Portfolio analysis is a method of evaluating the effectiveness and value of various units in a company’s portfolio. It is a strategic tool that informs decisions such as resource allocation across business units or product lines, and whether you should invest more in, divest, or maintain certain units as they are. For example, Virgin’s portfolio includes an airline, record label and telecommunications business units to name a few. While portfolio analysis is a multi-business strategy, smaller firms can conduct a similar analysis on their individual product lines or services.
Well-known frameworks for portfolio analysis include:
- Assessing the market growth rate and relative market share of each business unit (Boston matrix);
- Assessing the attractiveness of the industry and each business unit’s competitive strength (McKinsey’s nine-box matrix); and
- Assessing a business unit’s standalone value and the ability to extract synergies (market-activated corporate strategy framework).
These methods all consider a firm on a per business unit basis in which you analyse each unit for its value. The first two approaches both examine the attractiveness of the unit’s environment and its ability to compete in that environment. The third method combines these two considerations as a single measure of standalone value while also advising the importance of the parent company’s ability to extract synergies from the business unit.
However, all these factors only focus on maximising the economic value of the firm whereas other considerations such as culture or social benefit may override the need to maximise dollars. This article will flesh out these three factors – standalone value, synergies and other considerations.
1. Standalone Value
You can holistically assess standalone value by the industry attractiveness and competitive strength of each business unit.
Structure, growth, players and other external forces will influence the attractiveness of an industry. Structural considerations include supply, demand and market growth rate, which in turn shape the conduct and financial performance of its players. For example, the sharing economy currently services a major untapped but increasingly popular market. A 2013 PwC report suggests that the sharing sector will grow from $15 billion to $335 billion by 2025, ten times faster than the rental sector. As an emerging industry, it is attracting many new entrants and resulting in record startup valuations for companies such as Uber and Airbnb.
Competitive strength also contributes to standalone value and can be segmented into quantitative and qualitative factors. Quantitative factors include the business unit’s market share, growth rate, profitability and debt/equity ratio. Qualitative factors include its brand name, values, core strengths and management. These factors, where unique and valuable, contribute to the business unit’s strategic advantage amongst its competitors.
For example, an airline such as Qantas or Virgin can service thousands of clients in the highly fragmented airline passenger industry. In contrast, a private jet charter company servicing corporate clients has far fewer client relationships to manage but risks losing much business if a single client withdraws. In this example, client relationships are a valuable business asset that increases the valuation of the unit.
As a strategic advantage, it also raises the barriers to entry for new competitors. However, this advantage would not be as valuable in a highly commoditised market – that is, where brand loyalty is far less important than price. In such markets, having high-profit margins which allow for the ability to offer low prices to customers would be a substantial strategic advantage.
2. Ability to Extract Synergies
The ability of the parent company to extract synergies from a particular business unit, relative to the ability of other firms to do so, is perhaps a more important consideration than the business unit’s standalone value. It may be more profitable to sell the business unit to another firm than to retain and collect the cash flows if the other firm is more suited to extract value from it. That is true even if the business unit is extremely valuable on its own.
For example, in 2012, Qantas sold its in-house catering business to Gate Gourmet, an independent airline catering service provider. As a non-core asset to Qantas, it was less able to extract value from it than the buyer, who was a specialist in the airline catering industry. Since cash flows from the business unit under Gate Gourmet’s management would be greater than with Qantas, its valuation and sale price was higher than the profits Qantas would otherwise have collected. The deal also allowed Qantas to devote more resources to its core assets and reduce maintenance and overhead costs of non-core functions.
Another example Google’s acquisition of YouTube. When Google bought YouTube in 2006, YouTube was making little revenue on its own and profited far more with the sale than they would have with developing their existing resources. At that time, YouTube’s standalone value was about $650 million. In addition to that, Google paid a $1 billion premium, appraising the potential synergies at that price, as it was well placed to extract more value from YouTube with its assets and resources. In particular, Google’s expertise in search algorithms and its data on people’s browsing patterns were two assets that it successfully monetised in YouTube by providing better navigation and more targeted ads.
3. Other Considerations
Non-economic considerations for merging, acquiring or divesting business units include purpose, cultural fit, feasibility and legal issues.
If the business unit is a charity, social venture or volunteering organisation, it may have much lower returns or even run at a loss to the parent company. However, the parent company may still have good reasons to retain it. The parent company provides and receives social benefit rather than only economic benefit.
Cultural fit or misfit can decide the fate of a merger or acquisition. In 1998, European automotive manufacturer Daimler-Benz merged with American Chrysler as Daimler-Chrysler. It was a promising trans-Atlantic market giant, but Chrysler employees felt controlled by the high-end, elitist management of Daimler-Benz. The merger ended after nine years when Daimler-Benz sold Chrysler for $30 billion less than its acquisition price.
Legal is another consideration such as whether the business unit can conform to local laws, especially with international purchases. There are also feasibility considerations such as how operationally practical it is to acquire or sell off a business unit, how long it would take to do so and at what additional cost.
These considerations suggest several potential actions for businesses:
- Sell off attractive business units if they are worth more to another firm;
- Retain average or even poor-performing business units if you can extract more value from them than any other owner could;
- For business units with a high standalone value, develop them or sell them off depending on your ability to extract synergies from them relative to others; and
- If you are not the best owner to run the business unit but are well positioned to improve its value, consider doing so before selling it to the best owner.
Portfolio analysis results in a better understanding of your business units or product lines and where you should allocate resources to maximise value. Major considerations are its standalone value, the ability of potential owners to extract synergies, and non-economic factors. Actions include developing business units to create assets as strategic advantages and sharing resources across business units to minimise overheads and maximise synergetic value. Where another firm is more suited to benefit from the business unit, it would be better to sell it to them if you can address non-economic concerns. Optimising and strengthening your portfolio of business units or product lines places your firm well in a position of economic strength.
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