Before investing in other business, know your Circle of Competence
Reliance, General Electrics, Kingfisher done these mistakes. Are you doing the same?
The mistake I am talking about here is going beyond your circle of competence.
Circle of competence
A circle of competence is the core attribute which matches a person’s skills or expertise. In simple words, do what you know the best. The area beyond that is not your competence. You should think twice before entering and diversifying in that area.
The model was developed by the great and popular investors: Warren Buffett and Charlie Munger. They clearly described limiting one’s financial investments and what can happen if you don’t stick to your core capabilities.
That simply means staying in your circle. While defining your boundary or circle, you might think that you have capabilities and competencies on areas which you have newly acquired by working on it for some time. But there is possibility of that area being the limitation on your expertise. See the below image:
Natural human nature:
Try something new if the existing path doesn’t provide you the value. Same goes with the business as well. If the core value doesn’t provide you the desired result, you move on to other business opportunities. Wait a minute! Are these really opportunities or just an attraction to divert you from your core competencies and eventually trap you in the situation where you’ll be one of the 90% of small-medium companies that fails.
Not coming as a hurdle between your business diversification and its growth opportunity. Just keeping you aware with some multi-national companies who terribly failed because of one bad decision.
Corporate Learnings Due To Moving Beyond The Circle of Competence
Vijay Mallya used to be called as ‘The king of liquor‘. Everything, whether financially or branding was going great for Kingfisher. Then there came a period of downfall starting from 2005. Kingfisher decided to diversify in aviations and start Kingfisher Airlines. A total different and unrelated industry from liquor which was their one of the primary and most profitable core businesses.
Warren said, “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.
Think of aviation industry which requires humongous amount of investment. In return, it contributed Kingfisher group of companies, the least amount of the share financially as they lack expertise in this sector. Kingfisher Airlines was south, if Kingfisher was North. Acquiring Deccan airlines to diversify further to overseas was an addition to their ongoing failure.
“That acquisition of Air Deccan marked the end of Kingfisher Airlines,” says a person who worked closely with Mallya during that phase and who did not want to be named.
Aviation business is a huge investment division and also which requires full time attention. Malya’s interest was too diverse and didn’t focus on streamlining and growing their core business.Entering into wrong service line and then further to a wrong acquisition, eats up the entire profit of the company.
Growing from $12 billion of market capitalisation to $410 billion in 2001 with over 600 business acquisitions, GE gained a lot of business stardom. You’ll be surprised to know the current 2019 market value of GE has shrunk to $76 billion. Also, they have been removed from top stocks list in 2019.
According to experts, the great fall in GE value is due to the diversification which at first place got them growth, stardom and goodwill. GE is the example which validates as well as contradicts the concept of circle of competence.This downfall play is somewhere caused by the people other than owners.
The growth paradox has been adopted where company needs to show their future growth in respect to raise capital further. Due to this, the top level executives of the company enters in mergers and acquisitions beyond their competency and gradually which leads to decrement of profit and thereby market value.
Reliance IndustriesReliance group believes in diversification where there is rapid growth opportunities.
Thereby, they have currently divested its 49% of shares of hydrocarbon business line which was seen as slow growth industry in near future. This money was invested in Jio, a connectivity and communication industry. Moving beyond their core activities has found to do wonder for Reliance industries. It has increased its EBITDA by more than 3x. Though we have to wait and watch the game whether this conglomerate diversification will really work for Reliance Industries in long run.
We have varieties of learnings from these corporates. I have figured out some reasons why companies move out of their competence boundary. Doing that may work for some company and may not for others.
Reasons Why Companies Step Out Of Their Circle of Competence
- Employees wants to increase their personal short term utility and performance.
- Following pursuit of growth where they grab different opportunities and move to industries with higher growth.
- Following competitors due to a fear of missing out.
- Half or Unstructured knowledge of other industries which is confused with their competencies.
- Ambitious growth perspective and a hunger for higher funding from external investors
Can companies create value beyond circle of competence?
Referring to above corporate case studies, the top tycoons have indulged in wrong investment and diversification decisions which were the reason of their terrible suicide. Whereas, there are some companies which have strategically achieved a higher market value by investing in the areas beyond their circle of competence.
I am not stopping you to grow and get better but as Warren said, “Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital.”
As someone rightly said, half knowledge is dangerous. In hindsight, risk is the first element to start any business.
Also, Don’t forget your roots.