New form of integration may be a smart way to do business

Friday 24th August 2001

By Peter V O'Brien

Regular references in company reports this year to concentration on "core businesses" can be contrasted with the idea of adding loosely related activities to a corporate structure to achieve diversification and risk limitation.

The concepts are also related to those of vertical integration, where companies (usually) produce the raw materials, process them into industrial and/or consumer products and then control the final outlet.

Companies heading down that track and controlling each stage of the distribution and sales chain would probably attract attention from regulatory authorities these days with charges of unfair trading, market domination and, possibly, monopolistic practices.

That does affect the integration process where there are competitive markets and well-defined product ranges.

There are many examples but the oil industry is a simple model. Not all groups involved in the oil industry have investments at every link in the chain, but many do, particular the majors.

They do basic exploration, extract the stuff, ship it to their totally or jointly owned refineries and transport the final product to outlets they may either own, or with which they have "tied-house" arrangements and some type of financial involvement.

That system is basically a concentration on "core businesses" but it is also a form of integration.

There are other forms. A retail chain, for example, may cover an exhaustive range of goods while another concentrates on, say, clothing.

In terms of Stock Exchange-listed companies in New Zealand, The Warehouse Group would be an example of the former and Hallenstein Glasson representative of the latter.

The contrast between core businesses (standalone, in this context) and the various forms of integration seems likely to become increasingly important for investors as the development of technology speeds up further.

Integration is taking on a new meaning, moving away from the vertical ("straight line") idea, where an organisation has interests in every step from raw material to final use, to what may be called "squared" or "cubed."

The computer industry is an obvious example, using the term in its broadest senses to cover hardware, software and the full range of other services now available. There are other examples, outside IT, but using its products and services.

Rural services company Wrightson has applied the new form of integration to its business.

The preliminary report for the year ended June 30 (and earlier documents) referred to the company's "solutions strategy" which managing director Alan Freeth said would "drive longer-term, sustainable earnings, reducing the exposure to commodity cycles and exchange-rate fluctuations."

Dr Freeth said the strategy was based around leveraging more value from the component parts of Wrightson. The parts were the bundle of products and services the company offered and its industry knowledge, intellectual property and alliances.

"The value of these component parts increases significantly, both for Wrightson and for the client, when they are combined into integrated packages or 'solutions'."

The report referred several times to the "solutions strategy," sometimes in rather vague terms, but gave a concrete example of a "prototype solution" for sheep and beef farmers in the Wairarapa which was said to be showing excellent results.

It was increasing revenue for Wrightson and significantly improving farm profitability for the clients involved.

The "solution" was said to have strengthened client relationships and provided "cross-sell" opportunities and a systems approach to achieving new volumes of business.

It may be too early to decide the merits of Wrightson's strategy. The company did several new things in recent years which flopped and the substantial profit growth last year came mainly from a buoyant rural sector enjoying solid improvements in commodity prices.

The basic concept has obvious merit. Any large company builds up areas of expertise, only indirectly related to its basic business.

Departments or divisions seen initially as administrative support units for the major revenue earners may be able to apply their knowledge to those revenue earners and provide internally generated, integrated packages to improve the quality of the total business.

That seems to be the theory. Finding the companies putting it into practice may be harder, particularly as a lot of the hyped-up talk from technology companies over recent years was only puff.

Acceptance of the new form of integration also comes up against the perceived division between the "old" and the "new" economies. The trick is to identify companies from the "old" that are taking up the best activities and systems from the "new."

Investors who can do that will race ahead of the pack.

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