Steinhoff: Bankruptcy Lessons

Let’s start by providing a bit of context to the Steinhoff story, then we can get on to discussing the up-to-date strategy and the progression of the company.

The initial start of the business, under the name of Steinhoff, came from Bruno Steinhoff in the early 1960s. In essence, he commenced the business, which was really aimed at household goods. It was aimed at starting in what was then Eastern Germany, sourcing for the West, so Western Europe and Western Germany. He really built the business up from that time. From the fall of the Berlin Wall in the late 80s, it opened up all of the production facilities that he had started in Eastern Europe to make them even more easily accessible to Western Europe than they were before. So Bruno Steinhoff was the founder of the business overall.

In parallel to that was a group of guys who were all at university together in South Africa, who joined Accenture, so nothing to do with Steinhoff at this stage. This was people like Markus Jooste and people like Danie van der Merwe who is now the CEO. They were all together at Accenture. And they made early investments in forests, particularly in Eastern Europe and also in Russia, essentially, investing in land and taking tax breaks as a result of the investment in forestry. They came together with Bruno Steinhoff in the late 80s, early 90s. I guess due to the combination of their forestry and timber and his largely furniture-based production capability. It seemed logical to merge the businesses together and become one. In essence, the beginning of the vertical integration of forestry timber going into furniture. That was really the commencement of the business, if you like.

Their early strategy was to invest in production and distribution capacity, so really expanding the Steinhoff business as it was, and trying to link manufacturing and sourcing together to try to create this manufacturer/ warehousing/ distributor of household goods and timber related products, both in Europe and, later, in Africa. This was a logical extension as South Africa was where they were. That's really the history of the business.

It's worth saying, as well, that in market positioning, they were aimed at being a low-cost producer and distributor. They were really aiming at the low-cost mass middle market business in Western Europe, South Africa, and then latterly in Australasia. That was the commencement of their business: really looking to control raw materials, some third-party sourcing, their own manufacturing base and then selling it at that stage into retailers that they didn't own.

The next extension, again, from the basis of these raw materials and manufacturing capabilities, was to start to acquire retailers. And that's what they began to do in the early 2000s. They acquired businesses in the UK, in Australia, in France and in Germany primarily. Those businesses were available to purchase and they were relatively cheap. They had a property portfolio that was of interest to Steinhoff i.e. there was some value to the business that wasn't just related to its trading capability. They could be linked into the existing resources that Steinhoff had upstream and kind of make them vertically integrated, at least that is the outward positioning of the business. Whilst they were buying these retail opportunities, they also managed to acquire greater aspects of manufacturing capabilities, particularly in beds. In the UK, they bought companies like Relyon, the bed manufacturer, and Sprung Slumber in Australia. They then looked at particle board manufacturing, which was really the bedrock of the furniture business. They acquired a business called PG Bison. They bought Unitrans which is a logistics operation, particularly operating in Europe.

That's really the positive side of their growth. I think shortly after that, around 2005/2006, they opened a sourcing office in Shenzhen in China, which was really aimed at that time at the furniture side of the business. From that, they expanded to third-party sourcing operations of furniture in Asia, to put that alongside their own direct manufactured capability. I would say at that stage they were semi-vertically integrated, but very much aimed at furniture and household goods.

It's particularly interesting that in the last 10 years, they started to buy so many retailers. Obviously, hindsight is a wonderful thing. Were there any real synergies or scale effects when you're buying so many different retailers from a sourcing and procurement standpoint of the raw materials, given the infrastructure they had?

That’s a good question and outwardly the answer would look like ‘yes’, but the reality was ‘no’. What was an interesting approach that they had as a result of the acquisitions was, as I mentioned earlier, they were buying businesses that were available and those businesses were available for a reason, of course. They weren’t trading that well and they were relatively cheap. But what Steinhoff were not was a turnaround organization, they didn’t have the skills and the capability in order to take those businesses and really make them grow - I’m talking primarily the retail ones.

So the management just left them alone? Left them as a standard identity?

Yes and no. What they did, in terms of the control element, was put in finance directors or CFOs who were closely aligned with the South African business. These were either people who had worked within Steinhoff in South Africa or were very well known to the South African operation. So the CFOs and finance directors who went into all of those retail organizations then took control of the business alongside an indigenous CEO, somebody who knew the operation in the countries that they were trading in. They really ran it as, if you like, a two-handed operation. It’s not unusual for CFOs to be heavily involved in running a business, but it’s particularly true in the Steinhoff case that, certainly in my experience, the CFOs were almost as dominant as the CEOs. They largely ran the balance sheets of those companies. But what they did leave to the CEOs was the direction of the business. And this is the paradox of their supposed vertical integration strategy, in that no retail business was required to buy from the manufacturing operation. They were all stand-alone profit centers and as such, were able to trade and buy as easily from third parties as they could from within the organization. And because the manufacturing side of the operation was typically - there were some exceptions - a profit center as well, they were, of course, selling with a margin.

So they were stand-alone P&L’s?

Yes, all stand-alone P&Ls controlled by the CFO. These were the parts of the business where they weren't that profitable and a lot of them weren't that profitable, they weren’t when they bought them, and they certainly weren't trading profitably. Many of them were cash generative, but that cash generation was largely siphoned off and was taken into a big pot in South Africa. So the CEOs of those organizations didn't really see the cash side of the business, they saw the trading P&L, clearly the essence is all costs and whatever. There were some cross-subsidies taking place. So if you take the UK as an example, the marketing costs of all of the UK operations were paid for centrally in South Africa. So marketing costs were taken off balance sheets in South Africa. As you can imagine, the furniture and bedding industry, particularly in the UK is very promotion-led with a straight-line correlation between marketing and sales.

If you're the CEO and you're working in Harveys or Bensons for Beds and such a core driver of your top line is marketing and promotions and yet you don't really see that spend or control that spend, from an organizational structure standpoint, how did people actually respond to that?

They bid for it, effectively. Typically, what would happen, if you were at a very senior management level, is people like Markus Jooste and Danie van der Merwe would arrive every three months, they would spend a day with the management of the business. In the case of the UK, we all used to go down to the office in Cheltenham. We would present to them things that had been going on in the three-month period. This was sales, customer feedback, customer information, et cetera. But you’d also, at that stage, be bidding for capital or things like marketing spend. Although the money came from South Africa, you largely put in the requirements that you had for marketing and you would put together an annualized marketing budget, and it was updated every quarter. In fairness to them, they were usually pretty free in agreeing, particularly around marketing. You would often run through the ad campaigns as part of the presentation that took place every three months and if you had a case for what you wanted to spend, they would agree. So they weren’t tight about marketing spend. They were much tighter with regards to capital expenditure associated with plant infrastructure, property leases, all of those kinds of things. In general, because they trusted implicitly the finance directors of all of those operations. The finance director was obviously at all of the meetings and presentations. If it got the nod from the finance director, it was deemed as being kosher by the South African management team then they would more or less go ahead with it.

Underneath all this was a business that was based in South Africa and listed on the Johannesburg Stock Exchange, and the currency movement in South Africa had obviously gone in the wrong direction overall. It’s difficult, almost impossible, to move money out of South Africa without a reason. So they essentially went on what would’ve been, if you’re being very purgative, a spending spree, with this acquisition of companies across Europe: spending money, getting the money out of South Africa.

Which is all part of the Germany story?

It is, yes. All of those acquisitions like Poco in Germany in 2008, Conforama in France in 2011. They were all part of that. Move the money out of South Africa, getting into Euros rather than South African Rand.

Looking back, what lessons did you learn from an organizational structure point of view that can leave a business at risk? I think the structure of an organization can encourage some bad behavior from CFOs or senior executives. What major lessons did you learn from Steinhoff in that sense?

I think there were several. Let’s talk about what one didn’t see, rather than what one did. What one didn’t see was the traditional senior management focus on sales and profit growth. I mentioned earlier that when you take on a business, you look at that business, you establish what the pluses and minuses are, where is it that we need to change things, do things, spend money, save money, recruit people, et cetera. There wasn’t this very aggressive stance on improving the operational standing of the business. So the sort of stuff you see now in the UK, you know Mike Ashley takes over House of Fraser and immediately you see changes in management, investments in some areas, all of that turnaround activity. I’m not putting Ashley up as a paragon of it, but just as an example.