Active portfolio management should always be “Plan A.” Corporations that consistently refresh their business mix outperform their peers in TSR by 3.5 percent over the long term, honing their portfolios to develop, acquire, and divest businesses to realize their enterprise strategy. The goal, after all, is not growth for growth’s sake but to maximize returns—which is achieved through a combination of growth and investing capital in an enterprise’s most important priorities. Yet despite its demonstrable success, the power of active portfolio management can go overlooked, a litany of excuses standing in the way of change. Remarkably, headwinds and tailwinds are often identified as the leading factors affecting financial performance, even when results are driven more by a strong strategy, solid execution, and traditional competitive forces at work.
Now, as the postpandemic growth boom subsides and a wave of cost-optimization programs runs its course, effective senior leaders are returning to first principles. They seek to maximize free cash flow from invested capital, making sure that each business aligns with company-specific capabilities and industry-critical trends. The best-performing corporations constantly consider whether they’re the right owners of every business in their portfolios. Then they act with intent: reallocating capital toward strategic priorities, acquiring and divesting businesses to align with their strategies, reinvesting proceeds into valuable opportunities, and overcoming decision biases to create more—and ideally, substantially more—shareholder value. Since markets evolve and competitors are constantly on the move, it’s unrealistic to expect that a portfolio that matched competitive conditions just a few years ago should remain the same today, let alone in the next few years. And because your company ultimately has finite resources (especially when it comes to capital, talent, and management attention), it’s unrealistic to expect that a static approach to resource allocation will enable each of your businesses to win and keep winning in their respective markets. In this article, we’ll look at five key insights for senior leaders as they take a fresh focus on active portfolio management.
1. Benchmark each asset’s performance against its external peers, not against each other
Let’s start with a quick quiz: If your corporation has an overall CAGR of 5 percent and owns a specific business that delivers a CAGR of 25 percent, is that business a keeper? The answer: it depends. If the business unit’s market growth is in line with its peers, then it likely could be an important, and perhaps neglected, source of value creation. But if the business unit’s market is growing at, for example, 40 percent per year—in other words, 15 percentage points faster than its own 25 percent CAGR—then it’s an underperformer; the operation is losing share and likely destroying value. It may need material investments to catch up and start winning. At a minimum, the causes for the underperformance should be diagnosed. Quite possibly, far from being a unit to invest in, your company should actually divest the business.
2. Be pragmatic about the real portfolio synergies that exist among your businesses and understand the upside that other owners could offer
There are trade-offs to owning different businesses regardless of their earnings. Each project in your portfolio competes for corporate resources—not just capital but management attention and organizational talent as well. It’s possible that synergies among your businesses pay for these costs, ideally many times over. Traditional sources of cross-asset synergies include selling (customer relationships, sales channels, access to markets or geographies, a “brand umbrella,” and specialized marketing expertise), producing (manufacturing footprint and utilization, supply chain network, engineering or production talent, and R&D expertise), and competitive insight (management expertise and access to market knowledge).
But it’s also possible that owning separate businesses results in “dis-synergies.” For example, a generics pharmaceutical business requires different capabilities from a pharmaceutical company with a portfolio of proprietary medications or a newer, typically nimbler biotechnology company; and a commodity chemicals business can be quite distinct from a specialty chemicals operation. Your businesses’ SG&A needs can vary substantially.
If portfolio businesses don’t contribute to one another, or if there is a list of material growth or margin opportunities that business unit teams are struggling to execute, perhaps a different industry player or an experienced private equity acquirer could deliver more upside—and pay a premium for the opportunity. The proceeds could then be invested into opportunities where your company has a clear competitive advantage, or released to your shareholders. The objective, again, is not to grow for growth’s sake; it’s to realize value on the capital your shareholders have entrusted you with.
3. Recognize and mitigate your own biases
Value creation can be foiled by decision biases—particularly (but not only) when it comes to sunk costs. It’s hard for senior leaders who may have made their mark by building up a division to sell once its trajectory has plateaued. Yet a perennial hockey stick projection is as unlikely to pan out this year as it was last year, and facing disappointed investors won’t get any easier. For better or worse, activist investors don’t get anchored in management biases. Executives who hold together a suboptimal portfolio for too long stir a recipe for activist interest (exhibit). Usually, it makes sense to at least hear out activist arguments.
Executives may also hesitate to pursue divestitures due to concerns about complexity, a perceived lack of interested buyers, and apprehensions about total enterprise size and earnings (however much executives know it’s preferable to lead a more value-creating company, it can still be tempting to run a larger one). To overcome decision biases that can affect business mix, leaders can take practical steps such as changing the burden of proof (that is, establishing, at least as a thought exercise, that a divestiture should be the default outcome for each business unless managers can prove why it should be retained); strictly categorizing businesses as “grow, maintain, or dispose”; and enforcing an explicit ranking of businesses by order of potential value creation. As usual, there’s no substitute for building and presenting a robust and stark discounted cash flow analysis and laying the results on the table. Emotional attachments should not be stronger than tangible returns.
4. There’s a cost to waiting—so get moving now
Trying to time the market is hard. Consider divestitures: an ill-fitting or noncore asset is unlikely to be worth significantly more in one or two years under your ownership—and certain to become even less of a strategic priority with each passing month, which, of course, means that its value will only decline compared with peers whose owners provide them with the resources they need. Yet in one recent survey, 77 percent of respondents reported that a divestiture decision was delayed by managers or the board. Those results are consistent with our experience. Managers consistently wait too long to sell assets, even as these businesses lose more value. By contrast, leaders who free up capital today have more options to invest in growth priorities for the businesses where they do have the capabilities to win.
Fighting inertia is equally challenging when it comes to acquisitions that bolster your strategic portfolio. The temptation to wait for an incrementally better price should be tempered by the cost of lost time and the possibility that the seller may decide not to divest after all—or to sell but to a different buyer, particularly one of your competitors. Moreover, capturing deal synergies takes time; very few acquisitions are truly plug and play. Even fast-moving integrations can take 18 months to two years to capture most of the synergies. We’ve found that programmatic acquirers are committed to pursuing the right acquisitions, even at a higher price, so long as a transaction creates long-term value. For sure, the risks of overpaying or conceding too much in deal negotiations should not be trivialized and can result in real costs themselves. Yet at all events, a positive outcome starts with committing to the deal thesis; if a transaction makes strategic sense, it’s best to start immediately and keep an open mind along the way.
5. Divestitures may be more complicated than they initially appear
As soon as a divestiture decision is made, most managers want to “move on” from the asset. But not all divestitures are created equal, and often a separation needs to be tightly managed. In fact, we’ve found that 45 percent of separation programs take longer than expected. Leaders cite greater complexity in business separations than they initially foresaw and a lack of dedicated internal resources as the most frequent causes for a delay. Regulatory delays are also increasing—but not always in predictable ways, which only adds to variability and uncertainty.
The challenges underscore that while portfolio management is a strategic undertaking, poor execution can frustrate the best of plans—and that tactical excellence can be a difference maker. Active portfolio management is an ongoing process, both in terms of determining the optimal business mix and following through with the resources and engagement needed to bring it to fruition. It takes insight and effort to create substantial value for shareholders. The lessons are evergreen. With many experts currently forecasting an uptick in buy-side opportunities, there’s no better time for managers to take a fresh look at their portfolios and get moving on turning conceptual refreshes into value-creating action.
Successful companies change their business mix year after year, and many of the most effective CEOs of the past two decades succeeded precisely because they doggedly refreshed their portfolios, particularly through acquisitions and divestitures. Waiting too long to change your business mix, by contrast, invites a worse outcome. Markets are constantly changing, and your competitors aren’t sitting still. The ideal time to get going is right now.
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