Strategic Divestiture - Trimming a Product Portfolio to Establish a Focused and Differentiated Position

Company: 
Machine-tool manufacturer of highly specialized, custom lasers machines and coating machines.
 
 
Executive Summary
 

• Lack of external financing options, diverging synergies, and changing market demands for the manufacturing of the product segments, customizable laser machines and parts coating machines, and the impact on the operating margins requires a reorganization of the assets.

 

• The reorganization will separate the segments in anticipation of a divestment of the laser machine product segment so that the capital raised can be used to formulate and implement a strategic initiative to create a global coatings company that will offer product lines in the manufacturing of coating machines, the supplying of coating services, and the value-adds and sales of patented material coatings from the R&D department. 

​Background
 
This manufacturing company consists of two product segments and significant R&D investment.  One product segment is that of customizable laser machines, the other of material coatings machines, with a by-product offering of coating services done in-house and research developments in new coatings that have been made available for in-house services and sale

​This company is globally positioned in an international strategic governance structure, meaning positioned to optimize low cost through global economics, but with a centralized management controlling all satellite locations.
 
The two product segments were able to benefit from many synergies of support operations, supply chains, and R&D.  Currently the outlook for the product segments suggests that these synergies are diverging as the laser machine segment moves from customizable to a standardized model and the coatings machines segment is moving away from self-coating to an 

​The company’s share price has stagnated.  The company commands an oligopolistic competitive positioning in the primary product segment, the manufacturing of coating machines, however there is no projected growth forecasted for this line as all parts coating is expected to be outsourced to companies that provide coating services.  The company currently does offer coating services, but a minor revenue contributor as opposed to a primary product line.  Any change to the product portfolio and overall strategy, must be internally financed as the company has exhausted external financing options.
 
 
The Product Segment Portfolio
 
               A note on the BCG Matrix and its use to evaluate the product portfolio.

​ 

• Customized Laser Machines

 
               The product segment comprises 25% of total revenues and commands only 5% share of a market that is shifting to standardization, which would equate to a BCG Matrix ‘Dog’.  The company was positioned to focus on the high-margin, customized laser machine with competencies for high-quality and innovation.  However, the forecast suggests that the market demand will shift to standardized laser machines.  While it is expected to grow 20% on average over the next 5 years, this segment is not currently pursued and has only had incremental investments made to expand this portfolio.
 
               This emerging demand for standardization is significantly less operating margin then the customized line.  Though the company could attempt to exploit its reputation for high-quality and innovation, the degree to which it would matter in a commoditized product line is not enough to command seller pricing.

​

• Parts Coating Machines

 
The product segment comprises 75% of total revenues and commands 30% of market share in a low-growth market that is expected to stagnate over the next 5 years, a BCG Matrix ‘Cash Cow’.  With an oligopolistic dominance in this segment, there is a seller pricing power and the cash flows from operations can be funneled back into the expansion of this segment to include the coating service and further R&D development of new material coatings.
 
The manufacturing of coating machines is capital intensive; however, these machines are high-quality and the same machines that are used to provide the coating services.  The Coating services line is expected to be the fastest growing product, growing 20% annually over the next 5 years.  This market is highly fragmented and regional with no major competitors dominating the space.  The line averages a 40% gross profit and 30% operating profit margin.  It is not without risk as it is a new technology that is being outsourced by the customer base since there has not been an industry wide adoption of the process or coatings.  It is highly specialized and would provide a differentiated competitive advantage.  This is a product line that has the potential to be a BCG Matrix ‘Star’ category.

​SWOT Analysis
 

• Strengths

 
               The market positioning and market share for the primary revenue driver, the coating segment is strong.  The coating segment is highly specialized and has enabled the company to develop quality production and innovative capabilities.
 

• Weaknesses

 
               The stagnate share price and lack of external capital funding options are the primary weaknesses for this company.
 

• Opportunities

 
               Having a dominant position within the coating machine manufacturing space and already offering coating services to some degree can create an early and dominant positioning in the coating service product line.
 

• Threat

 
The lack of growth within primary segment of coating machines is a threat to revenues and due to the capital-intensive operation, solvency.  The laser machine segment moving away from the high-margin, customized lasers to a lower margin, standardized laser creates a further tightening of operating capital.

Financial Forecasts

Forecasted Product Line Gross Margins

​Strategic Formulation
              
               Capital!
 
External financing facilities have been exhausted so all capital for strategic initiatives must be internally generated. The strategic initiative needs to create a competitive advantage.  Limited capital strongly suggests divesting from a product line.
 
The forecasted gross margins on product lines and forecasted revenues of current business segments suggest that the current customized laser machine line and the standardized laser machine line, which also is the suggested direction for the line, would not be as promising as the coating machine and coatings service line.  The coatings machines, the specialized coatings service, and the R&D, that has given differentiated competencies into coating materials, all present the best opportunity for creating a competitive advantage. 
 
The coatings machine product line is, potentially, a BCG Matrix ‘Cash Cow’, defined as having a high market share of 30% in a low growth segment.  This segment is oligopolistic, and while it is not expected to grow, provides a steady cash flow and the equipment and expertise required to pursue the coatings service and the coatings material development product lines.  The specialty combined with the divestment will enable a repositioning as the global provider of coatings solutions from equipment to service to materials and further differentiation through value-adds from development of specialized coatings. 
 
Because of its global position, it could additionally leverage this reach by pushing coating services and materials globally to its developed customer base.  The current fragmented state of coatings services provides an opportunity to exploit its reach through synergies within the segment and potentially benefit from economies of scale and even pursue a horizontal integration strategy as market share is gained region to region.      
 
 
Implementation
 
 
Laser Product Line
 
There were substantial synergies developed amongst the laser machine product line and the coatings machine product line. These two segments must be separated to act independently to the greatest degree possible before any sell-side M&A activities can take place.  In addition, the market for sell-side activity for the industry showed be tested before a full commitment can be made for divestiture.  If full divestiture is not an option, there is also an option for a spin-off of the laser machine product segment into a joint venture with a capital partner such as a private equity company.
 
The future reliance upon R&D should merit special attention given that the engineers and R&D department may have been used for both product segments.  The R&D department and its facilities and personnel should be the first area to be segmented.  This area will determine the level of differentiation of the coating services and the value-adds of coatings materials.  It should be noted that once the laser segment is its own entity, it will have its own assets. liabilities and resources, inclusive of labor and intellectual property and this aggregation is what will be divested.
 
Managerial autonomy must be transferred to the laser machine segment and all compensation, bonuses, and performance metrics but reflect the activities in the new entity.  Thorough communication as to the intent to sell, assigned accountabilities, and multi-level responsibilities is essential to managing employee reaction to the change.  Attention should be given to associate performance with compensation to minimize any negative productivity change as a result of the intent to divest.
 
The degree to which a sell-side benefit of an incremental investment into the setup for a standardized laser machine manufacturing line may need to be studied.  If the market is moving in that direction, this more standardized line could prove to be an attractive selling point. 
 
 
Coating Product Line
 
The coatings segment will need to appoint leadership for the new coating services product line and initially report to an executive management member to ensure top-down involvement in the strategic initiative and maintain accountability.
 
The coating materials development may benefit from its own dedicated budget, a patent process, and a cataloguing of its tested and available specialized material coatings so that value-adds may compliment the new coating services product line. 
 
The marketing and sales team will need additional training on the new coating services product line and the value-adds associated with new coating materials such as durability and longevity.  A marketing and sales strategy that focuses on high-quality product positioning and corresponding pricing strategy is required.
 
A change management initiative implementing a direct association between compensation and productivity should be carried out.  Measurement may be linked to the product line, coating machines or coating services, and the overall performance but should also include measures beyond the financial to include customer surveys, internal process performance, and employee training and development.      
 
 
Critical Success Factors and Performance Measurement
 
A balance scorecard approach, in addition to a strategy map of critical success factors (CSF), objectives, and KPIs, will guide the short-term path to transition into the new initiative while tracking progress toward the long-term vision.
 
The first critical success factor is to coordinate a divestment to raise capital so that a focus can be placed on repositioning the company into the high-quality coatings company offering machines, services, and patented material coatings.
 
The second critical success factor is to communicate through marketing, sales, and direct contact, the new positioning and offerings to the current customer base and to inquire as to their needs in the coating services line.  Outsourcing of this activity from these customers will continue into the near future and the ability to meet their needs will make this product line successful.  Customer needs and satisfaction will assist in the capacity planning and capital budgeting for the new coating service segment.
 
The third critical success factor is the training program that is required to learn about the coating service and the material development.  Perhaps, since this product line was a much smaller add-on to the larger machine manufacturing product line, only a handful of employees needed the expertise and knowledge to provide the coating service, but as a primary product line, the factory will need a level of understanding of the coating services to be successful.
 
The CSFs are more than financial, which is why the balance scorecard approach should be considered.  The success of this strategic initiative is heavily dependent upon internal processes, customer satisfaction, and employee training.  Some measures that would be beneficial to the scorecard are as follows:
 
               Financial
                              Revenue Growth
                              Operational Income
                              ROIC
                              R&D Spend
              
               Customer
                              New Customers by Product Line
                              Current Customer Orders by Product Line
                              Total Orders by Product Line
                              Value-Adds by Order Ratio
                              Customer satisfaction Surveys
 
               Internal Processes
                              Utilization and Productivity Ratings
                              On-time orders by product line
                              Delayed orders by product line
                              Reworks, Scraps
                              Warranty Claims
 
               Learning and Growth
                              Total Material Patents
                              Employee Satisfaction
                              Hours of Training per Employee
                              Employee Turnover
 
Closing
 
The preparation of the laser segment for sell-side M&A activity is a time-consuming endeavor and requires a strategic mapping of its own to create a separate entity.  This will require managerial reorganization, process restructuring, liquidity separation and legal filings.  The sell-side will also require that there is market for the product segment but given that there must be a competitor with a larger market share and the fact that the line is highly specialized and a differentiator for competitiveness then there should be interested parties.
 
Leveraging the current customer base purchasing the coating machines as potential clients for overflow and outsourcing of coating services could potentially provide regular orders and revenue early in the transition.  This could also be carried out prior to the divestment of the laser line with small investments moved from the laser line to the coating services to increase current service capacity.
 
Special attention will need to be given to the logistics changes that will come with the accepting of incoming parts, storage, transport through the manufacturing facility and processes and then finally to the loading dock for return.  This activity will change the value chain activities as the activities and inventory for the manufacture of the coating machines will be very different than the receiving of parts for finishing and return shipment.  These value chains will need to be designed to maximize support synergies where possible but also draw attention to areas that may require additional IT and asset development.