Changing your Business Strategy
Watsco - from manufacturing to 'buy and build'
Aaron (AJ) Nahmad, the President of Watsco, responded to the question, “What Defines you?” with:
“It’s not what we do but how we do it”
In a sense this distinction captures the essence of the importance of strategy, which, simply put, is the translation of ‘what’ to ‘how’.
For it is Watsco’s strategy and time horizons for the strategy which make them such an interesting case story.
Watsco are one of the leading distributors of HVAC in the US. If you don’t know what HVAC then you’re in good company, for it was a new one on me until I started exploring this company in more depth.
HVAC refers to Heating, Ventilation and Air Conditioning, and as the company puts it heating and ventilation are necessities rather than luxuries.
But first a few numbers:
The company’s shares trade on the New York Stock Exchange and current value is $18.55 Billion (21/3/24).
They have acquired 67 HVAC distributors in the last 33 years.
They carry over 200,000 products and supply over 120,000 active contractors.
They have a network 673 locations across USA, Canada, Mexico and Puerto Rico
Over a 10 year period operating income has grown 270% from $225m to $832m
The Nahmad family own 52.6% of all voting shares
Average annual sales income has grown by 15%
CULTURE FOOTPRINT
In the following analysis I’ll apply the seven Building Blocks of the Ceannas Culture Footprint. The metaphor of the culture footprint sets out to capture the systemic (interconnected) nature of culture in the same way the concept of our ‘carbon footprint’ represents complexity of the impact that human behaviour has upon greenhouse gas emissions. By understanding our ‘footprint’ (both Carbon and Culture) we can make informed decisions about what behaviours to change.
The Culture Footprint is not a climate or engagement tool. These surveys can play an important role in monitoring the ‘health’ of an organization but are essentially symptom focused, whereas the Culture Footprint is driven by a focus to identify, understand, and analyse the root cause of cultural success, or failure.
The Culture Footprint doesn’t measure culture in terms of saying it’s good or bad, for it recognises the reality that different organisations can seek to build quite different cultures depending on their location, industry, cycle of growth or circumstances and still experience success.
WATSCO CULTURE FOOTPRINT
LEADERSHIP
Up until 1989 Watsco was a manufacturer of HVAC. However, in that year CEO Albert H Nahmad made the decision to shift from manufacturing to distribution and from that moment on the business has never looked back.
Under his leadership, Watsco has grown from a market capitalisation of $22 million in 1989 to $9.8 billion at the end of 2022, generating a compounded annual growth rate of total shareholder return of 18%.
One of the features of wise leadership is the capacity to make courageous decisions. Who knows how risky it might have appeared back then but many businesses find it difficult to leave behind their roots and change tack in such manner. Nahmad has no such hesitations.
However, from the very start Nahmad laid down some fundamental principles which still inform the business to this day.
Adopting a long-term perspective
Linking compensation to long-term growth
Promoting employee ownership
Delivering exceptional customer experience
An entrepreneurial spirit
Respecting the company owners, managers and employees of the companies they acquired.
Conservative management of debt
Central to their growth strategy has been the acquisition of other distributors. As noted above, 67 over a 33 year period.
Watsco’s respect for the companies they acquire allows them to retain their own culture, brand name, managers, and sales organisations.
Their strategy is to build upon the value of the acquired operation by providing an alternative exit strategy for the former owner. This often leads them to be the preferred bidder in comparison to those who would prefer to swallow an operation and deliver structural efficiencies but lose the essence of what they actually bought.
A further dimension of the Leadership Building block is the extent to which the company trusts and empowers its leaders.
There are 673 business leaders in the group who run their own Profit and Loss accounts, and who are empowered to make business decisions on local dynamics rather than corporate mandates.
MANAGEMENT
It was Warren Buffet’s business partner Charlie Munger who once said:
“Show me the incentive and I will show you the outcome.”
Munger was alluding to the fact that incentives usually incentivise inappropriate behaviours. Yet when it come to Watsco the compensation scheme is perfectly constructed and aligned to fit with their goal of long-term growth.
The scheme is based on the principle that compensation should be highly dependent on long-term shareholder returns.
In line with this principle the company focuses on equity based compensation plans which are intended to promote long-term performance and foster an ‘ownership culture’.
In a manner similar to Handelsbanken, the Swedish based bank, employees cannot access that equity until the age of 62.
The intention of this ‘ownership culture’ is that it balances strategic risk taking and long term value creation and aligns the interests of high-performing leaders with the interests of the shareholders.
If anyone leaves before the age of 62, other than for death or disability, their shares are forfeited!
WARMTH
Warmth is apparent on the way Watsco treats the companies it acquires. It appears to be respectful and sensitive to the feelings of the previous owners, and their employees.
It also stresses that the commitment and passion of its people are what drives Watsco’s success.
The concept of Watsco as a family is a recurring theme with new companies welcomed into the fold but also trusted enough to retain their own identity
ENTREPRENEURSHIP
From the very first days of adopting its new business strategy Watsco has sought to foster an entrepreneurial spirit.
It has enabled that spirit through the high levels of decentralisation and what it calls
“Competition of ideas’
whereby people are encouraged to have a voice and the best idea wins as long as it’s in the long-term interests of the company.
The company has also differentiated itself from its competitors through the use of technology, which it has used to enable the companies is has acquired to benefit from and add significant value to their existing operations.
Their digital e-commerce platform grew 5% in 2023 to $2.4 billion, or approximately 34% of total sales.
Their app, which had 43,000 monthly users, has led to higher growth, lower customer attrition and lower costs for the company, which led to a further $49m investment in technology in 2022.
The company has also established Watsco Ventures, which is their own investment fund which invests seed finding and later stage investments into related technology advancements, especially those related to environmental efficiency.
Aligned to their environmental goals the company has adopted the strapline:
Coolest Green Company
It recognises that HVAC accounts for 50% of energy use in US homes, and that the installation of their more efficient systems have been the equivalent, in terms of reducing carbon emissions, of removing 2.6 million cars from the road each year.
EDGE
Edge, or focus on performance, results and success permeates the business but it does so with a strong caveat that this must not come at all costs.
Short-term success, regardless of how much it might yield, will always come second to the longer-term goals and perspective of the business.
Nevertheless, the company has sufficient edge to implement its policy that people lose their right to long-term equity if they leave the business, and I get the feeling that anyone who sought personal gain over collective benefit wouldn’t be encouraged to hang around for too long.
LEARNING
The company claims to have a comprehensive learning culture.
It places significant focus on their entrepreneurial and decentralised culture that:
“empowers people to develop a growth mind-set and focus on continuous improvement so they can reach their highest potential.”
As with most large companies it has a learning management platform but I can find little evidence of anything much beyond the >99,000 technical training hours completed by US employees.
TEAMWORK
There is a strong sense of Teamwork, especially at the local level by the high level of delegation and empowerment creating local loyalty and sense of belonging.
CONCLUSION
Watsco are a fascinating business. Beginning with their strategic decision to move from manufacturing to distribution
The leadership of Albert Nahmad, who started as CEO in 1972, and who still remains as Chairman has provided significant continuity of strategic thinking.
The fact that between him and his son Aaron (AJ) they own 52.6% of voting stock gives the stability that enables them to take such a long term perspective that other companies, with much shorter horizons, cannot compete.
It cannot be ignored that this strategy has yielded a compounded annual growth rate 18% making it a true industry leader.
As a direct consequence of the stability provided by the leaders, the core of the Watsco culture is the interplay between seven critical factors:
Long-term thinking aligned to shareholder interest
A compensation scheme that incentivises long-term thinking through ‘employee ownership’
An acquisitive strategy that seeks out businesses that fit with their values
The trust they place in their leaders and the empowerment they give them
The manner in which they have embraced and employed technology
An entrepreneurial mindset which liberates people to come up with new ideas, and
Their conservative approach towards debt
The fact that they can combine some of these intuitively oppositional strategies such as high technological innovation with conservative management of debt; and long-term compensation with an entrepreneurial mindset, creates a very different culture than is the norm.
As was alluded to earlier Culture is a consequence of the systemic relationship between a multitude of factors. In many organisations these relationships can be accidental or unobserved. In Watsco they seems to be be much more deliberate and strategic, with leaders who link everything back to the long-term growth and success of the business.
Yet in common with several other very successful companies who have featured under the Leadership Spotlight they have built their success on a highly decentralised model where they trust and empower local leaders to deliver on their behalf.
So, in summary:
It’s not so much WHAT that Watsco does, but the HOW they go about it.
The power of employee ownership seems to unlock something that just doesn’t exist in other companies and its something that I look forward to exploring further as this series of case-stories extends over the coming weeks.