Last week’s media coverage of the equity investment made by Investindustrial in Aston Martin has thus far focused entirely on the transaction, so I thought it might be interesting to step back a bit and take a look at how this new arrangement will deliver shareholder value for the company’s owners.
A recap on the meaning of strategy, value and competitive advantage
Most people are familiar with the terminology used in articulating strategy, but often become bogged down in the semantics of what ‘strategy’ actually means. The most common mistake is using the term strategy to describe a ‘very important’ plan – whether this arises from a limitation in our vocabulary or just the overuse of business shorthand, it serves to undermine the true meaning often with disastrous consequences.
Put in its most simplest form, a strategy must compose of two key elements – a plan to make the most effective use of limited resources, and the response to a competitive environment in which those resources must be deployed to achieve a meaningful goal. Without a competitive element to your plan, it is not strategic. Likewise, unless your plan articulates the trade-off between the resources available and their most effective use, then it’s not a strategy.
The word ‘strategy’ originates from the Greek word ‘στρατηγία’ (strategia), meaning office of general or command/generalship. Naturally it refers to the process of military warfare, where the goal is to make the most efficient use of limited resources to gain an advantage over your adversaries. Strategy therefore involves making a choice and also exploiting the weaknesses of your rivals to deliver a decisive advantage.
..the goal is to make the most efficient use of limited resources to gain an advantage over your adversaries.
The reason why this definition is important, is because the decisions taken in a strategy will fundamentally alter the value of the organisation which executes them. This is where a strategy is said to positively or negatively impact shareholder value, but in order to understand why this is true we first need to define what is meant by ‘value’.
Economists have long argued over the one true definition of shareholder value, but essentially it’s the sum of all strategic decisions that affect a company’s ability to efficiently increase the amount of free cash flow it generates over time – where free cash flow represents the operating cash flow (i.e. earnings) less the expenditure involved in generating those cash sums.
In its simplest form, a company is able to deliver value to its shareholders if the platform it operates to generate those earnings is more powerful than its competitors. All things being equal and assuming the rest of the business is run efficiently, this means that the company with a competitive advantage in a market will require less effort to deliver the same level of earnings as its competitors. And a company’s strategy, represents the decisions taken by its management to establish and maintain that competitive advantage.
This competitive advantage doesn’t just underpin a company’s ability to harvest earnings in a market (i.e. its competitive power), it also determines how ‘long’ this earning ability is likely to be sustained. The strategy of a business therefore represents the decisions about which of the company’s resources should be used in building a sustainable competitive advantage, and the harvesting of that advantage to deliver the highest returns for its shareholders.
With this in mind it is possible to directly correlate strategy with competitive advantage and with shareholder value, and then optimise a business to maximise its limited resources to the benefit of its owners.
Think of it as ‘The Art of War’ and you won’t go too far wrong – in military parlance, the spoils of victory are the bonuses (i.e. profits) recovered after winning, these spoils correlate to the value a business generates for its shareholders, while the choices and decisions which led to winning them are the strategy.
That’s the boring bit out of the way, let’s now relate this to Aston Martin and the decision made to partner with Investindustrial.
Aston Martin’s investment in product and market development
In last Friday’s announcement we learned that Investindustrial will be making a cash payment of £150 million for a 37.5% stake in Aston Martin, then working together with the company’s other shareholders to invest around £500 million over the next five years in developing new models and pursuing growth in the emerging markets of China, India and the Middle East.
Whether this is a competitive level of commitment, only Aston Martin can really say, for it depends on the quality of programmes already underway and the assets currently in place, but it’s worth bearing in mind this investment in product and operational development represents around 20% of annual revenues, which in most industries would signify a major transformation.
Some observers have noted how small this sum of money seems for a global car company, with BMW for example investing over $1.4 billion in engine development during the next 12 months alone. But Aston Martin barely competes with BMW (except at M6 Coupé and Gran Coupé level), instead its main luxury rivals from Bentley, Ferrari, Porsche and Lamborghini provide a better context against which to understand the strategic nature of the company’s capital investment plans.
Since Volkswagen acquired Bentley Motors in 1998 it has invested more than £1 billion in new model developments and improvements to the company’s engineering and production facilities in Crewe. Such investment is ongoing, but represents an average run-rate of less than $120 million per year – whereas Aston Martin has proposed to spend around $160 million each year until 2017.
With sales of 7,593 cars in 2011 (down from a 2007 peak of 10,000 cars pre-downturn) on a turnover of US$1.5 billion, Bentley’s R&D spend equates to around 8% of annual revenues which is well below Aston Martin, but then Bentley is already delivering an impressive 7.5% EBITDA compared to a little over 1% for Aston Martin (so it needs to put in more effort just to keep pace).
In this respect, Aston Martin’s strategy will be aimed at building a competitive advantage and lowering the gearing of this investment ratio, delivering higher earnings for less spend.
The one further caveat to bear in mind (and the reason why I’m skirting lightly over the figures) is how each of Aston Martin’s competitors choose to capitalise their R&D spend and recognise these in their accounts. Since all, apart from Aston Martin, are part of larger corporations it’s likely that all sorts of accounting treatments are in play (justifiably or not) which makes the comparison of public data less than reliable.
Ferrari announced earlier this year that it would be investing around $70 million over the next two years in developing the range of new engines for Maserati’s Quattroporte and Kubang SUV, plus top-end Alfa Romeo and Lancia models. The Italian sports car marque already spends around $140 million each year on product development on 2011 sales of 6,800 cars generating around $2.4 billion. This equates to around 6% of annual revenues, which again makes Aston Martin’s planned 20% investment seem more than reasonable.
Porsche are in a different league, volume (and profitability) wise – with revenues of $18 billion equating to around 20 times that of Aston Martin. With an operating profit margin of 18.5%, no wonder Volkswagen were so keen to buy the remaining shares in Porsche earlier this year. And despite plans to spend more than $1 billion per year on new models, that is still only around 5.5% of annual revenues.
And finally Lamborghini, with sales of 1,600 cars in 2011 and a global turnover of $420 million, the House of the Raging Bull is the smallest of the five luxury sports car makers. In the absence of any investment figures we can’t draw too many conclusions, but it’s unlikely to differ far from the other premium VAG marques, which would seem to confirm that Aston Martin’s $750 million investment over 5 years is far from ‘coasting’ and is just what the Dr (Bez) ordered to begin catching up their immediate rivals.
Aston Martin’s strategy for growth and profitability
While the headline investment figure will help refuel Aston Martin’s technology assets and the development of new models, the most immediate opportunities lie in tackling the booming luxury markets in China, India and the Middle-East. Last month the Vanquish was launched in China, and a native Regional Director was appointed, tasked with implementing the company’s bespoke service propositions (Service Clinic and ‘Q’).
Of its four rivals, Bentley, Porsche, and Ferrari have been most successful in cracking the world’s fastest growing market, with Lamborghini and Aston Martin faring less well – although the United States and China are now Lamborghini’s largest markets.
In 2011 Bentley recorded a +97.6% sales growth, with Porsche next up at +35.4% and Ferrari trailing the VAG-pair with just +10%.
Given how closely the demographics of Aston Martin’s customer base follows Bentley, this represents a large proportion of its near-term potential, even before any product development is taken into account. And with 85% of Bentley sales attributed to the Continental (GT Coupé, Flying Spur and GT Cabriolet) clearly Aston Martin’s all-new Vanquish and DB9 have a straight-out battle on their hands in 2013.
Despite Aston Martin’s financial limitations during the past three years (during which time it reduced its workforce by 30 percent), the company has not been idle, developing some of the industry’s most sophisticated customer management processes and an engagement experience that they believe is second to none. The company’s Director of Strategy & IT, Bradley Yorke-Biggs, described it in an interview last year as “..not an evolution of how we engage the customer; but more of a revolution.”
But what about the scale and “purchasing power” of the big manufacturers?
At a briefing at the company’s Gaydon headquarters last year, Aston Martin’s CEO Dr. Ulrich Bez said “All the projects that we are doing have to make a profit. We can’t afford a project that is just a marketing tool.”
Indeed, even the 740bhp One-77 turned a profit. Costing a little over $50 million to develop, the company sold all 77 of the $1.7 million supercars within a period of great economic uncertainty.
Dr. Bez, who has a doctorate in engineering, believes that Aston Martin can buy in the expertise when needed. This approach was endorsed in KPMG’s 2012 Global Automotive Executive Survey, which found that 34.5% of automotive executives preferred partnerships and alliances as the means to access new technologies and products, rather than the more traditional M&A investment.
This has been extensively proven in the past 12-years that Renault and Nissan have worked together, and is predicted to become even more widespread as manufacturers seek ways of tackling the industry’s rampant over-capacity and de-risk the development of hybrid and fuel-cell technologies.
Despite some analysts disappointment that Daimler-Benz was not part of last Friday’s Investindustrial announcement, this does not preclude Aston Martin working with Mercedes, Audi or any other major OEM in developing new powertrains and connected vehicle solutions. Indeed, according to Bez, it’s an advantage, since Aston Martin retain control of their customer experience and thus one of the marques unique competitive advantages.
The infusion of new capital couldn’t come a moment too soon, as Andrew Jackson, an analyst at research firm Datamonitor, said in a recent Bloomberg Businessweek article, “The models are starting to have a slight whiff of Sunday dinner being used in sandwiches later in the week. It leaves the impression of a company stretching itself as far as it can. In an industry where they really need to be cutting edge.”
That may be true, but one virtue of this forced austerity is an understanding of how to make a small amount of resource go a long way. That’s another competitive advantage, one which delivered a profit margin in 2011 nearly ‘double’ that of Mercedes-Benz.
The venn-diagram of its competitive advantage, shows a company with no obvious market advantage, and yet a brand monopoly on being the arbiter of ‘cool’ and one of the industry’s most efficient operational platforms.
In the automotive sector, Aston Martin represents one of the more impressive examples of strategy in action. Balancing the competing demands of resource-hungry priorities with the need to maintain its brand, the desirability of its products and the experience delivered to customers. It knows its strengths and doesn’t waste time or investment on the opportunities it cannot win.
The challenge it now faces is to take this focus, self-awareness and operational agility and scale it up to produce twice or three times as many cars. Although large corporations may indeed ‘feel’ safer for minnows such as Lamborghini, Bentley and Rolls-Royce, they are undeniably less efficient environments for delivering shareholder value and less responsive to market needs.
This is Aston Martin’s advantage in an industry bloated by over-capacity and the race towards greater size and less efficiency, perhaps small and fleet-of-foot might end up winning the day after all.
* * *
* * *