MISTAKES TO AVOID IN THE ESTABLISHMENT OF A SUBSIDIARY COMPANY

LEARNING FROM EXPERIENCE

BY

RAY WILLIAMS MA MPhil MBA

After years of using an Agent to distribute their Outdoor Leisure Products in the United Kingdom Market, the Top Management of a French Public Company decided to cancel the contract with their Agent and to establish a new subsidiary company.

The Driving Force for this radical decision was influenced by the high profits made by the Agent during strikes in the UK which led to a huge increase in consumer demand for the company’s portable gas lighting products and cooking products.

On reflection, the Parent Company made some fundamental mistakes and the Objective of this Paper is for MBA students and Corporate Directors to Learn from Experience so that they do not make the same mistakes as the French Parent Company

POOR MARKET ASSESSMENT

The Parent Company failed to make a proper and detailed assessment of the UK Market – Market Size less spikes due to short term demand such as during Power Strikes, Market Trends, Competitive Strenghts & Weaknesses, New Legislation restricting the storage of gas products, retail distribution trends, changing consumer tastes & trends in the UK Holiday Market such as the growth of Overseas Package Holidays and the impact on its traditional Outdoor Leisure markets.

As a result, Expectations were raised for the new subsidiary company based on unrealistic market data.

FALSE COMPARISONS

The Parent Company made false comparisons such as expecting the same performance in the UK as their subsidiary company in Germany. They ignored fundamental financial structural differences and other major differences which made comparisons false and created unfair pressures on the new Top Managemnt of the UK subsidiary company. They failed to analyse in depth market differences and structural differences between countries.

AGENT COUNTER REACTION

The contract with the Agent meant that on cessation of the trading agreement, all unsold stock would have to be re-purchased by the Parent Company. However, the Parent Compny made the new subsidiary company purchase the unsold stock resulting in the new subsidiary carrying too much stock at a very high cost – a very large burden in Year 1 of Trading.

The parent company also failed to take into consideration Agent Counter Reaction such as –

The Agent sold products at a premium price, flooding the distribution chain and preventing the new subsidiary from achieving hign normal sales in Year1.

The Agent decided to create their own range of products and became a serious new competitor selling mainly on price and forcing a reduction in gross margins of the subsidiary in order to maintain Market Sha

UNDERCAPITALISATION

One of the most fundamental mistakes made by the Parent Company was to Undercapitalise the new subsidiary – a very common mistake made by Parent Companies.

The subsidiary was forced to rely on bank borrowings to fund the agent stock buy back, pay salaries and expenses and fund a Television Campaign in order to unblock the distribution pipeline caused by the hostile strategy of the Agent.

As a result, the subsidiary company was doomed to make a loss in Year1 and some members of the Parent Company started to blame unfairly the subsidiary company for the losses and not themselves..

Fortunately, due to the newly formed Top Management of the subsidiary, the company made pre-tax profits for the next 10 years in spite of the hurdles they had to fa

DIVIDEND POLICY

When the subsidiary company became profitable, the Parent Company implemented a 100% Annual Dividend Policy which meant that the subsidiary never created a Retained Profits buffer fund which could have reduced bank borrowings and increase future years profitabilty.

The Parent Company had capitalised the German subsidiary and they continued to make false and unfair comparisons with the UK subsidiary, ignoring the different financial structures between the two subsidia

PUNITIVE GROSS MARGIN INCREASES

In later years, the Parent Compnay decided that they wanted to inflate the profitability of their manufacturing company in France. As a result, they reduced the Gross Profit Margins of the UK subsidiary by 17 % - over and above the normal annual increase in subsidiary puchasing prices. This resulted in a massive reduction in the Pre-Tax Profits of the UK subsidiary company and gave a false assessment of the true underlying profitability of the subsid

NOT INVENTED HERE

In order to improve the performance, the Top Management of the subsidiary put forward many ideas for Diverification in order to counteract a Stagnant Market, Strong Price Competition, the Negative Results of Parent Company Policies and the restrictions caused by Legislation. The Parent Company ignored all the suggestions and instead pursued a policy of Product Diversification within small potential growth markets and with products more suitable for the French M

NEGATIVE IMPACT OF PARENT COMPANY NEW OWNERSHIP

Whilst the subsidairy was striving to grow, there were major changes in ownership of the Parent Company.

Phase 1 – the Parent Company was sold to a major Finance Company whose strategy was – Reduce Costs, Increase short term profits – and sell the Parent Company at an inflated profit. Thus, radical research & development during this period was blocked.

Phase 2 – the Finance Company sold the Parent Company to a well known International Oil and Gas Company who continued the strategy of cost reduction to increase short term profitability. Thus, for a few years the subsidiary had to suffer from a Parent Company Management whose strategy was based on short termism – a dangerous strategy for long term growth and long term survival.

Constant changes in ownership and Top Management can have a disasterous effect on subsidiAry performance and Management morale.

LESSONS FROM EXPERINCE

MAKE A THOROUGH AND REALISTIC ASSESSMENT OF THE MARKET BEFORE LAUNCHING A SUBSIDIARY

CAPITALISE THE NEW SUBSIDIARY COMPANY AND DO NOT FORCE THE FLEDGLING SUBSIDIARY TO RELY TOTALLY ON BANK BORROWINGS

ASSESS THE HOSTILE STRATEGY OF THE AGENT AND REALISE THE FACT THAT A NEW COMPETITOR MIGHT BE CREATED

GIVE THE SUBSIDIARY A CHANCE TO BUILD ANNUAL RETAINED PROFITS                                         

DO NOT MAKE FALSE COMPARISONS BETWEEN SUBSIDIARIES

DO NOT BE TOO GREEDY WITH A 100% DIVIDEND POLICY IN THE SHORT TERM

ENCOURAGE CREATIVE EXPANSION IDEAS

BE REALISTIC IN PERFORMANCE EXPECTATIONS IN THESHORT TERM

THINK LONG TERM STRATEGY

DELEGATE MORE RESPONSIBILTY TO THE LOCAL TOP MANAGEMENT