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The key is to not restructure in an uninformed or uncoordinated way – either cutting all over the place to survive, or chasing deals and investments to boost valuation. This type of “traditional restructuring'' almost always ends up being value destroying and saps the organization of energy at a time when it is needed most.
What we call Value-Based Restructuring offers a model to get the balance right and establish a strong path for sustainable and profitable growth. It includes a four step approach:
Step 1: Start with a value perspective
The starting point is to really understand the value each segment of the business is creating for customers – both today and in the future given the expected changes in the market. This is a fundamentally important step, because this time it will not be about putting things back together to how they were. Covid-19 has dramatically changed demand structures and consumer behaviors, some of which are more than likely to outlive the present crisis (e.g., accelerated digitalization, remote working, localization). In this environment historical benchmarks are practically useless. Instead it is important to restructure holistically guided by a view of where value will be created. This also means going beyond a simple value bridge to go one to two levels deeper.
A recent client in the technology industry approached this issue by asking two questions:
- Which segments will create most value / profit in the future?
- Where will cash be generated?
To get initial transparency they performed a portfolio analysis by business segment (e.g., product categories, regions, customers). They quickly found out that while there were various segments contributing disproportionate value, there were many areas that were actually margin dilutive. In addition, they looked at the industry and market trends to take a bold position on the promising future value propositions and revenue models vs. their competition. With a solid understanding of this value baseline, they identified the first hypotheses to deliver substantial cost reductions without destroying the investments needed in areas important for the future. This wasn’t a long drawn out 6 month study, but a disciplined 6-week cycle designed to drive them to make tough decisions.
Step 2: Simulate future profit scenarios to set the right targets
A static restructuring approach no longer works to prepare for the “new normal.” Dynamic scenario modelling for the top line and profit simulation per business segment are essential requirements. In most restructuring efforts only the top line is simulated, and cost reduction targets are either assigned by top management guidance or via benchmarking. This imposes the risk of value destruction in promising future segments and product categories.
When the senior executive team of an automotive supplier initiated their restructuring discussion, a clear and aligned understanding on the expected market impact in the “new normal” was foundational. The executive team developed various EBITDA simulations per business segment, based on the assumed degree and speed of market recovery. They found across the probability weighted scenarios that likely drops in sales resulted in a disproportional drop in margins, since costs could not be adjusted as quickly as the top line was impacted. A clear understanding of the variable and fixed costs associated with each segment helped in determining an ambitious yet realistic and sustainable EBITDA target.
In addition, scenario thinking was used to simulate different options on how to plan the cornerstones of their transformation. For instance, they were faced with the question of whether to restructure a specific segment for growth or to prepare it for exit – two fundamentally different starting points for planning a restructuring effort that needed to be decided early on in order to set the right and differentiated targets for all business segments in the portfolio.
Step 3: Zero base the “affordable” future cost structure, differentiated for each business segment and along the entire P&L
When the Chief Financial Officer of a technology company looked at what she could afford to meet the future profitability targets, she looked at the cost structure of every business segment as opposed to the company overall. What was affordable differed significantly from business to business – depending on the specific value the segment generated at the time, and on its future value potential considering market dynamics. Hence, both top line measures and cost reduction targets were distributed in a disproportionate manner. Different parts of the portfolio (e.g. business units, product categories, regions) had to shoulder different contribution levels in terms of incremental revenue generation and cost reduction.
Zero basing the cost structure for each of the businesses helped clarify where to invest and how to pay for it. For each P&L item, it was decided what was really needed, nice to have or not necessary. This involved assessing all activities and re-building them in terms of costs and FTEs based on the following classification:
Step 4: Do the work across the value chain
Every element of value creation needs to be worked on in this exercise. No stone can be left unturned - including addressing sales, pricing, production, manufacturing costs, logistics, R&D and G&A functions. This needs to be a “sleeves rolled up” exercise with management re-designing both what work is done and how it is done. Merely ordering budget cuts and behavior changes won’t be enough. Real changes on the frontline and shop floor must happen. Often we find that value creation workshops involving both management and the frontline to define and specify actions can accelerate the realization of tangible change. Our experience shows that this type of hands on approach gets the organization engaged and even excited about the restructuring process - helping them feel accountable for a better future vs. at effect of circumstances and management.
Conclusion
Restructuring does not need to be feared. Each of the companies we referred to in this article emerged stronger and better from their restructuring events - with one actually increasing valuation by 8x. Value-Based Restructuring can be a powerful lever to unleash organizational energy and create a sustainable, exciting and profitable future. If you find yourself at a restructuring crossroads, we invite you to take advantage.
Alexander Nedelchev (formerly Strategy& partner), Christoph Knoblinger and Tobias Baumer also contributed to this article.
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