F&A Advisor: Don’t get stuck in the middle

By Hobson Hogan I recently attended a conference on alternative investments for asset managers and investors. The attendees were mostly representatives from large institutional investors, endowments, hedge fund managers, and corporate bankers. The conference focused on the outlook for hedge funds and real estate funds in the future. I was interested in hearing what some of the top investors on Wall Street think about the overall market and real estate in general. I would like to say that I came away from the conference with some good news for the North American market. However, that was not the case. The fact of the matter is that many of the structural issues that led to the busting of the real estate bubble are still present and in many cases are worsening, not improving. When it comes to real estate, the news was dire. Fundamentals have not improved and, while some asset values have increased due to the lack of “solid deals,” the market has become binary— simply made up of winners and losers. Binary markets are not relegated to real estate properties; much of the economy is becoming characterized by firms making a choice on how they want to compete on price or service, and building an organization to fulfill that strategy. While business is not likely to improve on any broad measure, there is no need to jump off a bridge. Business will not stop; it is just going to be ultra-competitive because demand will continue to be constrained. In an industry where there is likely too much capacity and competition, it is often helpful to glean lessons from other industries that have dealt with bouts of oversupply, such as airlines, retail, and energy. Here is a sampling of how other industries have faced tough times and how they successfully navigated the storm: 1. Gained efficiencies through consolidation 2. Aligned cost structures and strategy to market realities 3. Leveraged information technology to improve efficiencies of the inputs The first lesson can be one of the more powerful catalysts for change. In the last oil bust, several major oil companies merged, including Exxon-Mobil, BP-Amoco and Chevron-Texaco. The resulting organizations cut out tremendous costs from their organizations and added additional scale to their businesses. The Exxon-Mobil merger, argued by some to be one of the most successful mergers, squeezed $2 billion in cost savings in the first year alone. These firms were able to eliminate redundant costs in accounting, human resources, and operations, saving the shareholders billions. When properly managed, scale can have immense advantages in lowering costs of services per unit of input. Some academics have argued that in today’s world there are only two strategies: win on price or win on service. There is a lot of truth to that observation, especially if you look at retail. Successful retailers have either created highly efficient distribution channels to bring you goods at low costs, such as Wal-Mart, Target and Costco, or they have created high service models, such as Nordstrom and Neiman Marcus. Gone are the days where you can succeed in the market by offering mid-range products with mid-range service. Could Wal-Mart attract Nordstrom shoppers by simply hiring a piano player? Not likely. Nordstrom would not likely be able to undercut Wal-Mart on price with grand pianos and marble floors in the cost structure, either. In a binary world, you have to make a choice and structure your firm around that reality. If you have purchased computer hardware lately or looked at back office software, there is very powerful hardware and software available to even the most cash-strapped start-up. Expensive accounting systems and other back office support is no longer a competitive advantage, as cloud computing has delivered high functionality for little upfront capital. The cost of connectivity has also dropped dramatically. This can allow boutique firms with specialized practices the ability to compete over large geographies without having to invest tremendously in infrastructure. In no way am I suggesting that engineering, architecture or environmental consulting is like selling an airline seat or a pair of shoes. However, it is becoming more evident in our economy that getting stuck in the middle is a bad thing. Every firm, if it wants to thrive, needs to be world-class at something. However, to be truly successful, a firm needs to adopt the proper strategy to fit its market reality. That may mean acquiring competitors and eliminating costs to provide value to your clients. Conversely, you may need to refocus on client service and stop trying to win in “commodity” type markets with gold-plated resources. There is no one prescription for success in the industry and not likely one strategy that will lead to success for a firm. However, if you find your firm is “stuck in the middle,” neither big nor small, neither specialized nor broad, then one thing is certain, history is not on your side.