Article

Creating a sustainably advantaged portfolio

Author: Andrew Lane – Director

In 2014 Monitor Deloitte defined the concept of an “Advantaged Portfolio” (source: Armstrong, Goodman, McTavish – The Crux of Corporate Strategy. Building an Advantaged Portfolio). The central thesis was that one of the central objectives of corporate strategy is for executive management to think holistically about a company’s portfolio of businesses—conceiving and spearheading ways to make the aggregate value of a company’s holdings durable over time, and greater than the sum of its parts. This vital mission comprises two central questions: In which businesses should we participate? And, how do we create value within and across our businesses? In other words, where will we play and how will we win, at the portfolio level? Monitor Deloitte found that the most successful portfolios exhibit three broad characteristics: They are strategically sound, value-creating and resilient.

Executives, academics and consultants have devised numerous frameworks for building and sustaining the optimal corporate portfolio. Our experience suggests that any successful portfolio design framework (as distinct from the portfolio itself) has to have three important features. To begin with, the portfolio framework must be multi-dimensional in its criteria, because portfolio evaluation and construction cannot solely be reduced to a simple 2 x 2 matrix; it must focus on the performance of the portfolio as a system, i.e., how the parts interact, and not just on the individual components; and it must be tailorable to the company in question, since each company has different goals and aspirations. Advantaged Portfolios is a framework designed to meet these criteria.

In the last few years, ESG has risen to the fore. The world has realised that business does have a role in society, beyond simply delivering profit to shareholders. Society now expects that business should play a positive role in meeting their social, economic and environmental requirements. Investors, customers and civil society are demanding this – to the extent that shareholder returns are now also compromised by unsustainable business models. Sustainability is now a core business issue. It belongs in the C-suite and is core to the strategic choices that businesses make. In this article we suggest that a Sustainably Advantaged Portfolio should not only be strategically sound, value creating and resilient, but that it should also be sustainable.

1. Sustainably Advantaged Portfolios first and foremost must be strategically sound. That means they must foster a strong competitive position, support multiple levels of innovation, and create synergy.

Competitively Positioned
When a portfolio is competitively positioned, its businesses in aggregate participate in more structurally attractive markets and can win in their chosen markets.

Balances Innovation
To be strategically sound, portfolios must also reflect an appropriate blend of innovation opportunities. The idea is to sow the seeds for growth across various time horizons (short, medium, and long-term) and various levels of risk and reward in line with a company’s ambition and risk tolerance.

Creates Synergy
For a corporate entity to create value over time, it must add value above and beyond that which could simply be created (and captured) within its existing stand-alone businesses. In other words, the value of the whole must be greater than the sum of the parts.

2. The second core characteristic of a Sustainably Advantaged Portfolio is that it creates more value than alternative portfolio options.

Maximises Intrinsic Value
A Sustainably Advantaged Portfolio is simply one whose intrinsic value is greater than that of competing portfolio options. Intrinsic value is best represented by the risk-adjusted cash flows (net of investments) a corporation’s existing (and expected future) businesses produce, and is best measured by discounted cash flow (DCF) analysis.

Addresses Capital Markets
As already noted, intrinsic (DCF) value should be the primary metric for assessing the value of a portfolio and different portfolio options. However, market value cannot, and should not, be ignored; it can be as important as intrinsic value in certain circumstances.

Finds the Right Owner
Even if a portfolio owner is creating significant intrinsic value for a business, the owner may not be creating as much value as another owner could.

3. A Sustainably Advantaged Portfolio is not only strategically sound and value-creating, it is also resilient. 

Survives Scenarios
A Sustainably Advantaged Portfolio is one that—in aggregate—is more likely to perform well in a variety of different, plausible, future environments, not just one that might reflect an executive team’s official future 

Builds Optionality
A Sustainably Advantaged Portfolio prudently builds optionality into its portfolio choices, thus enabling multiple potential routes to value in the future.

Weighs Feasibility and Risk
A Sustainably Advantaged Portfolio is one whose feasibility and risk are more attractive than alternative portfolios, given the company’s ambition and risk appetite.

4. Finally, a Sustainably Advantaged Portfolio must be sustainable as well

Creates Social Value
A Sustainably Advantaged Portfolio is one that – in aggregate – delivers social impact to the society and communities that it operates in. Social impact is best defined by the intended beneficiaries in terms understood by them. This could include improved living conditions, better education, basic healthcare or other pressing social needs 

Creates Environmental Value
To be sustainably advantaged, a portfolio must meet society’s expectations in terms of improving the environment and addressing climate change 

Creates Economic Impact
Host countries and communities expect that business should deliver economic impact to them. This could be in the form of jobs, local procurement, taxes, royalties or similar

A Sustainably Advantaged Portfolio of businesses—one that is strategically sound, value-generating, resilient and sustainable—is at the heart of every successful company. The twelve attributes we discussed illustrate what a Sustainably Advantaged Portfolio looks like, at least at the most basic level for a typical company. They can serve as a valuable guide for executives in their ongoing work to define the businesses in which they should participate and the ways in which they create value within and across their businesses.

Of course, building a “Sustainably Advantaged” portfolio is not easy. It is not a matter of assessing things on just two or three dimensions. It is not simply a matter of evaluating the strength of individual businesses. Nor is it an arithmetic or algorithmic exercise or a matter of applying a rigid set of criteria to all companies.

Developing a Sustainably Advantaged Portfolio is more about creativity and optimization than linear calculation. It requires viewing portfolio options through a wide array of lenses, as well as evaluating both individual and system effects. And it requires using criteria tailored to the company at hand and the societal context at hand. Most of all, however, designing Sustainably Advantaged Portfolios requires hard work: the hard work of wrestling with data, making trade-offs, and making tough choices. In fact, in our view, management must be prepared to hold challenging, data-rich, iterative discussions about what to do (as well as what not to do) when creating a Sustainably Advantaged Portfolio. Because at the end of the day, good strategy is all about choices. And making the right choices is fundamental to sustaining growth and competitive advantage in turbulent times.

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