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How to proactively transform the business for long-term success

Proactive transformations and their successful execution can help companies realize their full potential.


In brief

  • Transformative actions do not necessarily result in value creation for companies.
  • By undertaking proactive transformations and executing them well, companies can position themselves for long-term success. 
  • Considering multiple transformative approaches or a combination of them is also crucial to help optimize business value.

During the pandemic, companies scrambled to adapt to the new normal. Crisis management strategies were drawn up to respond to an alphabet soup of possible recovery trajectories. Transformative initiatives covered areas such as environmental, social and governance (ESG), digital transformation, supply chain management and portfolio optimization. Other forms of transformative actions included human resource optimization, marketing spend reduction, financial restructuring, M&As and partnership or collaboration. Yet, transformative actions do not always translate into value creation for companies.

An EY-Parthenon report, Transformation in Southeast Asia: four archetypes of outperformers, studied the top 70 listed companies by market capitalization across seven sectors in Southeast Asia (SEA) — specifically Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam. The study found companies that proactively undertook transformative actions to ride out the disruptive impact of the COVID-19 pandemic saw outperformance compared with reactive transformers. Importantly, it revealed possible correlations between their performance and their transformation approaches.

Four archetypes of outperformers

The study found four archetypes of outperformers: proactive transformers, serial transactors, active investors and holistic transformers. 

Proactive transformers are companies that undertake transformation even when they are already outperforming against industry competitors. Companies that undertake transformation when underperforming against industry competitors are considered reactive transformers. The study found that in the periods following transformation, proactive transformers in SEA saw a 13 percentage point outperformance on total shareholder return (TSR) compared with reactive peers.

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Further, the study also found that the ROIs of proactive transformers were approximately 50% higher than those of reactive transformers due to the reduced cost of proactive transformation and outsized returns.

The second archetype, serial transactors, is a subset of proactive transformers, and they transact (i.e., acquire or divest) more than reactive companies. The study found that serial transactors in SEA transacted more than their reactive peers by 13% on average in 2018–21 and were 23% more active during the economic slowdown in 2021. Historical evidence also suggests that transactors had a TSR that was 25% higher than that of non-transactors in the period after the global financial crisis.

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According to EY-Parthenon analysis, global M&A activity in H1 2022 was resilient despite major geopolitical and financial head winds. Globally, there is still a strong appetite for cross-border deals, although companies are more selective in who they do deals with. Given this optimism, there will likely be more new and transformative dealmaking in the months ahead. 

 

The third archetype, active investors, is also a subset of proactive transformers.  These companies invest more than reactive transformers, and this is reflected in their TSR outperformance. According to the EY-Parthenon study, companies that outperformed industry competitors in the years following their transformation also consistently had a higher investment rate compared with their peers. On average, the outperformers have a 17% higher capital expenditure spending as indicated by their capex-to-sales ratio, compared with their underperforming peers in the period before and during the pandemic.

 

Typically, active investors seek to invest in people, assets and technology. In today’s competitive environment, companies need the right skill sets and capabilities to meet current and future business needs. Active investors are achieving this by investing in workforce reskilling and bringing in new talent with diverse capabilities. Similarly, active investors are also investing to acquire assets and technology to enhance business performance.

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The last archetype, holistic transformers, are companies that undertake transformation on multiple fronts. In the EY-Parthenon study, over 90% of the holistic transformers pursued ESG initiatives. Eighty-three percent invested in digitalization, while 51% invested in supply chain management. Conversely, these companies paid little attention to key levers of transformation, including balance sheet and financial restructuring. In doing so, they are missing a big opportunity to enhance business performance as an optimized balance sheet has a significant impact on the company’s ROE and cash flows.  

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Restructuring as a consideration in business transformation

Transformation is not just for companies facing financial distress. Businesses that had been resilient during the pandemic have also undertaken transformative actions that helped to position them for long-term success.

 

Transformation via business restructuring — be it an operational turnaround or a financial restructuring — can be a vital tool to preserve or enhance value for a company and its stakeholders. Executives can maintain or create value in their organizations through numerous ways from refinancing and cash flow improvements to the divestment of assets and management of liabilities. 

 

Among companies in SEA, restructuring is typically perceived to be associated with companies in distress and therefore often seen as a reactive tool, rather than a proactive one. However, this perception is expected to change over time as companies increasingly focus on performance improvement and optimization of the balance sheet through working capital improvements, divestment of noncore assets and capital structure changes. Therefore, even financially stable companies should consider enhancing business performance through restructuring. For companies facing some level of stress or distress, quick proactive actions can facilitate a turnaround of the business. Hence, when undertaking a transformation project, companies should not discount restructuring as an initiative, which can be a way to turn adversity into opportunity.

Impediments to business transformation 

Many companies face concerns such as the current uncertain market conditions, higher interest rates, sluggish stock market performance and illiquidity of capital flows. Further, many have yet to fully shake off the impact of the COVID-19 pandemic. Such businesses may therefore be hesitant to embark on a large-scale transformation program, which will likely require heavy investments in resources.

Yet, what these companies fail to realize is that proactiveness toward transformation during economic downturns is helpful. Investing in business transformation journeys or embarking on them earlier can set them up for success after transformation when the economy recovers and is on the upswing.

Further, initiatives such as digital transformation are typically expensive, with unclear business cases that boards may struggle to navigate. It is critical that such initiatives are combined with a cash release through cost optimization, working capital optimization and financial restructuring.

Five imperatives for successful transformations 

Successful transformations are only as good as their execution, which will only be evident when the transformation plan is implemented. Here are five imperatives that will support a successful transformation program:

1.    Align the CEO and board

The CEO should align with the board on the purpose of the transformation and its value for the organization. Boards that have difficulty aligning their goals and objectives with those of the CEO and other management members will stifle the company’s transformation progress.

2.    Set aspirational targets and incentivize success

Research indicates the assumption that employees are more likely to buy into lower goals is a fallacy.1 It also found that in some situations, higher goals are perceived to be easier to attain but even when that is not true, employees can still find them to be more appealing. Incentives that are over and above those available in a business-as-usual setting and aligned with the objective of transformation should be put in place early on and linked to clear outcomes. According to other research, companies that introduced financial rewards tied directly to transformation targets achieved a multifold increase in TSR compared with companies lacking in similar programs.2

3.    Set up execution rigor and get commitment from the top

A dedicated chief transformation officer will help maintain effective program management and governance. In addition, a weekly time commitment from the senior leadership is crucial to maintain accountability.

4.    Calibrate the journey

Transformations must balance the costs with the potential upsides and find ways of taking key stakeholders along the journey through robust communication.

5.    Build capabilities

Invest to improve functional, technical and leadership capabilities in the organization as well as in the right tools for employees.

There is no single transformative approach that companies should look to. Instead, transformation can be a multitude or combination of approaches that include acquisitions, digitalization or even divestments and restructuring to help optimize business value.

With the economy picking up following the pandemic, it is timely for companies to explore business transformation, unlock their full performance potential and achieve long-term value. 



Companies should not consider only a single transformative approach to help optimize
business value. Instead, they can consider many approaches or a combination of them,
including acquisitions, digitalization or even divestments and restructuring. 




Summary

Amid current geopolitical and economic uncertainties, companies should consider undertaking transformative actions proactively. Even when the company is resilient, a proactive approach toward transformation can help position it for long-term success. Companies should also consider multiple transformative approaches or a combination of them to help optimize business value. 

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