C&C II : RIO Di JAIMM
Item 'DI : Analysis of Strategic Issues
IMODUCTION
1. The purpose of this session La to identify the main strategic issues
which will need to be resolved if we are to be successful in achieving
the objectives we have sot ourselves.
2. The ground that I intend to cover Ls summarl.sed an the first slid*:-
(a) I will start by recalling our objectives and the strategies that
have previously been agreed.
(b) I will then go an to review the prospects for the business
environzent and the implications for the Group.
(c) Following an from this, I will pick up an some of the key points
made by David Allvey in his review of the financial Forecast.
(d) Finally, I will suggest the Issues which I believe to be most
Important and an which I think we need to concentrate over the
remainder of the conference.
3. Let us start by considering our agreed objectives and strategies.
B.A.T INDUSTRIES' OLMCTIVES
David Allvey has already sumarised our main Financial Objectives and what
I would like to do now is to extend these to cover the more qualitative
aspects of the objectives and strategies for the business.
Although these are familiar to most if not all of the people here, I think
It is a good discipline to remind ourselves what they are to ensure that we
are still. satisfied as to their validity.
1. Our central objective is to provide our shareholders with an
above-average return on their investment in B.A.T Industries through
dividends growth and through increases in the capital value of their
shareholding (SLIDE II).
2. We believe that to do this we need to alm for earnings per share
growth of at least 15% P. a.
3. Our guideline objectives for the individual businesses are derived
from this central Group objective and our &La is far each bus
within the Group co achieve a return such that it generates sufficient
cash both to cover the cost of servicing the funds employed in the
business (through dividend and interest payments) and to achLeve
self-funded profits growth at rates La line with the target for the
Group overall.
4. Provided that a business is achieving an acceptable level of return,
the cash generated can either be invested in supporting its own growth
or it can support growth elsewhere in the Group, either directly or
through acquisition. Rowever, It is obviously more satisfactory to be
upporting organic growth and for this reason we have an objective for
high proportion of our businesses to be positioned in such a way
that they have a good potential for growth. %C
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5 An important qualitative objective is that our businesses should seek
to be in leadership positions in their markets with strengths based an
defined competitive advantages since it is only through this that we
can have reasonable confidence of our ability to meet our quantitative
objectives.
6. To Prevent the dissipation of financial and managemenc resources, we
also ain co focus an a limited ramp of activities in Tobacco,
Retailing, Paper/Pulp and Financial Services.
7. Finally, we have an objective to control the risk profile of the
business and this is taken into account both La determining the
Industrial and geographical split of the Group's activities and also
in the objective to ain for a DebrAquity ratio limited to around 50%.
AGIM STRATECIES
1. Our current strategies were largely set In place as a result of the
Strategy Review carried out in 1982 and have evolved consistently
since then. Those strategies can be summarised as follows
(SLIDE IIZ):-
(a) To maintain or improve the returns from Tobacco and to continue
to pursue profits growth in this activity - coalising, however,
that this will noc be enough to utilize all the cash generated.
M To improve the returns in Retail and Paper/Pulp and to seek to
position these businesses for sustained long term profitable
growth.
W To enter Financial Services and to establish this as a major
Group gctivit7-
(d) To withdraw progressively from activities outside the sainstroam
of Group development.
2. We also have a strategy to concentrate our development in North
America and in Europe. In doing this, we have not made a decision to
withdraw from our involvement in the rest of the world. Howevor,
taking into account the relative prospects and the risks involved, now
investment in the developed countries in the North Atlantic region is
considered to offer better prospects than investment elsewhere.
3. It could be argued, of course, that taking Into account the relative
prospects for growth, combined with reasonable political stability.
the Pacific Basin would offer ov*n better prospects than the North
Atlantic but we have taken the view that we have a stronger base on
which to build closer to home and until this is firmly established, ve
do not have a sufficient capability for an aggressive pursuit of
expansion in the Pacific las in area. This does not mean that we
should ignore these 3arkets and the success achieved with the export
of cigarectos to Japan, Korea and Taiwan is an illustration of what
can be achieved. However, for the time being at least. these NJ
countries are likely to have more significance as export markets CD
rather than as markets in which to invest.
4. Taking an overall view. we have bean reasonably successful in
implanting our agreed strategies and this has bean reflected both La
the composition of the Group and also in the financial results that
have been achieved.
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5. While this Ls encouraling however, we also need to look at the
potential for maintaining progress in the future, measuring ourselves
against the objectives to achieve competitive leadership and to be
positioned for growth. I shall return to this later when I consider
6. :ach of the major activities in more detail.
afore doing this, however, we need to consider the influence of the
business environment on the Group.
mm BUSINESS UVIROMW
1. In assessing our past success, a signif icanc factor which must be
taken into account is that we have been operating in a very fawwrable
environment with sustained economic growth. In addition, we have had
the advantage of price levels in the US cigarette market influenced by
the desire of R.J. Reynolds and Philip Morris to maintain a strong
cash flow LA order to finance their diversification.
2. Taking the world as a whole, the period since 1983 has been
characterised in the developed countries by sustained growth and, to
1986 at leasc, by reducing levels of inflation.
3. The economies of the developing countries have been lass successful
with wide variations in growth rates and, in many countries, very high
rates of Inflation. -Despite this, the developing countries have still
benefited from the high growth rates in the developed countries
ling then to boost exports and to meat some at least of their debt
:ervicing requirements.
4. What we need to consider now is how the future is likely to compare
with the past.
5. -he next slide shams the consensus forecast for economic growth in
ome of the major countries of interest to the Group. You will see
;red this that there Ls general expectation that growth will be less
La 1999 than La 1998 and that 1990 will be lower again. Of course,
those are only forecasts and recent experience has been that the
actaal per!ormAnce of the economy has exceeded the forecasters
xpectations, with growth holding up much better than expected.
Despite this. however, I think we must still be prepared for growth
lower than in the recent past. This will have particular implications
for our Retail and Paper/Pulp businesses and these have already been
reflected La the forecasts and plane for these activities.
6. Taking a regional view, the initiative to move towards a Single
European Market will improve the overall prospects in the EEC. It
will also be significant in creating opportunities as the structure of
the market changes and as restrictions on cross-border trading are
relaxed. ,.I suggests that it may be appropriate to give special
emphasis to seeking opporzunictes within Europe over the next few
years.
7. Elsewhere La the world, the pressures on the economies in the
developed countries are likely to lead to reduced exports from the
developing countries leading in turn to a worsening of the economic
and political climate, especially in Latin America and in other
countries with a debt problem.
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8. The next slide (SLIDE V) shows the forecasts for inflation
demonstrating the upward movement that has already occurred. la this
case, the forecasters may have erred on the side of optimism and it
would be wise co be prepared for some further increase in infLacion.
9. One of the means used by Governments to combat this trend has been an
increase in interest rates and apart from affecting the Group
directly, this will also act as a brake on growth.
10. There is slightly better news for the Group an exchange races
(SLIDE VI) where a comparison of the current exchange ra t*s . with their
purchasing power parities shows Sterling to be overvalued in relation
both co the US Dollar and the Dautschemark. Since the financial
forecast is constructed at constant exeunp rates, this
undo rv a I uat ion of the profits from the US and Germany represents an
added potential for growth over the longer term when, as expected, the
currencies move towards their purchasing power parities.
11. Despite this positive factor, the overall prospect is for an
environment which will be less favourable than in the recent past and
this has been taken into account in the discussion of the prospects
for each industry group.
12. However, although it is obviously important that we take the general
conomic environment into account in our planning. we must not be
economic eaviro by it. Achieving growth at the rates which we have
sac ourselves as targets depends an identifying specific opportunities
to grow much faster than the average for the economy as a whole. This
depends on being innovative and creative. on establishing competitive
advantage and on pursuing aggressive strategies. We must be able to
do this in bad times as -doll as good and this is the approach we must
follow within each of our major activities.
13. Before moving on to chis, howevec. let us first consider the prospects
for the Group as a whole as shown by the Group Financial Forecast.
GROUP FINANCIAL PORECAST
1. In his paper, David Allvoy showed that based an the forecasts in the
Operating Group Plans, the Earnings Per Share for the period to 1993
are forecast to increase at an average of 15% p.a. in line with the
Group's objectives.
2. Over the period, there is a forecast net cash generation of
11.6 billion but this is critically dependent an the cash
contributions from Tobacco. with a cuaulacive cash flow from trading
of over L4.3 billion over the next five years.
3. Important conclusions from the Financial Forecasts are:-
W The need to secure the profits which are included in the
forecasts for the existing businesses.
(b) The importance of the cash flow from Tobacco.
(c) The limits, at least in the next 2-3 years, an the resources
available for mxjor investments in expanding, developing or
repositioning the Group's businesses.
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4. These conclusions have been taken Into account when considering the
issues for each of the major industrial activities.
S. At the same time. chore is also a Group issue in considering what might
be done to increase the total resources available to support the Group's
development.
6. One way of increasing the resource availability is to realist surplus
"sets and there is an exercise in progress at present where the Centre
is considoriag with the Operating Groups whether some asset realisation
might be appropriate.
7. As an extension of this, we also used to continue to consider actively
the divestment of businesses which are either not capable of'sioating the
Group's performance criteria or which are peripheral to the min
directions of strategic thrust. Obvious candidates for consideration La
this respect are VC Instruments and the Zurotoc business in Germany. In
both cases, chore is 12plicic agreement that the longer cars future for
these businesses must lie outside the Group and the main Issue is
determining the optimum timing for divestment.
8. We will continua co consider at the Contra what action we might take to
Increase the resource availability of the Group. WUc I would Like us
to concentrate an at this conference Ls the opportunities open to us for
development and the resources we will need to pursue these.
9. Let us start by considering Tobacco.
TOBACCO
I. The Tobacco businesses are important as the major source of cash to
support the dividend and to invest in other aczivitios.
2. However, it is also an Important source of profits and in considering
the strategies for these activities, we should look first at the ways in
which we can grow these profits.
3. The consolidated Group forecast for 1989-1993 shows trading profits from
Tobacco growing at 92 p.a. and levels of profitability which are
suf to generate a substantial cash surplus.
4. Key issues for discussion in the session on Tobacco (SLIDE V11) will
be:-
(a) Are" of sensitivity in these forecasts and in the underlying
assumptions.
(b) Likely developments in the competitive environmenc with particular
reference to the extent to which the new financial pressures on
R.J. Reynolds and Philip Morris and the comparatively poor showing
of the other major Tobacco companies represents an opportunity for
B.A.T Industries.
(c) Likely technological-trends in products and processes within the
industry and the adequacy of the current R&D programme an a meano
for enabling the Group to establish a competitive advantage C@
through having a capability to build an the recent good record in
launching innovative now products and in establishing facilities
for lowest cost productint.
(d) Opportunities for strengthening the curcent rather weak market
position in Europe and the costs of doing this relative co the
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5. Finally, I think we should also take the opportunity to discuss how
far the expanded Tobacco Strategy Review Team meets the need for
coordinating Group policies and strategies and to discuss whether any
further strengthening of co-operation might be desirable.
TTNANCULL SUVICES
1. FiaancLal Services is now the second largest contributor to Group
profits and will soon overtake Tobacco as the largest.
2. An important characcariscLc of the activity is that It can expand at
fast rates without needing additional injections of funds.
3. a key strategic issue (SLIDE Vill) will be the extent to which we are
happy with the current spread of activities, taking into account the
prospects for each class of activity.
4. We will also need to discuss whether there are any specific
weaknesses we need to eliminate or any specific opportunities we wish
to pursue, taking into account the likely developments in the market
and especially those resulting from changes In the regulatory
environments and from the European Single Market initiative.
5. An important Issue will be the proposed priorities for investment,
which will need to be discussed in relation to the relative
attractiveness of the opportunities open to the Group and to the
levels of resources required for the pursuit of those opportunities
which are considered to be most attractive.
6. In view of the scale of investment that aight be required in order to
become escablished in a now market, we may also need to consider the
implications of possible Joint Ventures as an alter-native to straight
investment.
7. We also need to consider organizational issues. At present, Eagle
Star and Allied Dunbar act separactly and although there is sow
co-ordinacion through the B.A.T Financial Services Board, it may be
appropriate to consider whether there might be some benefit in
considering ocher structures for pursuing development.
S. All of chase are part of the wider question which was posed yesterday,
which is to determine how we can beat grow our Financial Services
activities.
RETAIL
1. In Retailing there are some success stories In Imasco, but none of our
other businesses except Argos mamcs the Group's criteria for earning
acceptable returns and having a proved p,ocancial for growth.
2. Argos has achieved a compound growth rate of 24Z p.a. in sales over
the five years 1983-1988 and is projeccing growth of 13% P. At. to 1993.
The returns in this business are such chat It is also projecting a
cash surplus of L140 million over the period and will pacrace a
further L50 million of borrowing capacity through its retained NJ
profits. C)
3. An Issue for discussion (SLIDE IX) will be tho 4bLlity to sustain the "IN
growth rates and profitability, taking Inca account market penetration %O
and the emerging increase in competition.
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4. .4 second issue will be the potential for developing now retail
businesses within B.A.T Stores, taking into account the relatively
poor record of success in past developments such as Country Market and
7he Jewellers Guild.
5. BATUS retail has shown sales growth of 7.1% p.a. and profits growth of
only Z-1Z P.&. over the past five years. The plans for 1989-1993 show
Sales growth of 8.5Z P. AL. , profits growth of 17.7% p.a. and RONA
rising from 15% in 1988 to 26.9% in 1993. However, the not cash flow
!or 1989-1991 is minus $215 million and, even after taking into
account sales of receivables and additional borrowing capacity, is
till positive only to the extent of $90 million up to 1991, before
:howing a surplus of $360 million in 1992-1993. The 1984-1988 annual
rates of growth for Saks at 7. 5Z and Marshall Field's at 9.5% compare
with 34-.2% for The Limited, 24.9% for Nordstrom, 21.9% for The Cap
and 28-2Z for Dillard Department Stores.
6. A key issue for discussion will be the nature of the new initiatives,
enabling BATUS to forecast performance which is so much better than
has been achieved historically.
7. A second issue will be the potential for achieving accelerated growth
once acceptable levels of performance have been achieved.
B. la Germany, the separation of Horton into a Galoria chain of 39 stores
and a residual Extra chain of 13 stores has been completed and IATTG
&.-a formulating plane covering both the development of the Calerls
chain and the ultimate disposal of the remaining stores. However, the
:xisring plans show relatively poor returns, at Least up to 1993.
ssues for discussion will be the ability of Borten to earn acceptable
rtcurns and to grow in a market segment which over recent years has
grown at only around 1% p.a.
10. For Imasco, the issues for discussion will be the future of Peoples
Drug and the way in which Shoppers Drug, Hardeas and UCS are expected
to contribute to the overall development of Imasco.
II. Timally, caking a more general view and taking into account our rather
li=itod success in retailing, it may be appropriate to ask what value
we are able co add to this activity.
12. This should then lead on to a rather wider discussion to determine
whether we see realistic options for growing the Group's retail
businesses in a way chat would meet our objectives.
PAM/PULP
1. The Group's main Paper/Pulp activities are Carbonlass Paper (including
Thermals) and Fine Papers. backed by Merchanting in Europe and by
Eucalyptus Pulp manufacture in Iberia and Brazil.
2. The market growth rates for Carboulass are tending to tail off, having
been over 10% in the early 1980'$ but falling to 7 or OZ for tht past
two years. The current forecast is for future growth at only 4-5% CD
p.a. and this, combined with increased competition. will make the
market significantly more competitive.
3. The main strategic issue for Paper/Pulp is-the need to formulate a (Jr.
renewal strac4gy repositioning the business in markets with prospects
for long term sustained growth better than those offered by
Carbonless. 4bb
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4. The development of the Thermals businesses can contribute to this
renewal '3uc the scale of the activity is still small in relation co
the Ca rbo nles business so that even after 5 years of an expected 20%
growth race. the total market for Thermal papers is still expected to
be only !OX of the market for Carbonless.
S. In the discussion of the options for business renewal (SLIM X), key
issues will be:-
(&) The Identification of businesses of significant size which are
capable of providing the levels of returns and growth rates
which are required to meet the Group's criteria.
(b) The investment required to establish the Group in a leadership
position in the chosen market sector.
(c) Alternative strategies for repositioning the business without
increasing the Group's total investment in Paper/Pulp.
(d) The opcions for accelerating growth in the Brazilian paper
business.
(a) The extent to which investment in Paper/Pulp by SAM. is an
attractive option for that business.
MANAGEKW TLSSURS
1. So far, I have concentrated an the evaluation of sensitivities, an the
identification of new opportunities for investment and an the
financial resources which would be required to pursue those.
2. However. there is another resource which is even more important than
the financial resource and that is the management resource.
3. A disappointing feature of the Group's performance over the past few
years has been the failure to evolve viable strategies for the longer
tam development of the Group's activities.
4. This has shown up in particular in the Retailing and Papec/Pulp
activities where the need to identify new growth opportunities and
renewal options is becoming increasingly urgent.
S. The failure to develop these strategies is evidence that we do not yet
have the quality of management that is necessary co do this either at
company level or soco particularly at Operating Group level.
6. Key issues to be discussed must be whether the current management
resource has the capability to add value at Operating Group level.
whether we are organisod to make the beat use of the management
resource available to us and whether we have system in place co
ensure that we recruit, develop, retain and motivate the quality of
Managers required to develop our businesses.
7. It is a measure of the importance placed an this subject that we have
scheduled it as the next item for discussion at this early stage of
the conference.
S. However. before inviting Tom Long to introduce the subject, are there
any questions or comments an the more general subject of the main
strategic issues for the Group? IN:
RS/ DJA 28th April 1989 (J",
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BAT Industries document for Province of British Columbia 22 April 1999