Senior executives seeking to gauge the effectiveness of their company’s corporate strategy might look at any number of factors: the company’s shareholder returns, its growth rate, its market share, or its price-to-earnings multiple. Yet none of these markers would tell the whole story. In fact, they might lead executives to precisely the wrong conclusions. (An excerpt from an article in S+B by Ken Favaro).
The one true measure of a corporate strategy is the profitability of its head office. Yes, that’s right, we’re talking about “corporate,” that “dead weight” of administrative functionaries most business unit leaders love to loathe as nothing more than an oppressive cost center that taxes the “real” parts of the business with onerous compliance requirements, excessive monitoring, redundant reporting, countless initiatives, endless meetings, and intrusive staff. Of course, in strict accounting terms, corporate headquarters is a cost center because it has no revenues. But it can and should be profitable. In fact, a profitable corporate center is both literally and figuratively at the center of corporate profit itself.
Drivers of Corporate Center Profitability
Six key functions explain the difference between “profitable” and “unprofitable” corporate centers.
First, profitable corporate centers sparingly use centralized services such as receivables, payables, financial reporting, payroll, IT, legal, HR, R&D, manufacturing, sourcing, and sales. They know that centralization does not come free—it can slow responsiveness, increase bureaucracy, uncouple costs from the revenues they support, and dilute accountability for top- and bottom-line results—and they know that there are diminishing returns to scale economies. Unprofitable head offices tend to overcentralize and then ignore the hidden costs of having done so.
A second key function is capital allocation. The corporate center adds value only if it can do a better job of allocating capital than the “invisible hand” of a vast, liquid, and ruthless capital market. A profitable corporate center does just that by attaining and using its inside knowledge, its ability to actively engage with the business units, its experience with the businesses that make up the company’s portfolio, and a highly disciplined process for funding business units. In these cases, businesses perform better than their peers because they have corporate leaders who are knowledgeable, informed, engaged, experienced, disciplined, and enterprising investors. Unprofitable corporate centers tend to think of capital allocation as rationing rather than investing.
Developing and deploying human capital is corporate’s third key function. Profitable corporate centers use the full breadth of the company’s business portfolio to offer a variety of flexible and rich career paths that will attract and develop people who can make a real difference to the BUs. They nurture the corporate brand as a recruiting asset when and where it has more equity than the individual BU brands. Deadweight corporate headquarters facilitate inbreeding, cultural silos, and hoarding of talent within units.
Business unit governance processes are a fourth key function of corporate headquarters. All companies require deadlines, policies, targets, plans, and more to operate well. But profitable corporate centers go beyond that. They work hard to shield the BUs from the worst of short-term behavior—be it from customers, employees, or, especially, shareholders—while also holding their feet to the fire when it comes to producing results. They challenge and help shape the strategies that underpin the BUs’ plans, rather than just sit back and wait until those plans are submitted for corporate’s review and approval. This determines how they set policies, allocate resources, manage the annual planning and budgeting processes, and centralize or standardize services; it basically drives everything else they do.
Unprofitable headquarters have a completely different attitude. They tend to ask, “How can the BUs help us do our job in running the company?” Thus, they tend to think of their governance role primarily as one of control and compliance rather than as one of adding value.
Perhaps the most valuable—and difficult—of all functions is the fifth: incubating, nurturing, and disproportionately investing in the company’s enterprise capabilities. An enterprise capability is something a company is able to do better than any other company. Profitable head offices actively identify capabilities anywhere in their organizations that can benefit all their businesses. They stay on alert for acquisitions that would enhance their businesses’ most important capabilities. They organize centers of excellence to nurture certain essential capabilities. They manage costs and capital to ensure that they are investing more and more effectively in their capabilities than any other company.
Finally, profitable corporate centers know that their ability to add value depends greatly on the nature and complexity of the company’s portfolio shape. Companies with profitable corporate centers tend to be made up of businesses that draw on the same few essential capabilities. This coherence in the company’s portfolio makes it easier to add value through the other five functions.
Corporate center profitability is the key gauge of whether a company is an accelerator, hindrance, or nonfactor in how well its businesses are able to compete and perform in their respective markets; it is the acid test of whether corporate is truly adding value in excess of its costs; and it is the true measure of a company’s corporate strategy. Every strategist should know what it is and how to achieve it.
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