Case F3
Business Divorce
Two breakups: ICI and Hanson
1
In 1993 and 1996 respectively, ICI (Imperial Chemical Industries) and Hanson plc demerged. ICI was split into two, and Hanson was divided into four. This type of business reorganisation is a radical strategy to adopt, and is likely to be only undertaken in the face of growing organisational and financial pressures. Both ICI and Hanson faced such pressures.
From a traditional economic point of view it might simply be argued that both ICI and Hanson had grown too big, with diseconomies of scale reducing their profits and making them less competitive. To some degree this was true. ICI, in particular, prior to the late 1970s, was seen as a highly bureaucratic conglomerate that had little strategic focus and was slow to respond to change. Even so, demerger was a radical form of surgery to deal with what was essentially a form of organisational inefficiency.
In fact, when we look more closely at ICI and Hanson we find that their problems were more to do with how they grew, and not necessarily with the process of growth itself. Both ICI and Hanson pursued growth strategies which involved diversifying their business interests. There were differences between them, however. Whereas ICI might claim that its diversification came mainly from new product development and its own R&D investments, Hanson diversified by acquiring other companies via merger and takeover. But despite these different approaches to the process of diversification, both companies came to experience very similar problems and a need radically to restructure their business operations.
The case of ICI
ICI was created in 1926, following the merging of the Britain’s four biggest chemical companies: Brunner Mond, Nobel Industries, United Alkali and British Dyestuffs. The merger was motivated by growing international competition, especially from Germany.
ICI’s big break came in 1933, when, by accident, it discovered polyethylene, or, as we know it by its trade name, Polythene. It has been calculated that, since 1933, ICI has patented a further 33 000 new inventions.
ICI remained firmly rooted in the UK market until the 1960s, where it operated as a virtual monopoly. In the 1960s it began to broaden its horizons and moved, usually via merger and acquisition, into Europe and the United States. At this stage of its expansion, ICI sought to produce in these countries similar products to those it was producing at home (which covered a very wide range of products indeed).
In the 1970s, as competition in the chemical industry intensified and ICI’s growth slowed, rather than reorganise its business interests by reducing its product range and focusing more closely upon its core business activities, ICI maintained business as usual. One of the principal reasons why it did not reorganise was simple inertia and opposition within its organisational structure. Even where products were failing, and clearly falling behind the products of rival companies, powerful divisional directors were reluctant to relinquish or scrap part of their domain. Change was very difficult to implement in the face of such vested interests.
ICI’s business environment was to take a turn for the worse with the UK recession in the early 1980s. The depth and length of the recession hit ICI hard, forcing it once again to look at its organisational and cost structure. Between 1978 and 1987 ICI was to shed some 50 000 jobs. It also began to devolve more responsibility for strategy and investment decisions to the company’s divisions.
By the early 1990s, following a further review of ICI’s strategy and organisation, it was decided that ICI would focus more clearly on core business activities, concentrating resources on pharmaceutical products, agrochemicals and seeds, specialities, explosives, paints, materials, and industrial chemicals. Its organisational structure was also revised, with clearer lines of responsibility established between different management levels.
In May 1991, the acquisition of 2.8 per cent of ICI’s shares by Hanson, a company with a reputation for acquiring businesses that it considered had undervalued stock, forced ICI once again to look at its organisational structure and at whether it was enhancing shareholder value. By this point in time, the pharmaceutical division of ICI was by far the most profitable component of the company. Profits from it were used to prop up the less profitable divisions, which tended to drag ICI share prices down. In other words, various parts of ICI were more valuable than the whole. It was quickly realised that, unless shareholder value was enhanced, a takeover might become inevitable.
It was decided that radical surgery was necessary and that ICI should be split along technological lines. On one side, there were the divisions of pharmaceutical and bioscience-related activities, and, on the other, ICI’s traditional chemical divisions.
Each group of businesses were argued to form an industrial cluster, where there existed strong technological and manufacturing links. For example both pharmaceutical production and agrochemicals combined biology and organic chemistry in their research and development programmes.
The supporters of ICI’s demerger argued that the synergy between its parts would be enhanced by creating these two clusters, which under the old ICI structure had deteriorated over time. The deterioration had occurred because businesses within ICI had become too diverse. They came less and less to share the same technological and manufacturing requirements. Thus services provided centrally by being part of ICI, such as access to technology and reputation, were either of no use, or something that each division could more successfully provide itself.
In 1993 the pharmaceutical and bioscience divisions of ICI were demerged to form a new company called Zeneca. The chemical division became the new ICI.
Business organisation following the demerger of ICI was simpler, and corporate objectives more easy to identify. In addition, as Owen and Harrison (1995) remark, the challenges facing managers at Zeneca and the new ICI could now be dealt with more effectively, given that the differences between them no longer forced them to compromise.
Zeneca’s task is to manage high growth based on innovative new products; the emphasis is on strengthening the company’s Worldwide sales organisation and on improving the productivity of research and development. ... ICI’s chemical businesses, by contrast, are cyclical, supplying such industries as mining, textiles, and construction. They are mostly capital intensive and much less dependent than Zeneca on research. Their goal is to achieve world market leadership for the areas in which ICI has a technological advantage; and their continuing urgent need is to reduce overheads, improve the utilisation of assets, and raise manufacturing efficiency.[1]
The key to understanding ICI’s problem lies in the diversity of its business interests, and the fact that this diversity, primarily as a result of technological change, grew over time. Different divisions within ICI’s operations required different strategies and approaches, which were either of no use to other divisions or even generated a conflict of interest.
The case of Hanson plc
Hanson, like ICI before it, was to demerge in the 1990s. In September 1996 it was announced that the conglomerate, with a turnover of £12 billion, was to split into four companies covering energy, Imperial Tobacco, chemicals and building materials.
Unlike ICI, Hanson operated via a relatively simple organisational structure, in which the headquarters involved itself very little in the formation of each business’s individual strategy. Businesses within Hanson were run very much as ‘stand-alone’ business units. The headquarters was more decisive when it came to finance and investment, where strict controls were imposed over expenditure decisions. The reasons for such a policy were clearly identified in what Lord Hanson saw as the corporation’s principle aim:
To invest in good quality basic businesses providing essential goods and services for the consumer and industry, and to obtain an improving return for shareholders by maximising earnings per share and dividend growth. [2]
Predictably, tight financial controls over investment and growth were put in place, as investment and growth tended to depress profitability and shareholder value in the short run. As a consequence, the favoured means of business growth for Hanson was via further acquisitions, rather than through strengthening existing business interests.
In total, it is estimated that Hanson bought 35 companies in agreed takeovers and a further six via hostile takeovers. It made 15 unsuccessful bids and took significant share holdings in a further 22 companies for a significant period of time.[3] Hanson’s acquisition strategy was to buy companies he thought were undervalued. The purchase of the Imperial Group in 1986 is one such example. Hanson purchased it at three times the book value. He subsequently sold many of Imperial’s assets to make a sizeable profit.
Things began to go wrong for Hanson in the 1980s, as growth began to slow and Hanson attempted to maintain high share dividends. In the past, the problem was easily overcome by acquiring new businesses. But now Hanson plc had become a victim of its own success. The size of the necessary acquisitions to meet the dividend requirements of shareholders was growing ever larger. This raised the problem not only of finding large potential acquisitions to meet the company’s requirements, but also of funding them.
As a result of Hanson’s acquisition strategy, it had become reliant on natural resource companies which operated with weak cash flows. As a consequence, funds for further acquisitions could only be raised by selling existing business assets, usually the most profitable ones. The difficulty was that Hanson’s portfolio of businesses was steadily weakening over time, as the best-performing stock was sold to purchase low-performing assets. In addition, many market analysts came to question the wisdom of Hanson’s acquisitions, and the degree of diversification it was creating.
JP Morgan and Company has developed a UK ‘Corporate Clarity Index’ which quantifies a company’s corporate clarity or degree of focus in its business portfolio, by identifying the different industries in which the firm operates, relative size of sales in each segment, and operating similarities among the firm’s different businesses. Firms are assigned a score on a 100-point scale: single segment firms score 100; widely-diversified firms typically score around 30. Applied to 133 UK firms between 1990 and 1994, the stock market rewarded clarifying firms in a two-year period following a major business shift as follows: clarifying firms outperformed the stock market by 8.5 per cent annually and outperformed diversifying firms by 14.5 per cent annually. In a two-year period, firms with increasing diversification and reducing clarity scores experienced a 6.0 per cent market-adjusted decline. Thus, investors penalised conglomerates for unrelated diversification and rewarded firms with improved corporate clarity and sharper focus.[4]
Hanson plc clearly fell into the category of diversified businesses that had a reducing level of clarity, and by 1996, with share prices falling, Hanson announced the conglomerate’s demerger.
Questions1.Identify the different types of diseconomy of scale? How might these be relevant in explaining the fortunes of ICI and Hanson?
2.What advantages and disadvantages are there with a growth strategy of diversification? Relate this to the experiences of ICI and Hanson.
3.Using company reports and other financial market sources consider what has happened to ICI and Hanson shares prior to and following demerger. Using share value as a guide to performance, do the various companies created from demerger appear to have been successful?
[1] G Owen and T Harrison, ‘Why ICI Chose to Demerge’, Harvard Business Review (April 1995)
[2] G Redmayne, ‘Demerger of the Hanson Conglomerate’, Company Accountant (April 1996)
[3] M Lynn, ‘The Hanson Inheritance’, Management Today (June 1996)
[4] P Stonham, ‘Demergers and the Hanson Experience’, European Management Journal (June 1997)