AT&T’s acquisition of Time Warner illustrates one strategy for a major player in a declining industry: diversify upstream or downstream. But it’s not the only viable approach, nor even the best.
AT&T’s core telephone business has been shrinking in recent years, though the company is very profitable and throws off plenty of cash, as reported in a good article about the business: “Operating revenues in wireless and landline phones and broadband plus DirecTV, accounting for 71% of the total, were all lower last year than they were two years earlier, despite a robust economy.”
The telephone business isn’t alone. Another consultant and I were discussing a local company with good profit margins and increasing market share, but in a declining industry. Technological change, including new business practices, have put many companies in an awkward position. Sometimes strategy seems more like flailing about to something, anything. Instead, a calm approach based on competitive economics makes more sense.
Acquiring upstream companies is not always a smart answer. To capture full value for Time Warner, AT&T will have to sell the media content to other delivery channels as well as their own. But those competitors may hesitate to help AT&T. Marketing to AT&T’s own customers may be a little easier, because of the existing relationship, but probably not by a lot. Most movie viewers don’t have brand loyalty to the studios (except for Disney within the children’s genre). And the Time Warner purchase may cause confusion among consumers. If the company advertises that the backlist, including Harry Potter and Matrix movies, is easily available to AT&T customers, will Verizon clients look for other movies?
The extreme of vertical integration was Ford Motor’s River Rouge factory, which included a dock for Ford’s iron ore freighters, a steel mill, and even a glass factory. It turns out that Rouge was too integrated, and no other companies use this extreme an approach.
Downstream integration is also possible, such as Apple opening retail stores to sell directly to consumers. This seems to be working for Apple, but the rarity of this approach indicates that most companies are not more profitable through vertical integration.
Unrelated acquisitions have been used, resulting in conglomerates. Investors generally dislike conglomerates, finding that executive leadership is spread too thinly, with few if any synergies enabling better sales or lower costs.
An approach too long overlooked focuses on a company’s assets and talents that could be deployed to serve other markets. Sprint is a great example. The name was first an acronym for Southern Pacific Railroad Internal Network Telecommunications. The railroad operated a telegraph service using its track rights of way. The telegraph was a vital part of coordinating trains. Southern Pacific realized that it had the assets and expertise to offer services beyond the traditional telegraph service. Thus Sprint was born.
A company is a shrinking industry can begin by thinking about talents within its organization. What do our people know how to do well? It’s better to be specific than general. That is, Sprint knew that it could keep wires connected and maintain a right of way. Too general approach would be a coal mining company saying “we know energy” and buying a wildcat oil business. The skills of operating an existing mine are far different than the skills needed to find previously-undiscovered oil and gas.
Assets are the second approach to maximizing value in a declining sector. Many businesses that struggle in modern retailing, for example, own desirable real estate. They may calculate their stores’ profitability without regard to real estate, meaning that stores on company-owned land appear to be more profitable than stores in leased locations. In fact, that land may be better used for another purpose, or developed by a different company.
Patents are another type of asset used for one product that may sometimes be used for a very different product, serving a different market.
Implementing a diversification plan based on current talents and assets will be risky, but all business entails risk. One good way to manage risk is through what Michael Raynor in The Strategy Paradox calls strategic options. A small company in the target industry is acquired, and the business is used to monitor the industry and learn the keys to success in that area. The small company can be expanded, or the knowledge it helps generates can be used to make a large acquisition. Or the idea can be abandoned cheaply.
The final alternative for a declining industry is to simply use its cash flow for the benefit of shareholders. Not wasting money is always good, and plenty of acquisitions end up being a waste. Pay dividends, buy back stock, and accept the company’s fate.
Running a business in a declining industry is not easy and seldom fun. Understanding that the industry is declining, and accepting the fact, does not mean sitting still. But wildly spending money on long-shot acquisitions is a bad idea in any industry.