from Cambridge - with an MBA (from Princeton), who came from a top post (deputy chief executive of the mining group RTZ) outside the company. This cosmopolitan background made him the antithesis of the school-leaver accountants who had built the group from careers within the company. Green once defined BTR's creators thus: 'Our culture was quite home-grown. We looked inside ourselves. We were all well-read, but none of us had been to Harvard.' Strachan broke that tradition the moment he stepped through the door.

For the seven months following his arrival, Strachan watched from a cramped office as the business world passed BTR by. By several accounts (though he keeps the experience to himself), his introduction to BTR was neither smooth nor welcoming. There was no informed handover as, for instance, was contemporaneously effected by GKN's Sir David Lees to his successor as chief executive, C K Chow. Alan Jackson, the robust Australian, hand-picked by Green to succeed him in 1990, clung tightly to the reins and reputedly constrained Strachan's access to the sprawling empire.

But Strachan still grasped the essential fact. He says: 'BTR managed the business by cost reduction and during periods of high inflation by aggressive price increases. But those two conditions had disappeared: we were under price-down pressures and we had reached a level of cost-reduction, with margins of 19%, that left little else to go for. We couldn't move any further in that direction.'

He had to turn BTR around, and do it fast enough to overhaul competitors which adjusted to the new realities some time ago. Mike Monkton and Mike Murphy of SBC Warburg Dillon Read said: 'BTR's view of the modern global economy and the business environment going forward is held in common with most multinational companies: globalisation of industries, disappearing economic borders, consolidating customer industries and consequent increasing competition and price pressures. The trouble is that this consensus view has been prevalent throughout the 1990s, while BTR appears to have espoused it fully only in 1996. In other words, it is behind and has some catching up to do.'

Strachan knew he would need time to make the change. At the outset, he told investors that it would be four years before they saw real progress.

But at first even Strachan did not fully appreciate the magnitude of the restructuring required. To catch up and overtake his rivals, it was obvious BTR had to focus resources on fewer businesses. The issue was the extent and the content of the disposal programme. After hugely diversifying BTR's portfolio by paying (many thought overpaying) £1.5 billion for the struggling electrical engineer Hawker Siddeley in 1991, Jackson had started to focus the group on 'industrial manufacturing'. He sold distribution businesses and, eventually, some non-engineering assets including BTR's only real consumer-goods company, Dunlop Slazenger. In September 1996, nine months after succeeding Jackson, Strachan increased the divestment total to annual sales of £2.3 billion, or just under a quarter of BTR as then constituted.

He named four 'major global groups' - automotive, power drives, process control and packaging and materials - which accounted for almost two-thirds of the then-remaining £7.7 billion annual sales. The remaining one-third came from three groupings - specialist engineering, building products and polymeric products - in a 'smaller global and regional' clump that looked like fertile ground for further disposals, but which also contained potential future core operations.

Strachan says the disposal list was an initial one and an interim step.

'It was a group of businesses which did not logically fit into the structure that we had come up with, namely to group the business by product and customer markets. It was a programme that needed to be driven very quickly, and the two things that needed to go with it were a recognition that our cash resources were very attenuated and that we needed a massive restructuring programme.'

Restructuring meant provisions, and Strachan took a hit of £622 million which cut pre-tax profits from £1.5 billion in 1995 to £679 million after exceptional charges. But by far his most dramatic reversal of historic BTR policy was to cut the dividend.

An (almost) ever-rising pay-out to shareholders had, along with (almost) ever-increasing earnings, been the cornerstone of old BTR's relationship with investors. But that record had come under increasing strain as earnings growth slowed to a crawl, and it was now at breaking point. The straw that was breaking the camel's back was BTR's warrants programme.

When Green and Ireland devised the warrants scheme in the late 1980s, it was hailed as a master touch. By triggering rights to convert into shares at a future, higher level than the existing share price, it attracted investors and guaranteed BTR a consistent stream of equity funding. It became, in effect, a rolling rights issue, oiling the wheels of the BTR growth machine. The warrants helped to create a virtuous circle: they part-funded the acquisitions of under-performing companies whose margins grew under the BTR system, generating profits growth and a higher share price.

By the time Strachan arrived, however, the circle had turned vicious.

BTR's flagging earnings growth was struggling to keep pace with the ever-increasing equity mountain piled up by warrant issues. And as the share price flagged, the warrants began to lose their attraction to investors.

Strachan had a double problem: he needed substantial cash to fund the turnaround - to compensate for years of under-investment, BTR would have to invest well above depreciation - yet one of the group's main funding sources was drying up.

'The dividend cut was a highly emotional issue,' Strachan says. 'Warrants had been a viable cash-raising alternative for a company that was growing rapidly, had a good record and expected to be continuing to do that over a long period. But the warrants really saddled the company with a very high service requirement. We issued far too much equity.'

The combination of rising dividends and exercised warrants meant that BTR's retained earnings ratio dropped over a decade from 65% of net profit in the glory days of the mid-1980s to just over 30% by 1995. Strachan had to staunch the outflow. So he cut the dividend - which Jackson had just hiked - by more than a third, from 14.7p to 9.6p. At the same time, the share price was slumping. It had peaked at 407p in 1994. Now it was below 300p and falling.

Getting the cut through BTR's board, along with the additional disposals and the general message that a total change in approach was needed, did not prove easy. Only two non-executives - Elwyn Eilledge, who had succeeded Ireland as chairman, and Jeremy Marshall, chairman of De La Rue - had not come from the ranks of BTR executives. And Eilledge, as former senior partner of BTR's auditors, Ernst & Young, was really family.

The practice of appointing former executives had been instigated by Green.

But like the warrants and many other aspects of BTR culture, what had once been a strength was, with performance waning, a manifest flaw. It had accentuated BTR's introspection and isolation from the business environment.

One current BTR director likens the old boardroom atmosphere to 'an inquisition: the non-executives sat on one side of the table grilling the execs on the other: "Why aren't you doing it the way we did?"'

By the time Strachan came to present his radical package, the climate had mellowed. Some of the former BTR executives were sympathetic to the case for a dividend cut. They recognised that the company needed to change tack. What they had difficulty in stomaching was Strachan's insistence that the fundamental terms on which BTR traded needed replacement. 'The historical growth had been by margin enhancement, which had left zero room for manoeuvre,' Strachan says. 'To sustain margins at the prevailing level of 19%, profits were going to decline.

'But if we didn't grow, shareholders were going to be deeply unhappy.

The only alternative was to get our fair share and more of the market growth. That challenged fundamentally the old BTR precept that market share didn't matter, because margins were all that counted.'

Top-line growth had to be BTR's new driver. But how to convert a management corps, weaned on margin maximisation, to the new credo? 'Getting that concept of growth across has probably been the most difficult thing, without any question,' Strachan says. However, he insists there was a recognition down the line that change was needed. 'We had some very good operators and they were highly motivated and anxious to change.

They were very enthusiastic about Delivering Profitable Growth.'

That catchphrase, Delivering Profitable Growth, was the title of the change programme that Strachan launched 13 months ago, in December 1996.

'This is at the heart of the change that's taking place in BTR, and it begins with the recognition that we don't operate in a vacuum,' he says.

In the first instance, Delivering Profitable Growth was a huge corporate census. A series of workshops were held worldwide, initially involving the top 500 managers, then later cascading down to several thousand. 'We began with a balance sheet and tried to put together a data bank for each business. We recognised that if people didn't stop and think where they were, they would be less willing to accept the changes that we were asking for,' Strachan says. The managers were asked between 250 and 300 questions about their markets, their competitors, their products; about commercialising new products; about levels of R&D spending; and about support staff. All the answers were collated by business group and at corporate level 'to see what the profile looked like', Strachan says.

Two main findings emerged: 'By people's own admission and recognition, we weren't very good in the marketing area. Marketing was not, historically, a core skill in BTR. There was very little concept of productive, positive relations with customers. Customers were on the receiving end of price increases: that was part of the expertise of BTR in the old days.'

The second finding was equally basic: 'Product development was generally thought to be behind the competition and we needed to put resources there. So Delivering Profitable Growth immediately attracted some higher costs to the business - costs which needed to be put in to achieve the kind of aggressive growth targets that we were talking about.'

Two other points were made. Strachan says: 'We didn't behave as some of our competitors did. We didn't have the kind of matrix organisation to deal with global customers.' And BTR was 'probably behind the competition in penetrating emerging markets'.

McKinsey, the management consultancy, worked with Strachan and his team to help develop the structure for the analysis, but Strachan says the resultant action was 'self-help - we weren't relying on outsiders to tell us what to do'.

The main action was to mutate the most sacred of BTR's sacred cows: the annual profit plan. This document, with the financial targets, ratios and concomitant disciplines it imposed on managers, was the wellspring of BTR's operating performance. But like other once-vibrant forces in the group, it had become ossified: 'In its later stages, it preoccupied management at all levels for three or four months of the year,' Strachan says. 'I came here in May and was told that by mid-June, a letter had to go out for the following year's profit plan. Even in Exxon or RTZ, companies with very long horizons, that would have seemed out of the question.'

As soon as he took over from Jackson, Strachan had begun the process of developing a strategy plan for each business. But with the census findings in front of him, that drive was intensified. During the first half of last year, Strachan went through detailed plans for implementing strategies for growth in each of the 22 business groups. Those fed into new-style profit plans concluded in October: 'They are not a series of financial schedules; those are at the back,' says Strachan. 'We haven't compromised on that, although we have changed those schedules to focus on growth as opposed to margins.'

The big difference was elsewhere in the document. Each business executive was required to look forward at least three years - five years, in some cases - to analyse their markets, and detail their strategies for expansion, customer development, product innovation and for increasing competitiveness.

Apart from starting to inculcate the new, strategic ethic into the marrow of BTR, the process also triggered one final, fundamental change. Strachan says: 'It began the thought process of how to complete our transformation into a focused engineering group.'

This strategic step put Strachan at one with the City, where analysts and, most significantly, investors, had been urging the new BTR executive management to be more radical in breaking down the old, diversified group.

SBC Warburg's Monkton and Murphy noted as late as September: 'BTR is fighting on too many fronts. To achieve what it needs to do, it will have to participate in the continuing consolidation of its industries. This requires resources, both financial and managerial, which are scarce.

'The group is generating too little cash after some £400 million consumed in rationalisation, capital expenditure above depreciation and working capital, and a further £400 million to pay the (reduced) dividend. Because the cash-flow is weak, it limits the scale of borrowing to below that which might appear desirable.' Fears that BTR's turnaround was bogged down at one stage pushed the share price to 183p, for investors an intolerable level.

For so long a king of cash generation, BTR had suffered operating cash outflows of £253 million in 1995 and £245 million in 1996. A large chunk of money had gone on one of Jackson's less helpful legacies: the £2 billion buy-in of the 38% minority of Nylex, BTR's Australian associate, priced at a premium of more than 25% to the company's market worth on the eve of the deal.

If the Nylex deal had been done to avert the possibility of a schism between BTR and its Australian offshoot, that logic was rendered obsolete by the announcement Strachan made on 11 September. Virtually all of the Nylex business was to be sold as part of a clear-out. Strachan said the company would sell businesses worth more than £2.8 billion, including all the polymeric operations and - in the biggest element of the programme - the packaging division that had previously been designated a core business.

Part of the cash that would be realised would be returned to shareholders, Strachan said.

The move effectively left three core groups - control systems, power drives and automotive - and a raft of specialised engineering companies, ranging from aero-engine overhaul to rail-signalling and paper-making machinery. It was welcomed by investors as marking a rational departure from BTR's conglomerate heritage. It also ran into criticism. Back in Melbourne, Jackson said BTR had made a mistake in focusing so tightly. Only by remaining a diversified industrial manufacturing operation, albeit with an engineering focus, could the company produce the earnings it needed, said Jackson: 'Of the four engineering businesses they have identified as their core businesses, I can't see how they will provide sufficient volume and profit to satisfactorily service the high capital of the company.'

Jackson neglected the fact that Strachan clearly aims to shrink the capital base - analysts are reckoning on a total £1 billion-plus share buy-back once the disposal programme is completed this year. But the former BTR chief had also posed the crucial question: can the new BTR deliver sufficient growth to break out of the downward spiral?

When the dust settled on the announcement, City reaction was cool. In the jittery stock market at the end of last year, BTR shares slumped below 200p, while Monkton and Murphy valued the new grouping at about 235p a share - a far cry from its one-time levels not so long ago.

But Strachan and his top team have drawn a line in the sand. Following a series of sensible acquisitions, BTR's new backbone is world number one or two in many of its activities.

Control systems, headed by Chris Burns - the only survivor of the Hawker Siddeley senior management - exemplifies what BTR is aiming to do. Under Strachan it has been almost trebled in size to become a £2 billion annual sales business, embracing batteries, valves, meters and sensors, which is moving progressively up the value chain away from basic component making to offer integrated solutions, including a hefty software element, to customers.

Strachan says: 'We are not in the business any longer of simply producing machines, engines, gears, valves or meters. That may be 80% of the content of what you are selling, but it's the route to market that is the most critical element. If you don't control that and the ability to specify the product to customers, it doesn't matter how big you are because your competitor can displace you.'

Control systems' progress has been aided by the fact that Burns introduced several of the features of the new BTR - including strong investment in innovation and strategic business planning - under the old regime. Burns himself believes this demonstrates that BTR managers can successfully be converted to the new culture of top-line growth and strategic pricing - to accept optimum, rather than maximum, prices in order to build volume.

Many managers have gone. Glancing at a top team photograph taken at his first management meeting in February 1996, Strachan says 19 of the 50 executives present 'aren't with us any more'. Inside the company, Strachan now appears to be fully in command: outside non-executives now outnumber the remaining ex-BTR executives (one of whom, Bob Faircloth, was advocating greater investment in product development and longer-term planning seven years ago when he ran against Jackson's successful campaign to become chief executive). Bob Bauman, the former SmithKline Beecham chief who heads British Aerospace, has replaced the short-lived Eilledge as chairman, bringing a high standing in the City that will take some of the heat off the executive team.

Making a physical mark on the group, Strachan has moved the head office up-market. BTR has not gone far - towards the top end of Victoria Street, near Westminster Cathedral - but the discreet elegance of the modernist interior nicely reflects his own ethos.

If Strachan and co succeed, BTR will be similarly transformed into a 21st-century combine at the forefront of the world engineering industry.

If they falter, however, BTR will be dismembered by other companies that have got there before them - Emerson Electric, Siemens, perhaps even Siebe, the British electronics and engineering combine. One thing is indisputable. As Strachan says: 'The old certainties of BTR are gone for ever.'

Andrew Lorenz is business editor of The Sunday Times.

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