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Corporate Centers Value Creation

 

In several multi-business groups, the different businesses comprising the group have developed their individual, appropriately tailored sources of sustainable competitive advantage, or areas of core competence.
These should be tailored to suit the specific environment that they face in the markets where they operate. As no other businesses within the group may operate in these markets or face these specific circumstances, there is no certainty that any of these competitive advantages will be common across the group. This of itself does not, however, destroy the economic rationale for the businesses staying together as a group.

Several large groups have spent considerable time and money in seeking to justify their continued existence by developing group-wide vision or mission statements. Unfortunately many of these do not indicate how remainingas a‘group’will create more value than canbe generatedby the component businesses comprising the group. Any such difference in value creation (whether positive or negative) is attributable to the influence of the corporate center.
Corporate centers differ both in what they try to do and how they try to do it. The‘how’dimension refers to the nature of the involvement of the center and the type and degree of intervention that the corporate center makes in the operations of the group’s businesses. At its very simplest, the corporate center can intervene directly by doing things for the businesses within the group, or it develops an indirect method of involvement by influencing how these businesses behave, i.e. more ‘showing and telling’ than actually ‘doing’ .
Similarly, a corporate center can only justify its own central cost levels in one of two ways: either it somehow reduces the total costs of the group or it does something that adds more value tothe group than the center itself costs.
One approach is the corporate center of the group that can develop its own, equally appropriately tailored, sustainable core competence, which will allow it to enhance the overall value of the businesses within the group.

The source of corporate advantage does not needto have the same fundamental basis as the individual competitive advantages that have been developed by the group’s various business units.

The corporate center often competes at a different level, on a different basis, against different competitors than the underlying business units within the group.
In many cases, the group, through its corporate center, competes primarily for the attention of investors in its relevant capital market; thus‘the competition’is made up of allthe alternative investmentsthat are available. These may not be direct competitors of the underlying businesses in terms of products and customers in any specific market, but may represent abroadercategoryof investment.
For example, Procter & Gamble’s largest global direct competitor would undoubtedly be Unilever, as they compete in many markets around the world for the same consumers with relatively similar products; e.g. washing powders. However, at the group level, investors considering purchasing Procter & Gamble’s shares on the USA stock market would probably compare this investment against the expected returns from alternative investments in other leading USA based, branded, fast moving consumer products companies. Thus other groups, such as Coca-Cola, Altria, Pepsi-Cola, Kelloggs, etc, become competitors at the group level, despite the absence of directly competing products. Despite thet rend towards global capital markets, most of Unilever’s investors are still based in Europe, and consequently they will tend to have a different list of potential alternative investments.
Competition at the corporate strategy level can therefore significantly differ from the competitive strategy basis.

However, in order to realise this potential added value, each corporate center has to ensure that it is operating within the appropriate configuration for its group. The appropriate configuration depends on the specific external environment that the group is facing andthe mix of businesses in the group.
It is important to understand where this increased value is coming from. Some strategies seek to create completely new value that would not otherwise have existed, while other strategies try to capture more of the already existing value available within an industry; this create or capture value concept is very important in the application of game theory to shareholder value analysis.

Where the corporate center applies its skills or knowledge to increase value, the result is much more likely tobe the creation of new valueby the underlying businesses. The whole purpose of this type of center is to change what the businesses do and these changes are normally clearly visible to their external customers.Thus new products may be created and launchedby thebusinesses, existing products maybe sold in innovative ways or to new market segments. This emphasis on transforming the underlying businesses, rather than improving their efficiency, has important implications for the leadership role required at the corporate center.

Nature of corporate involvement
The two sources of corporate advantage that we refer to as economies of scale and knowledge can be implemented within a group in significantly different ways. In some groups, the corporate center actually carries out certain key activities on behalf of the individual business units. This centralisation may involve only support activities that are common across the group.T ypical examples are accounting processes such as accounts payable processing which may be done globally, information technology, recruitment, management development andtraining. However, centralisation may extend to some of the core processes of component group businesses, e.g. sourcing, procurement, logistics, production, sales, andeven marketing.

The critical issue is the justification for this centralisation and the resulting direct interference in the affairs of individual group businesses. Many of these individual businesses will resent any such direct meddling by the corporate center. One obvious economic justification is that it is significantly cheaper to carry out these activities for the group as a whole,rather than to duplicate them within each of the businesses. Thus this direct style of intervention may be done to reduce the total costs of the group, through achieving economies of scale in these centralised activities.
Alternatively the corporate center can seek to reduce the total costs of the group via a more indirect method of involvement. This normally involves setting financial targets and other performance measures for each business.

The corporate center therefore generates an economy of scale for the group in this important area of management planning and control. The individual businesses rely upon the governance processes established by the center, rather than needing to develop their own.

This type of corporate center sometimes provides ‘advice and guidance’ (quite often in the form of a‘large stick’) to those businesses that are not performing well enough, i.e. they have not responded to the ‘carrot’ of the financial incentives associated with achieving the center’s targets. However, this type of corporate center does not normally get involved either in‘doing’things on behalf of the businesses or directly running the businesses within the group.
Indeed this type of corporate center is more likely to sell or close down non-performing business units within the group’s portfolio. Thus, although the corporate center has an indirect method of involvement in terms of managing its businesses, it may actively and directly intervene in order to manage the portfolio of businesses within the group. Acquisitions and divestments often form a significant part of the role carried out by these indirect cost reduction focused corporate centers.

A very different indirect nature of involvement can also be value adding.The main focus of this type of corporate center is in creating new know-how within the group, rather than reducing costs across the group. As a key part of this role the corporate center establishes aclear vision for the group as awhole and states a setof values (often referred to as guiding principles, etc.) that all group businesses must subscribe to. This type of corporate center is creating a sense of belonging and trust within the group. Consequently the unquestioning adherence to short-term financial targets reinforced by the threat of a‘big stick’or, even worse, divestment from the group or outright closure have no place within this corporate configuration.

As these corporate centers have only an indirect involvement in the operations of the group’s businesses, their own key role is facilitating the creation of new corporate know-how. This quite commonly requires collaboration across the boundaries of the existing organisation structure. Hence the importance of trust within the group, so that two or more business units can willingly work together to develop a new potential group source of added value, without destructive and delaying arguments about who pays for what and who gets what share of the potential return. This type of corporate center may therefore increase the total costs incurred by the group, but it tries to create far more added value from the creative stimulus and values leadership that it gives to the businesses.

However, there are many other groups where knowledge (as opposed to generating economies of scale to reduce group costs) is also the key source of corporate advantage but where a more direct intervention by the corporate center is required.The individual businesses within this type of group may have developed individually strong, knowledge based, sustainable competitive advantages; such as brands, customer service processes, differentiated products or process advantages. However, either the group structure or the management capabilities/resources of the individual business units are restricting the exploitation of this knowledge. For example, a business unit may be focused on a specific geographic region of the world, while its technology advantage or brand may have far broader applicability.

The value-adding role of the corporate center is not therefore to facilitate the development of new knowledge as this already appears to be happening around the group, but to ensure that the existing knowledge is fully exploited across the group. This may simply involve ensuring total global availability within the group, so that the full economic potential of each such competitive advantage is realised. Normally, however, real life is not that simple. Merely telling all the other business units about the‘great new product’available from Division X does not make anything change. Indeed, in many cases, this total global availability can be achieved more easily without any interference from a corporate center. If a business unit does not possess the management capabilities or resources to exploit fully any new knowledge based competitive advantage, it can enter into licensing agreements with other business units within the group or, failing that, with external third parties.

The corporate center should be looking more deeply at the sourcesof competitive advantage that exist within the group. Such a corporate center may identify a particular business unit that has successfully developed and is currently exploiting a range of strong brands in its own markets.This business unit may well possess brand development and exploitation expertise, which could have great value if it could be utilised elsewhere within the group.This knowledge may be far more valuable to the group than simply transferring the business unit’s specificbrands globally, as they may have been tailored to suit its particular competitive environment.
Therefore the corporate center can intervene directly in spreading this brand development know-how to those other parts of the group where it should be of value.This requires a great deal of information at the corporate center concerning the particular circumstances of the various businesses in the group. It also needs managers at the corporate center with leading edge skills in systems and process management to ensure that this knowledge transfer is successfully achieved. In a numberof suchgroups, this hasresulted inthe centralisationofcertain core processes (such asbrand management, new product development and launch) in an attempt to control directly the group-wide exploitation of such critical knowledge based assets. As mentioned above, this form of centralisation is not done in order to reduce costs; it is done to speed up and optimise the exploitation of existing knowledge across the group.

The different roles for corporate centers
The four possible value-adding combinations indicate significantly different roles for the corporate center in each of these configurations. In addition, these differing roles mean that significantly different key skills are needed at the center.These distinguishing features have led us to come up with generalised descriptions for each style of corporate center.
The primary role for an indirect type of involvement combined with a cost-reducing, economies of scale based source of corporate advantage is to establish appropriate control processes for the businesses within the groups . An important part of these control processes is the setting of financial targets, but how these financial targets are actually achieved is delegated to the individual businesses. However, the corporate center must have the skills to identify what is achievable by the underlying business units, albeit with some difficulty and stretch. Clearly, setting totally unreasonable and unrealistic financial targets will be counter-productive from a group perspective as the business unit management teams will rapidly become demotivated.
Thus the key skills needed at the corporate center for the configuration are those of financial management .
A relatively small group of highly skilled corporate financiers and financially oriented managers can control, and alter when necessary, a large portfolio of relatively diverse businesses, provided that the appropriate planning, control and reporting systems have been put in place. Thus a ‘corporate governance’ based economy of scale can be achieved.

However, the other type of indirect corporate involvement has a fundamentally different primary role, which requires an almost diametrically opposed set of skills in the corporate center.Where the corporate advantage is based on knowledge and the value added by the corporate center is facilitating the creation of new corporate know-how, a focus on any individual business unit’s adherence to its own financial targets may not be appropriate. The emphasis is on stimulating creativity and innovation across the group and, particularly, among separate business units. Corporate center managers therefore must create an environment where the businesses not only feel encouraged to take controlled risks, but also to share their learning (from both their successes and, perhaps even more importantly, their failures) with their colleagues in other parts of the group. This requires the establishment of a clear vision and an appropriate set of values for the group. However, it is essential that the center’s management is then seen to ‘walk the talk’ consistently in the way that it deals with the businesses in the group. The key skills of vision/values management are thus vital if a strong group identity is to be developed and a high degree of trust can be built up between both individual businesses and the center and across the business units directly.

In the target oriented and financial management focused corporate center these objectives would normally be unachievable. In many cases there is no group identity in the minds of the business units and they do not completely trust the center, nor does the center totally trust the business units. Further, the center may discourage direct contact from one business unit to another, as it prefers to exercise tight control over the individual businesses in the group, creating a ‘divide and rule’ environment, albeitbyan‘indirect’process.

The vision/values management oriented corporate center also still has only an indirect influence on the actual business units within the group. Therefore its management team requires highly developed communication and counselling skills, if the group’s vision and values are to be widely and accurately adopted. In the other two corporate center configurations, there is a much more direct form of involvement; consequently the required skills are verydifferent.

Where the center is seeking to leverage existing knowledge across the group, the skills required at the center are primarily those of systems and process management. It is essential to distil the key elements that truly underpin a sustainable competitive advantage in one business unit so that these elements can be applied in other businesses across the group. In other words, a vital role for the center is to codify the know-how that already exists in a single business. By codifying this know-how, the center transforms it into corporate knowledge that can then be exploited across the group.

The center can ensure that this corporate knowledge is applied wherever relevant within the group through its direct intervention. This can be achieved with minimal disruption to the continued successful exploitation within the originating business unit. However, inorder to do this, there will almost automatically be a significantly larger corporate center than with either of the indirect styles of involvement.

The value adding is, of course, not achieved by reducing total group costs and, accordingly, the key test is whether the center can justify its size andcosts.
If the group is to achieve the maximum value added from the corporate center’s attempts to leverage existing knowledge, there are three sets of key skills/knowledge needed within, or available to, the center. Systems and process management skills are needed for the codification/ distillation of the existing knowledge prior to its being leveraged acrossthe group. In addition, the corporate center must have anexcellent understanding of the businesses within the group, in order to identify those other businesses where this particular competitive advantage is applicable.The center can also seek to add new business units to the group where this knowledge can also be leveraged to create substantial added value. A related but separable skill relates to the evaluation of this particular competitive advantage.The center must be capable of understanding the relative strength and defendability of this advantage when it is taken out of its current specific competitive context. This evaluation must be done before the group invests substantial resources in first codifying the advantage and then attempting to leverage it elsewhere within the group. Many competitive advantages turn out to be so context specific that their leveraging potential is in reality very limited.

The remaining combination of type and source also involves direct intervention but with a focus on reducing total group costs.The resulting emphasis tends to be onthe center actually doing things forandon behalf of its business units. Thus the center’s primary role can be described as centralising, in order to achieve economies of scale for the group as awhole.These group savings are often achieved at some cost to the individual businesses, and it is clearly important that the financial justification properly takes these negative impacts into account.
The costs often arise from the corporate center’s desire to standardise those processes and activities that it centralises, so as to maximise its apparent cost savings. The standardised process may significantly adversely affect the way in which particular units conduct their businesses.

In some cases the adverse impact is so great that they opt out of the centralised activity, despite the increased costs to the group that result.
If these disfunctionalities are to be avoided, the corporate center needs a high degree of supply chain management skills, so that it can centralise those processes that generate a high level of true net savings for the group.This may necessitate a lower level of centralisation or of using a more flexible centralised process that can accommodate the wide range of specific requirements of thebusiness units.

This analysis of the primary roles of corporate centers and their consequently required key skills shows how different these corporate centers are in practice.
As the centralising corporate center is most heavily involved in doing things for the other parts of the group, our style descriptor is that of manager. This can be contrasted with the other direct intervention style where the center focuses on ensuring that existing knowledge is fully leveraged across the group. Our descriptor for this corporate center style is consultant, as the key involvement is to ensure that it can be, and is, done rather than totally taking over the activity on an ongoingbasis.
The indirect style of involvement which relies on financial management skills in order to set targets andcontrols for the business units we describe as a shareholder. This is due partly to the almost exclusive focus onthe financial returns generatedby the business unitsbut, even more fundamentally, because of the corporate center’s willingness to dispose of its investment in a subsidiary if this return is perceived as inadequate, or if a sufficiently high price is offered by a prospective purchaser.

Corporate Center Design
Any corporate center that seeks to create value through operating in the creative configuration has to overcome three significant challenges. First,it has to achieve a very high degree of buy-in from a wide range of people across the organisation to the key vision and associated set of values that the center establishes as the core common elements of the group. Second, it has to achieve this while employing an indirect method of involvement in the underlying businesses. Third, even achieving this buy-in does not guarantee the creation of added value by the corporate center, as the true reason for continuing as a group is generated by the business units working together to create new corporate know-how.
Thus the corporate center has to establish an environment across the group that motivates people from different business units to work together to create new value-adding ideas for the group. The corporate center can facilitate this process by bringing different parts of the organisation together to work on group basedprojects and itcanalso encourage more informalcontacts across the group. Both of these can be stimulated by more formal corporate center-sponsored group-wide events such as conferences, training programmes,R&D exhibitions and a regular communication process covering all the business units.

The corporate center is trying to create a strong group identity that subsumes the individual business unit cultures into a greater whole. This should mean that, although the separate businesses within a creative configuration group may operate in very different markets employing different technologies incorporated into dramatically different products that are sold to different types of customers, all the business units in the group have a common feel to them. Consequently managers at various levels can be moved around the group by the corporate center. Such moves, particularly at very senior levels, are oftenusedas awayof reinforcing the group’svisionandvalues.

The critical role of the center in the creative configuration is the development and communication of, and achieving commitment to, this corporate vision and set of values. As a result, the real corporate center should be quite small and cohesive. However, in some creative configuration groups, there may seem to be a quite large corporate center as some critical know-how creating processes, such as Research and Development, appear to be centralised. As is discussed in depth in this chapter, the key issue is where the control over these R & D resources resides. In a creative configuration group, these resources are actually controlled, and often provided, by the business units rather than being directly controlled by the corporate center.

If the corporate center is successful in stimulating the creation of new corporate know-how, it faces a fourth challenge. The center now has to find away of exploiting this new know-how without destroying, or at least severely damaging, the very fabric of the group.

However if the corporate center can find a mechanism to exploit the new know-how while maintaining the innovative corporate culture, it can continue to create value in the most sustainable way . Unfortunately there is an obvious danger of continually creating new know-how but never managing to exploit any of it to create shareholder value.

It is in practice possible to maintain a position in the creative configuration even though the corporate center appears to be quite large, as long as most of there sources located in this center are actually controlled by the business units.

Canon Case
Canon was founded in 1933 as the Precision Optical Research Laboratory, from which it developed its base in precision mechanics to fine optics. It has been producing lenses in-house since 1939 and developed an X-ray camera in 1940. From here, it moved into new technologies such as medical equipment, semiconductors and microelectronics producing calculators, copiers, word processors and computer peripherals. The group has always retained the manufacture of key value-adding components in-house.
The corporate center sees its main role as the development and constant re-emphasising of the vision of the company. It believes that technological leadership is critical to its future success and that this depends upon innovation across both technologies and existing product groups. This explains the centralisation of basic technology research that may have relevance to more than one business group. Canon is organised into globalproduct divisionswith local salesunits, sothat its primary strategic drivers are the product groups with the geographic regions and functional disciplines playing a secondary role. Consequently the centralised Research & Development and Marketing resources are accountable to the individual product groups. This means that while all resources are seen as belonging to the group, they are effectively ‘loanedout’ to the business units to work on cross-functional projects. These task-forces have the authority to make their own decisions and have been responsible for several major new product innovations.
The creation of this large ‘virtual’ corporate center allows most managers to pass through it at least once in their career and this creates a very strong identification with the group,rather than with their original business unit. this is very important to the organisational culture needed in the creative configuration, where employees should identify with the group before their own division.
If most managers ‘pass through the center’and realise that they still retain a great deal of managerial discretion and authority when ‘working there’, there is likely to be the high level of trust between the center and the business units that is also essential in the creative configuration.
However, this process also provides the corporate center with the ability to challenge the performance of the business units, particularly with regard to innovation but also regarding cost structures. This should result in a healthy and constructive debate between the center and the business units about the strategy that is required to deliver the center’s challenging vision. In a successful creative configuration group such as Canon, the business units should consequently view the corporate center as being value adding and essential to the continued existence of the group.

IBM Case
IBM’s initial vision under Tom Watson Snr was to ‘sell service’ and to ‘meet the emerging needs of our customers’and its initial dominance of the computer industry was achieved employing exactly those ideas. IBM built an infrastructure capable of coping with the computer business so that the group had over 400,000 employeesby the end of 1986. because of market competition, IBM reported losses for 1991 and 1992 of $2.8bn and $5.0bn after a profit of $6.0bn in 1990. Lou Gerstner, the newly hired CEO in 1993, urged the business units to co-operate rather than compete, and refocused the group’s software development on distributed networks.
Originally IBM’s corporate center allowed and effectively encouraged competition within the group, thus manufacturing business units could produce any products within the range and quote selling prices to any of the sales and marketing divisions. The logic was that if they were forced to compete internally, they should be very competitive externally, given that many of IBM’s business units were bigger than its external competitors. Also this organisation structure continually re-emphasised the importance of mainframe computers to the current profitability of the group; 12 out of 13 major business groupings were highly dependent upon sales of mainframe computers. Not too surprisingly therefore, the proportion of R & D expenditure devoted to mainframe development actually increased in the period prior to Lou Gerstner’s arrival.
Gerstner opened up the company to buying technology if they hadn’t got it, and to selling their technology to other companies, including competitors. He looked at strategic alliances and acquisitions as being valid to accelerate the rate of change of focus within the group. Thus IBM acquired Lotus Development for $3.5bn late in 1994 and also bought a large number of systems integration and consultancy businesses during the second half of the 1990s.
In 1997 this new focus was formally recognised with the creation of a Global Services Division. This new services business was competing directly against focused systems consultancies, such as Accenture, Cap Gemini , Sema, EDS. These competitors applied a very different business model to that previously used by IBM. The consultancies made profits onthe services that they provided and often supplied any required hardware at their cost. IBM’s business model had been the reverse; the profit was made on supplying the computer hardware, and the software and consultancy was provided to gain the hardware sale. Interestingly IBM’s internal financial planning and control system had emphasised product profitability analyses rather than highlighting the profitability of the group’s major customers.

Value adding corporate centers are very demanding, set stretching visions with tough values standards that have to be lived up to, and they are totally focused on creating value.

 

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