Aiming for the silver now will bring gold when the tide turns, writes Robert Heller.
"Recession - what recession?" Such were the bold words of Richard Lines, the executive chairman who lost job and reputation in the furore about MTM's profits for 1991 - the year he so tempted fate. Lines was proudly telling an Economist conference on "Managing in Recession" how effective strategy had brought MTM prosperity among the ruins.
His subsequent comeuppance doesn't invalidate the thesis. It's a counsel of despair to argue that recession can never be defeated: that no company can override a savage downturn, no matter how effectively its strategy is devised. True, short-term setbacks hamper medium and long-term aims, simply because, like British industry after Mrs Thatcher's Mark One recession, you're beginning the race well behind the starting line. But no management in a cyclical business like chemicals (MTM's ?RACKET?) can expect unfailing growth: even in less volatile markets, three decades of unbroken advance in earnings (like that of the doughty US group, Emerson Electric) are exceptions that prove the rule.
Joining the rare exceptions is a legitimate aim. But the bull's-eye won't be hit (and wasn't at Emerson) without rigorous planning for future profits and strict monitoring of present results - in relation to both future and past. The last point is pivotal. Genuine budgeting has long replaced historic management accounting, in which actuals are compared with a year before; comparing results against forecast is a far more dynamic way of managing a business through its financial reporting. But looking back is essential to establishing strategic trends - showing which businesses are forging ahead, and which sliding down the slippery slope, taking one year with another.
That phrase - taking one year with another - makes the further point that calendar years aren't significant for any reason other than convenience. Growth figures are determined by where you start the series, and where you finish. Nor need calendar dates apply to return on capital. A solid strategy, allowing for recession, will target a minimum, silver return in the off-years, with a yield in the golden days which is fit to bring joy to the hearts of shareholders - and even bankers. Curiously enough, MTM's returns only just passed the half-way mark in Management Today's latest profitability league, with a 15.9% net return on invested capital. While in the same League, its figures were not in the same class as Laporte's (29.7%), or the same world as Rentokil's (38.3%). The latter is a prodigy of profitable consistency worthy of US champions like Emerson.
The latter's sales dipped by 4% before the storms of 1991, but profits still edged up by 3%. More important, its return on equity was a high 19.6% - the result of that meticulous, strategic "profit planning". MTM "planned" its profit, too, by the weird, far from wonderful method of capitalising not only development spending and process development costs but interest on construction projects. That its auditors didn't rebel until lately is one of the less sweet mysteries of life.
Paradoxically, the unfudged figures show a seriously lower return but a much faster growth rate. After massage, profits grew by 46% in 1990: without massage, the result would have been 95%. The share price might well have performed better under the second dispensation - which only stresses again the fallibility of year-to-year growth rates as a guide to strategic merit. In competitive markets, a high return on equity won't be sustained without growth: but a profound strategic truth is that pursuing growth ahead of returns grievously threatens the latter.
That inevitably applies to acquisitions, and casts a cold light on fruity deals like Thorn EMI's £510-million purchase of Virgin Music. The purchaser is confident of trebling profits to avoid diluting earnings per share. But to match its own formidable return on equity in 1990 (24.5%), Thorn must screw £126 million of net profit from Virgin - and that's half of the music group's total sales in 1990-91.
Strategically, the buy looks grand enough, giving Thorn 18% of the world market and adding another huge chunk of masonry to the music-and-rental empire for which management has shed so much else. But as Emerson's master-strategists never forget, strategy executed at the expense of profitability is self-defeating. Much of the corporate suffering during the economic bloodshed of 1991 flowed from strategic rather than government error. "Recession - what recession?" Indeed: good strategists make sure that it isn't home-made.