Turning Around in Rio
The heading of this review is not a reference to dancing or pirouetting on the streets of Rio, Brazil. Rather it is referring to the performance turnaround of mining giant Rio Tinto by Sam Walsh who took over as CEO in early 2013 after a period where the company generated record financial losses.
Sam credits the turnaround to three main factors.
1. Increasing the rigour to gain approval to fund new investments.
This involved shifting the onus of investment decision making from a central committee to a focused group of experienced and knowledgeable Executives who would be directly accountable for the performance of the new venture.
Thus the ante was increased on the proponents of new ventures to diligently assess and approve a venture as compared to the past where such proponents were essentially making a sales pitch.
The target earnings (hurdle rate) required to gain approval was also increased to an internal rate of return (IRR) of 15% to safeguard against assumptions about the future which were ‘stretched’ beyond what was reasonable, in order to get the project over the line.
2. Focus on cash and less on earnings
Business assessment shifted away from a revenue and profits based approach to a cash approach. Why? Because corporate reporting regulations have changed so much in recent times to the extent that the earnings of a company don’t always reflect its’ true underlying performance. Cash on the other hand is either there or it is not.
3. Look Outside the Company to Gain Efficiency
Rio’s efficiency measures were inspired from what it learned from the non-mining sector. One example that was applied by Rio included the use of driverless trucks to transport raw materials which reduced labour costs (an idea from farming).
A second initiative was the establishment of remote mine site management from one central location in Perth which today controls 15 mines simultaneously. Not only has this reduced costs but has synthesised production planning and allowed Rio to recruit top talent in Perth that would otherwise not have been available because these people were not interested in living in remote locations.
Clearly Rio Tinto has instigated practical and positive changes within the company based on good ole fashioned know how and a common sense approach that positions it well to deal with the current tough economic conditions.
However, is a rule to pass up investment opportunities if they do not meet the metric of achieving 15% IRR is the best way forward? If that is the criteria then if Rio is ever faced with two investment opportunities where one delivers the required IRR but achieves lower value in absolute dollar terms, it will be selected rather than the opportunity that generates millions more value in dollars terms but falls just under the required 15% IRR. This would be detrimental in the long term.
Investment analysis is a complex undertaking and it is best to always assess opportunities from multiple standpoints both financially and non-financially so that fully informed decisions can be made.
Reference: “The CEO of Rio Tinto on Managing in a Hyper Cyclical Industry”, Sam Walsh, Harvard Business Review, March 2016