Each year PwC release a comprehensive report on the state of the mining industry. What can we learn from the PwC Mine 2016 report? According to the headlines, the major miners blew the boom. Strategic choice requires a willingness and capacity for both ‘clear eyed analysis and bold action’. The PwC report numbers suggest that ‘bold action’ overwhelmed ‘clear eyed analysis’. Over the period from 2010-2015 the top 40 mining companies invested $623B. They have written down $199B. Ouch!
Their report argues that shareholders were not fully rewarded for the high commodity prices as management ploughed cash into bigger and more marginal assets. Indeed, a senior executive from a major gold miner tells me that they actually produce less gold during times of ‘boom’ prices!
So, what are we to make of this?
Firstly, let’s not pretend surprise. This is text book stuff: viz.
“growth in a commodity is an industry phenomenon, driven by an increase in overall demand. The growing demand pulls up profit, which, in turn, induces firms to invest in new capacity. But most of the profits of the growing competitors are an illusion because they are plowed back into new plant and equipment as the business grows … but in a commodity industry, as soon as the growth in demand slows down, the profits vanish for firms without competitive advantages. Like some sort of economic black hole, the growing commodity industry absorbs more cash from the ordinary competitor than it ever disgorges” … Rumelt (2011) Good Strategy, Bad Strategy
Secondly, are we playing [ii] ‘Monday morning quarterback’?
As McKinsey has observed, we are all great strategists in hindsight. The real challenge is “what to do when you’re in the middle of it all, under real world constraints and pressures of running a large, modern company”. This is true. But it doesn’t give anyone a leave pass for poor decision-making. I remember the story of a senior industry executive wandering the corridors, telling anyone who would listen: “I get paid to make the big calls”. Indeed. So when they get them wrong, a degree of criticism is not unreasonable.
There were undoubtedly some egregious errors of judgement during this period. Rio’s acquisition of Alcan ($38B; write down $25B) and Anglo’s acquisition of Minas-Rio ($6B plus $8B capex; write down $5B) are stand outs.
Should the mining companies have withheld the expansion plans and given cash back to shareholders? Maybe. But mining executives faced a classic multi-party ‘prisoner’s dilemma’. You would have to believe that the other majors would display the same ‘discipline’. This is an inevitable structural dilemma of a free market economy. Free markets do not handle lumpy volume additions efficiently.
For me, the greater vulnerability in the decision making was the tendency to ‘lock on’ to the strategic narrative. Once the iron ore sector had locked onto the mantra that China steel will grow to more than 1Btpa this became the strategic framing within which expansion decisions were made. The majors have now walked back from that narrative.
Of course, for some, their decision making was just poor. I saw one company’s price forecast during the latter stages of the boom that would have had you rolling with laughter. Another company director declared: iron ore won’t fall below US$100/t while I’m alive. This was never a credible position.
Finally, what about shareholder value? Somewhat ironically, at the end of the boom global mining CEO’s started espousing the importance of shareholder value. It begs the question: at what point in the cycle did we forget about shareholder value?
But what about shareholder value?
The report reinforces the vast gulf between the investment horizons of companies and many shareholders. A quick check on one of the top 40 miners revealed that 85% of their shares were traded every year [ii] during 2010-2015. These shareholders are traders who compete not on the basis of an investment thesis, but on the basis of who has the best algorithm incorporating short term pricing. The PwC graph of market capitalisation versus commodity price index highlights the dominance of the short term pricing.
Executives do need to focus on creating value. Investors, shareholders who buy and hold the stock, do so on the basis that they believe the investment story around the commodity and they have confidence in the resources & capabilities of that particular company. The commodity story is theirs to own. The capability is for the executives to demonstrate. The rest is noise.
What do we do? The answer is not smarter people [iii]. But it is smarter decision making. Advances in our understanding of decision making have not been matched by improvements in practice. How confident are you in the quality of your strategic decision making? Here are three practices that you could incorporate into your strategic decision making process:
- Look back twice as far as you look ahead in understanding the industry dynamics.
- Once your business has locked onto a strategic narrative adopt an ‘outsider’ perspective to challenge the mindset … deliberately search for ‘weak signals’
- Ignore the noise … good leaders are able to triage their time and energy and focus on the consequential
[i] Apologies for the American expression … I couldn’t think of an Australian equivalent
[ii] That is 85% by number: it is likely that more than 15% of shares were held by longer term investors.
[iii] If you think it is smarter people, read about Long Term Capital Management which was run by finance veterans, PhD’s, professors and two Nobel Prize winners. When it failed they exposed banks to more than US$1Trillion in default risks.