Can Restructuring Revive the Asian Locomotive?

By Keith W. Rabin, President,
KWR International, Inc

After the onset of the Asian financial crisis in 1997, there was considerable discussion about the need to revive the Asian and European "locomotive" to allow the U.S. economy to slow down. The U.S. economy began to weaken significantly last year. While this can be seen as a necessary consequence of the speculative dot.com era, the events of September 11th accentuated negative pressures, which are now further exacerbated by the fallout from the Enron debacle. As a result, Asia and the rest of the world sit nervously. They await the resurgence of U.S. demand, which they believe supports the health of their own economies. However, they are likely to be disappointed.

While many analysts predict a U.S. upturn in the near future — the Fed has less leverage to reduce interest rates, consumer debt is at exceedingly high levels, and corporations are under extreme pressure to maintain a conservative accounting posture. Their optimism therefore seems misguided, as there is little to support the sustained momentum required to drive a strong advance in U.S. equity markets.

Wall Street demands linear earnings growth quarter over quarter, and this will be a real challenge for U.S. firms moving forward. Much of the profit growth that underpinned the U.S. bull market of the 1980s and early '90s was based on widespread corporate restructuring and rationalization. U.S. firms, however, have been engaged in operational reorganization for almost two decades. While there are certainly pockets of efficiency to be gained moving forward, the easy gains have already been achieved. The incremental benefits of additional cost-based initiatives are unlikely to have anywhere near the impact on corporate profitability and efficiency as those of the past.

Put another way, if you weigh 300 pounds and drink and smoke heavily, you will show dramatic improvements if you change your behavior and begin to eat right and exercise regularly. Once, however, you achieve your optimal weight and become a marathon runner, there is little one can do to maintain the same degree of incremental improvement short of introducing steroids or other solutions that ultimately may do more harm than good.

Given their limited ability to increase profitability through cost-based initiatives, U.S. firms need to shift their focus toward alternative solutions that can deliver the top line revenue growth needed to justify the price/earnings multiple they desire. This generally entails either a growth through acquisition or expansion strategy or one that calls for innovation and the introduction of new products, services or business models.

Companies such as Citigroup, Tyco and GE have been highly successful employing a financially driven acquisition-oriented strategy, though this too is ultimately based upon the cost reductions that can be achieved through corporate integration. Additionally, the current move toward cleaner accounting and the difficulty these firms have had of late maintaining an attractive acquisition currency in the form of a high share price, call into question whether this will remain a viable strategy during the next stage of the business cycle. An alternative model calls for organic or international expansion. Firms such as McDonald’s and Walmart, financial service firms and many export oriented manufacturers have chosen this route, but in many ways this is dependent on the strength of the economies into which these firms seek to expand.

Potentially the most attractive option calls for growth through innovation. This requires "creative destruction" and a shift toward new business models, technologies and the products of tomorrow. While companies must engage in R&D and move rapidly to stay ahead of the curve, massive change is extremely hard to predict and implement. One has only to look at the large debts taken on by telecom firms who unsuccessfully sought to develop models that would deliver extraordinary growth within the mature industries in which they operate. One can also look at the graveyard of companies that promised to harness the Internet or Enron, Lucent, and Xerox to see how difficult it is to reinvent large multinational corporations.

Growth through innovation also requires capital spending. With the U.S. recession and corporate efforts to cut costs, capital spending has been slashed in almost every sector. Tech and telecom-related firms, the areas most likely to show dramatic innovation, have been hit particularly hard. Such capital expenditures bloodletting could become too severe, further aggravating the ability of the U.S. economy to achieve the growth now being forecast.

Corporations in Asia and other parts of the world, however, have by and large not participated in the wholesale move toward restructuring seen in the U.S. and the U.K. in the 1980-90s. While this has put them at a disadvantage, it also means these gains are before them. If these companies were able to move beyond the admittedly serious social, political and institutional obstacles needed to introduce these reforms, they could introduce enormous profitability growth in a relatively short period of time. This would result in a tremendous upward shift in valuations as investors began to shift their capital accordingly.

Viewed another way, in 1982, the year former U.S. Treasury Secretary William Simon initiated a leveraged buy-out of Gibson Greetings, which many view as the start of the U.S. restructuring craze, the Dow Jones index traded as low as 770. By the end of 1995, before the Internet and dot.com phase took off, we saw a rise of over 400% above 5,000. Most of this increase can be attributed to the productivity increases allowed by corporate reengineering and restructuring.

Therefore, while a sustained recovery of U.S. market growth appears dependent on unpredictable factors such as the success of broad-band penetration, advances in biotechnology or other applications that promise to be the "next big thing", Asian markets can deliver enormous gains through the tried and true methods of cost-based restructuring.

Of course, it should be recognized this is only a short-term solution. Once having achieved this advance, they will then be in the same boat as the U.S. and other economies that have engaged in cost-reduction strategies. This will require they successfully introduce the same kind of revenue-based solutions now needed in the U.S., or they will not be able to preserve the gains they will have achieved.

By that time, however, the U.S. locomotive should again be picking up steam, having had sufficient time to work its excesses out of its system. Countries and corporations who have engaged in serious efforts to rationalize and reorganize their macro- and micro-economies, however, will be better prepared to compete as a result.