AN OPERATING CORPORATE GROWTH STRATEGY: Building a Fortune 500 Manufacturing Business (7th article in the series on M&A)

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I  write about two of the factors I consider central to successful growth and I used to build JPIndustries (JPI) in to A Fortune 500 Corporation at a time of economic recession, high interest rates and an exodus of manufacturing operations from the mid west: synergy and homogeneity.

You are probably saying to yourselves that synergy was a concept of the 1960’s which was not notably and successfully employed by the conglomerates which coined it, and that homogeneity reminds you more of processing milk than of conducting business.

But these words, synergy and homogeneity are Creek.  And I of Greek origin. I believe   that understood and applied correctly, the concepts expressed by these words    have clear practical meanings and direct application to business growth.

First: synergy.

Synergy comes from the Greek synergia, meaning “working together”. From the same root we have synergism, which means cooperative action of separate agencies such that the total effect is greater than the sum of the effects taken independently. This is the basis for the famous 2+2=5 definition of synergy promoted as the strategy of the conglomerates of the 1960’s.

I would propose to you that in the 1960’s the term synergy was poorly understood and in many cases poorly applied. That is the fault not of the concept, but of its utilization. And I would further propose that, correctly understood and applied the concept of synergy works.

What did synergy mean in the 1960’s? The term was primarily used in conjunction with the rise of the savvy, aggressive, optimistic, and irreverent group of outside-the-establishment young men who built the conglomerates of the era . . . men like Tex Thornton of Litton Industries, James Ling of Ling-Temco-Bought, Charles Bluhdorn of GTW, and Harold Geneen of ITT, to name the best-known. Synergy then meant putting together groups of widely varying companies within one corporate structure or conglomerate which became the “extra” in the sum. The Corporation could enable the member companies to do better than they might have done separately by balancing the effects of differing market cycles or financial performance; attracting more investors to the resulting presumably more stable earnings growth; and providing easier access to capital and high-powered staff work.

In many cases, however, the conglomerate interpretation of synergy did not work nearly so well as anticipated. In the financial area, moving money from high performers into less viable ventures or into still further acquisitions tended to focus resources on the weakest or to move them out of the current operations entirely. Wide diversity of numerous units also strained the financial capacity of the conglomerate to fund all company components sufficiently to meet competitive challenges. Moreover, the combining of numerous unrelated companies eventually caused a drop in confidence or interest or both among analysts and investors, who had to work much harder and commit more of their own resources to understanding these increasingly complex organizations. By 1973, Forbes magazine headlined, “2+2=?”. The story noted the early days when conglomerates were relatively interesting and tremendously exciting. Wall Street gave reported conglomerates price/earnings ratios as high as 50 during the ‘60’s -but by mid ‘70’s, the median price/earnings ratio of conglomerates was “a miserable 5”.

Finally, in the majority of cases, unrelated operational diversity put a severe strain on management. The individual conglomerate units were in markets in which the corporate management had little or no knowledge or experience. The flow of data coming in didn’t help much because of management’s inability to interpret and apply it to advantage. Management often found it convenient to invoke the concept of synergy to justify a move they wanted to make, but then frequently did not take action to achieve the claimed benefits either because the next quest became more exciting or because the corporate leadership did not understand the acquired business well enough to direct it.

The second and related concept is homogeneity.

The word comes from the Creek roots hom and genos, meaning “of the same type or nature,” related or akin to.

In terms of commerce, homogeneity means concentration on businesses which are similar or related. This is exactly what the conglomerates of the 1960’s, and many but not all, did not do.

In the 1960’s, the conglomerates by-and-large failed to realize that to achieve true synergy or “working together” there must first be a high degree of homogeneity among the business operating units. Instead, what many conglomerates called synergy was no more than the integration of the balance sheets at the top, with little thought as to whether the operations supporting those balance sheets were in any way compatible. The result was failure to achieve the integrated focus of action which might have helped their enterprises to become more productive, more innovative, and more competitive.

In contrast I would like to discuss the application of these concepts of synergy and homogeneity at JPI and the contribution of these concepts to the dynamic growth we enjoyed.

JP chose to concentrate in a small number of manufacturing industries which management believed our backgrounds and experience qualified us to manage the operations and finances effectively.

It might be said that we approached managing our growth in four phrases: definition, strategy, process, and implementation.

Before the first acquisition was made, we defined the basic criteria for JPI business endeavors. Products should be small durable goods which are finished products or components, priced at less than $1000 per unit, and sold in a developed industry. Companies should have above average potential for improvement in earnings based on the improved management or expanded market position or both which JPI leadership could provide.   Plumbing-ware and engine components were then identified as the most attractive Industries for  participation,

We then used the concepts of homogeneity and synergy, as well as a commitment to multidimensional markets, as key elements of acquisition strategy.

First: where are the similarities of the potential acquisition with our current companies? Are there similar products or complementary products? Common technologies? Identical marketing patterns?

Second: how could the potential acquisition contribute to the group as a whole beyond the obvious addition of its own current volume and earnings? Greater manufacturing efficiencies? Market expansion? Sales leverage?

Third: what might the potential acquisition contribute to the diversification and balance of markets in which JPI products are sold? New markets opened? Current markets expanded or strengthened?

Answers to these questions focused on the contributions an acquisition could make to JPI’s industry group and corporate goals and were thus critical factors in the decision to proceed with negotiations. Let me illustrate the results of this strategic thinking approach from our experience.

JPI has acquired five companies in the plumbing-ware field. Three were faucet manufacturers: SAYCO in 1980, Bradley corp., and Federal-Huber Corporation. Another, Garvin/Guarantee Specialties that made plumbing stampings and components such as drains and strainers. The largest acquisition made in this industry was Briggs Plumbing-ware. Inc. Briggs produced ceramic items including toilets, lavatories and bidets as well as enameled steel tubs.

Our strategy was to buy companies whose product lines contribute to an ever-wider JPI plumbing ware franchise. Every purchase is planned to work together to increase our market presence and thus our leverage as the nation’s largest and most diversified secondary supplier.

What to synergize?

In my opinion, a company can synergize effectively only what is functionally homogeneous. The most critical areas seem to be manufacturing and marketing/sales . . . manufacturing because it represents the heaviest capital investment and fixed assets/costs, marketing/sales because it is so tightly tied to the established and evolving style, distribution network (channels) and demand patterns of specific industries.

JPI purchased three faucet companies. Products included several styles of single and double-handled as well as washer less faucets – all very similar and all manufactured in roughly the same way. Because of the great operations similarities in faucet manufacturing, JPI was able to merge the three companies into one, thus producing the same range of products much more cost-effectively at one manufacturing facility under one management.

Moreover, the distribution channels for faucets were the same as those for all other types of plumbing-ware. When JPI bought Briggs, we immediately became a significant factor in the industry and we gained a national sales force. Thus, JPI realized a further advantage in faucet sales as well as a broadening of Briggs’ product line by transferring sales responsibility for faucets from manufacturers’ representatives to the Briggs sales force. The transfer enabled our salespeople to meet a wider range of the customer’s needs using more of our products with minimal additional investment.

The Briggs’ pottery or vitreous china plants also illustrated this strategy. When the Wartsila group from Sweden decided to cease production of vitreous china in the U.S., JPI bought their plant at Colton, California, The addition of that plant provided JPI with a much-needed west coast manufacturing and distribution center and thus greatly increased sales potential in the important western markets. The five pottery plants were homogeneous in operations, but varied sometimes significantly in technology development and application. JPI began to make strides in improving the performance of all five plants markedly by exploiting opportunities for synergy. Significant advantages were achieved by identifying the plants most advanced in such areas as mold design, utility of technology and quality control, and applying these superior methods in all five plants. Also, we were better able to balance our production scheduling among the plants on the basis of what products are in demand and where.

Overall, the consolidation of homogeneous or similar functions within our current operations and the on-going acquisition of companies in the plumbing-ware   enabled JPI to achieve market share, service options and cost efficiencies which no one of these companies could have achieved independently.

In the engine components sector, JPI also adhered to its basic criteria. There have been four significant acquisitions in this area: American Metalcraft, that made steel and aluminum stampings for the automotive industry as well as for other industries such as industrial building products and refrigeration.

The Weyburn-Bartel Group the largest independent manufacturer of camshafts in the western world.  Customers included manufacturers of automobiles and trucks, farm equipment, ships and locomotives. Penske made metal automotive stampings.  That operation was later merged into AMC.  JPI’s acquisition of D.A.B. Industries, Inc. included various types of fluid film engine bearings, power transmission friction plates, and bushings for automobiles, light trucks, and a variety of non-automotive engines and vehicles.

While there is a lesser degree of homogeneity in production techniques among the engine group operations, there is a high correlation in the markets they serve and in some instances, in their applications.

The best engine component example of our strategy in action was in the aftermarket automotive sales. D.A.B. had an excellent position in the aftermarket under our trade name Michigan Engine Bearings. Weyburn-Bartel, which makes camshafts, did not sell to the aftermarket prior to our acquisition. We could gain greater leverage and added sales by offering aftermarket customers a wider range of engine parts. Thus, Weyburn-Bartel camshafts were an excellent candidate to package with D.A.B. engine bearings. The combination offered initial OEM vs, aftermarket balance for Weyburn-Bartel and as well as increased promotional opportunities for both product lines at minimal added cost.

Looking toward the future, this aftermarket packaging opportunity focused JPI’s attention on additional products which would enhance our aftermarket engine components impact and thus triggered acquisition activity specifically planned to provide further synergy.

Market diversification

In both plumbing ware and engine components, JPI also looked for wider market diversification. In plumbing ware, for example, JPI was selling to both residential housing and commercial building sectors, both for new installation and for remodeling. In engine components, JPI was selling to original equipment manufacturers and the aftermarket, to automotive and non-automotive customers, and to the international firms as well as those in the U.S. Diversification helped to offset economic cycles in individual industry segments and thus contributed to stability in growth and performance.

Definition and strategy were followed by the actual acquisition process. Once we decided that the fit would be good, we negotiated and signed a letter of intent. And then we took a step which is to my knowledge, highly unusual if not unique. As part of the final negotiations, JPI developed a concrete action plan for the potential acquisition. We assigned one of our two senior vice presidents to lead a team which analyzed the company thoroughly in such areas as products and markets; competitive environment; product line strategies; manufacturing problems; management information systems; capital expenditures; management assessment; and financial statement analysis. On the basis of the action plan, we made the final “go – no go” decision.

A “go” decision triggered both the action plan and renewal of acquisition strategy considerations in terms of our next move.

The final phase was implementation. The action plan for a new acquisition was initiated within two days of the closing. Management of the acquired firm was gathered together with JPI leadership to review the plan, to which many of them had considerable input; to make any needed adjustments; and to focus on priorities. Our initial goal was to accomplish the turnaround or immediate improvements possible. Our longer range goal was to develop the internal growth potential of the business within the context of JPI. Our compound growth   rate   of   more   than   15 to 20%   in   sales,   earnings   and earnings per  share which we achieved.

Establishing a third leg

JPI went through this same four-phase approach in our consideration of establishing a third leg. For the initial acquisition in a new field, size was also a factor of primary importance. Would candidate X be large enough to command a strong market positron by itself?   Or, if not, would other complementary companies meeting JPI’s criteria be available for purchase?

I would like to leave you with the proposition that the rapidly-changing business environment of today and tomorrow demands and will reward the clear-sighted pursuit of homogeneity and synergy in organizations. Peter Drucker, in his book Managing in Turbulent Times, says, “… in turbulent times, the first task of management is to make sure of the institution’s capacity for survival, to make sure of its structural strength and soundness, of its capacity to survive a blow, to adopt to sudden change, and to avail itself of new opportunities.” A significant part of that management mission is the proper selection and cultivation of appropriate products, whether goods or services. Drucker made two especially pertinent comments on that issue. First, he said that in many markets one cannot service by offering products which are simply the least risky and are adequately profitable. Instead, in many markets, one prospers only at the extremes – either as one of the few market leaders who sets the standard or as a specialist supplying a narrow range of products or services but with such advantage in knowledge, service and adaption to specific needs as to be in a class of one’s own. Second he says, and I quote:

Most profitable units

“The most profitable businesses over long periods of time are single-product businesses with the right product, the IBMs or GMs* The least profitable businesses over long periods are single-product businesses with the wrong product – typically the traditional steel Industry in developed countries. But businesses diversified around a core of unity and especially around market unity are as profitable and successful as single-product businesses in the right products.”

JPI had chosen the single set of product criteria which I mentioned earlier: small durable goods which are finished products or components, priced at less than $1,000 per unit, and sold in a developed industry. Subsequently we carefully selected those industries in which we could achieve leadership and/or specialist positions and targeted our acquisitions activity to expand and strengthen around that core of market unity.

We looked for businesses which had similar or complementary characteristics including markets, materials, manufacturing processes, marketing and sales patterns, and distribution channels. That’s homogeneity. Then we concentrated on getting those various elements to work together by focusing our resources on maximizing productivity and thus on maximizing results. That’s synergy.  These were the keys to JPI’s dynamic growth.  JPI was merged in to a larger corporation and its share holders, on average, had significant gains well above those reflected by companies in the metal, ceramic, and plastic working industries

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