The Philippines would seem to be an unlikely place to find perspectives on management and governance. Hit hard by the 1997 Asian crisis, the country endured two years of fiscal mismanagement and economic decline under the administration of President Joseph Estrada, who was removed from office in January 2001; a heavy depreciation of the currency; and a global slowdown. Most companies in the Philippines have suffered accordingly.

Survivors of such economic volatility can offer valuable lessons. Ayala Corporation has come through the past five years with its businesses and reputation untarnished,1 which is more than many other conglomerates in Asia can say. Founded as a distillery in 1834, the company soon expanded into trading and agriculture, and it now operates businesses ranging from land to water, light-rail to auto retail, and telephones to banking. Ayala companies currently represent some 25 percent of the market capitalization of the Philippine Stock Exchange.

The Brothers Zobel: Jaime Augusto (left) and Fernando

For seven generations, the family of the company’s current president and CEO, Jaime Augusto Zobel de Ayala II, has guided it with a rare mix of adaptability, financial conservatism, and increasingly transparent governance. Although the merits of the conglomerate model are disputed in Western management circles,2 Mr. Zobel argues that conglomerates have a natural role in emerging markets, where successful ones can capitalize on their reputation and reach. He discussed these views and his company’s evolution with Ken Gibson, a director in McKinsey’s Jakarta office.

The Quarterly: The conglomerate model is under scrutiny. Does it have a particular rationale in emerging markets?

JAZA believes that one builds trust by not doing everything by himself

Jaime Zobel: In emerging markets, you find yourself owning businesses for a whole host of reasons. The first is simply the limited size of the market. You can grow only as fast or as far as the market will let you. Once businesses reach that limit, the law of diminishing marginal returns comes into play, and it is better to look for other opportunities.

More immediately, though, you often need to become a catalyst for the infrastructure needs of the country. Being a property developer, for example, there are many variables we want to see in place for real-estate values to go up. One is the infrastructure that gives people the quality of life they desire: clean running water, say, or efficient transport. At first glance, these may not be natural businesses for Ayala Corporation. But in an emerging market like ours, the government does not always have the resources to meet these basic infrastructure needs.

Our involvement in a light-railway system is a perfect example of this. It was initially under the sponsorship of people who needed some help with a project of that magnitude. Since we had a strong interest in making it happen, we threw our hat into the ring. Reassured by our track record and financial credibility, other parties agreed to provide the necessary financing. And so, suddenly, we owned a stake in a railway.

The Quarterly: Is that how Ayala entered its primary businesses?

Jaime Zobel: For Globe Telecommunications, certainly, but our family has been involved in property and banking since the 1850s. In real estate, our most significant transformation really came after the Second World War, which devastated the whole of central Manila. We had a raw piece of property on the outskirts of the city, at Makati, and saw a unique opportunity to transform the place into a fully integrated urban environment. Makati is now the country’s premier business and residential district, and its development laid the foundation on which Ayala Land still prospers.

Our telecommunications business, Globe, was launched in the early 1990s, when the government was seeking to liberalize the economy in a very aggressive fashion and whole sectors were opening up that, traditionally, we had found difficult to enter. The government wanted to create competition in the industry just when the technology was shifting to wireless and the economy was beginning to grow again. We believed a revolution was about to take place—without being sure how it was going to take place or in what form, but definitely a revolution that we did not want to miss. Our opening came when ITT, the largest investor in Globe at that time, decided to sell all of its telecom holdings around the world. Rather than sell out with ITT, we opted to take a majority stake, bring in a strategic partner, and build up the company’s franchise.

The Quarterly: How does the holding company add value to such disparate businesses?

Jaime Zobel: The major shift in our organizational thinking occurred in 1991. Rather than just have a real-estate company that was increasingly diversifying into other fields, we spun the real-estate operations off into a separate company and left Ayala Corporation as the holding company of that and all its other businesses. Since then, we have followed the strategic logic of an investment company. We enter businesses that have potential for growth and for which we have a value-adding proposition, and we manage them to grow into leadership positions domestically. That means the holding company has to do whatever it takes to give each business the independence, financial flexibility, and governance structure it needs to compete. What Ayala adds is an understanding of local business conditions, access to capital markets and finance, the reputation to attract both partners and talented managers, and proven management processes. t the core is the trust that accompanies the Ayala name. We recognize the value of that trust and work hard to protect it.

The Quarterly: How does that look in practice?

Jaime Zobel: It means different things for different companies. For example, you cannot have a viable telecommunications business unless you can finance a nationwide network. Yet in the early stages, very few sources of capital would have bet on Globe to be able to take on the monopoly player3 and succeed. But we strongly believed in Globe’s prospects, and together with Singapore Telecom, the other major shareholder, we put in the equity to give the business critical mass. We also felt that while the management team of Globe needed some strengthening, this looked like a risky career shift for some of the people we wanted to work for it. With Ayala’s reputation as an employer, we were able to entice them to join us. Similarly, we were able to attract partners with the technical expertise we needed.

The Quarterly: In addition to the original need to establish complementary businesses, are there continuing synergies between them?

Jaime Zobel: Synergies are not the main reason for holding on to these businesses. Rather, it is our continuing ability to add value to them. Nonetheless, we obviously try to explore potential synergies whenever we can.

One such area is the cross-selling of group products and services. Our major holdings—Globe, BPI,4 and Ayala Land—all have large and loyal customer bases that we can use for data sharing, payment schemes, loyalty programs, and the like. For example, Globe’s prepaid customers can reload their cards on any of BPI’s ATMs across the country. We have also generated savings of nearly 16 percent from consolidating our purchasing by taking advantage of an e-procurement and e-bidding company called Bayantrade.com, which we established with five other major business houses in the Philippines.

The Quarterly: You have said that a new division—AC Capital, which is responsible for all of Ayala Corporation’s domestic nonlisted businesses—has venture capital disciplines. What does that mean?

Jaime Zobel: Over the years, we have become involved in a number of smaller businesses, looking to build them up to leadership positions during our old ten-year time frame. But with the volatility we are now seeing and the reality of capital constraints, we have to start focusing our resources on the opportunities that will provide the best possible return to our shareholders and make those opportunities count. So we have put all of our noncore holdings—some well established and some entrepreneurial but not yet of significant size—into AC Capital, where we can give them a stricter financial focus. That isn’t to say that they won’t be nurtured as opportunities. But a stronger, more clearly defined financial discipline will better identify the winners and weed out the rest. In the past, for example, we evaluated our subsidiaries on the traditional metrics of return on equity, operating margins, net income, and the like.

During the past year, we have been turning toward the concept of economic value added,5 a metric we believe instills greater capital discipline and better reflects the value our managers are creating.

The Quarterly: The test of AC Capital will be the ability to pull out of a business when the time is right. Historically, hasn’t this been difficult for conglomerates?

Jaime Zobel: Exactly. In the past, we were less rigorous about finding an exit once significant value had been added. We simply hadn’t thought it through clearly enough. Now we have. We are looking much more closely at our subsidiaries’ ability to generate cash from nonstrategic assets and so to deliver cash to the parent, which can use it more efficiently, or to bring in a strategic partner and dilute equity. That decision may be based on our ability, or the lack of it, to take a company to the next level, on our belief that an industry is no longer structurally attractive or growing, or simply on the feeling that there’s a better use for the capital. For example, until recently we had a majority stake in a food business that was consistently profitable, but we could not build it up to a leadership position in the Philippines, let alone regionally. Yet it was a major player in certain segments, which made it attractive to a lot of potential buyers. At the time, the decision to sell was a difficult one to make because our philosophy was still evolving. If we were to revisit the decision again today, it would be much easier.

The Quarterly: What governance standards do you pursue across both AC Capital and the listed subsidiaries?

Jaime Zobel: We are helped by the fact that we have tried to take our companies public as soon as they can stand independently. Our holding company is a public company, and the three major subsidiaries beneath it are all public companies, each with clear shareholder structures. We have also been migrating our accounting and disclosure practices toward international standards, ahead of what is mandated by the Philippines’ Securities and Exchange Commission or the Philippine GAAP.6 And since we are in partnerships in each of the subsidiaries, their governance is shared by others whose standards and structures are quite exacting. We have been working with the Mitsubishi Group for 28 years and with Singapore Telecom for 10 years, with J. P. Morgan in the past, and more recently with Deutsche Telekom and DBS Bank.

The Quarterly: You are a great believer in the combination of stable family and partner interests, on the one hand, and the institutional investors of a public company, on the other. Why?

Jaime Zobel: In the West, the pendulum seems to swing between the model of the tightly controlled family company and that of the widelyheld public company. I feel strongly that between these two extremes lies the most sustainable model. There is an ever-increasing tension between the institutional investors’ focus on quarterly results and the need for long-term strategy and stability. Widely held public companies are seeing a dramatic rise in their CEO turnover, often because there is no single large institution willing to tell the CEO, “Look, hang in there. Let’s agree on our long-term strategy. Even if it takes a short-term hit, you know we’ll back you up.” CEOs are having to roll the dice in a bigger and bigger way, and chances are that they’ll fail occasionally.

To resist that pressure, what we try to do at Ayala is to structure partnerships that can agree on a long-term vision and to provide stability at the board level. By going public at the same time, we get the dynamic tension from the outside institutional-investor community to deliver financial returns over the short to medium term. There is no perfect solution, but I think your odds of succeeding are higher under this kind of structure. You have a better chance of riding out difficult situations and getting yourself into competitive positions, and you have flexibility in raising capital.

The Quarterly: Can you point to an example?

Jaime Zobel: When we were hit in 1997 by the stress and uncertainty of the Asian financial crisis, capital markets completely dried up and many Philippine companies could not raise financing. But with a stable and supportive board, we were able to insulate Globe from the volatility of the markets and put in equity for some aggressive expansion plans. Fortunately, the formula worked, creating about $2 billion in market value over the four years since. If Globe had been widely held, with no controlling shareholders, I doubt that we would have been able to complete Globe’s strategy. Similarly, that stability has helped us to ride through our foreign-debt pressures. The parent company accumulated nearly $1 billion in debt by the end of 2000. The opportunities that we saw for strengthening Globe and BPI were extremely attractive given how their rigid industry structures were shifting. But the local capital markets were simply not large enough for our financing needs. Although our revenues were mostly in pesos, we had to go offshore for funds. Our hedging costs have been high, but coming out of the recent political crisis7 we just could not risk keeping our foreign debt unhedged. If we had been under pressure to deliver on quarterly earnings targets, we might have hesitated on these leveraging decisions, and some great opportunities for long-term value creation would have slipped by.

The Quarterly: You keep a controlling interest in Ayala’s hands, and your businesses are based in the Philippines, the market you know best, so you have even greater control. Has there ever been tension between you and your partners?

Jaime Zobel: Yes, I would say so. But you build trust only by not doing everything yourself, and we are trying to benefit from the expertise of all sides. Tension is part of the game. It increases from time to time and tends to ease off when times are good. We have gone through some very difficult times in all our businesses and that has caused some tensions between our partners and us. But I would say it is just like any human relationship. In the end, it is all about how those tensions are managed and how partners bring themselves to a common vision. These are more human issues than technical ones: how you handle yourself and how you build trust. This is why people who take on senior positions need personal skills as much as business skills.

The Quarterly: Unlike most family-owned conglomerates, you do not have a parallel private business network. How do you keep family and business separate?

Jaime Zobel: When Ayala Corporation went public in 1976, we made a very conscious decision that we didn’t want to find ourselves in any conflict of interest. All matters that directly relate to the family are elevated one level, to a single family holding structure. Although this is not a public company, its ownership in Ayala Corporation is direct and free of the opacity and layering that one might find in other structures. Through that family structure, we choose who will represent us in the governance of the public holding company and act with one voice. Like all other shareholders, the family receives dividend income from its stake. All family members are then free to do with their share as they please so long as they do not invest in ventures that compete with Ayala Corporation’s businesses. This is an unwritten rule but we take pains to follow it. It ensures that if a partner invests with us, it will not be competing with another entity in which a family member has an interest.

The Quarterly: With such a large family stake, how do you feel about nepotism?

Jaime Zobel: As the majority owner, we obviously have the right to be involved in how things are run, even in a public company. But ownership does not confer the right to management of a public company; it depends on what the individual can bring to the table. We are always tightening the rules for a family member’s right to be involved. What are the professional skills needed? Does the family member have a proven track record? In fact, while ours is a relatively large and extended family, there are only three of us—my father, my brother, and I—who are directly involved in running the company. The CEOs of all our subsidiaries and affiliates are people of the highest caliber who are not from our family and are promoted and rewarded strictly on professional merit. Anything else would prevent us from attracting individuals like that and so limit the growth potential of the business.

The Quarterly: What future do you see for the family-owned business?

Jaime Zobel: Family businesses will always be around, and in many ways they are the soul of entrepreneurial success. But if a family business wishes to succeed on a scale that involves raising large amounts of capital, it will need to conduct itself as transparently as a public company might so that potential partners or creditors know exactly what they are getting into. Investors will avoid situations where they cannot quantify the risk they are taking on.

The Quarterly: Does your interest in governance and transparency extend to the national level—in the markets and in politics?

Jaime Zobel: That’s a whole other, very long conversation! But, basically, national reform is in our interest. We have long decided to meet what we believe are global ethical and governance standards so that we can succeed in a world where those standards are set. But in emerging markets, where institutional foundations need strengthening, those ethical standards can, ironically, be a competitive disadvantage. Others can take advantage of the system’s malleability, if only in the short term. Thankfully, investors are now much more willing to vote with their feet when standards are not met. As a group, we try to keep business and politics separate, which is not particularly easy to do in a country like the Philippines. But while we try to help out behind the scenes in pushing for reform, there were two notable occasions when we expressed our concerns quite vocally. The first was in 1986, when the original People’s Power movement succeeded in deposing then-President Marcos, and the second was during the impeachment proceedings against then-President Estrada, early last year. In both instances, we felt strongly that the public trust had been violated to such an extent that the continuation of these men in power would almost certainly have plunged our country into economic and social chaos.

The Quarterly: Does it do Ayala Corporation any harm to express those views?

Jaime Zobel: It might have in the past, but now I think there are enough businessmen in the country who share our views. The leadership of the government now also truly thinks that way. This is a difficult country to rule in many ways, and nothing happens overnight. But there is enough momentum and enough of us are now speaking our minds—using whatever influence we have to make things happen—and that is hope.