5 Rules for Multiplying Value Through Alliances

Episode #399 5 Rules for Multiplying Value Through Alliances

ALLIANCES MADE FORMULA ONE SUCCESSFUL

In the last few years, I’ve become a fan of Formula One (F1) Motor Racing. I discovered the sport through Netflix’s Drive to Survive documentary. It is truly intriguing to peek behind the curtain into such a complex and highly competitive business (not to mention the sporting aspect).

We’ve produced a few episodes of No Bullsh!t Leadership over the years on various aspects of F1:

• Ep.179: Survival of the Fittest was my first outing, examining the F1 business itself;
• Ep.275: When Should You Let Someone Go? was based on former Haas boss, Guenther Steiner’s perennial problem with the dog eating his homework; and, more recently,
• Ep. 344: Building a Winning Culture, where I took a deep dive into Zak Brown and the McLaren turnaround story.

For me, business is fun and exciting, and I’m a voracious consumer of business podcasts. I’ve just added a new one to my listening rotation thanks to my colleague, Brad Shaw, who’s the CEO of Sydney-based tech company, livepro.

The podcast is called Acquired, and it is an absolute cracker. If you’re not listening to it already, I can highly recommend it. It’s actually been going for over 10 years, so I’m a bit late to the party.

Each episode is a long-form, deep dive into the strategy and performance of a successful business. It’s like a mini-documentary, with the average episode generally three to four hours long. The hosts explore these businesses at a depth that would normally be reserved for buy-side analysts.

Imagine my excitement then when I discovered the most recent episode of Acquired focused on the evolution of the F1 motor racing business. It was this four-and-a-half-hour epic that led me to today’s topic .

A RICH, WHITE MAN’S HOBBY?

The F1 business is the poster child for multiplying value through alliances. F1 had its roots in the early 20th century, but the World Drivers’ Championship was first contested in 1950. This competition was highly unstructured: just a series of race meets.

There was no central body for planning and coordination, and the industry itself was highly fragmented, with each team negotiating its own deals with individual race venues, and individual sponsors. TV rights weren’t even a thing yet, either.

Think about what this means in practical terms. At the time, there were 9 teams and 15 races. That’s 135 separate contractual agreements. Each of these deals could be wildly different, and they generally attracted small payments of around, say, $10,000 per team per race.

Think of this from the fan’s perspective: There was no guarantee of any particular team turning up to any given event: not ideal if you’re trying to grow a spectator sport!

Enter Bernie Ecclestone. Bernie came into the sport in 1972 when he bought the Brabham Racing team, and he quickly saw the potential for greater consolidation in the sport.

Over the next 10 years, he pulled off some bold, high-value moves that changed the face of F1. In doing so, he laid the foundations for taking F1 from a rich, white man’s hobby to the global powerhouse it is today… and he made himself extremely rich in the process.

CONSOLIDATING THE SUPPLY OF TALENT

Bernie’s first move was to centralise race fee negotiations. With every team negotiating its own appearance fees with the track owners, they had no leverage whatsoever. It was expensive, it was piecemeal, and it left a huge amount of power in the hands of race promoters.

Bernie convinced the other team owners to let him negotiate the fees with the race promoters on their behalf, and he guaranteed that they would earn no less than they were already earning. This gave them scale, and a consolidated supply channel to go to market with.

It worked out stunningly for the F1 teams, so they didn’t even complain when they found out that Bernie was clipping the ticket at a much higher rate than they’d originally agreed. Race fees went to $40,000 virtually overnight, quadrupling each team’s payments. By the mid-70s, they were up to $150,000 per race, and by the end of the decade, $200,000 per team per race.

Bernie also renegotiated freight and logistics costs. These days, the F1 calendar crisscrosses the globe with 24 races covering five continents. The cost of transporting the equipment and personnel between races is by far the biggest cost for the F1 organising body.

All these benefits came purely from Ecclestone seeing the opportunity for combining forces to achieve a common purpose.

The other key area of Bernie’s vision was to leverage the F1 alliance in broadcast rights. When he came in, F1 was making precisely $0 from broadcast rights. Even though it might be considered early days in terms of sports broadcasting, at that same time, the NFL was already making around $50 million annually from selling its TV rights to the US networks.

So, of course, Bernie started a new company to produce a central TV feed, which it could then syndicate to Europe’s 90-odd national broadcasters.

Initially, the broadcasters got access for free. But later, once the audience had been established, those rights became extremely valuable. Build the demand first, then monetise the supply: he was quite the visionary.

Within a few years, with the emergence of cable TV, those rights were worth $25 million per annum, the majority of which flowed personally to (yep, you guessed it) Bernie Ecclestone!

These early moves laid the foundations for the sport today. In 2017, Liberty Media, the current owner, paid $8bn to acquire Formula One. But in the 45 years that Ecclestone had been involved in the sport, it had been transformed from a random assortment of independent races (which effectively functioned as nothing more than a black hole for team owners’ money), into a global media enterprise.

It was cranking out $250m in annual revenue ,with a 50%-plus EBITDA margin.

Today, F1 earns $3.4bn in revenue, and the individual teams generate another $2bn in sponsorships. The total enterprise value of F1, when you include the F1 itself and each of the 11 competing teams, is roughly $60bn.

This all began with Bernie Ecclestone’s vision for creating a high-value alliance: he centralised negotiating power relentlessly; he had an instinct for seizing undervalued assets (like TV rights); and he was happy to play every stakeholder off against every other stakeholder.

But he couldn’t have gotten away with it unless he understood the need to harness untapped value through alliances.

His shrewd business sense is unquestionable… but I reckon he’s also that guy who, after you shake his hand, you have to count your fingers.

COMBINING UNIQUE ASSETS

The best example from my corporate career on how to multiply value through alliances was the joint venture (JV) deal that CS Energy struck with Alinta Energy in 2017.

The deal was brought to me by my Executive, Strategy and Commercial, Owen Sela. Owen is undoubtedly one of the sharpest commercial minds that I worked with during my whole corporate career, and it just so happened that Owen had worked with Alinta’s CEO, Jeff Dimery, in another life.

Jeff and Owen both realised that, even though the Queensland retail electricity market was deregulated, it was still effectively a duopoly between two companies: Origin Energy and AGL.

The basis for the CS Energy / Alinta alliance was really simple: each of us had control of a valuable asset that the other didn’t, and we saw the potential for combining these assets to create a powerful market force.

Alinta was an experienced retailer. They had marketing expertise, and large call centre and billing infrastructure that served several other Australian states… but they weren’t operating in Queensland, because that would mean having to take market share from two established incumbents.

Alinta had no competitive advantage to underpin an entry into the Queensland market.

CS Energy, on the other hand, had a very small retail presence, serving only large commercial and industrial customers. We didn’t have an offering for household consumers and small businesses. What we did have was a fleet of power stations that were collectively the lowest cost generation in the state (and back then, CS Energy generated about one-third of all Queensland’s electricity).

Alinta had the retail capability required to immediately capture a share of the residential retail market.

CS Energy had low-cost generation capacity.

The natural advantages of each company was clear, but that still wouldn’t have been enough to build an alliance as powerful as the JV we ended up creating. The factor that can’t be underestimated is that both companies were 100% aligned in a common goal, and we had a similar risk appetite.

It’s sort of weird, given that Alinta is a privately held company, and CS Energy was a stodgy old GOC. But we were incredibly well-matched culturally, because of our strong commercial mindsets, and we believed in market disruption with an almost Richard Branson-like glee at the thought of taking market share from two lazy incumbents.

It was a match made in heaven.

We were able to combine the strengths of each company in a JV where we profited in relatively equal terms. CS Energy brought the generation, locked in at a price that gave certainty to Alinta, and Alinta brought everything else.

Not only was this hugely successful as a business venture, but it even forced structural changes in the market:

1. The price opportunity was so good that it drove a change in customer behavior. In a market where customer churn was (historically) extremely low, the potential benefit of getting substantially lower prices gave customers an incentive to switch.
2. It accelerated regulatory intervention to manage the gap between standing offers and discounted deals: once again, a benefit to consumers through price transparency and tariff certainty. And,
3. It proved that a new entrant could be successful in Queensland. Before this deal, it was almost accepted that a new entrant wouldn’t be able to acquire scale quickly, as consumers were just unlikely to switch.

This is a classic example of value being generated through a well-matched alliance.

5 RULES FOR MULTIPLYING VALUE THROUGH ALLIANCES

In business, it’s easy to become inwardly focused. When that happens, a lot of potential opportunity can be left on the table.

Here are my five rules for multiplying value through alliances. If you get into the habit of thinking about these, you’re going to be much more likely to identify the opportunities that you may not have been open to before:

1. Scale matters.

It’s important to look for opportunities to consolidate demand. Think of something as simple as procurement. If you’re buying 10 widgets, you’re going to pay a lot more than if you’re buying 10,000 widgets.

This explains why larger companies have central internal capabilities for things like procurement and IT. There’s also a consolidation of supply. The F1 story is a classic example of taking a fragmented supply arrangement and introducing the power of collective bargaining.

The Labour Union movement worked this out a lot of years ago.

2. Optimise for the whole.

What unique value can you create by combining respective strengths? You’d be surprised at how much value you can create in even the smallest negotiations by first trying to understand the overall potential value of a deal.

One of my favorite negotiation books is Negotiation Genius. A key concept of this work is that you have to focus on value creation first, and then value capture second.

There comes a time in every negotiation when you have to argue the toss on how much value flows to each party. This is the same in alliances as it is in any other negotiation. But before you think about how to slice up the pie, it’s important to make the pie itself as big as it can possibly be.

How can you bring different elements into the deal to make it more valuable overall? What things are important to you, but not so important to them, and vice versa?

I expand this concept in more detail in Ep.75: Negotiation Fundamentals.

3. Understand your leverage points.

This is about knowing what your counterpart values the most. In the Alinta JV, the obvious headline need that they had was a source of low-cost generation to back their market entry.

But what did they value the most? Price? Or certainty of supply?

What else could we bring to the table in terms of risk sharing that would make the deal more palatable to Alinta’s shareholders? Who would have decision-making accountability for the various parts of the JV that required tweaking once the deal went live? What safety nets could be put in place to reduce the risk in worst-case scenarios? And how could all these things be packaged to maximise the value of the eventual market offering?

This is where the skill and nuance of alliances really comes to the fore.

4. Solve your counterpart’s problems.

It’s not hard to work out what most benefits you, and the vast majority of your time is going to be spent thinking about your end of the deal: your financial outcomes, and your risk profile.

But every moment you spend thinking about your counterparts’ problems is time well spent.

For example, procurement professionals are focused (sometimes too narrowly), on how to improve their company’s commercial advantage. They rarely think about how it might solve their counterparts’ problems, but this can be a rich source of value:

• Does a supplier value the working capital benefit that comes from improved payment terms?
• Do they value the scale that your contract brings, because it underwrites the recovery of their fixed costs?
• Are they a new supplier who may not have established their brand, and who would benefit from testimonials and references?

If you don’t listen carefully and ask these questions, you’re never going to find out. But once you do, it can be a great way to create value for your business by solving their problems.

5. Think about your counterparts BATNA.

When it comes to dividing up the pie, you’ve got to know how far you can push the friendship. So, there’s this thing called BATNA: the Best Alternative To a Negotiated Agreement.

If you know what your counterpart’s BATNA is, you’ll be able to establish their walkaway point. It’ll also give you an idea of how motivated they might be to create an alliance with you. This, like a few of the other rules I’ve spoken about, gives you a good understanding of where your counterpart sits, and therefore a much greater likelihood of being able to do a deal.

When doing the deal with Alinta, we knew that their BATNA was to not enter the Queensland market at all… quite a motivating objective to consider.

ALLIANCES RADICALLY MULTIPLY VALUE

The power of alliances can bring incredible value to your team, and it’s not just major deals between big companies. Even internally, inside your own organisation, think about the alliances that could potentially add value to what your team does.

If you want to make this happen, you’ve got to be constantly on the lookout, and ask yourself one critical question: “Who can I join forces with to create more value than I could on my own?”

This is a neglected key to value creation that only the best leaders embrace. They have no fear whatsoever of the potential complexity and ambiguity of an alliance… just a relentless passion for multiplying the value that they can create.