Controlling the Controllable

Executive Perspectives on Planning and Risk in an Unpredictable Global Market

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MODERATED BY

ALLEN ROOT
VICE PRESIDENT
KAILASH ANALYST
INDUSTRIAL STRATEGIST
BAIRD

PANELISTS

DAVID HUBERFIELD
SPECIAL ADVISOR
INDUSTRIAL GROWTH PARTNERS
MAC MOORE
EXECUTIVE VICE PRESIDENT, OPERATIONS
TWIN DISC
NICK SANTHANAM
SENIOR PARTNER
GLOBAL LEADER, INDUSTRIAL PRACTICE
MCKINSEY & COMPANY
Who anywhere two years ago would have predicted that oil would be down in the $40 range from well over $100? How do you crystal ball that in a traditional Michael Porter Five Forces analysis?

Long at the forefront of globalization, Industrial companies have significantly broadened their horizons in terms of production and distribution opportunities. And while the benefits have been considerable, the resulting landscape is also more interconnected and interdependent – a place where a natural disaster, a terrorist attack or even a surprising political outcome in one location can impact operations around the globe.

Baird asked a panel of global Industrial company executives and consultants to discuss the new challenges of operating in a more interconnected world. All agreed that change is a constant and that agility, adaptability and flexibility have become absolutely necessary to success.

ALLEN ROOT

HOW DOES THE EVER-PRESENT REALITY OF UNPREDICTABLE GLOBAL MARKET EVENTS IMPACT THE WAY INDUSTRIAL COMPANIES APPROACH STRATEGIC PLANNING AND INNOVATION?

MAC MOORE

As I think back on almost 40 years in industrial businesses, the theme that comes to mind over and over is that, as an industry, we so often seem to get tripped up by concentration and lack of diversification. I think that we all need to do a much better job of assessing risk in our businesses – geographic risk, market segment risk, vendor risk or specific customer risk. We're all more vulnerable to global forces that have become more pronounced, including supply chain disruptions and huge swings in commodity pricing. This is true for even the smallest businesses. I believe we all have to think more proactively about what could happen. Things that ten years ago seemed to be remote possibilities are more prevalent and more real.

Risk management was completely different just a few decades ago. We've taken such a cold shower in oil and gas the past year. Who anywhere two years ago would have predicted that oil would be down in the $40 range from well over $100? How do you crystal ball that in a traditional Michael Porter Five Forces analysis with your key executives?

Now we're taking a deeper dive and more thorough look at risk analysis. And perhaps we're being a little more pessimistic, thinking more about Plans B and C. I think we're devoting more intellectual rigor to the process. That sounds kind of stuffy, but I mean it. I think we're really vetting our options a little more deeply. We're modeling things perhaps more carefully. So implicit in this is more analysis, more discussion, more thoroughness.

NICK SANTHANAM

Most companies realize they have to do things differently in this market. How quickly they react and adjust their strategic planning is an entire spectrum.

I think the number one thing companies need to do better is agility. If you compare where we are now to the Industrial Revolution, where the sector took off, I would say disruption is happening 10 times faster. It's taken us about 10–15 years to double GDP versus 150 years from the Industrial Revolution. We're at 300 times the scale if you consider that the U.K. had about 9 million people at the beginning of the Industrial Revolution compared with 3 billion people currently in all emerging markets. All of this leads to a pace of change today that is 3,000 times greater. Today's companies need to move fast–they need to know when a change is really happening, identify the type of change, figure out their play, determine how to act and actually act. The speed of response has to be significantly higher. Some companies are definitely doing it well, but many are not.

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DAVID HUBERFIELD

In addition to my current role at IGP, I previously ran TASI for the firm and I've had a number of executive and operational roles at many industrial companies over the years. IGP owned TASI through a significant growth spurt and one of the ingredients was agility in how we planned and executed. There are several things I recommend managers do to encourage agility in planning. First – involve as many people as you can. The more people you have who understand the message, the quicker they'll execute on the message, changes to the message and changes to the strategy. Second – keep it simple. Third – keep your planning documents short, brief and to the point. Discuss strategy all the time so that it's not a once-a-year exercise. Lastly – don't dig your heels in. When it's wrong, it's wrong. If you look for that last spreadsheet, that last ROI, that last survey, you'll never get anything done. I think it's a matter of finding the right balance of intuition, fact and analysis that gets you to the objective. But when it's not working or one of your markets is clearly in some kind of more-than-short-term decline, then course-correct. These points were always central to our ability to navigate global markets.

MAC MOORE

It's not just the agility but the willingness to change course when necessary. A favorite idea is I believe the products have a right to die and that we need to be looking at our product portfolio in terms of this notion, questioning whether we really need to be quite as extensive.

I feel it's my job to get out and communicate, communicate, communicate to our team and articulate the implications of emerging trends for our business. I think it's a huge challenge, and there are things we can and should be doing better. I want to make sure that our managers are focused globally and that they're motivated to work as one focused global organization. I tell them to be actively watching for emerging trends, to be willing to revisit some of their strategic assumptions more often.

Don't dig your heels in. When it's wrong, it's wrong. If you look for that last spreadsheet, that last ROI, that last survey, you'll never get anything done.
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I believe the products have a right to die and we need to be looking at our product portfolio in terms of this notion.

NICK SANTHANAM

Also, how much a particular change impacts your business really depends on where you sit in the value chain. I lead McKinsey's Industrial practice, and we work with clients that make semiconductor chips and electronic components all the way up to the companies that make a range of full systems such as industrial motors, kitchen equipment and jet engines. We've found that those closest to the consumer see a bigger impact from major changes. Whether it is the rapid urbanization in emerging countries like China and India, the oil boom and bust, or the overall "new normal" of a shared economy in an increasingly global environment, they are feeling the impact of uncertainty more. Across the value chain from semiconductor and component companies to full systems, we find roughly a quarter of companies are well-geared to survive these disruptions and are "secure," so to speak.

Many of the companies that are doing well are leveraging two common tools to make their strategic planning as a journey instead of a once-a-year exercise. This typically entails continually re-examining the critical assumptions embedded in their business models for resilience to unthinkable events, doing shorter and quicker loops between setting the strategy, driving the strategic planning, moving to AOP/budgeting and then going back to reassess the strategy. They're also getting better at scenario planning – articulating possible futures and defining strategic options in the face of uncertainty. By employing these tools, these companies are able to better prepare their organizations for multiple plausible outcomes.

ALLEN ROOT

HOW DOES THE INHERENT UNPREDICTABILITY OF THE GLOBAL LANDSCAPE IMPACT OPERATIONS?

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DAVID HUBERFIELD

Global landscapes have always been unpredictable, but we are way more interconnected today. It used to be global diversity brought strategic offsets – one geography up, another down. Today the interdependence means events in one geography affect others quickly, so the adaptability of your organization is key. To get there, I emphasize broad-based communications, posting information everywhere so the whole team can optimize adaptability and nimbleness. Boards have become more engaged tactically and strategically with their management teams.

In addition to all of this, I think timelines have just compressed. Customers who were quite happy to wait a year for something like a full-scale system solution a year ago now want it in six or nine months. Some want it in weeks, and you go, "I've never done this in weeks. I've done this in six or nine months." I think what people that I've worked with have come to believe is you can do almost anything you want if you set your mind to it. While you might think it's not possible as a steady diet to run an organization at this 120% level, you can do it. It requires a kind of philosophy change and almost a cultural change. The industrial world probably doesn't move at this pace naturally, but your customers do, so you have to.

MAC MOORE

It is becoming so much more difficult to plan inventory and maintain delivery performance. The just-in-time order fulfillment model is a wonderful concept in a steady or rising economy. But the reality is that we are all better capital managers today across the supply chain. This implies a very conservative approach to sales forecasting and inventory retention. So for industrial businesses with longer lead times like Twin Disc, there is a fundamental disconnect in this environment between efficient working capital management and reliable order fulfillment.

Today the interdependence means events in one geography affect the others quickly, so the adaptability of your organization is key.

ALLEN ROOT

SOME GLOBAL MARKET CATALYSTS OCCUR QUICKLY AND WITHOUT MUCH WARNING. CAN YOU THINK OF EXAMPLES THAT HAVE IMPACTED THE COMPANIES YOU'VE WORKED FOR OR WITH IN RECENT YEARS? HOW DID THEY RESPOND AND WHAT DID YOU LEARN?

MAC MOORE

While it can be a double-edge sword, Twin Disc is fortunate to be fairly well-established internationally in terms of both product distribution and manufacturing. That kind of provides a natural strategic hedge against some of these global market events.

That said, there were two events in particular that really had a significant and adverse impact on our business. One was the dramatic decline in oil pricing, and the second was an unanticipated bankruptcy at one of our key suppliers. Our response to the vendor closure was timely and as effective as it could be: We reduced expenses, we looked as other vendors. But it really was a hard lesson in the reality that there aren't a lot of short-term planning options, and that there doesn't seem to be a neat device or traditional planning tool when you face a catastrophic market decline or a critical vendor bankruptcy. So, in both cases we found ourselves on risk analysis and Plan B and C contingency planning.

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NICK SANTHANAM

All companies have a strategy. Top-quartile companies have a dynamic reprioritization approach to strategy. They realize that the "playbook" is not the Bible – it is not immune to challenge. You have to be able to recognize when it's time to do something else.

A great example of this is if you go back to 2011, when the tsnumai hit Japan. Japan is the world's third-largest economy, and a lot of the Industrial supply chain sits there. After the tsunami, a number of supply chain footprint questions were raised. "Do we need to have multiple suppliers?" "Do we need to get vertical integration?" "What's our risk mitigation plan?"

What I found very interesting is some companies said, "Look, the tsunami is the kind of event that happens infrequently, and I'm not going to do something differently in the aftermath." Others fixed their "Japan supply chain issues." Best-in-class companies implemented much better, more agile planning for risk – how they identify, manage and mitigate risk. Right now, we are seeing it in the aftermath of changes in China and Brexit. The speed of response is significantly different between companies that are doing something about these events versus those that are simply choosing to live with the changes or just reacting to them.

My view has been that it's our job as managers of business to be successful with whatever deck of cards we're dealt, in whatever environment we're in.

DAVID HUBERFIELD

Clearly, the number one change that we've had to take advantage of and participate in is globalization. In my past CEO role and board work, there have always been exogenous events. We had the Asia crisis in 1998. We hyperventilated about Greece. For a long time we had mini-invasions involving Russia and Ukraine and certainly Crimea and Georgia. Most recently, Brexit emerged as a major economic and political event.

My view has been that it's our job as managers of businesses to be successful with whatever deck of cards we're dealt, in whatever environment we're in. You don't retreat under the bedsheets just because there are these external events that knock you off course. I think it's really important to take the long view. The change, operationally, has been that businesses just have to get better and better at strategy and execution.

The components of those processes seem to be more finely tuned than ever before – things like speed, agility, adaptability and a little humility to know when you've screwed it up and got it wrong. All of that should enable you to focus with customers and try to discern the drivers that create opportunity in the midst of these external events.

ALLEN ROOT

WHICH MACRO TRENDS ARE YOU KEEPING AN EYE ON TODAY AND HOW DO YOU SEE THEM UNFOLDING OVER TIME?

MAC MOORE

Our products are fairly complex, and we're very dependent on skilled labor and machining. We're going to be staying very close to shop floor technology and labor market trends.

For example, people ask if we're insourcing or outsourcing more and the answer is both. That's because some past assumptions about both are upside-down today. A company that decides to take advantage of lower labor costs in one market may not find the opportunity quite as compelling when analyzed in the full context of product delivery cost. Unexpected logistics costs, overruns in packaging costs, delays in the supply chain – sometimes, moving operations back to the U.S. can actually offset labor costs. That's part of why I think it's so important to go back and revisit your previous assumptions.

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DAVID HUBERFIELD

I worry about trade barriers and tariffs that I think work to the disadvantage of companies that I've been involved in as well as companies that export a lot. My own view is that the global markets need to stay open. I would think most people in the C-suite or close to it want that. It's good for us.

From an operating perspective, I think it's crucial to continue the talent conversation. The one thing I regret when I look back – my "What would you do differently?" moment – is about talent acquisition in the Industrial marketplace. If I ever encounter something even remotely close to 2009, which I hope never happens to all of us again, I would think more deeply about talent retention. I probably wouldn't have made some of those balance-sheet expense decisions and trimmed my technical talent pool so far. It is so difficult to build top-notch management teams and have them be cohesive throughout your organization and around the world.

There's a critical lack of top-notch engineering talent in the United States. The talent gap has certainly widened here, particularly on the software and electrical engineering side. Customers are shrinking their supply bases and want more from you as a supplier as automation and the systematization of solutions take hold. It's a tough predicament, because you're trying to run profitable businesses, and yet you need enough of the right people to get the job done quickly because customers are much more demanding. If you're quicker, you win business. Hire the best talent. Don't decide you're going to hire a suboptimal person and save yourself a few thousand a year. Hire the best because, at the end of the day, the best will pay for themselves.

Don't decide you're going to hire a suboptimal person and save yourself a few thousand a year. Hire the best because, at the end of the day, the best will pay for themselves.
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NICK SANTHANAM

If you look at the last 15 years, the Industrial sector has been the third best-performing sector in terms of economic profits, generating roughly $420 billion in delta between ROIC and WACC times the invested capital. However, these 15 years have not been homogeneous. The first phase of 2001–2007 was a period of rapid growth, with the industry growing at 9.7% CAGR and creating $120 billion of economic profit. The second phase from 2008–2010 was a period of slump and recovery, when the industry generated about $85 billion in economic profits. The last phase from 2011–2015 was a period of flatlining, when the industry generated $215 billion of economic profits but growth largely disappeared as the growth rate flatlined at -2.2% CAGR.

How will the next five years look? We believe that will be dictated by trends and subtrends in six areas: demographic shifts, geographic regions, social behavior, geopolitical and regulatory events, technology and the end markets.

We believe trends in technology and social behavior will drive the biggest disruption in the Industrial sector. For example, technology infrastructure – storage, computers and networks – is becoming cheap and even "free," which is leading to a proliferation of end devices. This in turn is driving an exponential increase in data generation, something we have never seen before. The monetization of this data will lead to different behavior and different business models, again things we have not seen before. The historical monetization model of "one-to-one," meaning I sell you something and you pay me, is being replaced by a "one-to-n" model, meaning I sell you something, and then n different people pay me. The Industrial sector hasn't figured out how to make this work yet. The puzzle of setting up this monetization model is an interesting challenge for the sector.

New companies and new segments will rise, and a bunch of current segments, product lines and companies, if they do not change, will become outdated. This will lead to more micro-cycles in the future – more booms and more busts, which will happen quickly. You will have more volatility, where certain segments are going to grow really fast while others will drop very quickly. Companies will need to be agile to dynamically reprioritize resources, bandwidth and mind share so they can capitalize when there is an opportunity. When there's no opportunity, they need to be able to say, "Okay, fine. Time to move on."

In the past, I would have said trend is your friend, but I would say going forward speed is your friend. Efficient and effective decision-making is critical. The businesses that are able to move faster will be able to capture a bigger portion of the profit. There's no question about it. It's true across the board, all the way from strategy, to strategic planning, and to developing the organization's DNA.

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In the past I would have said trend is your friend, but I would say going forward speed is your friend. Efficient and effective decision-making is critical.
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