Last week saw UK company Capita make one of the frankest admissions of failure in corporate strategy that I’ve seen in some time. Jonathan Lewis, the company’s recently appointed CEO, announced to London’s investment community that “significant change” is required and that the company – which employs about 70,000 people and has annual revenues of approximately £5bn ($6.9bn) – had become “too complex,.. is driven by a short-term focus and lacks operational discipline and financial flexibility.” He followed up with a bitter cocktail of news for investors that included a profit warning, a rights issue and the indefinite suspension of the company’s dividend.
So, what is Capita?
Capita is commonly referred to in the media, and even by the investment community, as an ‘outsourcing company’. Along with competitors like Concentrix and Serco, the company does the work that private companies and public organizations have decided – for better or for worse – should be performed by a third party supplier. Capita and its peers have benefitted from a strong growth in this market in recent decades as struggling private and public organizations have tried to improve shareholder return or operational effectiveness by outsourcing non-core back office and front office services.
Spun-off from the UK’s Chartered Institute of Public Finance and Accountancy in 1987, Capita enjoyed rapid growth as it helped clients contract out an incredibly broad range services. In 1991 the company had just 320 employees and revenues of £33m; by 2016 it had expanded to 73,000 employees and achieved revenues of ~£4.9bn. That growth was fueled – intentionally – by a string of acquisitions and a readiness to take on an increasingly diverse range of services across an increasingly wide range of markets.
The result, inherited by Mr Lewis when he took over the corporate reigns late last year, was a large, complex and highly diversified business with revenues drawn from a mix of public and private sector work. By the company’s own assessment, it had a “diverse reach across 11 key vertical markets and deliver a vast range of services”. Yes, you read that correctly, 11 key vertical markets! To give you a flavor of the scope of what the company does Capita provides customer services on behalf of retailer Marks & Spencer; it has designed and implemented mortgage intermediary software for ‘high street’ banks; it helps the UK’s National Health Service with translation services; and it collects central London’s congestion charge from motorists.
Diversification – that’s a good thing, right?!
Many businesses, driven by growth or a desire to reduce risk, seek to expand into new markets, sectors and geographies. They extend their product line from widgets to include gismos; expand into adjacent geographies; chase clients in new market sectors. Typically, they believe that opportunities to grow in the business’s existing space are limited, that the expansion will be easier/reduce risk or that it will provide a greater rate of return on capital.
But a strategy to grow through diversification has risks and limits. GE, arguably one of the most successful conglomerates in corporate history, was a recent notable example of this. In November 2017 the company’s CEO, John Flannery, announced an aggressive corporate restructuring and told the financial markets that the company intended to focus on three just core areas – health care, aviation and energy. The “GE of the future,” he said “is going to be a more focused industrial company”.
So, what does it take to diversify successfully? Well, that will depend in part on the nature of the market in question, but there are probably three key elements required:
- Firstly, as a company expands into new markets it must continue to deliver in its existing markets; it cannot take its ‘eye off the ball’. This probably sounds ridiculously obvious, but it’s too often overlooked. Expansion (especially via acquisition) can be a substantial drain on management time and organizational ‘bandwidth’. The greater the degree of complexity in a business’s services, sectors and geographies, the harder for that business to structure itself and its service offering in a way that it can successfully compete in all its markets
- Second, the investment of time and resource into the new market must provide a better return than if the same investment was made in the company’s other markets
- Lastly, the company must be able to bring value – in the form of price, efficiency, technology or service – to the clients it is serving in the new market. If it can’t then its unlikely to be able to compete and arguably has no place even being in that market.
The limits to Capita’s diversification ‘play’
As I mentioned earlier, Capita grew swiftly in its first quarter century driven by rapid expansion in the UK outsourcing market. The company successfully convinced clients to entrust it to perform services worth hundreds of millions of dollars in revenue per year. It became the largest business amongst its peer group, its scale built on diversity.
The result was a vast corporation whose services, markets and sectors are so diverse that they seem to lack almost any kind of unifying identity. This is typified in how Capita describes itself: “a leading UK provider of technology enabled customer and business process services and integrated professional support services”. Sorry, what?! This sprawling corporation almost inevitably gave birth to the company’s sprawling diversification strategy (See below from the company’s own website)
But Capita failed to make a success of this strategy. The move into new markets did jeopardize its wider business.
It failed to effectively build internal talent. The investments made in ‘specialist businesses’ was at the expense of investment in its existing businesses and some areas of technology that might have helped to differentiate it from a growing pack of competitors.
Probably driven by a short-term focus on analysts’ expectations, Capita over-relied on acquisitions for growth. By its own admission it failed to leverage those investments, leaving them partially integrated and missing out on operational and cost efficiencies. All this contributed to a cost base that undermined competitiveness.
Perhaps worst of all, Capita failed to consistently deliver on client expectations. This came at a critical time in the lifecycle of the UK’s outsourcing market. With market growth slowing to low single digit CAGR, the company seemingly failed to realize that future prosperity rests on its ability to deliver on its obligations to clients… Capita is first and foremost a service company, not an outsourcing company!
So where to next for Capita?
Jonathan Lewis’s announcement last week signaled the end of Capita’s diversification strategy (at least in its current form). It was a painful ending; Capita’s share price lost a third of its value in a single day. Mr Lewis launched a transformation program that he says will last more than two years… a long period of potentially unpleasant medicine.
But investors can take some cheer: Mr Lewis acknowledged the central role that developing a new strategy will play in transforming Capita. He acknowledged the importance of digital transformation and automation as key elements in Capita’s ability to deliver value – in the form of cost savings and efficiency – to its clients. He clearly ‘gets’ the need to focus on a smaller number of business (where it can effectively compete) and to ensure that any remaining organizational complexity will not threaten cost competitiveness.
Mr Lewis said that the future for Capita is one where it will “focus… resources on a smaller number of markets that are likely to deliver the best prospects for the group, particularly ones where we have the potential and the capability to create value.” I for one will be eagerly watching to see if Capita’s new strategy will return the company to the level of growth it has enjoyed in the past.
What’s your view – have you seen other examples of diversification eroding competitiveness of a company’s core business? Any notable examples of diversification used effectively?
Concept and Perspective 