The break-up of a corporate group or conglomerate is often viewed as a moment of failure.
What do we mean by a break-up? A break-up could include the closure of international branches or the sale of entire businesses in specific geographies, such as in 2020 when Tesco sold its entire portfolio of Asian stores in a deal worth £8 billion.
Depending on the circumstances surrounding the break-up and the inherent value in the international elements being disposed of, the headlines may sound less or more positive. At its core, regardless of whether large £figures are quoted in the legal documentation, a break-up is designed to achieve only one thing: to support the profitability and solvency of the wider corporate group.
The general presumption from the layperson on the street is that the larger a business gets, the more money it will make. However, in this article, we’ll explore why splitting a large international group of businesses could be a positive step that may improve the returns to shareholders.
Managing an international group is expensive
The larger an organization, the more levels of management are required. This simple law of the business universe cannot be evaded. The more complexity and time zones and geographies, the more middle managers will be required to control and monitor its performance. The CEO of a large corporate group will not have the time to spare for local regulatory requirements and labor rules. They’ll need to delegate such decisions to VPs for continents, country managing directors, and regional managers.
The problem with middle management is the incremental overhead that generates no additional revenue. It is, therefore, a burden upon the profitability of an organization to have a lengthy command structure. Each arm of a business must generate more revenue to simply cover the additional cost caused by this management structure.
In most cases, the economies of scale achieved by expanding globally will more than offset this management cost. But some industries have only limited economies of scale, such as businesses that operate in markets with tight and varied local rules and regs that force the business to trade quite differently in each location.
This means that sometimes, restructuring may be the only way to avoid bankruptcy.
You cannot be an expert at everything
Successful companies survive because they perform at the peak of their industry and have a competitive advantage over the average new start-up that tries to join the market. This allows the company to enjoy an abnormally high-profit margin, which in turn allows it to raise capital easily to “copy and paste” the business model into other locations around the world. Bankruptcy
However, many business models don’t translate very well in foreign territories. Food chains soon decide they need to change their menu to cater to local tastes, and fashion companies decide to launch new ranges that they feel will appeal to local fashion trends.
Once the business decides to move away from its original business model, it is acknowledged that its secret formula, which proved successful in the domestic market, doesn’t actually work as well abroad. Tweaks and changes may or may not improve the situation, but ultimately the corporate group is now competing from a far weaker position than in their own market.
This may lead to lower footfall per store or a need to compete more fiercely on prices to attract buyers. This is detrimental to margin and may suggest that the company would be better off focusing on its domestic market and letting a local expert run its foreign business.
Featured Image by Gerd Altmann from Pixabay
