Speaking at last month’s Cambridge Energy Research Associates’ Global Energy Plenary last month, Enron President and CEO Jeff Skilling advocated the de-capitalization of assets as a route to enhanced profitability. Skilling sees three current trends in the energy industry; the decline of vertical integration, the de-capitalization of assets and a focus on specific activities where ‘benefits of scale and competitive advantage can be realized.’
Ford Motor Co.
Skilling uses the evolution of the motor industry to illustrate the move away from vertical integration. Ford Motor Co. used to own its own forests, sawmills and rubber plantations! Then there was Toyota, which turned the industry into a complex broad-based market for parts and services, where the car manufacturer no longer owns everything, but scours the world seeking out low cost, high quality components, a more flexible business model.
Historically, such de-integration was limited by the cost of interaction. Technology is changing this by collapsing such costs, creating new forms of organization. “We'll see a big shift to de-verticalization over the next ten years.” Skilling’s next hobbyhorse is de-capitalization. Most companies have far too much of their balance sheets tied up in capital assets offering a low rate of return. The calculation goes like this. If you want a 5% real growth rate, then you need an 18-20% return on assets.
So for an oil company, producing assets should be hived off to institutional investors who would be more comfortable with a 9-10% return. Thus, a typical oil company could release around half of its balance sheet assets. What do you do when you have de-verticalized and stripped your own assets? Focus on your core competencies. Enron’s role in this? Providing services to re-integrate the value chain and “focusing on a couple of activities we are very good at.” It seems to be paying off. Enron will be number 6 on the next Fortune 500, and the company’s market capitalization has grown from $ 2.2 billion to $ 74 billion in 2001.
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