Global study analyses new management imperatives for companies in capital-constrained marketplace

Free cash flow will be the catalyst for change, the chief financial officer will become the chief value officer and investment decisions will become polarised. This is according to Business Redefined: Generating Returns, an international study by Cap Gemini Ernst & Young and global business advisory firm Ernst & Young released today.

The study, based on interviews with more than 60 CFOs and top financial executives from companies around the world in the technology, communications and entertainment (TCE) industries, finds that companies at the convergence of telecommunications, media and entertainment and technology face a difficult business paradox in 2002.

They must manage for growth and, in some cases, redefine their business models, but they must do so in an arena of capital scarcity and other significant financial limitations.

Faced with a financial backlash from unprecedented investor optimism and industry overspending in the late 1990s and early 2000, the study finds that these executives must now walk a tightrope as they seek to address the challenges of continuing industry convergence and technological transformation without the benefit of additional outside financing.

"Our analysis concludes that business is being redefined in five distinctive ways," says David Purnell, the partner heading up Ernst & Young`s technology, communications and entertainment division (TCE) in SA.

He explains that the strongest issues outlined in the study include:

• .         With capital scarce, free cash flow is the new catalyst for change. Companies must now finance growth through their own cash flow.

• .         Across-the-board cost-cutting to improve profitability will backfire for some companies.

• .         The CFO is becoming more critical and involved in business issues, as well as financial controls, in this new environment.

• .         Investments will become polarised, focusing on either infrastructure or the customer.

• .         A return to profitable growth depends on the customer and the ability of numerous companies in all three sectors to work interdependently to deliver the value-added services customers want to buy.

"Telecommunications, media and entertainment and technology companies all have been challenged to almost instantly address the issues of profitability and cash flow, without losing sight of the need for continued business innovation to re-ignite growth," says Purnell. "This study makes clear that companies will need to walk this tightrope with extreme caution and a realistic view of the evolution of their markets. Cost-effectively delivering customer value should be the focus of every company."

CFOs agreed that telecommunications, technology and to a lesser degree, media and entertainment companies are now paying the price for a go-go era of overspending. The study finds that both investors and management lost sight of essential fiscal and business realities. "Despite plenty of evidence to the contrary, they underestimated the cost of delivering new services and, more importantly, the time it would take for customers to adopt new technologies and services on a large scale," says Purnell.

For example, US venture capitalists, who were lured by the vision of a broadband-connected society and sky-high market capitalisation, increased their investments in these sectors from 1998 to 2000 by five-fold-from $20 billion to more than $100 billion. In Europe, wireless companies paid exorbitant sums for next-generation licences. They spent $46 billion for third-generation (3G) licences in Germany and $32 billion in the UK. Meanwhile, media and entertainment companies also increased debt as they went on a merger and acquisition spree.

After looking closely at the bottom line impact of mounting financial losses and escalating investment requirements, investors finally pulled the plug. As a result, capital markets are virtually closed and the investment community is focused intensely on free cash flow as a means of valuing companies. "Businesses are now faced with a near-absolute imperative to achieve and maintain operational and financial efficiency," says Purnell.

In this new environment, CFOs say cash and profitability is what counts. They must quickly and emphatically bring expenses in line and operate their companies with a renewed sense of fiscal discipline.

However, the study cautions, simply falling back on cost-cutting measures to improve profitability won`t solve the problems faced by most of these companies. This research shows that across-the-board cost-cutting can often put at risk an organisation`s ability to grow profitably, which is a critical measure of corporate value. According to the study, investors typically give companies a valuation premium of two-to-three times for profitable growth.

"It`s a difficult and complex balancing act, one that is making the CFO once again ascendant in the executive suite, according to the study," says Purnell. However, it is also a scenario that calls for a new kind of CFO, with a mixture of financial acumen and business savvy and the ability to balance the requirements for discipline and innovation, profits and growth.

According to the study, focus will be an essential success factor for these companies. Telecommunications companies, for example, will need to place their bets on either owning the customer or the infrastructure.

Additionally, the study highlights the fact that companies in the telecommunications and technology industries will need to finally come to grips with the principles of value-pricing and customer-centric business planning in order to improve ROI and incremental revenue opportunities on existing investments. For some companies, the change will require fundamental changes in their business models.

The continuing convergence of telecommunications, media and entertainment and technology means that the fate of these three industries is now inextricably linked. The study finds that companies, more so than ever, will need to look beyond corporate boundaries, and even traditional industry boundaries, for answers. Media and entertainment companies, for example, are dependent on the delivery of last mile broadband into the home and on the development of new communications and entertainment platforms. Conversely, network service providers and equipment manufacturers are dependent on the creation of applications and other content that will drive demand for their products and services.

Single, breakthrough services from individual companies will not save most players in this converging marketplace. Rather, it will be a "ValueWeb" of network transport and access providers, content packagers and equipment manufacturers who each deliver a piece of the answer for the customer.

"One of the great lessons of the past several years is the primary position of the customer in the evolution of this industry and marketplace," said Purnell. "The customer ultimately determines how quickly the industry will return to profitable growth, and how quickly these markets evolve into a true connected society. Only the customer can decide which services and products have real value and how quickly the market adopts them. It`s the customer who stands at the centre of today`s ValueWeb," concludes Purnell.